U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2005
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _______________
Commission File No. 814-00631
Homeland Security Capital Corporation
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(Exact Name of Registrant as Specified in Charter)
4100 North Fairfax Drive, Suite
1150, Arlington, Virginia
Delaware 52-2050585 22203-1664
-------- ---------- ----------
(State or other (IRS Employer (Address of principal executive
jurisdiction Identification No.) offices) (Zip Code)
of incorporation)
Registrant's telephone number, including area code: (703) 528-7073
Common Stock, par value $.001 per share
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(Title of Class)
Indicate by check mark if the registrant is a well-known season issuer, as
defined in Rule 405 of the Securities Exchange Act of 1934. |_| Yes |X| No
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of
1934. |_| Yes |X| No
Indicate by check mark whether the registrant (1) 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. |X| Yes |_| No
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of the Regulation S-X is not contained herein, and will not be contained, to
the best of registrant's knowledge, in any definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
|_| Large accelerated filer |_| Accelerated filer |X| Non-accelerated
filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act) Yes |_| No |X|
The aggregate market value of common stock held by non-affiliates of the
Registrant as of June 30, 2005 was approximately $3,672,421 based on the closing
price on the Over-The-Counter Bulletin Board market. For purposes of this
computation, shares held by certain stockholders and by directors and executive
officers of the Registrant have been excluded. Such exclusion of shares held by
such persons is not intended, nor shall it be deemed, to be an admission that
such persons are affiliates of the Registrant. There were 4,440,560,075 shares
of the Registrant's common stock, par value $.001 per share (the "Common Stock")
outstanding at April 13, 2006.
DOCUMENTS INCORPORATED BY REFERENCE
Not applicable
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This Annual Report on Form 10-K contains forward-looking statements that involve
certain risks and uncertainties. Homeland Security Capital Corporation's actual
results could differ materially from the results discussed in the
forward-looking statements. See "Description of Business", "Risk Factors" and
"Forward-Looking Statements and Associated Risks."
TABLE OF CONTENTS
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS..............................1
PART I.......................................................................2
Item 1. Business..........................................................2
Item 1A. Risk Factors......................................................7
Item 1B. Unresolved Staff Comments........................................12
Item 2. Properties.......................................................12
Item 3. Legal Proceedings................................................12
Item 4. Submission of Matters To a Vote of Security Holders..............12
PART II.....................................................................12
Item 5. Market For Common Equity, Related Stock Holder Matters and
Issuer Purchases of Equity Securities.....................................12
Item 6. Selected Financial Data..........................................14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results Of Operations.................................................15
Item 7a. Quantitative and Qualitative Disclosures About Market Risk......20
Item 8. Financial Statements and Supplementary Data......................20
Item 9. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure..................................................21
Item 9A. Controls and Procedures.........................................21
Item 9B. Other Information...............................................22
PART III....................................................................22
Item 10. Directors and Executive Officers...............................22
Item 11. Executive Compensation..........................................24
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder........................................26
Item 13. Certain Relationships and Related Transactions..................27
Item 14. Principal Accountant Fees and Services..........................28
Item 15. Exhibits 8-K; Financial Statement Schedules.....................30
SIGNATURES..................................................................33
EXHIBITS
Exhibit 10.13 2005 Stock Option Plan
Exhibit 31.1 Section 302 Certification by Chief Executive Officer and
Principal Accounting Officer
Exhibit 32.1 Section 906 Certification by Chief Executive Officer and
Principal Accounting Officer
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FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Information included or incorporated by reference in this filing may
contain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). This
information may involve known and unknown risks, uncertainties and other factors
which may cause our actual results, performance or achievements to be materially
different from the future results, performance or achievements expressed or
implied by any forward-looking statements. Forward-looking statements, which
involve assumptions and describe our future plans, strategies and expectations,
are generally identifiable by use of the words "may," "will," "should,"
"expect," "anticipate," "estimate," "believe," "intend" or "project" or the
negative of these words or other variations on these words or comparable
terminology.
This filing contains forward-looking statements, including statements
regarding, among other things, (a) our projected sales and profitability, (b)
our Company's growth strategies, (c) our future financing plans and (d) our
anticipated needs for working capital. These statements may be found under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business," as well as in this prospectus generally. Actual
events or results may differ materially from those discussed in forward-looking
statements as a result of various factors, including, without limitation, the
risks outlined under "Risk Factors" and matters described in this filing
generally. In light of these risks and uncertainties, there can be no assurance
that the forward-looking statements contained in this filing will in fact occur.
We disclaim any obligation to update any forward-looking statements contained
herein after the date of this Annual Report.
-1-
PART I
ITEM 1. BUSINESS
History
Homeland Security Capital Corporation (formerly Celerity Systems, Inc.)
(together with any subsidiaries shall be referred to as the "Company," "we,"
"us" and "our") was incorporated in Delaware on August 12, 1997. The Company's
original business was to develop and manufacture, at third party plants, digital
set top boxes and digital video servers for the interactive television and high
speed Internet markets.
On June 3, 2003, the Company elected to become a business development
company ("BDC"), to be regulated pursuant to Section 54 of the Investment
Company Act of 1940, as amended (the "Investment Company Act"). A business
development company is an investment company designed to assist eligible
portfolio companies with capital formation and management advice. Accordingly,
the Company changed its business plan to primarily seek investments in
developing companies.
In September 2004, the Company entered into a business development
agreement with Sagamore Holdings, Inc. ("Sagamore") with an effective date of
October 4, 2004. The Company received 7,500,000 shares of Sagamore Common Stock
as consideration for its agreement to provide future services regarding capital
formation and management advice. The Company has reviewed the valuation of the
Sagamore stock using fair value, and, based on the liquidation preference of the
outstanding shares of preferred stock, management has considered the value of
the stock as nil. Also, the Company has rendered no specific services to
Sagamore. Accordingly, the Company has included the value of the Sagamore stock
in its financial statements as nil and not recognized any revenue from the
transaction.
In 2004, the Company had investments in two companies, the first being in
a wholly-owned subsidiary called Celerity Systems, Inc., a Nevada corporation
("Celerity-Nevada") and the other a minority interest in Yorkville Advisors
Management, LLC ("Yorkville"). In the fourth quarter of 2004, Celerity-Nevada
was closed with the business and related assets sold. In 2005, Yorkville carried
out a winding up of its affairs and liquidated its assets. Yorkville returned
the Company's investment in Yorkville as a liquidating distribution.
On December 30, 2005, at a special stockholders meeting, the stockholders
of the Company voted to amend the Certificate of Incorporation of the Company to
change the name to `Homeland Security Capital Corporation' and voted to withdraw
the Company's election as a BDC. Accordingly, the Company has changed its
business plan to primarily seek acquisition of companies that provide homeland
security products and services.
As part of the Company's new business strategy, we acquired a majority
interest in Nexus Technologies Group, Inc. ("Nexus") on February 8, 2006 through
the purchase of $3.4 million in preferred stock. Nexus is a mid-Atlantic
security integrator for the corporate and governmental security markets. Based
in Hawthorne, N.Y., Nexus' subsidiaries began operations in 2001. Nexus
specializes in non-proprietary integrated security solutions, including access
control, alarm, video, communication, perimeter protection and bomb and metal
detection security systems. Where applicable in this annual report, references
to the "Company," "we," "us" and "our" shall include Nexus.
Business Overview
The Company is seeking to build consolidated enterprises through the
acquisition and integration of multiple businesses in the homeland security
industry. We will seek to create long-term shareholder value by taking
controlling interests in companies that provide homeland security products and
services and helping them develop through superior operations, management and
acquisitions. Our value creation strategy is designed to foster significant
growth at our platform companies by providing leadership and counsel, capital
support and financial expertise, strategic guidance and operating discipline,
access to best practices and industry knowledge. We are targeting emerging
companies in fragmented sectors of the homeland security industry. These target
companies are generating revenues from promising security products and services
but face challenges in scaling their businesses to capitalize on opportunities
in the homeland security industry.
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Our goal is to become the leading consolidator of product and service
companies in the fragmented homeland security industry. We believe that our
strong intergovernmental relationships, the operating and acquisition expertise
of our management team, and our ability to address the needs of our management
teams will allow us to achieve our goal of being the "consolidator of choice" of
acquisition candidates in the homeland security industry.
In order to achieve our goal, we will focus on: (1) identifying
acquisition candidates which meet our consolidation criteria including the
presence of a strong management team as a platform company; (2) attracting and
acquiring companies through implantation of our decentralized management
approach coupled with strong performance incentives including the use of
earnouts and contingent purchase payments for selling managers; (3) achieving
operating efficiencies and synergies by combining non-customer related
administrative functions, implementing system and technology improvements and
purchasing products and services in large volumes; and (4) acquiring follow-on
companies that provide complementary products or services to our platform
companies
We will offer a range of operational and management services to each of
our companies through a team of dedicated professionals. Our companies will
compensate us for such services. We engage in an ongoing planning and assessment
process through our involvement and engagement in the development of our
platform companies, and our executives provide mentoring, advice and guidance to
develop the management of these companies.
In general, we expect to hold our ownership interest in our platform
companies as long as we believe that the company meets our strategic criteria
and that we can leverage our resources to assist them in achieving superior
financial performance and value growth. When a company no longer meets our
strategic criteria, we will consider divesting the company and redeploying the
capital realized in other acquisition and development opportunities. We may
achieve liquidity events through a number of means, including sales of an entire
company or sales of our interest in a company, which may include, in the case of
public companies owned by us, sales in the open market or in privately
negotiated sales and public offerings of the company's securities. We may, in
certain cases, take our companies public through a registered spinoff or stock
dividend distribution by distributing our subsidiary's stock held by us to our
public stockholders and subsequently registering such shares with the United
States Securities and Exchange Commission (the "Commission"). Alternatively, we
may utilize a rights offering with respect to particular platform company. A
rights offering is an initial public offering of a company directed to our
stockholders. It involves the grant by a company to our stockholders of
transferable rights to buy shares of the company's stock at a price established
by the company, us, and the underwriter, and supported by two independent
valuations. Our stockholders are able to exercise the rights, thereby
participating in the initial public offering.
The Industry
We believe the homeland security industry is among the fastest growing
industries in the United States. We expect that the billions of dollars of
governmental and private sector expenditures for homeland security should result
in increased demand for homeland security products and services. We believe that
this anticipated growth should create attractive acquisition opportunities with
significant potential for capital appreciation.
The homeland security industry is not an easily defined market. In July
2002, the Department of Homeland Security published the National Strategy for
the Homeland Security, which defines homeland security as "a concerted national
effort to prevent terrorist attacks within the United States, reduce America's
vulnerability to terrorism, and minimize the damage and recover from attacks
that do occur." It identifies six mission areas:
o Intelligence and Warning
o Border and Transportation Security
o Domestic Counterterrorism
o Protection of Critical Infrastructure and Key Assets
o Defense Against Catastrophic Threats
o Emergency Preparedness and Response
-3-
According to Homeland Security Research Corporation, a market research
firm, assuming no new major terrorist attack, the worldwide homeland security
market, including private sector expenditures, is forecasted to grow by nearly
100% from $231 billion in 2006 to $518 billion in 2015. According to USBX
Advisory Services, an investment bank serving the security industry, the overall
security industry is highly fragmented with over 130 large, public players and
thousands of emerging private companies in the industry. Another significant
trend impacting the homeland security industry is the growing decentralized
procurement for homeland security products and services between federal, state
and local levels. We believe that the highly fragmented nature of the homeland
security industry and of its procurement, is driving growth and consolidation of
the industry.
Our Solution
We offer the financial, managerial and operational resources to address
the challenges facing our companies. We believe that our experience in
developing and operating companies enables us to identify and attract companies
with the greatest potential for success and to create value for our
stockholders.
Management and Operational Support
We offer management and operational support to our platform companies. We
believe these services provide our companies with significant competitive
advantages in their individual markets. The resources that we can provide our
companies in order to accelerate their development include the following:
o Marketing. The identification of the company's market position and
the development and implementation of effective market penetration,
branding and marketing strategies.
o Business Development. Providing access to the initial reference
customers and external marketing channels that generate growth
opportunities through strategic partnerships, joint ventures or
acquisitions.
o Technology. The strategic assessment of technology market
opportunities and trends; the design, development and
commercialization of proprietary technology solutions; and access to
complementary technologies and strategic partnerships.
o Operations. Significant management interaction to optimize a
company's business, ranging from the establishment of facilities and
administrative processes to the operations and financial
infrastructure a growing enterprise requires.
o Legal and Financial. The development of appropriate corporate, legal
and financial structures and the expertise to execute a wide variety
of corporate and financial transactions.
We engage in an ongoing planning and assessment process through our
involvement and engagement in the development of our companies. Our executives
provide mentoring, advice and guidance to develop the management of our
companies. Our executives will generally serve on the boards of directors of our
companies and work with them to develop and implement strategic and operating
plans. Achievement of these plans is measured and monitored through reporting of
performance measurements and financial results.
We believe our business model provides us with competitive advantages. Our
decentralized management approach allows managers of our acquired companies to
benefit from the economies of a larger organization while simultaneously
retaining local operational control, enabling them to provide flexible and
responsive service to customers. Such an approach could, however, limit possible
consolidation efficiencies and integration efforts. In addition, although our
management team has experience in acquiring and consolidating businesses, we are
unlikely to have experience in the specific sectors of the homeland security
industry that we select for consolidation. We, therefore, expect to rely in part
upon management of acquired companies or other individuals who are experienced
in the sectors which we pursue for consolidation.
Operating Strategy
Capitalize on Cross-Selling Opportunities. We intend to leverage our
current client relationships by cross-selling the range of services offered by
our various platform companies. For example, we believe cross-selling
opportunities will increase as we acquire businesses in other sectors of the
homeland security industry.
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Achieve Operating Efficiencies. We intend to achieve operating
efficiencies within our various platform companies. For example, as new
businesses are acquired, we believe our existing technology infrastructure can
support additional customers. At the corporate level, we will also seek to
combine certain administrative functions, such as financial reporting,
insurance, employee benefits and legal support and to realize volume purchasing
advantages with respect to travel and other purchases across the Company.
Leverage Platform Company Autonomy. We plan to conduct our operations on
decentralized basis whereby management of each platform company will be
responsible for its day-to-day operations, sales relationships and the
identification of additional acquisition candidates in their respective sectors.
Our senior management will provide the platform companies with strategic
oversight and guidance with respect to acquisitions, financing, marketing,
operations and cross selling opportunities. We believe that a decentralized
management approach will result in better customer service by allowing
management of each platform company the flexibility to implement policies and
make decisions based on the needs of customers. This is in contrast to the
traditional consolidation approach used by other consolidators in which the
owners/operators ad their employees are often relieved of management
responsibility as a result of complete centralization of management in the
consolidated enterprises.
Implement Technology. We intend to utilize technology to enhance our
efficiency and ability to monitor our various companies. We believe we will be
able to increase the operating margin of combined acquired companies by using
operating and technology systems to improve and enhance the operations of the
combined acquired companies. We believe that many of our acquired companies have
not made material investments in such operating and technology systems because,
as independent entities, they lack the necessary scale to justify the
investment. We believe the implantation of such systems may significantly
increase the efficiency of our acquired companies.
Acquisition Strategy
Identify and Pursue Strategic Consolidation Opportunities. We intend to
capitalize upon consolidation opportunities in the homeland security industry by
acquiring companies in growing sectors that will benefit from economies of scale
having some or all of the following characteristics: (i) generating revenues and
preferably profits with established customers; (ii) long-term growth prospects
for products and services offered; (iii) experienced management team willing to
continue managing the enterprise; (iv) significant acquisition consideration
that is performance-based; and (v) a highly fragmented sector of the homeland
security characterized by significant potential smaller acquisition targets with
few market leaders in the sector. We believe that the homeland security sectors
in which we will pursue consolidation opportunities are fragmented and often
headed by owners/operators who desire some liquidity and may be unable to gain
the scale necessary to access the capital markets effectively or to access the
government markets that are characterized by complex and bureaucratic processes,
protracted sales cycles, and diffused procurement between federal, state and
local levels.
Acquire Complementary Businesses. We intend to acquire businesses that
offer marketing services in which each of our platform companies operates. We
believe that adding geographic breadth and increasing our presence within
geographic regions will allow us to service its clients more efficiently and
cost effectively. As our customers' industries continue to consolidate, we
believe that national coverage and technology capabilities will become
increasingly important.
Acquire Strategic New Businesses. We believe that there are numerous other
attractive fragmented sectors within the homeland security industry, such as
products and services for the intelligence industry, medical and public health
disaster management, surveillance and monitoring, or remote sensing. By entering
any one or more of these sectors, we may realize additional operating and
revenue synergies across our platform companies, and may leverage existing
relationships with to create cross-selling opportunities.
Business Development Agreements
The Company entered into two agreements in 2004 in which the Company was
to receive shares of common stock for providing capital formation and management
services in the future. However, no consideration has been received and no
services performed as of December 31, 2005 and to the date of this report. The
Company and the respective parties have terminated the agreement.
Celerity-Nevada
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Celerity-Nevada was a wholly owned subsidiary that engaged, either
directly or indirectly through third parties, in the production, sale and
distribution of digital set top boxes and digital video services.
Celerity-Nevada, through arrangements with other parties, offered end-to-end
systems for customers. It also provided a comprehensive content package for
educational users with over 1,300 titles available, and a content package,
Celerivision, for use in entertainment deployments, such as condominiums, the
hospitality industry, and multihousing properties. Celerity-Nevada also
maintained valuable software functionality and applications, which it
incorporated in some of its products and services. The Company played an active
role in supervising the operations of Celerity-Nevada. On September 14, 2004,
the Board of Directors of the Company determined that Celerity-Nevada would
cease operations and perform an orderly liquidation of its business interests
and related assets. Accordingly, in November 2004, Celerity-Nevada sold its
business and certain assets related to the business activities plus cash of
$15,000 for working capital, to Escent Systems, Inc. in exchange for 25% of
Escent Systems, Inc. stock. Because of the lack of operations and uncertainty of
continued operations, Celerity-Nevada has not assigned any value to the
investment.
Yorkville Advisors Management, LLC
On December 1, 2003 the Company purchased a minority interest in
Yorkville. Yorkville is the investment manager of a private equity fund that is
a principal holder of equity securities of the Company. The purchase price
amounted to $5,240,000. The acquisition was funded through the sale of
2,000,000,000 shares of Common Stock to the aforementioned private equity fund,
resulting in net proceeds of $4,000,000 and the balance paid using the proceeds
received from the issuance of convertible notes payable. During the year ended
December 31, 2004, the Company received $1,255,000 in distributions from this
investment, which has been recorded as dividend income in the consolidated
statements of operations.
On February 11, 2005, the Company became entitled to receive a
consideration equal to the original purchase price of $5,240,000 less certain
related party debt of approximately $1,500,000 in connection with the Company's
Preferential Rights Membership Interest in Yorkville, pursuant to the terms of
Yorkville's Limited Liability Company Agreement, as amended. Accordingly, upon
its receipt of the distribution, the Company no longer has any ownership
interest in Yorkville.
The Company's ownership interest in Yorkville was originally a minority
Common Membership Interest. Pursuant to the terms of a Second Amendment to the
Limited Liability Company Agreement of Yorkville entered into on January 31,
2005 among Yorkville and the other equity owners of Yorkville, the Company's
minority Common Membership Interest was reconstituted as Preferential Rights
Interest. As a result, the Company became entitled to receive dividends and
other distributions of Yorkville's available assets in an amount up to the
purchase price paid by the Company for its original Common Membership Interest.
The $5,240,000 preferential distribution to be received by the Company
represents the entire purchase price paid by the Company for its original Common
Membership Interest.
Recent Business Developments
On February 8, 2006, we acquired a majority interest in Nexus. Nexus
provides integrated security systems for the corporate and governmental security
market. With offices in the New York City and Philadelphia areas, Nexus serves
the entire mid-Atlantic region. Nexus launched its own brand of security
integration, which leveraged more than 50 years of industry experience. By
utilizing the latest technologies, Nexus provides innovative, engineered and
scaleable solutions to effectively protect people, property and assets for
regional and national organizations.
Nexus has a reputation for its expertise in system engineering and
installation of enterprise-wide and integrated security solutions for: access
control, photo identification, visitor management, closed circuit television,
perimeter detection, intrusion detection and intercom system as well a variety
of other services through its four offices and its strategic network of partners
located throughout North America. Nexus' competencies include: engineered
design, network integration, project managed installations, CAD documentation,
system commissioning and professional on-going support.
Employees
As of April 12, 2006, we had 32 full time employees. All employees
fulfilled management or administrative roles. This level of staffing is adequate
for the current level of operations. Our employees are not represented by a
union or governed by a collective bargaining agreement and we believe that our
relationship with our employees is good. We also employ a number of contractors
and consultants on a regular basis.
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ITEM 1A. RISK FACTORS
This Annual Report on Form 10-K contains forward-looking statements,
within the meaning of the Federal securities laws, about our business and
prospects. The forward-looking statements do not include the potential impact of
any mergers, acquisitions, divestitures or business combinations that may be
announced after the date hereof. Our future results may differ materially from
our past results and from those projected in the forward-looking statements due
to various uncertainties and risks, including but not limited to those set forth
below, one-time events and other important factors disclosed previously and from
time to time in our other filings with the SEC. If any of these risks or
uncertainties actually occurs, our business, financial condition or operating
results could be materially harmed. We disclaim any obligation to update any
forward-looking statements contained herein after the date of this Annual
Report.
We have a limited operating history which makes it difficult to evaluate our
current business and future prospects
The Company intends to consolidate companies in the homeland security
industry. Until its recent acquisition of Nexus, the Company had not generated
any revenues other than interest income on its cash since 2003. The Company's
ability to generate revenues and earnings (if any) will be directly dependent
upon the operating results of such acquired business and any additional
acquisitions, and the successful integration and consolidation of those
businesses. No assurances can be given that we will be successful in generating
revenues and earnings based on our business model.
We are dependent upon key personnel who would be difficult to replace and
whose loss could impede our development
The Company believes that its success will depend principally upon the
experience of C. Thomas McMillen, its Chairman and Chief Executive Officer.
Although Mr. McMillen has substantial experience in acquiring and consolidating
businesses, our other personnel does not have significant experience in managing
companies formed for the specific purpose of consolidating one or more
industries or in managing businesses in the homeland security industry. As a
result, the Company likely will depend on the senior management of any
significant businesses it acquires in the future. Such acquired senior
management may not be suitable to the Company's business model or combined
operations.
If the Company loses the services of one or more of its current
executives, the Company's business could be adversely affected. The Company may
not successfully recruit additional personnel and any additional personnel that
are recruited may not have the requisite skills, knowledge or experience
necessary or desirable to enhance the incumbent management. The Company does not
intend to maintain key man life insurance with respect to any of its executive
officers. See "Management."
Appropriate acquisitions may not be available which may adversely effect our
growth
The Company has only recently begun its acquisition program. On February
8, 2006, the Company acquired majority ownership of its first business, Nexus.
The results of the Company's planned operations are dependent upon the Company's
ability to identify, attract and acquire additional desirable acquisition
candidates, which may take considerable time. The Company may not be successful
in identifying, attracting or acquiring additional acquisition candidates, in
integrating such candidates into the Company or in realizing profits from any
acquisition candidates, if acquired. The failure to complete additional
acquisitions or to operate the acquired companies profitably would have a
material adverse effect on the Company's business, financial condition and/or
results of operations.
If our consolidation strategy is not successful, our operations and financial
condition will be adversely affected
One of the Company's strategies is to increase its revenues, the range of
products and services that it offers and the markets that it serves through the
acquisition of additional homeland security businesses. To date, the Company has
completed one acquisition and has signed nonbinding letters of intent with the
two other companies. Investors have no basis on which to evaluate the possible
merits or risks of any future acquisition candidates' operations and prospects.
Although management of the Company will endeavor to evaluate the risks inherent
in any particular acquisition candidate, the Company may not properly ascertain
all of such risks.
Management of the Company has virtually unrestricted flexibility in
identifying and selecting prospective acquisition candidates and broad
discretion. Management may not succeed in selecting acquisition candidates that
will be profitable or that can be integrated successfully. Although the Company
intends to scrutinize closely the management of a prospective acquisition
candidate in connection with evaluating the desirability of effecting a business
combination, the Company's assessment of management may not prove to be correct.
The Company may enlist the assistance of other persons to assess the management
of acquisition candidates.
One of the key elements of the Company's internal growth strategy is to
improve the profitability and increase the revenues of acquired businesses. The
Company will seek to improve the profitability and increase the revenues of
acquired businesses by various means, including combining administrative
functions, eliminating redundant facilities, implementing system and technology
improvements, purchasing products and services in large quantities and
cross-selling products and services. The Company's ability to increase revenues
will be affected by various factors, including the Company's ability to expand
the products and services offered to the customers of acquired companies,
develop national accounts and attract and retain a sufficient number of
employees to perform the Company's services. There can be no assurance that the
Company's internal growth strategies will be successful.
-7-
Our inability to successfully integrate our acquisition may adversely affect
our operations and financial condition
The Company's business model is based upon an aggressive and rapid
acquisition program. No assurance can be given that the Company will be able to
successfully integrate its future acquisitions without substantial costs, delays
or other problems. The costs of such acquisitions and their integration could
have an adverse effect on short-term operating results. Such costs could include
severance payments to employees of such acquired companies, restructuring
charges associated with the acquisitions and other expenses associated with a
change of control, as well as non-recurring acquisition costs including
accounting and legal fees, investment banking fees, recognition of
transaction-related obligations and various other acquisition-related costs. Any
failure by the Company to make acquisitions would have a material adverse effect
on the Company's business, financial condition and results of operations.
Moreover, the Company may be unable to replicate the success in consolidating
various industries that other consolidators have achieved.
The Company may not be able to execute successfully its consolidation
strategy or anticipate all of the changing demands that consolidation
transactions will impose on its management personnel, operational and management
information systems and financial systems. The integration of newly acquired
companies may also lead to diversion of management attention from other ongoing
business concerns. In addition, the rapid pace of acquisitions may adversely
affect the Company's efforts to integrate acquisitions and manage those
acquisitions profitably. Moreover, it is possible that neither management of the
Company nor management of any of the acquired companies will have the necessary
skills to manage a company implementing an aggressive acquisition program. The
Company may seek to recruit additional managers to supplement the incumbent
management of the acquired companies but the Company may not have the ability to
recruit additional managers with the skills necessary to enhance the management
of the acquired companies. Any or all of these factors could have a material
adverse effect on the Company's business, financial condition and/or results of
operations.
Competition and industry consolidation may limit our ability to implement our
business strategies
The Company expects to face significant competition to acquire homeland
security businesses from larger companies that currently pursue, or are expected
to pursue, acquisitions as part of their growth strategies and as the industry
undergoes continuing consolidation. Such competition could lead to higher prices
being paid for acquired companies.
The Company believes that the homeland security industry will undergo
considerable consolidation during the next several years. The Company expects
that, in response to such consolidation it will consider from time to time
additional strategies to enhance stockholder value. These include, among others,
strategic alliances and joint ventures; purchase, sale and merger transactions
with other large companies; and other similar transactions. In considering any
of these strategies, the Company will evaluate the consequences of such
strategies, including, among other things, the potential for leverage that would
result from such a transaction, the tax effects of the transaction, and the
accounting consequences of the transaction. In addition, such strategies could
have various other significant consequences, including changes in management,
control or operational or acquisition strategies of the Company. There can be no
assurance that any one of these strategies will be undertaken, or that, if
undertaken, any such strategy will be completed successfully.
Failure to qualify for investment company act exemptions could adversely
effect our growth and financial condition
The regulatory scope of the Investment Company Act extends generally to
companies engaged primarily in the business of investing, reinvesting, owning,
holding or trading in securities. The Investment Company Act also may apply to a
company which does not intend to be characterized as an investment company but
which, nevertheless, engages in activities that bring it within the Investment
Company Act's definition of an investment company. The Company believes that its
principal activities, which will involve acquiring control of operating
companies and providing managerial and consulting services, will not subject the
Company to registration and regulation under the Investment Company Act. The
Company intends to remain exempt from investment company regulation either by
not engaging in investment company activities or by qualifying for the exemption
from investment company regulation available to any company that has no more
than 45% of its total assets invested in, and no more than 45% of its income
derived from, investment securities, as defined in the Investment Company Act.
-8-
There can be no assurance that the Company will be able to avoid
registration and regulation as an investment company. In the event the Company
is unable to avail itself of an exemption or safe harbor from the Investment
Company Act, the Company may become subject to certain restrictions relating to
the Company's activities, as noted below, and contracts entered into by the
Company at such time that it was an unregistered investment company may be
unenforceable. The Investment Company Act imposes substantive requirements on
registered investment companies including limitations on capital structure,
restrictions on certain investments, prohibitions on transactions with
affiliates and compliance with reporting, record keeping, voting, proxy
disclosure and other rules and regulations. Registration as an investment
company could have a material adverse effect on the Company.
Our financial condition could be harmed if businesses we acquire failed to
comply with applicable laws or have other undisclosed liabilities
Any business that we acquire may have been subject to many of the same
laws and regulations to which our business is subject and possibly to others,
including laws and regulations impacting companies that do business with
federal, state and local governments. If any business that we acquire has not
conducted its business in compliance with applicable laws and regulations, we
may be held accountable or otherwise suffer adverse consequences, such as
significant fines or unexpected termination of contracts. Businesses we acquire
may have other undisclosed liabilities we do not discover during the acquisition
process that could result in liability to us or other unanticipated problems,
such as product liability claims. Unexpected liabilities such as these could
materially adversely affect our business, financial condition and results of
operations.
Costs arising from our any future acquisitions could adversely affect our
financial condition
Any acquisition that we make could result in the use of our cash,
incurrence and assumption of debt, contingent liabilities, significant
acquisition-related expenses, amortization of certain identifiable intangible
assets, and research and development write-offs, and could require us to record
goodwill and other intangible assets that could result in future impairments
that could harm our financial results. We will likely incur significant
transaction costs pursuing acquisitions, including acquisitions that may not be
consummated. We may not be able to generate sufficient revenues from our
acquisitions to offset their costs, which could materially adversely affect our
financial condition.
If we are unable to effectively manage our growth, our ability to implement
our business strategy and our operating results will likely be materially
adversely affected
Our efforts to acquire and collaborate with complementary businesses have
placed, and will likely continue to place, a significant strain on our
management, administrative, operating and financial infrastructures. Our
management will be required to devote considerable time to our acquisition and
integration efforts, which will reduce the time they will have to implement our
business and growth strategy. To manage our business and planned growth
effectively, we must successfully develop, implement, maintain and enhance our
financial and accounting systems and controls, integrate new personnel and
businesses and manage expanded operations. We are still in the process of
developing and implementing our operating and financial systems, including our
internal systems and controls, which will be critical to properly managing
expanded operations. This process will be made more difficult as a public
company, because, among other things, we are required to develop effective
internal controls over financial reporting and to comply with the related
management certification and auditor attestation requirements of the
Sarbanes-Oxley Act of 2002. If we are unable to make these improvements in our
operating and financial reporting systems and to otherwise effectively manage
our growth, our ability to implement our business strategy and our operating
results will likely be materially adversely affected.
Because our operating results may fluctuate significantly and may be below
the expectations of analysts and investors, the market price for our stock
may be volatile
Our operating results are difficult to predict and may fluctuate
significantly in the future. As a result, our stock price may be volatile. The
following factors, many of which are outside our control, can cause fluctuations
in our operating results and volatility in our stock price:
o expenses incurred in pursuing and closing acquisitions and in
follow-up integration efforts;
o changes in customers' budgets and procurement policies and
priorities, and funding delays, particularly with respect to
government contracts;
-9-
o new competitors and the introduction of enhanced products from new
or existing competitors;
o unforeseen legal expenses, including litigation and bid protest
costs;
o unanticipated delays or problems in releasing new products and
services; and
o the amount and timing of our investments in research and development
activities and manufacturing improvements.
The deferral or loss of one or more significant contracts could materially
adversely affect our operating results, particularly if there are significant
sales and marketing expenses associated with the deferred or lost contracts.
Additionally, we base our current and future expense levels on our internal
operating plans and sales forecasts, and our operating costs are to a large
extent fixed. As a result, we may not be able to sufficiently reduce our costs
to compensate for an unexpected near-term shortfall in revenues.
Actual or anticipated fluctuations in our operating results could cause
our stock price to decline. Due to fluctuations in our operating results, a
period-to-period comparison of our results of operations may not be a good
indication of our future performance. In any particular quarter or quarters, our
operating results could be below the expectations of securities analysts or
investors and our stock price could decline as a result.
Government spending priorities may change in a manner adverse to our business
A substantial portion of our revenues may result from sales of our
products and services to federal, state and local governments for programs in
the homeland security industry, many of which are funded by the Department of
Homeland Security and other federal government agencies. Our business may depend
to a significant extent on continued government expenditures on homeland
security and related programs and policies. Government contracts are conditioned
upon the continuing availability of legislative appropriations. Congress and
state and local legislatures typically appropriate funds for a given program on
a fiscal-year basis even though contract performance may take more than one
year. As a result, at the beginning of a major program, a contract is typically
only partially funded and additional monies are normally committed to the
contract by the procuring agency only as appropriations are made for future
fiscal years. While spending authorization by the federal, state and local
governments for homeland security programs has increased in recent years, and in
particular after the September 11, 2001 terrorist attacks, future expenditures
for these programs may decrease or shift to programs in areas where we do not
provide products or services. A significant decline in government expenditures
or a shift of expenditures away from programs that are supported by our products
and services could materially adversely affect our business, revenues and
operating results.
Obligations of our chief executive officer may create a conflict of interest
that could adversely affect the Company<129>fs operations
Our Chairman and Chief Executive Officer, C. Thomas McMillen ("McMillen")
is required to devote at least 25 hours per week to the Company pursuant to an
employment agreement, dated as of August 29, 2005, with the Company (the
"McMillen Employment Agreement"). Mr. McMillen also serves as Chairman of
Fortress America Acquisition Corporation ("FAAC"), a blank check company that
completed an initial public offering in July 2005 that is seeking a merger or
acquisition target in the homeland security industry. The officers and directors
of FAAC, including McMillen, have agreed in principle, until the earlier of a
business combination, liquidation or such time as they cease to be an officer or
director, to present to FAAC for its consideration, prior to presentation to any
other entity, including the Company, any business opportunity which may
reasonably be required to be presented to them under Delaware law, subject,
however, to any pre-existing fiduciary or contractual obligations they might
have. The initial target business or businesses that FAAC acquires must have a
collective fair market value equal to at least 80% of its net assets of its net
assets at the time of acquisition or approximately in excess of $34 million. The
Company's acquisition focus is primarily on companies with market values less
than $20 million. While the McMillen Employment Agreement does not preclude
McMillen from competing with the Company through his position as an officer of
FAAC, the initial acquisition focus of the two companies from a size-standpoint
will be significantly different. It is possible that FAAC will become a
competitor of ours if the business it acquires serves markets or sectors of the
homeland security industry the Company is serving.
-10-
In 2003, McMillen also co-founded Global Secure Corp., a homeland security
company providing integrated products and services for critical incident
providers. While McMillen's employment agreement with the Company does not
preclude him from competing with the Company through his ownership interest in
Global Secure Corp., McMillen has currently no active role with Global Secure
Corp. It is possible that Global Secure Corp. will become a competitor of ours
if the Company acquires companies serving the critical incident response
marketplace.
General Risks
We May Need To Raise Additional Capital On Terms Unfavorable To Our
Stockholders
Based on our current level of operations, we believe that our cash flow
from operations will be adequate to meet our anticipated operating, capital
expenditure and debt service requirements for the next calendar year. However,
we do not have complete control over our future performance because it is
subject to economic, political, financial, competitive, regulatory and other
factors affecting the defense and security industries. Further, our acquisition
strategy will likely require additional equity or debt financings. Such
financings could also be required to support our traditional and recently
required operating units. There is no assurance that we will be able to obtain
such financings to fuel our growth strategy and support our existing businesses.
Our Common Stock Is Deemed To Be "Penny Stock," Which May Make It More
Difficult For Investors To Sell Their Shares Due To Suitability Requirements
Our common stock is deemed to be "penny stock" as that term is defined in
Rule 3a51-1 promulgated under the Exchange Act. Penny stocks are stock:
o with a price of less than $5.00 per share;
o that are not traded on a "recognized" national exchange;
o whose prices are not quoted on the NASDAQ automated quotation system
(NASDAQ-listed stock must still have a price of not less than $5.00
per share); or
o stock in issuers with net tangible assets less than $2,000,000 (if
the issuer has been in continuous operation for at least three
years) or $5,000,000 (if in continuous operation for less than three
years), or with average revenues of less than $6,000,000 for the
last three years.
In addition to the "penny stock" rules promulgated by the Commission, the
NASD has adopted rules that require that in recommending an investment to a
customer, a broker-dealer must have reasonable grounds for believing that the
investment is suitable for that customer. Prior to recommending speculative low
priced securities to their non-institutional customers, broker-dealers must make
reasonable efforts to obtain information about the customer's financial status,
tax status, investment objectives and other information. Under interpretations
of these rules, the NASD believes that there is a high probability that
speculative low priced securities will not be suitable for at least some
customers. The NASD requirements make it more difficult for broker-dealers to
recommend that their customers buy our Common Stock, which may limit your
ability to buy and sell our stock.
Stockholders should be aware that, according to the Commission, the market
for penny stocks has suffered in recent years from patterns of fraud and abuse.
Such patterns include (i) control of the market for the security by one or a few
broker-dealers that are often related to the promoter or issuer; (ii)
manipulation of prices through prearranged matching of purchases and sales and
false and misleading press releases; (iii) "boiler room" practices involving
high-pressure sales tactics and unrealistic price projections by inexperienced
sales persons; (iv) excessive and undisclosed bid-ask differentials and markups
by selling broker-dealers; and (v) the wholesale dumping of the same securities
by promoters and broker-dealers after prices have been manipulated to a desired
consequent investor losses. The Company's management is aware of the abuses that
have occurred historically in the penny stock market. Although the Company does
not expect to be in a position to dictate the behavior of the market or of
broker-dealers who participate in the market, management will strive within the
confines of practical limitations to prevent the described patterns from being
established with respect to the Company's securities.
We Do Not Expect To Pay Dividends With Respect To Our Common Stock Which May
Hinder Our Ability To Attract Additional Capital
The Company has not paid any dividends on its Common Stock to date. The
payment of any dividends will be within the discretion of the Company's Board of
Directors. It is the present intention of the Board of Directors to retain all
earnings, if any, for use in the Company's business operations and, accordingly,
the Board of Directors does not anticipate declaring any dividends in the
foreseeable future.
-11-
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
In November 2004, the Company entered into a lease for a facility with
approximately 1,500 square feet of office space at 146 Maryville Pike, Suite
201, Knoxville, Tennessee. The initial term of the lease is from November 15,
2004 to November 14, 2007, with an option to renew for two additional three-year
periods. Lease payments are $850 per month including all utilities and property
maintenance expenses. In December 2004, the Company amended the lease so as to
add approximately 1,100 additional square feet of office space for an additional
$350 per month for a twelve-month period. The lease for the additional space was
not renewed and it has expired. Effective September 12, 2005, the principal
office of the Company was moved to 4100 North Fairfax Drive, Suite 1150,
Arlington, VA 22206-1664. The Company has entered into an arrangement to pay
$4,000 per month for this office space. The Company is winding up its affairs in
Knoxville, TN and is negotiating for the termination of the existing lease.
ITEM 3. LEGAL PROCEEDINGS
In September 2004, Joseph Banta, et al. filed an action in the United
States District Court for the Eastern District of Tennessee at Knoxville,
Tennessee in the amount of approximately $72,000. The Company has accrued this
amount at December 31, 2004 and the claims were settled in full in January 2005.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held a Special Meeting of its stockholders (the "Special
Meeting") on December 30, 2005 for the following purposes: (i) to elect four (4)
directors to the Company's Board of Directors (the "Board"), two of which to be
elected by the holders of a majority of the outstanding shares of Common Stock
(the "Common Stock Director-Nominees") and two (2) of which to be elected by the
holders of a majority of the outstanding shares of Series F Preferred Stock of
the Company (the "Preferred Stock Director-Nominees"); (ii) to vote on an
amendment to the Company's Certificate of Incorporation to change the name of
the Company to "Homeland Security Capital Corporation"; (iii) to vote on an
amendment to the Company's Certificate of Incorporation to increase the number
of authorized shares of Common Stock of the Company from 5,000,000,000 to
20,000,000,000; (iv) to vote on the adoption of the "Celerity 2005 Stock Option
Plan" (the "2005 Plan"); and (v) to vote on the withdrawal of the Company's
election to be treated as a BDC under Section 54 of the Investment Company Act.
The Common Stock Director-Nominees were C. Thomas McMillen and Carl J.
Rickertsen. The Preferred Stock Director-Nominees were Zev E. Kaplan and Philip
A. McNeill. At the Special Meeting, the holders of a majority of the outstanding
shares of Common Stock elected both Common Stock Director-Nominees, approved of
the name change of the Company, the increase in the number of authorized shares
of Common tock, the adoption of the 2005 Plan, and the withdrawal of the
Company's election to be treated as a BDC under the ICA. Also at the Special
Meeting, the holders of a majority of the Series F Preferred Stock elected both
Preferred Stock Director-Nominees.
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCK HOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Market Information
The Common Stock ceased trading on the Nasdaq SmallCap Market on October
21, 1999. The Company's Common Stock is currently traded on the OTC Electronic
Bulletin Board under the symbol "HMSC.OB".
The following table sets forth, for the fiscal periods indicated, the high
and low bid prices of a share of Common Stock for the last eight quarterly
periods. Such quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
This information was obtained from the Pink Sheets, LLC.
-12-
Fiscal Year 2005 High Low
-------- --------
4th Quarter (October - December, 2005) $ 0.0038 $ 0.0019
3rd Quarter (July - September, 2005) $ 0.0026 $ 0.0010
2nd Quarter (April - June, 2005) $ 0.0029 $ 0.0008
1st Quarter (January - March, 2005) $ 0.0027 $ 0.0010
Fiscal Year 2004 High Low
-------- --------
4th Quarter (October - December, 2004) $ 0.0039 $ 0.0011
3rd Quarter (July - September, 2004) $ 0.0018 $ 0.0008
2nd Quarter (April - June, 2004) $ 0.0019 $ 0.0010
1st Quarter (January - March, 2004) $ 0.0038 $ 0.0012
Fiscal Year 2003 High Low
-------- --------
4th Quarter (October - December, 2003) $ 0.0330 $ 0.0050
3rd Quarter (July - September 2003) $ 0.0180 $ 0.0020
2nd Quarter (April - June, 2003) $ 0.3100 $ 0.0009
1st Quarter (January - March, 2003) $ 0.0027 $ 0.0011
Holders
As of April 13, 2006, there were approximately 322 holders of record of
the Common Stock.
Dividends
We have not paid dividends on our Common Stock since inception and do not
intend to pay any dividends to our stockholders in the foreseeable future. We
currently intend to reinvest our earnings, if any, for the development and
expansion of our business. The declaration of dividends in the future will be at
the election of our Board of Directors and will depend upon our earnings,
capital requirements and financial position, general economic conditions and
other factors our Board of Directors deems relevant.
Equity Compensation Plan Information
The following table sets forth certain information as of December 31,
2005, concerning our equity compensation plans:
Number of
securities
to be
issued Weighted
upon average
exercise exercise Number of
of price of securities
outstanding outstanding remaining
options, options, available
warrants warrants for future
and rights and rights issuance
----------- ----------- -----------
Plan category (a) (b) (c)
----------- ----------- -----------
Equity compensation plans approved by security
holders 580,000,000 .0008 140,000,000(1)
Equity compensation plans not approved by
security holders(2) 216,000,000 .0014 0
----------- ----------- -----------
Total 796,000,000 .00096 140,000,000
=========== =========== ===========
(1) Available for issuance pursuant to the 2005 Plan.
(2) Includes non-qualified options to purchase common stock issued to each of
our non-employee directors.
Recent Sales Of Unregistered Securities
2005
-13-
On October 6, 2005, we entered into a Securities Purchase Agreement with
Cornell Capital Partners, LP ("Cornell"), pursuant we issued to Cornell a total
of $1,000,000 of Series F Convertible Preferred stock, par value $0.01 per share
(the "Series F Preferred Stock"). Upon the termination of the Company's status
as a BDC under the Investment Company Act the Series F Preferred Stock became
convertible at the option of Cornell into such number of fully paid and
non-assessable shares of our Common Stock, as is determined by dividing (a) the
sum of (i) $1,000,000 (the original purchase price for the Series F Preferred
Stock), plus (ii) all accrued but unpaid dividends thereon by (b) the conversion
price then in effect. As set forth in the Certificate of Designation of the
Series F Preferred Stock, the conversion price is $0.001, as adjusted from time
to time as provided in the Certificate of Designation. As of December 31, 2005,
none of the Series F Preferred Stock has been converted into shares of Common
Stock.
The Company converted $10,724, including accrued interest, of the
convertible debentures into 7,149,333 shares of Common Stock.
2004
The Company issued 140,000,000 shares of its Common Stock to various
persons for cash for a total of $193,500.
The Company converted $247,125, including accrued interest, of the
convertible debentures into 241,727,920 shares of Common Stock.
The Company issued 1,500,000 shares of Common Stock with a value of $2,250
as payment for certain directors' fees.
The Company issued convertible debentures in the principal amount of
$537,500.
2003
The Company issued 66,385,617 shares of Common Stock with a value of
$70,623 as payment for certain consulting and fees, payroll and accounts payable
items.
The Company converted $2,703,932, including accrued interest, of the
convertible debentures into 1,088,283,880 shares of Common Stock.
The Company converted $322,500 of Series B Preferred Stock and $40,000 of
Series E Preferred Stock into 2,645,000 shares of Common Stock.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data should be read in conjunction with out
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and notes thereto. As
discussed in Notes 1 and 2 to the Consolidated Financial Statements the Company
elected to become a Business Development Company on June 3, 2003. The results of
operations for 2003 are divided into two periods, the "As a Business Development
Company" period and "Prior to becoming a Business Development Company" period.
Different accounting principles are used in the preparation of the financial
statements of a business development company under the Investment Company Act of
1940 and, as a result, the financial results for periods prior to June 3, 2003
are not comparable to the period commencing on June 3, 2003 and are not expected
to be representative of our financial results in the future.
-14-
As a Business
Development Company
---------------------------
Period from
Year Ended Year Ended June 3, 2003 Period from Year Ended Year Ended
December 31, December 31, to December January 1, 2003 December 31, December 31,
2005 2004 31, 2003 to June 2, 2003 2002 2001
------------ ------------ ------------ --------------- ------------ ------------
Income Statement Data:
Unrealized gain (loss) on
investments $ 48,907 $ (290,887) $ (842,121) $ -- $ -- $ --
Dividend income -- 1,255,000 65,000 -- -- --
Revenues -- -- -- -- 649,815 403,997
Net loss attributable to
common stockholders (1,307,345) (353,260) (941,132) (617,716) (4,609,706) (4,791,361)
Net loss per common share from
continuing operations, basic
and diluted $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ (0.08) $ (1.17)
Total assets $ 1,263,024 $ 5,323,447 $ 5,507,140 N/A $ 2,129,293 $ 3,709,977
Long-term debt 222,500 2,287,012 2,089,485 N/A 3,117,520 2,980,168
Redeemable preferred stock 100,000 -- -- N/A 362,500 1,010,000
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- ------------------------------------------------------------------------------
The following information should be read in conjunction with the
consolidated financial statements of HSCC and the notes thereto appearing
elsewhere in this filing. Statements in this Management's Discussion and
Analysis or Plan of Operations and elsewhere in this prospectus that are not
statements of historical or current fact constitute "forward-looking
statements."
Overview
The Company was incorporated in Delaware on August 12, 1997. The Company's
business was to develop and manufacture, at third party plants, digital set top
boxes and digital video servers for the interactive television and high speed
Internet markets. On June 3, 2003, the Company elected to become a BDC to be
regulated pursuant to Section 54 of the Investment Company Act. A business
development company is an investment company designed to assist eligible
portfolio companies with capital formation and management advice. After the
election to become a BDC, the Company changed its business plan to primarily
seek investments in developing companies.
In September 2004, the Company entered into a business development
agreement with Sagamore with an effective date of October 4, 2004. The Company
received 7,500,000 shares of Sagamore common stock as consideration for its
agreement to provide future services regarding capital formation and management
advice. The Company has reviewed the valuation of the Sagamore stock using fair
value, and, based on the liquidation preference of the outstanding shares of
preferred stock, management has considered the value of the stock as nil. Also,
the Company has rendered no specific services to Sagamore. Accordingly, the
Company has included the value of the Sagamore stock in its financial statements
as nil and not recognized any revenue from the transaction.
In 2004, the Company had investments in two companies, the first being in
a wholly-owned subsidiary called Celerity-Nevada and the other a minority
interest in Yorkville. In the fourth quarter of 2004, Celerity-Nevada was closed
with the business and related assets sold. Yorkville returned the Company's
investment in Yorkville to the Company as a liquidating distribution.
-15-
On December 30, 2005, at a special stockholders meeting, the stockholders
of the Company voted to amend the Certificate of Incorporation of the Company to
change the name to 'Homeland Security Capital Corporation' and voted to withdraw
the Company's election as a BDC. Accordingly, the Company has changed its
business plan to primarily seek acquisition of companies that provide homeland
security products and services.
As part of its new business strategy, on February 8, 2006, the Company
acquired a majority interest in Nexus. Nexus, with offices in the New York City
and Philadelphia areas, provides integrated security systems for the corporate
and governmental security market. Nexus, whose operations began in 2001,
leverages more than 50 years of industry experience. By utilizing the latest
technologies, Nexus provides innovative, engineered and scaleable solutions to
effectively protect people, property and assets for regional and national
organizations.
Results Of Operations
Year Ended December 31, 2005 Compared To Year Ended December 31, 2004
Realized Loss On Investments
In 2004, the Company recorded a realized loss on its investment in
Celerity - Nevada of $290,887. This loss was due to the effect of recording
advances at fair value. There were no realized losses on investments in 2005.
Dividend Income
From its investment in Yorkville, 2003, the Company has received $0 in
2005 and $1,255,000 in 2004 in proceeds, which have been recorded as dividend
income in the statements of operations. On January 31, 2005 the members of
Yorkville amended its Operating Agreement to establish a new class of membership
with preferential rights. The Company's investment interest was converted to
this new class of ownership. The preferential rights allowed the Company to
receive its investment purchase price returned in cash by December 31, 2005, but
receive no other dividend income distributions. The Company received this
distribution in full in 2005 and recorded it as a reduction of its investment.
Operating Expenses
Operating expenses, which consist entirely of general and administrative
expenses, were $1,007,984 for 2005 compared to $714,215 for 2004, an increase of
41.1%. Increased operating expenses in 2005 can be attributed to higher
personnel expenses (approximately $215,000) due to the addition of executive
personnel because of the changes to the strategic refocus of the Company's
operations. The Company increased its marketing costs by approximately $12,000,
its legal and professional costs by approximately $175,000 due to the
implementation of the new focus. These expenses were partially offset by
reductions in facility occupancy costs including related depreciation of
approximately $108,000.
Amortization Of Debt Offering Costs
Amortization of debt offering costs for 2005 was $40,529 compared to
$125,374 for the year ended December 31, 2004, or a decrease of 67.7%. This
decrease results from a lower level of debt being converted to common shares and
no new debt offerings 2005 as compared to 2004.
Beneficial Conversion Feature - Convertible Notes
Non-cash interest expense relating to amortization of a beneficial
conversion feature for the various convertible debentures issues amounted to
$242,988 and $380,027 for the years ended December 31, 2005 and 2004,
respectively. This decrease of 36.1% results from a lower level of debt being
converted to common shares in 2005 as compared to 2004 and no new debt with
beneficial conversion feature being offered in 2005.
Interest Expense
Interest expense for 2005 was $98,055 compared to $187,887 for 2004, a
decrease of 47.8%. In 2005, the Company paid a significant amount of debt from
the proceeds from the liquidation of its investment in Yorkville and did not
issue new debt. This resulted in lower average debt outstanding during 2005 as
compared to 2004.
-16-
Settlement Of Debt
During 2005 and 2004, the Company settled certain trade payables,
convertible debentures and accrued interest of approximately $3,055,000 and
$611,000, respectively. These debt settlements resulted in a realized gain of
$33,304 recorded in 2005 compared to $89,016 for 2004, which represents a change
of 62.6% over 2004. Also, in 2005, there was a related party gain of $81,901,
which was credited to APIC.
Net Loss Attributable To Common Stockholders
As a result of the foregoing, the Company had a net loss of $1,307,345, or
$0.00 per share, for the year ended December 31, 2005 compared to a net loss of
$353,260, or $0.00 per share, for the year ended December 31, 2004.
Year Ended December 31, 2004 Compared To Year Ended December 31, 2003
Realized Loss On Investments
Since the election to operate as a BDC, the Company has recorded a
realized loss on its investment in Celerity-Nevada. This loss is comprised of
two elements:
2003
Effect of recording advances at fair value $ 342,121
Effect of recording equity
investments at fair value 500,000
----------
842,121
==========
2004
Effect of recording advances at fair value 290,887
----------
$1,133,008
----------
The write-down of the Company's advances to and investment in
Celerity-Nevada recognized that without additional sales, there was a
substantial risk that Celerity-Nevada would not be able to continue operation.
On November 4, 2004, Celerity-Nevada entered into an Asset Purchase Agreement
with Escent Systems, Inc. whereby Celerity-Nevada sold its assets and
interactive video business to Escent Systems, Inc. in return for 25% of Escent
Systems, Inc.'s equity. Celerity-Nevada also provided $15,000 in cash toward the
working capital of the new venture. Because Escent Systems, Inc. has limited
sales history and lack of necessary product and content development capacity,
Celerity-Nevada has determined that the fair value of the investment to be nil.
Dividend Income
Since its investment in Yorkville on December 1, 2003, the Company has
received $1,255,000 in 2004 and $65,000 in 2003 in proceeds, which have been
recorded as dividend income in the statements of operations. On January 31, 2005
the members of Yorkville decided to wind up its operations and amended its
Operating Agreement to establish a new class of membership with preferential
rights. The Company's investment interest was converted to this new class of
ownership. The preferential rights allow the Company to receive its investment
purchase price returned in cash by December 31, 2005, but receive no other
dividend income distributions.
Operating Expenses
Operating expenses, which consist entirely of general and administrative
expenses, for 2004 were $714,215 compared to 2003 of $651,267, or 9.66%.
Increased operating expenses in 2004 can be attributed to higher payroll
expenses (approximately $150,000) due to adjustment for the reversal of certain
accrued wages of $90,000 in 2003 offset by management implemented cost saving
initiatives for legal, accounting and occupancy costs.
Amortization Of Debt Offering Costs
Amortization of debt offering costs for 2004 was $125,374 compared to
$467,871 for the year ended December 31, 2003. This decrease of 73.2% results
from a lower level of debt being converted to common shares and debt offerings
with minimal offering costs in 2004 as compared to 2003.
-17-
Beneficial Conversion Feature - Convertible Notes
Non-cash interest expense relating to amortization of a beneficial
conversion feature for the various convertible debentures issues amounted to
$380,027 and $905,800 for the years ended December 31, 2004 and 2003,
respectively. This decrease of 58.1% results from a lower level of debt being
converted to common shares in 2004 as compared to 2003.
Interest Expense
Interest expense for 2004 was $187,887, a decrease of 59.8% compared to
$467,869 for the entire year ended December 31, 2003. In 2003, the Company
recorded a charge for liquidated damages of approximately $228,700 due to the
late filing of certain registration statements in 2003. In 2004 the Company did
not incur any such charge.
Settlement Of Debt
During 2004 and 2003 the Company settled certain trade payables,
convertible debentures and accrued interest of approximately $611,000 and
$4,099,000, respectively. These debt settlements resulted in a realized gain of
$89,016 recorded in 2004, a decrease of 94.8% compared to $1,711,080 for the
entire year ended December 31, 2003.
Net Loss Attributable To Common Stockholders
As a result of the foregoing, the Company had a net loss of $353,260, or
$0.00 per share, for the year ended December 31, 2004 compared to a net loss of
$1,558,848, or $0.00 per share, for the entire year ended December 31, 2003.
Liquidity And Capital Resources
From our inception through December 31, 2005, we have raised approximately
$47,428,000 through the issuance of common and preferred stock and debt. We had
cash balances on hand of $1,094,061 as of December 31, 2005 and $1,863 as of
December 31, 2004. Our primary need for cash is to fund our ongoing operations
until such time that the income from our acquired companies generates enough
proceeds to fund overall operations. In addition, our need for cash includes
satisfying current liabilities of $498,304 consisting primarily of accounts
payable of $384,792, accrued interest of $64,911 and judgments, defaults and
other payables of $48,601.
On October 6, 2005, we entered into a Securities Purchase Agreement with
Cornell pursuant we issued to Cornell a total of $1,000,000 of Series F
Preferred Stock. Pursuant to the agreement, upon the termination of the
Company's status as a BDC under the Investment Company Act the Series F
Preferred Stock would become convertible at the option of Cornell into such
number of fully paid and non-assessable shares of the our Common Stock, as is
determined by dividing (a) the sum of (i) $1,000,000 (the original purchase
price for the Series F Preferred Stock), plus (ii) all accrued but unpaid
dividends thereon by (b) the conversion price then in effect. As set forth in
the Certificate of Designation of the Series F Preferred Stock, the conversion
price is $0.001. As of December 31, 2005, no shares of Series F Convertibles
Stock have been converted by Cornell.
On August 29, 2005, the Company entered into term sheet agreement with
Cornell to enter into a $50 million standby equity distribution agreement (the
"SEDA Financing"). The SEDA Financing is contingent upon the Company's
withdrawal of its BDC status under the Investment Company Act, which withdrawal
was made on January 5, 2006. Based on the SEDA term sheet, Cornell shall commit
to purchase up to $50 million of Common Stock of the Company over the course of
24 months after an effective registration of the Common Stock. The Company shall
have the right, but not the obligation, to sell Common Stock to Cornell, in an
advance up to $1,000,000. Upon closing, the Company shall issue to Cornell
restricted shares and/or warrants of the Company's Common Stock in an amount
equal to 2% of the Commitment Amount based on a share price of $0.001 per share.
The number of restricted shares issued shall be limited to less than 4.9% of the
total outstanding shares of the Company at closing. Upon each advance, Cornell
shall receive directly from escrow cash compensation equal to 5% of the gross
proceeds of such advance. The Company shall sell to Cornell Capital the Common
Stock at a purchase price equal to 98% of the market price, which is defined as
the lowest closing bid price of the Common Stock during the five consecutive
trading days after the date an advance notice is given to Cornell Capital. As of
April 17, 2006, the Company has not received any definitive documents in
connection with the SEDA Financing. The final terms and conditions of the SEDA
Financing may be subject to modification as mutually agreed upon by the Company
and Cornell Capital at the time of entering into definitive agreements.
-18-
Our holdings of 7,500,000 shares of Sagamore common stock received in
September 2004 as consideration for the Company entering into a service
agreement has not, and is not expected to, generate dividends for the
foreseeable future.
During the year ended December 31, 2005, we had a net increase in cash of
$1,092,198. Our sources and uses of funds were as follows:
Cash Flows From Operating Activities. Net cash used in operating
activities amounted to $1,877,458 in the year ended December 31, 2005, compared
to net cash provided of $379,473 for the year ended December 31, 2004. The
positive cash flows primarily result from non-cash expenses of $14,085 from
depreciation, $242,988 on beneficial conversion of convertible notes, $40,529 on
amortization of debt offering costs, $268,304 for settlement of debt and other
cash flow adjustments offset by the net loss of $1,307,345 incurred in 2005 and
changes in current assets and liabilities of $604,185.
Cash Flow From Investing Activities. We provided cash of $5,240,000 in
investing activities in the year ended December 31, 2005 from the liquidation of
the investment in Yorkville Advisors Management, LLC.
Cash Flows From Financing Activities. We used $2,270,344 in net cash from
financing activities, consisting primarily of payment of notes payable to
related parties of $500,000, repayment of related party debentures and other
debt of $2,198,099 and the purchase of treasury stock of $417,968. Funds were
received from the issuance of Series F Preferred Stock of $1,000,000 net of
costs of $154,277.
As of December 31, 2005, we had net working capital of approximately
$740,414. During the second half of 2005, the Company changed its business focus
to concentrate on the homeland security industry, which should have a positive
impact on the operations of the Company in the future. We had no significant
capital spending or purchase commitments at December 31, 2005.
Contractual Obligations And Commercial Commitments
The following chart sets forth the Company's contractual obligations and
commercial commitments as of December 31, 2005.
Payments Due by Period
------------------------------------------------
Less After
than 1 1-3 4-5 5
Contractual Obligations Total Year Years Years Years
-------- -------- -------- -------- --------
Long-Term Debt $222,500 $222,500 $ -- $ -- $ --
Current Obligations 404,691 404,691 -- -- --
Operating Leases 19,550 10,200 9,350 -- --
Unconditioned Purchase
Obligations -- -- -- -- --
Other Long-Term Obligations -- -- -- -- --
-------- -------- -------- -------- --------
Total Contractual Cash Obligations $646,741 $637,391 $ 9,300 $ -- $ --
======== ======== ======== ======== ========
New Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R "Shared Based Payment".
This statement is a revision of SFAS Statement No. 123, "Accounting for
Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and its related implementation guidance. SFAS 123R
addresses all forms of shared based payment ("SBP") awards, including shares
issued under employee stock purchase plans, stock options, restricted stock and
stock appreciation rights. Under SFAS 123R, SBP awards result in a cost that
will be measured at fair value on the awards' grant date, based on the estimated
number of awards that are expected to vest and will be reflected as compensation
cost in the historical financial statements. This statement is effective for
public entities that file as small business issuers - as of the beginning of the
first interim or annual reporting period that begins after June 15, 2005. The
Company is in the process of evaluating whether the SFAS No. 123R will have a
significant impact on the Company's overall results of operations or financial
position.
-19-
Critical Accounting Policies And Estimates
Use of 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.
Fair Value of Financial Instruments - The carrying amount of items
included in working capital approximates fair value because of the short
maturity of those instruments. The carrying value of the Company's debt
approximates fair value because it bears interest at rates that are similar to
current borrowing rates for loans of comparable terms, maturity and credit risk
that are available to the Company.
Debt Offering Costs - Debt offering costs are related to private
placements and are being amortized on a straight line basis over the term of the
related debt, most of which is in the form of convertible debentures. Should
conversion occur prior to the stated maturity date the remaining unamortized
cost is expensed.
Investment Valuation - Investments in equity securities are recorded at
fair value, represented as cost, plus or minus unrealized appreciation or
depreciation, respectively. The fair value of investments that have no ready
market, are determined in good faith by management, and approved by the Board of
Directors, based upon assets and revenues of the underlying investee companies
as well as general market trends for businesses in the same industry. Because of
the inherent uncertainty of valuations, management's estimates of the values of
the investments may differ significantly from the values that would have been
used had a ready market for the investments existed and the differences could be
material.
Income Taxes - The Company accounts for income taxes using the asset and
liability method, whereby deferred tax assets and liabilities are determined
based upon the differences between financial reporting and tax bases of assets
and liabilities and are measured using the enacted tax rates and laws that will
be in effect when the differences are expected to reverse. A valuation allowance
related to the deferred tax assets is also recorded when it is more likely than
not that some or all of the deferred tax asset will not be realized.
Off-Balance Sheet Arrangements
There are no off-balance sheet arrangements entered into by the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
The Company does not have any exposure to market risk as it relates to
changes in interest rates as all of the borrowings of the Company are at a fixed
rate of interest.
The Company has no cash equivalents or short-term investment which are
subject to market risk.
Foreign Currency Risk
The Company does not do any business that has any risk of foreign exchange
rate fluctuations.
Equity Security Price Risk
We do not have any investment in marketable equity securities; therefore,
we do not have any direct equity price risk.
Commodity Price Risk
We no not have any business involving commodities; therefore, we do not
have any commodity price risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Notes thereto can be found beginning with
"Index to Financial Statements," following Part III of this Annual Report on
Form 10-K.
-20-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Effective April 22, 2005, the Company dismissed Marcum & Kliegman LLP as
its independent registered public accounting firm. Marcum & Kliegman's reports
on the Registrant's consolidated financial statements for each of the fiscal
years ended December 31, 2004 and 2003 did not contain an adverse opinion or a
disclaimer of opinion, and was not qualified as to uncertainty, audit scope, or
accounting principles. However, Marcum and Kliegman's reports each contained an
explanatory paragraph about the Company's ability to continue as a going
concern. During the years ended December 31, 2004 and 2003, as well as the
subsequent interim period through April 22, 2005, there were no disagreements on
any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedures, which disagreements if not resolved
to their satisfaction would have caused them to make reference in connection
with their reports of the Registrant's consolidated financial statements for
such years.
On May 3, 2005, the Company engaged HJ & Associates, LLC as its principal
accountant to audit the Company's financial statements.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. Our management, with the
participation of our chief executive officer and principal accounting officer,
has evaluated the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end
of the period covered by this Annual Report on Form 10-K. Based on such
evaluation, our principal executive officer and principal financial officer have
concluded that as of such date, our disclosure controls and procedures were
effective.
Management's Annual Report on Internal Control Over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). Under the supervision and with the participation of C.
Thomas McMillen, our Chief Executive Officer and Principal Accounting Officer,
we conducted an evaluation of the effectiveness of our internal control over
financial reporting as of December 31, 2005 based on the guidelines established
in Internal Control -- Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Our internal control
over financial reporting includes policies and procedures that provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external reporting purposes in
accordance with U.S. generally accepted accounting principles. Based on the
results of our evaluation, our management concluded that our internal control
over financial reporting was effective as of December 31, 2005.
Changes in Internal Control Over Financial Reporting. There was no change
in our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act) that occurred during the quarter ended
December 31, 2005 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
-21-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The following sets forth the name, age and positions, of the Company's
executive officers and directors as of April 13, 2006. Also set forth below is
information as to the principal occupation and background for such persons. No
family relationships exist between these individuals and they have not been a
party to any bankruptcy or receivership proceeding, any criminal proceeding, or
has been enjoined from participating in any business, including the securities
industry or otherwise during the last five years. No director or officer is a
director of any other reporting company.
Executive Officers And Directors
Our executive officers and directors are as follows:
Name Age Position Period Served
- ------------------ --- --------------------- ---------------------------
C. Thomas McMillen 53 President, Chief August 30, 2005 to Present
Executive Officer and
Chairman of the Board
Carl J. Rickertsen 46 Director December 30, 2005 to
Present
Zev E. Kaplan 53 Director December 30, 2005 to
Present
Philip A. McNeill 46 Director December 30, 2005 to
Present
Below are biographies of our executive officers and directors:
C. Thomas McMillen, President, Chief Executive Officer And Chairman Of The Board
Mr. McMillen, age 53, has served as the Company's Chief Executive Officer and
President since August 30, 2005. Mr. McMillen also currently serves as Chairman
of Fortress America Acquisition Corporation, a blank check company focused on
the homeland security industry, which completed its initial public offering in
July 2005. In March 2003, Mr. McMillen co-founded Global Secure Corp., a
homeland security company providing integrated products and services for
critical incident responders, and served as its Chief Executive Officer until
February 2004. From February 2004 until February 2005, Mr. McMillen served as a
consultant to Global Secure Corp. From December 2003 to February 2004, Mr.
McMillen served as Vice Chairman and Director of Sky Capital Enterprises, Inc.,
a venture firm, and until February 2005 served as a consultant. From March 2003
to February 2004, Mr. McMillen served as Chairman of Sky Capital Holdings, Ltd,
Sky Capital Enterprises' London stock exchange listed brokerage affiliate. Mr.
McMillen has also been Chief Executive Officer of Washington Capital Advisors,
LLC ("Washington Capital"), a merchant bank and one of our stockholders since
2003. Mr. McMillen also served as Chairman of TPF Capital, its predecessor
company, from 2001 through 2002. Mr. McMillen has also been an independent
consultant throughout his career. Mr. McMillen received a Bachelor of Science in
Chemistry from the University of Maryland in 1974, and a Bachelor and Master of
Arts from Oxford University as a Rhodes Scholar in 1978.
Carl J. Rickertsen, Director
Mr. Rickertsen, age 46, is currently Managing Partner of Pine Creek
Partners, a private equity investment firm, a position he has held since January
2004. From January 1998 until January 2004, Mr. Rickertsen was Chief Operating
Officer and a Partner at Thayer Capital Partners, a private equity investment
firm. From September 1994 until January 1998, Mr. Rickertsen was a Managing
Partner at Thayer. Mr. Rickertsen was a founding Partner of three Thayer
investment funds totaling over $1.4 billion and is a published author. Mr.
Rickertsen is also a member of the Board of Directors of MicroStrategy, Inc., a
software company; Convera Corporation, a search-engine software company; and
United Agri Products, a distributor of farm and agricultural products. Mr.
Rickertsen received a B.S. from Stanford University in 1983 and an M.B.A. from
Harvard Business School in 1987.
-22-
Zev. E. Kaplan, Director
Mr. Kaplan, age 53, is the founder of a law firm concentrating its
practice in the areas of transportation, infrastructure, government relations,
business and administrative law. Mr. Kaplan is currently General Counsel to Cash
Systems Inc., a publicly traded company in the financial services business, a
position he has held since March 2005. From April 1995 to the present, Mr.
Kaplan has been General Counsel to the Regional Transportation Commission of
Southern Nevada, where he played a key policy role in the start-up of the local
transit systems and their facilities. In addition, Mr. Kaplan has had a key role
in the planning and financing of numerous major public infrastructure projects
in Las Vegas. Prior to starting his law firm, Mr. Kaplan spent 15 years in
government service in the following capacities: Senior Deputy District Attorney
with the Clark County District Attorney's Office-Civil Division; General Counsel
to the Nevada Public Service Commission; and Staff Attorney to the U.S. Senate
Committee on Commerce, Science and Transportation. Mr. Kaplan received his J.D.
from Southwestern University School of Law in 1978 and attended Georgetown
University for post-graduate legal studies; received an MBA from the University
of Nevada, Las Vegas in 1978; and received a B.S. from the Smith School of
Business at the University of Maryland in 1974.
Philip A. McNeill, Director
Mr. McNeill, age 46, is a Managing Partner and the Chief Investment
Officer of SPP Mezzanine Partners, the General Partner of SPP Mezzanine Funding,
LP, a position he has held since November 2003. Prior to forming SPP Mezzanine
Partners, Mr. McNeill served as Managing Director of Allied Capital Corporation,
where he was co-head of its Private Finance and Mezzanine activities and a
member of its Investment Committee. From the time of his appointment as Managing
Director in 1998 until he left Allied Capital in 2002, the company grew from
approximately $740 million in assets to nearly $2.4 billion. Mr. McNeill joined
Allied Capital directly from M&T Capital, the SBIC investment division of M&T
Bank, where he was a Vice President of M&T Capital/M&T Bank and an investment
professional from 1988 to 1993. Mr. McNeill serves on the Board of Advisors of
the National Foundations for Teaching Entrepreneurship for the Greater
Washington Region and volunteers to mentor young entrepreneur students in
inner-city schools. Mr. McNeill graduated from Syracuse University in 1981 with
a B.S. in Business Administration, with concentrations in Accounting, Finance,
and Law & Public Policy. Mr. McNeill earned his MBA from Harvard Business School
in 1985.
Term of Office
Each director holds office until our annual meeting of stockholders and
until his successor is duly elected and qualified. Officers are elected by our
Board of Directors and hold office at the discretion of our Board of Directors.
Family Relationships
To our knowledge, there are no family relationships between any of the
directors or executive officers of the Company.
Legal Proceedings
To our knowledge, none of the Company's directors have been involved in
legal proceedings.
Committees Of The Board Of Directors
Audit Committee. Philip A. McNeill and Zev E. Kaplan serve as the members
of the Audit Committee. Both are independent members of the Board. The functions
of the Audit Committee are primarily to: (i) provide advice to the Board in
selecting, evaluating or replacing outside auditors, (ii) review the fees
charged by the outside auditors for audit and non-audit services, (iii) ensure
that the outside auditors prepare and deliver annually a Statement as to
Independence, (iv) meet with outside auditors to discuss the results of their
examination and their evaluation of internal controls and the overall qualify of
financial reporting, and (v) meet with the outside auditors to discuss the scope
of the annual audit, to discuss the audited financial statements. The Audit
Committee met two times in 2005. Mr. McNeill serves as the audit committee
financial expert.
Compensation Committee. Carl J. Rickertsen, Philip A. McNeill and Zev E.
Kaplan serve as the members of the Compensation Committee. The Compensation
Committee is responsible for making recommendations to the Board regarding
compensation arrangements for the Company's officers and for making
recommendations to the Board regarding the adoption of any employee benefit
plans and the grant of stock options or other benefits under such plans. The
Compensation Committee met one time in 2005.
-23-
Audit Committee Reports. Philip A. McNeill, a member of the Audit
Committee, has reviewed and discussed with its independent auditors the matters
required to be discussed by SAS 61. The Audit Committee has received the written
disclosures and the letter from the independent accountants required by
Independence Standards Board Standard No. 1, and has discussed with the
independent accountant the independent accountant's independence. Based on these
reviews and discussions, the Audit Committee recommended to the Board that the
audited financial statements be included in the Company's Annual Report on Form
10-K for the most recent fiscal year.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act, requires the Company's Directors and
executive officers, and persons who beneficially own more than 10% of a
registered class of the Company's equity securities, to file with the Commission
initial reports of ownership and reports of changes in ownership of Common Stock
and the other equity securities of the Company. Officers, Directors, and persons
who beneficially own more than 10% of a registered class of the Company's equity
securities are required by the regulations of the Commission to furnish the
Company with copies of all Section 16(a) forms they file. Based solely on a
review of reports filed with the Company, it appears that Mr. McNeill did not
file with the Commission the required reports under Section 16(a) of the 1934
Act for the fiscal year 2005.
Code of Ethics
On March 16, 2004, the Board of Directors of the Company adopted a written
Code of Ethics designed to deter wrongdoing and promote honest and ethical
conduct, full, fair and accurate disclosure, compliance with laws, prompt
internal reporting and accountability to adherence to the Code of Ethics. This
Code of Ethics has been filed with Commission as an Exhibit to the Company's
Form 10-K for the year ended December 31, 2003.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth the annual and long-term compensation for
services in all capacities for the fiscal years ended December 31, 2005, 2004
and 2003. Mr. C. Thomas McMillen became our Chief Executive Officer on August
30, 2005. Mr. Legnosky's withdrew as President, Chief Executive Officer and
Chairman of the Board on August 30, 2005, however, he has retained employment
since that date.
Summary Compensation Table
Annual Compensation Long Term Compensation
------------------------------------------------------ --------------------------------------------
Awards
-----------
All Other Restricted Securities
Annual Stock Underlying All Other
Name and Principal Position Year Salary Bonus Compensation Award(s) Options Compensation
- ----------------------------- ------------ ------------ ------------ ------------ ------------ ------------ ------------
C. Thomas McMillen, 2005 $ 40,293 $ 125,000 -- -- 580,000,000(1) --
Chairman of the Board, 2004 $ 0 -- -- -- -- --
Chief Executive Officer and 2003 $ 0 -- -- -- -- --
President
Robert B. Legnosky 2005 $ 121,875 $ 20,000 -- -- -- --
Former Chairman of the
Board, 2004 $ 84,167 --
Chief Executive Officer and 2003 $ 63,333 --
President
(1) On August 29, 2005, McMillen was granted option to purchase 580,000,000
shares of Common Stock pursuant to the McMillen Employment Agreement. Of
these options, 116,000,000 shares of Common Stock vested on August 30,
2005 the date the Employment Agreement was executed by the parties
thereto.
Option/SAR Grants Table
The following table sets forth, for the fiscal year ended December 31,
2005 certain information regarding the options/SARs granted to the named
executive officers of the Company.
-24-
% Total
Options/SARs
Granted to
No. of Employees Grant
Securities in year Exercise Date
Underlying ended or Base Present
Options/SARs December Price Value
Granted 31, 2005 ($ per Expiration ($ per
Name (#) (%) Share) Date share)(1)
------------ ------------ ------------ ------------ ------------
C. Thomas
McMillen, Chief
Executive
Officer and
President 580,000,000 100% .0008 8/29/2015 .0008
(1) The estimated grant date present value has been calculated using a
Black-Scholes option-pricing model with the following material
assumptions: (i) a risk-free interest rate of 4.40%] (at August 29,
2005), (ii) expected volatility of 427%, (iii) an expected life of
10 years and (iv) no dividend yield.
Aggregated Option/SAR Exercises And Fiscal Year-End Option/SAR Values
Table
The following table sets forth certain information regarding options
exercised in the fiscal year ended December 31, 2005 by the named executive
officers of the Company.
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money
Options/SARs at Options/SARs at
Shares Fiscal Year End (#) Fiscal Year End (R)
Acquired on Value Exercisable/ Exercisable/Unexercisable
Name Exercise (#) Realized ($) Unexercisable (1)
- ------------------ -------------------------- -------------------------- -------------------------- --------------------------
C. Thomas McMillen -- -- 232,000,000/348,000,000/ 185,600/278,400
(1) In accordance with the rules of the SEC, values are calculated by
subtracting the exercise price from the fair market value of the
underlying Common Stock. For purposes of this table, fair market value is
deemed to be $.0016 per share, the closing price of the Common Stock as
reported on the OTC Electronic Bulletin Board on December 30, 2005, the
last trading day of 2005.
Long-Term Incentive Plans - Awards In Last Fiscal Year
The Company did not grant any long-term incentive plan awards in the
fiscal year ended December 31, 2005.
Director Compensation
Each Director of the Company, except Mr. McMillen, is entitled to receive
$20,000 in annual compensation for his services on the Board, of which $5,000
will be paid each calendar quarter. Each Director of the Company will be
reimbursed for reasonable expenses incurred in connection with their service on
the Board.
Upon election to the Board of Directors on December 30, 2005, each
director except Mr. McMillen, was granted options to purchase 72,000,000 shares
of Common Stock, of which 8,000,000 vested upon their election to the Board, and
the remainder will vest in 8,000,000 increments at the end of each calendar
quarter thereafter. The exercise price for the stock options granted upon
election was $.0014 per share, which represents the closing sales price on the
date of the grant. These options expire 10 years from their grant date.
Stock Option Plans
-25-
There were 796,000,000 options outstanding at December 31, 2005 and no
options outstanding at December 31, 2004.
On August 29, 2005, the Board adopted the 2005 Stock Option Plan under
which the Company reserved 720,000,000 shares of Common Stock for issuance.
Participants eligible under this plan are key employees and non-employee
Directors. In connection with his employment by the Company and appointment to
the Board on August 29, 2005, McMillen was previously granted options to
purchase 580,000,000 shares of Common Stock (the "McMillen Options"). The
McMillen Options vested (or will vest) as follows: (i) options to acquire
116,000,000 shares of Common Stock vested on August 29, 2005, and (ii) options
to acquire 116,000,000 additional shares of Common Stock will vest at the end of
each of the first, second, third and fourth calendar quarters following the
initial vesting date.
Employment Contracts
On August 29, 2005, the Company and Mr. McMillen entered into the McMillen
Employment Agreement whereby the Company hired Mr. McMillen to serve as its
Chief Executive Officer and President for a term of two years, and renewable by
mutual agreement of the Company and Mr. McMillen. Mr. McMillen's initial annual
salary under this agreement was $120,000 with the possibility of a performance
bonus. Pursuant to the McMillen Employment Agreement, McMillen was awarded
options to acquire a total of 580,000,000 shares of Common Sock as described
above. Mr. McMillen also received a sign-on bonus of $125,000.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER
The following table sets forth, information with respect of the beneficial
ownership as of April 13, 2006, for any person who is known to the Company to be
the beneficial owner of more than five percent (5%) of the Company's Common
Stock.
Shares
Beneficially Percent
Name and Address Title of Class Owned of Class (1)
- ---------------------------- -------------- -------------- --------------
Cornell Capital Partners, LP Common Stock 370,698,873(2) 8.35%
101 Hudson St
Jersey City, NJ 07302
(1) Applicable percentage of ownership is based on 4,440,560,075 shares of
Common Stock outstanding as of April 13, 2006, together with securities
convertible or exercisable into shares of Common Stock within 60 days for
each shareholder. Beneficial ownership is determined in accordance with
the rules of the Commission and generally includes voting or investment
power with respect to securities. Shares of Common Stock subject to
securities that are currently exercisable or exercisable within 60 days of
April 13, 2006 are deemed to be beneficially owned by the person holding
such securities for the purpose of computing the percentage of ownership
of such person, but are not treated as outstanding for the purpose of
computing the percentage ownership of any other person.
(2) Out of these shares, 50,000,000 shares of Common Stock were acquired as
compensation pursuant to a Securities Purchase Agreement, dated February
6, 2006, by and between the Company and Cornell Capital, pursuant to which
the Company issued to Cornell Capital a Convertible Debenture in the
amount of $4,000,000, which debenture is convertible into Common Stock.
The conversion price of the Debenture shall be equal to the lesser of (1)
$0.01 or (2) a ten percent discount to the lowest daily volume weighted
average price of the Common Stock for the thirty days preceding
conversion. Cornell Capital is entitled to convert the Debenture at a
conversion price into Common Stock, provided that Cornell Capital cannot
convert into shares of Common Stock that would cause Cornell Capital to
own more than 4.9% of the issued and outstanding Common Stock. The
Debenture has an interest at 5% per annum and the principal amount will be
payable on the third anniversary of the effective date of the Debenture.
The remaining shares of Common Stock beneficially owned by Cornell Capital
were acquired from the issuer through various private placement
transactions.
-26-
Directors And Executive Officers
The following table shows the amount of capital stock of the Company
beneficially owned by the Company's directors, executive officers named in the
Summary Compensation Table and by all directors and executive officers as a
group as of April 13, 2006.
The applicable percentage of beneficial ownership is based on
4,440,560,075 shares of Common Stock outstanding as of April 13, 2006 together
with securities convertible or exercisable into shares of Common Stock within 60
days for each shareholder. Shares of Common Stock subject to securities that are
currently exercisable or exercisable within 60 days of April 13, 2006 are deemed
to be beneficially owned by the person holding such securities for the purpose
of computing the percentage of ownership of such person, but are not treated as
outstanding for the purpose of computing the percentage ownership of any other
person. Beneficial ownership, which is determined in accordance with the rules
and regulations of the SEC, means the sole or shared power to vote or direct the
voting or to dispose or direct the disposition of our common stock. Unless
otherwise indicated, all of the shares are owned directly, and the person has
sole voting and dispositive power. Except as otherwise indicated, the business
address for each of the following persons is 4100 North Fairfax Drive, Suite
1150, Arlington, Virginia 22203-1664.
Shares
Beneficially Percent
Name and Address Title of Class Owned of Class
- ----------------------------------- -------------- -------------- --------------
C. Thomas McMillen Common Stock 1,598,000,000(1) 35.9%
Carl J. Rickertsen Common Stock 16,000,000(2) 0.4%
Zev E. Kaplan Common Stock 16,000,000(3) 0.4%
Philip A McNeill Common Stock 16,000,000(4) 0.4%
All Officers and Directors as Group Common Stock 1,646,000,000 37.6%
(1) Mr. McMillen acquired 1,250,000,000 shares of Common Stock pursuant to the
terms of that certain Stock Purchase Agreement, dated August 29, 2005, by
and between McMillen and Cornell. On August 29, 2005, McMillen was granted
option to purchase 580,000,000 shares of Common Stock pursuant to the
McMillen Employment Agreement. Out of these, 116,000,000 shares of Common
Stock vested on August 29, 2005, the date the Employment Agreement was
executed by the parties thereto.
(2) Mr. Rickertsen was granted options to purchase 72,000,000 shares of Common
Stock pursuant to the terms of the 2005 Stock Option Plan, of which
8,000,000 were exercisable on December 30, 2005. The balance vests in
8,000,000 increments each calendar quarter thereafter.
(3) Mr. Kaplan was granted options to purchase 72,000,000 shares of Common
Stock pursuant to the terms of the 2005 Stock Option Plan, of which
8,000,000 were exercisable on December 30, 2005. The balance vests in
8,000,000 increments each calendar quarter thereafter.
(4) Mr. McNeill was granted options to purchase 72,000,000 shares of Common
Stock pursuant to the terms of the 2005 Stock Option Plan, of which
8,000,000 were exercisable on December 30, 2005. The balance vests in
8,000,000 increments each calendar quarter thereafter.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On December 1, 2003, the Company purchased a minority interest in
Yorkville for a purchase price of $5,240,000. Yorkville is the investment
manager of a private equity fund that is a principal holder of equity securities
of the Company. The acquisition was funded through the sale of 2,000,000,000
shares of Common Stock to the aforementioned private equity fund, resulting in
net proceeds of $4,000,000 and the balance paid using the proceeds received from
the issuance of convertible notes payable. During the year ended December 31,
2005, the Company did not receive any dividend income from this investment.
-27-
At December 31, 2004, the Company had an outstanding note payable to a
principal holder of equity securities of the Company in the amount of $500,000.
This note was repaid in 2005.
At December 31, 2004, the Company had an outstanding demand note payable
to a former member of the Company's Board of Directors in the amount of $10,000
that arose from the normal course of business. This note was repaid in 2005.
On February 11, 2005, the Company became entitled to receive a
distribution of $5,240,000 from Yorkville in connection with the Company's
Preferential Rights Membership Interest in Yorkville, pursuant to the terms of
Yorkville's Limited Liability Company Agreement, as amended. Accordingly, upon
its receipt of the distribution in 2005, the Company no longer has any ownership
interest in Yorkville.
The Company's ownership interest in Yorkville was originally a minority
Common Membership Interest. Pursuant to the terms of a Second Amendment to the
Limited Liability Company Agreement of Yorkville entered into on January 31,
2005 among Yorkville and the other equity owners of Yorkville, the Company's
minority Common Membership Interest was reconstituted as Preferential Rights
Interest. As a result, the Company became entitled to receive dividends and
other distributions of Yorkville's available assets in an amount up to the
purchase price paid by the Company for its original Common Membership Interest.
The $5,240,000 preferential distribution was received by the Company in 2005 and
the proceeds represent the entire purchase price paid by the Company for its
original Common Membership Interest.
We believe that each of the above referenced transactions was made on
terms no less favorable to us than could have been obtained from and
unaffiliated third party. Furthermore, any future transactions or loans between
the Company and its officers, directors, principal stockholders or affiliates,
and any forgiveness of such loans, will be on terms no less favorable to us than
could be obtained from an unaffiliated third party, and will be approved by a
majority of our directors, including a majority of our independent and
disinterested directors who have access at our expense to our legal counsel.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
HJ & Associates audited our financial statements for the year ended
December 31, 2005 and Marcum & Kliegman audited our financial statements for the
year ended December 31, 2004.
Audit Fees. During the year ended December 31, 2005, HJ & Associates
billed us an aggregate of $29,643 for professional services rendered for:
o Audit of our annual financial statements included in our Annual
Report on Form 10-K for the years ended December 31, 2005.
o Review of our financial statements included in our Quarterly Reports
on Form 10-Q for the year ended December 31, 2005.
During the year ended December 31, 2004 Marcum & Kliegman billed us an
aggregate of $56,192 for professional services rendered for:
o Audit of our annual financial statements included in our Annual
Report on Form 10-K for the years ended December 31, 2004 and 2003.
o Review of our financial statements included in our Quarterly Reports
on Form 10-Q for the years ended December 31, 2004 and 2003.
Audit-Related Fees. During the years ended December 31, 2005 and 2004
Marcum & Kliegman and HJ & Associates billed us an aggregate of $0 for services
rendered other than those described above under the heading "Audit Fees."
Tax Fees. During the years ended December 31, 2005 and 2004 Marcum &
Kliegman and HJ & Associates billed us an aggregate of $0 for services rendered
other than those described above under the heading "Audit Fees."
All Other Fees. During the years ended December 31, 2005 and 2004 Marcum &
Kliegman and HJ & Associates billed us an aggregate of $0 for services rendered
other than those described above under the heading "Audit Fees."
-28-
All services provided by HJ & Associates or Marcum & Kliegman have been
pre-approved by the Audit Committee before HJ & Associates or Marcum & Kliegman
began to perform those services.
No services were rendered by HJ & Associates pursuant to paragraph
(c)(7)(ii)C of Rule 2-01 of Regulation S-X.
-29-
PART V
ITEM 15. EXHIBITS 8-K; FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as part of this report:
See index to Consolidated Financial Statements attached, which are filed
as part of this report.
(b) Exhibits:
Exhibit No. Description Location
- ------------ -------------------------------- ---------------------------------
3.1 Certificate of Incorporation of Incorporated by reference to
Registrant Exhibit 3.1 to the Registration
Statement on SB-2 filed with the
SEC on August 13, 1997
3.2 By laws of Registrant Incorporated by reference to
Exhibit 3.2 to the Registration
Statement on SB-2 filed with the
SEC on August 13, 1997
3.3 Certificate of Designation of Incorporated by reference to the
Series C Preferred Stock Registration Statement on Form
SB-2 filed with the SEC on
October 18, 2001
3.4 Certificate of Designation of Incorporated by reference to
Series D Preferred Stock Exhibit 3.4 to Form 10-KSB filed
with the SEC on March 27, 2002
3.5 Certificate of Designation of Incorporated by reference to
Series E Preferred Stock Exhibit 3.4 to Form 10-KSB filed
with the SEC on March 27, 2002
3.6 Certificate of Amendment to Incorporated by reference to
Certificate of Incorporation of Exhibit 3.6 to Form 10-KSB filed
Registrant, dated August 23, 2002 with the SEC on April 15, 2005
3.7 Certificate of Amendment to Incorporated by reference to
Certificate of Incorporation of Exhibit 3.7 to Form 10-KSB filed
Registrant, dated April 17, 2002 with the SEC on April 15, 2005
3.8 Certificate of Amendment to Incorporated by reference to
Certificate of Incorporation, Exhibit 3.1 to Form 8-K filed
dated January 5, 2006 with the SEC on February 2, 2006
3.9 Certificate of Designation for Incorporated by reference to
the Series F Convertible Exhibit 99.2 to Form 8-K filed
Preferred Stock with the SEC on October 7, 2005
3.10 Certificate of Designation for Incorporated by reference to
the Series G Convertible Exhibit 3.1 to Form 8-K filed
Preferred Stock with the SEC on February 14, 2006
4.1 Form of Underwriter's Warrant Incorporated by reference to
Exhibit 4.1 to Amendment No. 1 to
Registration Statement on SB-2
filed with the SEC on October 8,
1997
-30-
Exhibit No. Description Location
- ------------ -------------------------------- ---------------------------------
4.2 Form of Convertible Debenture due Incorporated by reference to
February 2009 Exhibit 4.1 to Form 8-K filed
with the SEC on February 14, 2006
10.1 Preferred Stock Term Sheet by and Incorporated by reference to
between Cornell Capital Partners, Exhibit 10.1 to Form 8-K filed
LP and Registrant with the SEC on August 31, 2005
10.2 SEDA Term Sheet by and between Incorporated by reference to
Cornell Capital Partners, LP and Exhibit 10.2 to Form 8-K filed
Registrant with the SEC on August 31, 2005
10.3 Employment Agreement by and Incorporated by reference to
between C. Thomas McMillen and Exhibit 10.3 to Form 8-K filed
Registrant with the SEC on August 31, 2005
10.4 Indemnification Agreement by and Incorporated by reference to
between C. Thomas McMillen and Exhibit 10.4 to Form 8-K filed
Registrant with the SEC on August 31, 2005
10.5 Securities Purchase Agreement Incorporated by reference to
dated as of October 6, 2005, by Exhibit 99.1 to Form 8-K filed
and between Registrant and with the SEC on October 7, 2005
Cornell Capital Partners, LP
10.6 Escrow Agreement, dated as of Incorporated by reference to
October 6, 2005, by and between Exhibit 99.3 to Form 8-K filed
Registrant and Cornell Capital with the SEC on October 7, 2005
Partners, LP
10.7 Securities Purchase Agreement, Incorporated by reference to
dated February 6, 2006, by and Exhibit 10.1 to Form 8-K filed
between Registrant and Cornell with the SEC on February 14, 2006
Capital Partners, LP
10.8 Investor Registration Rights Incorporated by reference to
Agreement, dated February 6, Exhibit 10.2 to Form 8-K filed
2006, by and between Registrant with the SEC on February 14, 2006
and Cornell Capital Partners, LP
10.9 Investment Agreement, dated Incorporated by reference to
February 6, 2006, by and between Exhibit 10.3 to Form 8-K filed
Registrant and Cornell Capital with the SEC on February 14, 2006
Partners, LP
10.10 Security Agreement dated February Incorporated by reference to
6, 2006, by and between Exhibit 10.4 to Form 8-K filed
Registrant and Cornell Capital with the SEC on February 14, 2006
Partners, LP
10.11 Agreement and Plan of Merger, Incorporated by reference to
dated February 8, 2006, by and Exhibit 10.1 to Form 8-K filed
among Nexus Technologies Group, with the SEC on February 14, 2006
Inc., Corporate Security
Solutions, Inc., CSS
Acquisitions, Inc. and certain
other persons named therein
10.12 Series A Convertible Preferred Incorporated by reference to
Stock Purchase Agreement, dated Exhibit 10.2 to Form 8-K filed
February 8, 2006, by and between with the SEC on February 14, 2006
Registrant and Nexus
Technologies Group, Inc.
10.13 2005 Stock Option Plan Filed herewith
14.1 Code of Business Conduct Incorporated by reference as
and Ethics Exhibit 14.1 to Form 10-KSB on
April 14, 2004
31.1 Certification of the Chief Provided herewith
Executive Officer and Principal
Accounting Officer pursuant to
Rule 13a-14(a) of the Exchange
Act
32.1 Certification of the Chief Provided herewith
Executive Officer and Principal
Accounting Officer pursuant to
18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
-31-
(c) Reports on Form 8-K:
Report on Form 8-K filed February 18, 2005 pursuant to Item 5 (Other
Events) reported that on February 11, 2005, the Company became entitled to
receive a distribution of $5,200,000 from Yorkville Advisors Management, LLC
pursuant to the terms of a Preferential Rights Membership Interest in Yorkville.
Report on Form 8-K filed April 19, 2005 pursuant to Item 5.02 (Departure
of Directors or Principal Officers) reported that, effective April 15, 2005,
David Leigh resigned as a member of the Board of Directors. Mr. Leigh resigned
for personal reasons and not based on any disagreement with the Company.
Report on Form 8-K filed April 27, 2005 pursuant to Item 4.01 (Changes in
Registrant's Certifying Accountant) reported that, effective April 22, 2005,
based on the recommendation of an approval by the audit committee and the Board
of Directors, Marcum & Kliegman has been dismissed as it independent registered
public accounting firm.
Report on Form 8-K filed May 6, 2005 pursuant to Item 4.01 (Changes in
Registrant's Certifying Accountant) reported that, effective May 3, 2005, based
on the recommendation of an approval by the audit committee and the Board of
Directors, HJ & Associates is engaged to provide services as its certified
public accountants.
Report on Form 8-K filed August 31, 2005 pursuant to Item 1.01 (Entry into
a Material Definitive Agreement) that the Company had entered into two term
sheets for a $51,000,000 financing commitment from Cornell Capital Partners, LP
to finance, in two parts, the Company's new strategic direction. The financing
will be subject to the execution of definitive documentation.
Report on Form 8-K filed August 31, 2005 pursuant to Item 5.02 (Departure
of Directors or Principal Officers; Election of Directors; Appointment of
Principal Officers) effective August 30, 2005, Robert Legnosky resigned as
President and a Director of the Corporation and the Corporation's Board of
Directors appointed C. Thomas McMillen to be the President, Chief Executive
Officer and a Director of the Corporation. In connection with his appointment,
Mr. McMillen and the Corporation executed an Employment Agreement and an
Indemnification Agreement. Mr. McMillen also purchased 1,250,000,000 shares of
Common Stock of the Corporation from Cornell Capital Partners, LP.
Report on Form 8-K filed August 31, 2005 pursuant to Item 8.01 (Other
Events) that it is the Corporation's intention to pursue a new strategic
direction; to focus on owning and operating small and mid-sized growth
businesses that provide homeland security solutions through innovative
technologies to both the public and private sector and to drive growth through
management, strategic guidance, capital and financial support, and government
marketing expertise.
The Corporation also announced its intention to seek shareholder approval
to change the name from "Celerity Systems, Inc." to "Homeland Security Capital
Corporation" in order to better reflect the Company's new direction and
objective to become a major player in the homeland security industry. As part of
its reorganization, the Company will seek shareholder approval to withdraw its
election as a business development company under the Investment Company Act of
1940, as amended.
Report on Form 8-K filed August 31, 2005 pursuant to Item 8.01 (Other
Events) that, effective September 12, 2005, the principal office of the
Corporation will be located at 4100 North Fairfax Drive, Suite 1150, Arlington,
Virginia 22203-1664.
Report on Form 8-K filed October 7, 2005 pursuant to Item 1.01(Entry into
a Material Definitive Agreement) that on October 6, 2005, the Company entered
into a security purchase agreement with Cornell Capital Partners, LP, under
which the Company issued to Cornell Capital Partners, LP $1,000,000 of Series F
Convertible Stock. Pursuant to the agreement, upon the termination of the
Company's BDC under the Investment Company Act, the Series F Preferred Stock
will become convertible at the option on the holder thereof, into Common Stock
of the Company, par value $0.001 at a conversion price, starting at $0.001 and
being adjusted from time to time. The Company will have the right to redeem all
or part of the Series F Preferred Stock at a redemption price equal to 125% of
the amount redeemed.
-32-
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
HOMELAND SECURITY CAPITAL
CORPORATION
/s/ C. Thomas McMillen
- -------------------------------
C. Thomas McMillen President, Chief Executive April 17, 2006
Officer and Interim Chief
Financial Officer
In accordance with the Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant in the capacities and
on the dates indicated.
Signature Title Date
- ----------------------- ---------------------------------- ----------------
/s/ C. Thomas McMillen President, Chief Executive Officer April 17, 2006
- ----------------------- and Chairman of the Board
C. Thomas McMillen (Principal Executive Officer)
(Principal Accounting Officer)
/s/ Carl J. Rickertsen Director April 17, 2006
- -----------------------
Carl J. Rickertsen
/s/ Zev E. Kaplan Director April 17, 2006
- -----------------------
Zev E. Kaplan
/s/ Philip A. McNeill Director April 17, 2006
- -----------------------
Philip A. McNeill
-33-
HOMELAND SECURITY CAPITAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of HJ & Associates, LLC ........................................... F-1
Report of Marcum & Kliegman LLP ......................................... F-2
Balance Sheets as of December 31, 2005 and 2004 ......................... F-3
Statements of Operations for the Years Ended
December 31, 2005, 2004 and 2003 ....................................... F-5
Statement of Changes in Stockholders' Equity (Deficit)
for the Years Ended December 31, 2005, 2004 and 2003 ................... F-6
Statements of Cash Flows for the Years Ended
December 31, 2005, 2004 and 2003 ....................................... F-8
Notes to Financial Statements ........................................... F-10
F-i
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Homeland Security Capital Corporation
(formerly Celerity Systems, Inc.)
Arlington, Virginia
We have audited the accompanying consolidated balance sheet of Homeland Security
Capital Corporation (formerly Celerity Systems, Inc.) as of December 31, 2005,
and the related statements of operations, stockholders' equity, and cash flows
for the year ended December 31, 2005. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
As discussed more fully in Note 7 to the financial statements, investments
amounting to $0 (0% of net assets) at December 31, 2005 have been valued at fair
value as determined by the Board of Directors. We have reviewed the procedures
applied by the directors in valuing such securities and have inspected
underlying documentation; while in the circumstances the procedures appear to be
reasonable and the documentation appropriate, determination of fair values
involves subjective judgment which is not susceptible to substantiation by
auditing procedures.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Homeland Security Capital
Corporation (formerly Celerity Systems, Inc.) as of December 31, 2005 and the
results of their operations and their cash flows for the year ended December 31,
2005, in conformity with U.S. generally accepted accounting principles.
/s/ HJ & Associates, LLC
- ------------------------------------
HJ & Associates, LLC
Salt Lake City, Utah
April 4, 2006
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Homeland Security Capital Corporation
We have audited the accompanying consolidated balance sheets of Homeland
Security Capital Corporation (formerly Celerity Systems, Inc.) (the "Company")
as of December 31, 2004 and the related statement of operations, stockholders'
(deficit) equity and cash flows for the year ended December 31, 2004 and for the
period from January 1, 2003 to June 2, 2003 and the period from June 3, 2003
through December 31, 2003. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We concluded out audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Homeland Security Capital Corporation (formerly Celerity Systems, Inc.) as of
December 31, 2004 and the consolidated results of their operations and their
cash flows for the year ended December 31, 2004 and for the period from January
1, 2003 to June 2, 2003 and the period from June 3, 2003 through December 31,
2003 in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note 2 to the consolidated financial statements, accounting
principles used in the preparation of the consolidated financial statements
beginning June 3, 2003 and the periods from June 3, 2003 (upon conversion to a
business development company under the Investment Company Act of 1940, as
amended) are different than those of prior periods and therefore are not
directly comparable.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 3 to the
consolidated financial statements, the Company has had recurring losses since
inception of approximately $43,470,000 and continues to suffer cash flow and
working capital shortages. As of December 31, 2004, the Company had negative net
working capital of approximately $1,713,000. These factors raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regards to these matters are also described in Note 3. The consolidated
financial statements do not include any adjustment that might result from the
outcome of this uncertainty.
As discussed in note 6 and note 8, the consolidated financial statements include
securities whose values have been estimated by the Board of Directors. Those
estimated values may differ significantly from the values that ultimately would
be realized.
Marcum & Kliegman LLP
New York , New York
March 11, 2005, except for Note 22(b)which is as of March 31, 2005
F-2
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARY
(formerly Celerity Systems, Inc.)
Consolidated Balance Sheets
December 31,
-------------------------------
2005 2004
-------------- --------------
Assets
Cash $ 1,094,061 $ 1,863
Other current assets 144,657 2,664
-------------- --------------
Total current assets 1,238,718 4,527
-------------- --------------
Fixed assets, net 24,306 38,391
Investment in Yorkville Advisors Management, LLC, at cost which
approximates fair value (see Note 6) -- 5,240,000
Debt offering costs, net -- 40,529
-------------- --------------
Total assets $ 1,263,024 $ 5,323,447
============== ==============
Liabilities and Stockholders' Equity
Accounts payable $ 384,792 $ 473,637
Judgments and defaults payable (including $213,400 to a related party
at 2004) 44,000 400,675
Accrued interest (including $188,366 to a related party at 2004) 64,911 321,629
Notes payable - related party -- 510,000
Other current liabilities 4,601 11,311
-------------- --------------
Total current liabilities 498,304 1,717,252
Convertible debentures - related party, net -- 583,517
Convertible debentures, net 222,500 1,703,495
-------------- --------------
222,500 2,287,012
-------------- --------------
Total liabilities 720,804 4,004,264
-------------- --------------
F-3
Commitments and contingencies -- --
Stockholders' Equity
Preferred stock, $0.01 par value, 3,000,000 shares authorized,
1,000,000 shares issued and outstanding at 2005 100,000 --
Common stock, $0.001 par value, 20,000,000,000 shares authorized,
4,397,728,539 and 4,796,102,805 issued and outstanding
in 2005 and 2004, respectively 4,397,729 4,796,103
Additional paid-in capital 41,822,550 40,555,128
Treasury stock, at cost - 226,843,599 shares at 2004 -- (561,334)
Accumulated deficit (45,778,059) (43,470,714)
-------------- --------------
Total stockholders' equity 542,220 1,319,183
-------------- --------------
Total liabilities and stockholders' equity $ 1,263,024 $ 5,323,447
============== ==============
The accompanying notes are an integral part of these consolidated financial
statements
F-4
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARY
(formerly Celerity Systems, Inc.)
Consolidated Statements of Operations
Prior to
Becoming a
Business
Development
As a Business Development Company Company
------------------------------------------------------ ----------------
Period from Period from
Year Ended Year Ended June 3, 2003 January 1,
December 31, December 31, to December 2003 to June
2005 2004 31, 2003 2, 2003
---------------- ---------------- ---------------- ----------------
Realized and unrealized gain (loss) on
investments $ 48,907 $ (290,887) $ (842,121) $ --
Dividend income -- 1,255,000 65,000 --
---------------- ---------------- ---------------- ----------------
Gross income (loss)
48,907 964,113 (777,121) --
General and administrative expenses 1,007,984 714,215 351,001 300,266
---------------- ---------------- ---------------- ----------------
Operating income (loss)
(959,077) 249,898 (1,128,122) (300,266)
Other income (expense)
Amortization of debt offering costs (40,529) (125,374) (372,808) (95,063)
Beneficial conversion feature - convertible
debentures (242,988) (380,027) (709,720) (196,080)
Interest expense (98,055) (187,887) (265,467) (202,402)
Settlement of debt 33,304 89,016 1,534,985 176,095
Other income -- 1,114 -- --
---------------- ---------------- ---------------- ----------------
Total other income (expense) (348,268) (603,158) 186,990 (317,450)
---------------- ---------------- ---------------- ----------------
Net loss attributable to common
stockholders $ (1,307,345) $ (353,260) $ (941,132) $ (617,716)
================ ================ ================ ================
Loss per common share, basic and diluted
Net loss per common share, basic and diluted $ (0.00) $ (0.00) $ (0.00) $ (0.00)
Beneficial conversion feature - preferred
stock (0.00) (0.00) (0.00) (0.00)
---------------- ---------------- ---------------- ----------------
Net loss per common share attributable to common
stockholders $ (0.00) $ (0.00) $ (0.00) $ (0.00)
================ ================ ================ ================
Weighted average shares outstanding -
basic and diluted 4,440,850,576 4,701,086,889 1,046,447,945 283,614,763
================ ================ ================ ================
The accompanying notes are an integral part of these consolidated financial
statements
F-5
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARY
(formerly Celerity Systems, Inc.)
Consolidated Statement of Changes in Stockholders' (Deficit) Equity
For the years ended December 31, 2005 and 2004 and 2003
Net Unrealized
Common Stock Additional Depreciation
Preferred --------------------------- Paid-In Treasury on
Stock Shares Amount Capital Stock Investments
---------- ------------- ----------- ------------ -------- ---------------
Balance, January 1, 2003 246,325,579 246,325 36,058,793 -- --
Issuance of convertible debentures
with beneficial conversion feature 198,200
Issuance of common stock as payment of
certain consulting fees, payroll and
accounts payable items 4,555,617 4,556 3,924
Conversion of convertible debentures to
shares of common stock 228,023,673 228,024 67,976
Conversion of convertible preferred
stock to shares of common stock 2,645,000 2,645 359,855
Net loss
---------- ------------- ----------- ------------ -------- ---------------
Balance, June 3, 2003 -- 481,549,869 481,550 36,688,748 -- --
Issuance of common stock for cash 3,149,833,333 3,149,833 2,016,667
Issuance of convertible debentures
with beneficial conversion feature 291,290
Issuance of common stock as payment of
director's fees 61,830,000 61,830 313
Conversion of convertible debentures to
shares of common stock 860,260,207 860,260 1,547,672
Net loss (842,121)
---------- ------------- ----------- ------------ -------- ---------------
Balance, December 31, 2003 -- 4,553,473,409 4,553,473 40,544,690 -- (842,121)
Issuance of common stock for cash 140,000,000 140,000 53,500
Issuance of common stock as payment of
certain consulting fees, payroll and
accounts payable items 1,500,000 1,500 750
Conversion of convertible debentures to
shares of common stock 241,727,920 241,728 5,397
Acquisition of treasury stock (751,141)
Cancellation of treasury stock (140,598,524) (140,598) (49,209) 189,807
Unrealized depreciation of investment
in Celerity NV (290,887)
Transfer of unrealized depreciation to
permanent loss on investment in Celerity NV 1,133,008
Net loss
---------- ------------- ----------- ------------ -------- ---------------
Balance, December 31, 2004 -- 4,796,102,805 4,796,103 40,555,128 (561,334) --
Issuance of 1,000,000 shares of
convertible preferred stock with
beneficial conversion feature 100,000 845,723
Amortization of beneficial conversion
feature and accretion of redeemable
convertible preferred stock 1,000,000
Conversion of convertible debentures to
shares of common stock 7,149,333 7,149 3,577
Gain on settlement of related party
debt 91,901
Acquisition of treasury stock (417,968)
Cancellation of treasury stock (405,523,599) (405,523) (573,779) 979,302
Net loss
---------- ------------- ----------- ------------ -------- ---------------
Balance, December 31, 2005 $ 100,000 4,397,728,539 $ 4,397,729 $ 41,922,550 $ -- $ --
========== ============= =========== ============ ======== ===============
F-6
Total
Stockholders'
Accumulated (Deficit)
Deficit Equity
-------------- -------------
Balance, January 1, 2003 (41,558,606) (5,253,488)
Issuance of convertible debentures
with beneficial conversion feature 198,200
Issuance of common stock as payment of
certain consulting fees, payroll and
accounts payable items 8,480
Conversion of convertible debentures to
shares of common stock 296,000
Conversion of convertible preferred
stock to shares of common stock 362,500
Net loss (617,716) (617,716)
-------------- -------------
Balance, June 3, 2003 (42,176,322) (5,006,024)
Issuance of common stock for cash 5,166,500
Issuance of convertible debentures
with beneficial conversion feature 291,290
Issuance of common stock as payment of
director's fees 62,143
Conversion of convertible debentures to
shares of common stock 2,407,932
Net loss (99,011) (941,132)
-------------- -------------
Balance, December 31, 2003 (42,275,333) 1,980,709
Issuance of common stock for cash 193,500
Issuance of common stock as payment of
certain consulting fees, payroll and
accounts payable items 2,250
Conversion of convertible debentures to
shares of common stock 247,125
Acquisition of treasury stock (751,141)
Cancellation of treasury stock --
Unrealized depreciation of investment
in Celerity NV 290,887 --
Transfer of unrealized depreciation to
permanent loss on investment in Celerity NV (1,133,008) --
Net loss (353,260) (353,260)
-------------- -------------
Balance, December 31, 2004 (43,470,714) 1,319,183
Issuance of 1,000,000 shares of
convertible preferred stock with
beneficial conversion feature 845,723
Amortization of beneficial conversion
feature and accretion of redeemable
convertible preferred stock (1,000,000) --
Conversion of convertible debentures to
shares of common stock 10,726
Gain on settlement of related party
debt 91,901
Acquisition of treasury stock (417,968)
Cancellation of treasury stock --
Net loss (1,307,345) (1,307,345)
-------------- -------------
Balance, December 31, 2005 $ (45,778,059) $ 542,220
============== =============
The accompanying notes are an integral part of these consolidated financial
statements
F-7
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARY
(formerly Celerity Systems, Inc.)
Consolidated Statements of Cash Flows
Prior to
Becoming a
Business
Development
As a Business Development Company Company
--------------------------------------------------- ---------------
Period from
Year Ended Year Ended June 3, 2003 to Period from
December 31, December 31, December 31, January 1, 2003
2005 2004 2003 to June 2, 2003
--------------- --------------- --------------- ---------------
Cash flows from operating activities:
Net loss $ (1,307,345) $ (353,260) $ (941,132) $ (617,716)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Settlement of debt (268,304)) (89,016) (1,534,985) (176,095)
Unrealized loss on investment -- 290,887 842,121 --
Depreciation and amortization 14,085 17,664 -- 17,289
Beneficial conversion - convertible notes 242,988 380,027 709,720 196,080
Amortization of debt offering costs 40,529 125,374 372,808 95,063
Loss on abandonment of fixed assets -- -- -- 46,561
Shares of common stock issued as payment
for consulting fees, payroll and
directors' fees -- 2,250 67,143 8,479
Changes in operating other current assets and
liabilities:
Inventories -- -- -- (34,322)
Other current assets (141,992) 4,100 (6,764) --
Accounts payable (8,803) 70,209 (325,708) (50,734)
Judgements and defaults payable (285,675) (141,214) -- --
Accrued interest (165,328) 78,007 215,486 212,222
Other current liabilities 2,387 (5,555) (157,995) (8,163)
--------------- --------------- --------------- ---------------
Net cash provided by (used in)
operating activities (1,877,458) 379,473 (759,306) (311,336)
F-8
Cash flows from investing activities:
Purchase of fixed assets -- (17,738) (38,317) --
Advances to Celerity Systems-NV -- (290,887) (297,356) --
Acquisition of minority interest in Yorkville
Advisors' Management, LLC -- -- (5,240,000) --
Liquidation of minority interest in Yorkville
Advisors' Management, LLC 5,240,000 -- -- --
--------------- --------------- --------------- ---------------
Net cash provided by (used in)
investing activities 5,240,000 (308,625) (5,575,673) --
Cash flows from financing activities:
Proceeds from notes payable - related party -- 500,000 15,000 25,000
Payments on notes payable - related party (500,000) (105,000) (163,950) --
Proceeds from convertible debentures -- 537,500 1,380,000 299,000
Principal payments on debt - related party (2,198,099) (500,000) (7,591) --
Proceeds from issuance of common stock -- 193,500 5,166,500 --
Purchase of treasury stock (417,968) (751,141) -- --
Proceeds from preferred stock offering, net of
offering costs 845,723 -- -- --
Debt offering costs -- -- -- (16,500)
--------------- --------------- --------------- ---------------
Net cash provided by (used in)
financing activities (2,270,344) (125,141) 6,389,959 307,500
Net increase (decrease) in cash 1,092,198 (54,293) 54,980 (3,836)
Cash, beginning of period 1,863 56,156 1,176 5,012
--------------- --------------- --------------- ---------------
Cash, end of period $ 1,094,061 $ 1,863 $ 56,156 $ 1,176
=============== =============== =============== ===============
The accompanying notes are an integral part of these consolidated financial
statements
F-9
HOMELAND SECURITY CAPITAL CORPORATION
(Formerly CELERITY SYSTEMS, INC.)
Notes to Consolidated Financial Statements
1. Organization and Nature of Business
Homeland Security Capital Corporation (formerly Celerity Systems, Inc.) (the
"Company"), a Delaware corporation, is a consolidator in the fragmented homeland
security industry. The company is focused on long-term value by taking
controlling interest and developing its subsidiary companies through superior
operations and management. The Company intends to acquire businesses that
provide homeland security product and service solutions, growing organically and
by acquisitions. The targets are emerging companies that are generating revenues
from promising security products and services but face challenges in scaling
their businesses to capitalize on the opportunities in the homeland security
industry. Prior to changing its focus, the Company was a closed-end management
investment company that was initially formed to design, develop, integrate,
install, operate and support interactive video services hardware and software
("interactive video") systems. On June 3, 2003, the Company elected to become a
Business Development Company ("BDC") that is regulated under the Investment
Company Act of 1940, as amended ("Investment Company Act"). A BDC is an
investment company designed to assist eligible portfolio companies with capital
formation and which are required to offer, and many times do render, substantial
and continuing management advice. As contemplated by this transaction, the
Company materially changed its business plan to primarily seek investments in
developing companies that offer attractive investment opportunities. However, at
its stockholders' meeting on December 30, 2005, the Company approved the
withdrawal of the Company's election as a BDC and the Company changed its focus.
On May 20, 2003, the Company formed a subsidiary, Celerity Systems, Inc. (a
Nevada corporation), ("Celerity NV"). The assets and liabilities related to the
existing interactive video business were transferred to Celerity NV for 100% of
the common stock. As this subsidiary is not an investment company, after June 3,
2003 it is not consolidated with the parent company. During fourth quarter 2003,
Management assessed its investment in Celerity Nevada and based upon market
conditions recorded a write-down of its investment to nil. In September 2004,
Management decided to close the interactive video business, write the assets
down to nil and have an orderly liquidation of the business and the assets of
Celerity NV. The Company subsequently entered into an asset purchase agreement
with Escent System, Inc. Celerity NV thereupon exchanged all of its assets and
business interests as well as a cash payment of $15,000 for working capital to
Escent Systems, Inc. in return for 25% of the ownership of Escent Systems, Inc.
Escent is a start up company without a significant sales history. The future of
the interactive video business is dependent upon continued research and
development of both equipment and content and Escent may not be able to secure
financing to fund that research and development. Therefore, the Company has
considered the fair value of its investment in Escent to be nil. The Company
exercises no business or managerial controls over Escent's operations and the
Company guarantees no debt or advances to Escent.
Since its designation as a BDC the Company's principal investment has been a
minority ownership interest in Yorkville Advisors Management, LLC (Note 6).
In accordance with Article 6 of Regulation S-X under the Securities Act of 1933
and Securities Exchange Act of 1934, the Company does not consolidate portfolio
company investments in which the Company has a controlling interest. However,
for periods after December 31, 2005, the Company will consolidate controlled
companies.
2. Conversion to Business Development Company and Subsequent Withdrawal
The results of operations for 2003 are divided into two periods. The period from
January 1, 2003 through June 2, 2003 reflects the Company's results prior to
operating as a BDC. The period from June 3, 2003 through December 31, 2003
reflects the Company's results as a BDC. Accounting principles used in the
preparation of the financial statements beginning June 3, 2003 are different
than those of prior periods and, therefore, the financial position and results
of operations of these periods are not directly comparable. The primary
differences in accounting principles relate to the carrying value of
investments.
At its annual meeting on December 30, 2005, the stockholders passed a resolution
to withdraw the Company's election as a BDC under Section 54 of the Investment
Company Act. The termination of the Company's BDC status occurred on January 5,
2006. Financial statements for periods subsequent to December 31, 2005 will be
prepared on the basis used prior to becoming a BDC.
F-10
3. Summary of Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements include the
accounts of Homeland Security Capital Corporation (a Delaware corporation) and
its wholly-owned subsidiary. All significant inter-company transactions and
balances have been eliminated in consolidation.
Use of 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.
Fair Value of Financial Instruments - The carrying amount of items included in
working capital approximates fair value because of the short maturity of those
instruments. The carrying value of the Company's debt approximates fair value
because it bears interest at rates that are similar to current borrowing rates
for loans of comparable terms, maturity and credit risk that are available to
the Company.
Fixed Assets - Fixed assets are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the underlying
assets, generally five years. Leasehold improvements are amortized using the
straight-line method over the shorter of the estimated useful lives of the
assets or the term of the lease. Routine repair and maintenance costs are
expensed as incurred. Costs of major additions, replacements and improvements
are capitalized. Gains and losses from disposals are included in income. The
Company periodically evaluates the carrying value by considering the future cash
flows generated by the assets. Management believes that the carrying value
reflected in the consolidated financial statements is fairly stated based on
these criteria.
Debt Offering Costs - Debt offering costs are related to private placements and
are being amortized on a straight line basis over the term of the related debt,
most of which is in the form of convertible debentures. Should conversion occur
prior to the stated maturity date the remaining unamortized cost is expensed.
2005 2004
---------- ----------
January 1, $ 40,529 $ 165,903
New debt offering costs 0 0
Amortization (40,529) (125,374)
---------- ----------
December 31, $ 0 $ 40,529
========== ==========
Investment Valuation - Investments in equity securities are recorded at fair
value, represented as cost, plus or minus unrealized appreciation or
depreciation, respectively. The fair value of investments that have no ready
market, are determined in good faith by Management, and approved by the Board of
Directors, based upon assets and revenues of the underlying investee companies
as well as general market trends for businesses in the same industry. Because of
the inherent uncertainty of valuations, management's estimates of the values of
the investments may differ significantly from the values that would have been
used had a ready market for the investments existed and the differences could be
material.
Revenue Recognition - For the interactive video business, the Company recorded
revenues upon shipment of goods and after all risks and rewards of ownership of
the related products has passed to the buyer. The Company recorded sales for
services upon the completion of training and ratably over the life of any
maintenance or support agreement. The Company's general sales terms required a
deposit with the order and the balance upon delivery, except for educational
sales that are handled on a net 30 basis. During the fourth quarter of 2004,
Management closed this business.
Dividend income is recognized when declared and paid by our investee.
Income Taxes - The Company accounts for income taxes using the asset and
liability method, whereby deferred tax assets and liabilities are determined
based upon the differences between financial reporting and tax bases of assets
and liabilities and are measured using the enacted tax rates and laws that will
be in effect when the differences are expected to reverse. A valuation allowance
related to the deferred tax assets is also recorded when it is more likely than
not that some or all of the deferred tax asset will not be realized.
F-11
Stock Based Compensation - In December 2002, the FASB issued SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure - an
amendment of FASB Statement No. 123" which is effective for financial statements
issued for fiscal years ending after December 15, 2002. This Statement amends
FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of Statement 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based compensation and the effect of the method
used on reported results. The Company continues to follow the pro-forma
disclosures for stock based compensation as permitted in SFAS 123.
In December 2005, the Company issued to directors and an officer of the Company
options to purchase 796,000,000 shares of common stock of the Company, par value
$0.001 per share (the "Common Stock") in the future. The Company recorded no
compensation expense for the current period, as the exercise price of the
options was equal to the fair market value of the Common Stock at the grant
date.
The Company had no stock options granted in 2004 or 2003. Further, the Company
recorded no compensation expense related to options granted in 2002 and 2005 as
the exercise price of the options was equal to the fair market value of the
Company's Common Stock at grant dates. In 2004, the Company's directors further
voided all existing options and warrants.
Had compensation cost for the options granted been determined based on the fair
value at the grant dates for awards under the Plan issued in 2002 and 2005
consistent with the method of SFAS 123, the Company's net loss would have been
adjusted to the pro forma amounts indicated below:
2005 2004 2003
-------------- -------------- --------------
Net loss $ (1,307,345) $ (353,260) $ (1,558,848)
Less: stock-based compensation expense
determined under fair value method (219,200) -0- -0-
-------------- -------------- --------------
Net loss as adjusted $ (1,526,545) $ (353,260) $ (1,558,848)
============== ============== ==============
Net value per share
Basic and Diluted - as reported $ (0.00) $ (0.00) $ (0.00)
Basic and Diluted - pro forma $ (0.00) $ (0.00) $ (0.00)
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants in 2005; risk-free interest rate of 4.4%, volatility between 426% and
456% and expected lives of ten years.
Valuation of Options and Warrants - The valuation of options and warrants
granted to unrelated parties for services are measured as of the earlier (1) the
date at which a commitment for performance by the counterparty to earn the
equity instrument is reached or (2) the date the counterparty's performance is
complete. Pursuant to the requirements of EITF 96-18, the options and warrants
will continue to be revalued in situations where they are granted prior to the
completion of the performance.
Recent Accounting Pronouncements -In December 2003, the FASB issued
Interpretation No. 46 (revised) "Consolidation of Variable Interest Entities"
(FIN46R), an interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements". Variable interest entities, some of which
were formerly referred to as special purpose entities, are generally entities
for which their other equity investors (1) do not provide significant financial
resources for the entity to sustain its activities, (2) do not have voting
rights or (3) have voting rights that are disproportionately high compared with
their economic interests. Under FIN46R, variable interest entities must be
consolidated by the primary beneficiary. The primary beneficiary is generally
defined as having the majority of the risks and rewards of ownership arising
from the variable interest entity. FIN46R also requires certain disclosures if a
significant variable interest is held but not required to be consolidated. The
effective date of revised Interpretation No. 46 varies but is effective for the
Company commencing March 31, 2004. The standard has not had a material impact on
its consolidated financial condition or results of operations.
F-12
In December 2004, the FASB issued SFAS No. 123R "Shared Based Payment". This
statement is a revision of SFAS Statement No. 123, "Accounting for Stock-Based
Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and its related implementation guidance. SFAS 123R addresses all
forms of shared based payment ("SBP") awards, including shares issued under
employee stock purchase plans, stock options, restricted stock and stock
appreciation rights. Under SFAS 123R, SBP awards result in a cost that will be
measured at fair value on the awards' grant date, based on the estimated number
of awards that are expected to vest and will be reflected as compensation cost
in the historical financial statements. This statement is effective for public
entities as of the beginning of the first interim or annual reporting period
that begins after June 15, 2005.
Impairment of Long-Lived Assets - The Company accounts for impairment of
long-lived assets in accordance with Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets". SFAS No. 144 established a uniform accounting model for long-lived
assets to be disposed of. SFAS No. 144 also requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by comparing the carrying amount of an
asset to estimated undiscounted future net cash flows expected to be generated
by the asset. If the carrying amount of the asset exceeds its estimated future
cash flows, an impairment charge is recognized by the amount by which the
carrying amount of the asset exceeds the fair value of the asset. At December
31, 2005, the Company believes that there has been no impairment of its
long-lived assets.
Advertising - The Company follows the policy of charging the costs of
advertising to expense as incurred. Expenses incurred were $11,541, 0 and $4,640
for the years ended December 31, 2005, 2004 and 2003, respectively.
Reclassifications - Certain prior year balances have been reclassified to
conform with the current year presentation.
The Company's consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. The Company has had recurring
losses since inception of approximately $43,470,000, and continues to suffer
cash flow and working capital shortages. As of December 31, 2004, the Company
had negative net working capital of approximately $1,713,000. These factors
raised substantial doubt about the Company's ability to continue as a going
concern.
The ability of the Company to continue as a going concern is dependent upon its
ability to successfully accomplish its business plan and eventually attain
profitable operations. The accompanying consolidated financial statements do not
include any adjustments that might be necessary if the Company is unable to
continue as a going concern.
In 2005, these conditions that raised substantial doubt about the Company's
ability to continue as a going concern have been alleviated due to additional
capital raised by the Company.
4. Election as a Business Development Company
On June 3, 2003, the Company filed with the Securities and Exchange Commission
to become a BDC, a company which is regulated under Section 54 of the Investment
Company Act. As a BDC, the Company may sell shares of its freely trading Common
Stock in amounts up to $5,000,000 in a twelve-month period. Shares sold are
exempt from registration under Regulation E of the Securities Act of 1933. On
June 4, 2003 the Company filed an Offering Circular Under Regulation E to sell
up to $4,500,000 of its Common Stock at a minimum price of $0.001 to a maximum
price of $0.02. Between June 3, 2003 and December 31, 2004 the Company sold
1,289,833,333 shares of Common Stock resulting in net proceeds of $1,360,000.
On December 30, 2005, the stockholders authorized the withdrawal as a BDC and
the Company changed its focus to pursue investment opportunities in the homeland
security industry.
5. Fixed Assets, net
Cost and related accumulated depreciation of the fixed assets are as follows:
2005 2004
---------- ----------
Property and equipment $ 42,978 $ 56,055
Accumulated depreciation (18,672) (17,664)
---------- ----------
$ 24,306 $ 38,391
========== ==========
Depreciation expense in 2005, 2004 and 2003 was $14,085, $17,664 and $17,289,
respectively. In 2003, the Company recorded a loss on abandonment charge on the
disposal of certain fixed assets of $46,561 in connection with certain abandoned
projects.
6. Investment in Yorkville Advisors' Management, LLC
On December 1, 2003, the Company purchased a minority interest in Yorkville
Advisors Management, LLC ("Yorkville"). Yorkville is the investment manager of a
private equity fund that is a principal holder of equity securities of the
Company. The purchase price amounted to $5,240,000. The acquisition was funded
through the sale of 2,000,000,000 shares of Common Stock to the aforementioned
private equity fund, resulting in net proceeds of $4,000,000 and the balance
paid using the proceeds received from the issuance of convertible notes payable.
These shares were issued subsequent to December 31, 2003. During the year ended
December 31, 2004 and 2003, the Company received $1,255,000 and $65,000
respectively in dividend income from this investment, which has been recorded as
Dividend Income in the consolidated statements of operations. In 2005, the
Company was informed that Yorkville was in the process of an orderly liquidation
of its business. Under the terms of a Preferential Rights Agreement, the
Company's membership interest in Yorkville has been converted into a new class
with certain preferential rights and shall receive consideration equal to the
original purchase price less certain debt of approximately $1,500,000 due to an
affiliated company of Yorkville. The Company received this consideration in full
and in cash by May 3, 2005.
F-13
7. Investment in Celerity Systems, Inc. (A Nevada corporation)
The following table represents Celerity NV's statement of operations.
Celerity NV had no operations in 2005. The following table represents Celerity
NV's statements of operations for the years ended December 31, 2004 and 2003.
2004 2003
------------ ------------
Sales 65,900 $ 247,945
Cost of Sales 299,200 86,949
------------ ------------
(233,300) 160,996
Inventory write-downs and adjustments 1,076,369
------------ ------------
Gross loss (233,300) (915,373)
General and administrative expenses 212,647 193,660
------------ ------------
Operating loss (445,947) (1,109,033)
------------ ------------
Other income (expense) (75,432) -
Interest expense (5,682) -
Settlement of debt 319,340 174,950
------------ ------------
Total other income (expense) 243,907 169,268
------------ ------------
Net loss $ (202,039) $ (939,765)
============ ============
The following table represents Celerity NV's balance sheets as of December 31,
2005 and 2004.
2005 2004
-------------- --------------
Total current assets
-------------- --------------
Total assets $ -0- $ -0-
Other current liabilities
-------------- --------------
Total current liabilities $ -0- $ -0-
Stockholder Deficit
Common stock 250 250
Additional paid-in capital 1,141,554 1,141,554
Accumulated deficit (1,141,804) (1,141,804)
-------------- --------------
Total stockholder deficit -0- -0-
-------------- --------------
Total liabilities and deficit $ -0- $ -0-
============== ==============
Celerity NV developed and manufactured, at third party plants, digital set top
boxes and digital video servers for the interactive television and high speed
Internet markets. Celerity NV also provided a comprehensive content package for
education users with over 1,300 titles available. Due to a lack of funding
Celerity NV had been targeting the education market, to the exclusion of other
markets available to us. During the fourth quarter of 2003, an informal
arrangement concerning a pending sale was terminated and the Company determined
that a significant portion of the inventory was not salable. As a result, during
the fourth quarter of 2003, Celerity NV recorded a reserve adjustment of
$1,068,870. The write down results from a lower of cost or market valuation on
certain parts and finished goods.
The Company charged Celerity NV for salaries and benefits and a portion of costs
as a facility charge. Additionally, the Company advanced funds for any inventory
purchases or other costs necessary to complete a sale or to maintain the systems
previously sold. During 2004 and 2003, the Company advanced $290,887 and
$342,121 to Celerity NV. No additional amounts were advanced during 2005. The
Company advances plus the initial investment of $500,000 in net assets
transferred to Celerity NV resulted in an unrealized depreciation on the
investment in Celerity NV of $1,133,008 as reflected in the statement of
operations of the Company since its formation as a BDC. At December 31, 2004,
the Company forgave its receivable from Celerity NV and Celerity NV credited
$641,804 to additional paid in capital.
F-14
In 2003, the subsidiary Company had sales of $247,945 to Kidston Communications,
representing 100% of its total sales. Kidston Communications operates in the
education market and is controlled by Edward Kidston, a director of the Company
until October 30, 2002. Kidston Communications had an agreement that it could
purchase products from our Company at a five percent discount to list price.
Because of lack of sales of systems and consequent lack of operating profits,
the Company's directors decided to cease operations and dispose of the remaining
business and related assets. Accordingly, the Company entered into a sales
agreement with Escent Systems, Inc. whereby the Company transferred all the
assets and business plus $15,000 for working capital in return for a 25% equity
position in Escent Systems, Inc. Since the net assets of Celerity NV had been
written to nil, there was no further loss recorded on the transaction. . Because
of the lack of operations and uncertainty of continued operations, Celerity NV
has not assigned any value to the investment.
8. Investment in Sagamore Holdings, Inc.
In September 2004, the Company entered into a business development agreement
with Sagamore Holdings, Inc. ("Sagamore") with an effective date of October 4,
2004. The Company received 7,500,000 shares of Sagamore Common Stock as
consideration for its agreement to provide future services regarding capital
formation and management advice. The Company has reviewed the valuation of the
Sagamore stock using fair value, and, based on the liquidation preference of the
preferred stockholder, management has considered the value of the stock as nil.
Also, the Company rendered no specific services in 2005 or 2004. Accordingly,
the Company has included the value of the Sagamore stock in its financial
statements as nil and not recognized any revenue from the transaction
9. Judgments and defaults payable
At December 31, 2004, amounts shown in this account reflect $151,275 in
judgements recorded against the Company and $249,400 of liquidated damages
accrued as a result of not filing an effective registration statement for
certain convertible debentures.
At December 31, 2005 amounts shown in this account reflect $8,000 in judgments
recorded against the Company and $36,000 of liquidated damages accrued as a
result of not filing an effective registration statement for certain convertible
debentures.
10. Income Taxes
The tax effects of temporary differences giving rise to the Company's deferred
tax assets (liabilities) at December 31 are as follows:
2005 2004
---------------- ----------------
Current -- --
Valuation allowance for net current deferred tax assets -- --
---------------- ----------------
Total net current deferred tax asset $ -- $ --
Noncurrent:
Net operating loss and research credit carryforwards $ 14,852,000 $ 13,508,000
Property and equipment -- --
---------------- ----------------
14,852,000 13,508,000
Valuation allowance for net noncurrent deferred tax assets (14,852,000) (13,508,000)
---------------- ----------------
Total net noncurrent deferred tax asset $ -- $ --
================ ================
As a result of significant historical pretax losses, management cannot conclude
that it is more likely than not that the deferred tax asset will not be
realized. Accordingly, a full valuation allowance has been established against
the total net deferred tax asset.
The Company's income tax benefit differs from that obtained by using the federal
statutory rate of 34% as a result of the following:
F-15
2005 2004 2003
------------ ------------ ------------
Computed "expected" tax (benefit) $ (444,000) $ (120,000) $ (530,000)
State income tax (benefit), net of
federal income tax benefit (52,000) (14,000) (62,000)
Beneficial conversion feature expense 92,000 129,000 359,000
Amortization Debt Offering 15,400 - -
Loss of benefit of deferred tax asset 388,600 5,000 233,000
------------ ------------ ------------
$ -- $ -- $ --
============ ============ ============
At December 31, 2005, the Company had an available net operating loss
carryforward of approximately $39,000,000. The increases in 2005 are due
primarily to the timing differences of certain inventory and accounts receivable
valuations which were recognized in the financial statements in 2003 and which
are being allowed as realized tax deductions in 2004. These deductions create
net operating loss carryforwards which in certain circumstances could become
limited due to a change in control of the subsidiary. These amounts are
available to reduce the Company's future taxable income and expire in the years
2011 through 2025.
11. Notes Payable, Long Term Debt and Equity Line of Credit
Notes Payable - Related Party
In April 2000, the Company received $195,000 from an individual who later became
a member of the Company's Board of Directors. The note was due in April 2002 and
bears interest at 9%. In April 2002, the Company defaulted on payments due of
$125,000 plus accrued interest, aggregating to approximately $135,000. The
Company agreed to a final settlement in 2003 which resulted in income from
settlement of debt of $1,012.
In November 2004, the Company received $500,000 from a principal holder of the
Company's equity securities. The note bears interest at 12% and is due interest
only on a monthly basis through November 2005 when the instrument matures and
the entire balance is due. The note was paid in full on February 18, 2005 from
proceeds from the liquidation of the Yorkville investment.
At December 31, 2004, the Company had an outstanding non interest bearing demand
note payable to a former member of the Company's Board of Directors in the
amount of $10,000. Settlement of the note was made in 2005 by a credit to
additional paid in capital.
Long Term Debt
In October and November 1998, the Company placed $450,000 of 7% notes with a
term of three years. Of the total notes placed, $300,000 were converted into
Common Stock upon the closing of a private offering in the first half of 2000.
On October 27, 2001, the Company defaulted on payments due of $150,000, plus
accrued interest. At December 31, 2003, the note had an outstanding balance of
$132,409. Written demand was received from each of the two note holders and the
notes were paid at their full carrying values in 2004.
In 2002, the Company issued $800,000 aggregate principal amount of 4%
convertible debentures resulting in net proceeds of approximately $726,000. The
debentures have a term of five years and are convertible into Common Stock, at
the option of the holder, at a price equal to 75% of the average closing bid
price of the Common Stock for the five trading days immediately preceding
conversion. At December 31, 2002, $400,000 of the debentures had converted to
shares of Common Stock and $400,000 was exchanged as part of the 10% convertible
debenture disclosed below.
F-16
In September 2002, the Company issued a 10% convertible debenture of $1,500,000
to a related party in exchange for 4% debentures due of $998,478, related
accrued interest of $161,522 and additional proceeds, net of approximately
$34,000 of offering costs, of approximately $306,000. This debenture was secured
by all of the Company's assets. This debenture had a term of five years and was
convertible into the Company's Common Stock, at the option of the holder, at a
price equal to 87.5% of the lowest closing bid price of the Common Stock for the
five trading days immediately preceding conversion, or $0.06 per share. The
Company recognized a beneficial conversion feature for the convertible
debentures as a discount on the convertible debentures and as additional paid-in
capital. This discount of $540,550 was to be amortized as a non-cash interest
expense over the five year period from the date of issuance to the stated
redemption date of the debentures. Upon conversion prior to the stated date of
redemption the remaining unamortized discount was be recognized as a non-cash
interest expense. During 2002, the related party sold $500,000 of this
debenture, of which none remains outstanding at December 31, 2005. During 2003,
the related party sold $145,000 of this debenture, of which none remains
outstanding at December 31, 2005. During 2004, $465,000 was paid to two
unrelated debenture holders at carrying value. At December 31, 2004, $285,000 of
the debentures had converted to 228,023,673 shares of Common Stock and $510,000
had been repaid. In February 2005, the remaining $705,000 outstanding amount,
due to a related party, was paid in full.
During 2003, the Company issued $429,000 aggregate principal amount of 5%
convertible debentures, resulting in proceeds, net of $16,500 of debt issue
costs, of $413,500. The debentures have a term of three years and are
convertible into Common Stock, at the option of the holder, at a price equal to
$0.001. The Company recognized a beneficial conversion feature for the
convertible debentures as a discount on the convertible debentures and as
additional paid-in capital. This discount of $328,200 would be amortized as a
non-cash interest expense over the three year period from the date of issuance
to the stated redemption date of the debentures. Upon conversion prior to the
stated date of redemption the remaining unamortized discount would be expensed.
During 2004, $369,000 of the debentures had converted to shares of Common Stock
and $10,000 had been repaid. The $50,000 which remained outstanding, all due to
a related party, was paid in full in 2005.
In 2003, the Company issued $1,250,000 aggregate principal amount of 5%
convertible debentures. These debentures have a term of three years and are
convertible into the Company's Common Stock, at the option of the holder, at a
price equal to 80% of the lowest closing bid price of the Common Stock for the
five trading days immediately preceding conversion. The Company recognized a
beneficial conversion feature for the convertible debentures as a discount on
the convertible on the convertible debentures and as additional paid-in capital.
This discount of $161,290 was being amortized as a non-cash interest expense
over the three year period from the date of issuance to the stated redemption
date of the debentures. Upon conversion prior to the stated date of redemption
the remaining unamortized discount would be recognized as a non-cash interest
expense. In May 2005, the debentures were paid off in full from proceeds from
the Yorkville liquidation.
The Company issued $537,500 aggregate principal amount of 5% convertible
debentures in 2004. The debentures have a term of two years and are convertible
into the Company's Common Stock, at the option of the holder, at a price equal
to $0.001. Since there was substantially no difference in the market value of
the stock at the date of the debenture compared to the exercise price, there was
no beneficial conversion feature for the convertible debentures. In 2004,
$25,000 of the debentures was repaid. In 2005, $10,000 of the debentures was
converted into 7,149,333 shares of Common Stock and $280,000 was repaid leaving
$222,500 remaining outstanding at December 31, 2005.
Equity Line of Credit Agreement
The Company issued $5,686,000 aggregate principal amount of 4% convertible
debentures in 2001 and $1,005,000 in 2000 under a line of credit dated December
31, 1999. The debentures have a term of five years and are convertible into the
Company's Common Stock at the option of the holder, at a price equal to 75% of
the average closing bid price of the Common Stock for the five trading days
immediately preceding conversion. As of December 31, 2004, $5,188,500 of the
debentures had converted to shares of Common Stock, $700,000 had been converted
into a 10% secured convertible debenture and $790,000 had been redeemed. At
December 31, 2004 there were $12,500 outstanding 4% convertible debentures and
none outstanding at December 31, 2005.
There is no effective registration statement as to the issuance of common shares
in connection with certain debentures, approximately $1,200,000, issued in 2001
under the 1999 Line of Credit Agreement. The Company is required to pay
liquidated damages in the form of increased interest, at the rate of 2% per
month to a maximum of 24%, on the convertible debentures as a result of our
failure to timely file such registration statement and have it declared
effective by the Securities and Exchange Commission. At December 31, 2005, we
have accrued $36,000, which represents all of the liquidating damages due, as
additional interest expense for this item. This amount has been included in
judgments and defaults payable as a demand payable in the accompanying
consolidated balance sheet.
Beneficial Conversion Features of Debt
The Company recognized a beneficial conversion feature for the various
convertible debentures issued in 2003 and 2002 as discounts on the convertible
debentures and additional paid-in capital. This discount of $489,490 and
$452,252 for 2003 and 2002 respectively, was to be amortized as a non-cash
interest expense over the three or five-year period between the date of issuance
of the convertible debentures to the stated redemption date of the debentures.
Upon conversion prior to the stated date of redemption the remaining unamortized
discount was immediately expensed. Non-cash interest expense amounted to
$242,988 and $380,027 for the years ended December 31, 2005 and 2004,
respectively.
At December 31, 2005, the Company has $222,500 in debentures outstanding, all of
which is due in 2006 and none of which has unamortized debt discount associated
with it.
F-17
12. Preferred Stock
Convertible Preferred Stock
Series B
In the first quarter of 2001, the Company consummated a private placement of 23
shares of Series B Convertible Preferred Stock resulting in gross proceeds of
$230,000. The preferred stock provided for preferential dividends at an annual
rate of 8%. The preferred stock is convertible into shares of Common Stock at a
conversion price equal to $0.50 per share, subject to availability, at any time
during the two years following execution of the subscription agreements.
Warrants to purchase one share of Common Stock for each two shares of Common
Stock issued upon conversion of this tranche of Series B Preferred Stock were
included. These warrants are exercisable for a two year period following the
date that the last share of the Series B Redeemable Convertible Preferred Stock
is converted into Common Stock and have an exercise price of $2.00 per share.
The Company allocated $132,000 of the proceeds to the warrants based on their
relative fair value.
The Company also consummated an additional private placement of 72 shares of
Series B Convertible Preferred Stock resulting in gross proceeds of $720,000,
and issued an additional 5 shares having a value of $50,000 as payment for
certain accounts payable and accrued wages. Prior to the Company converting to a
BDC in 2003, the Company converted the Series B preferred stock into 645,000
shares of Common Stock.
Series D
In the first half of 2002, the Company consummated a private placement of 5.4
shares of Series D Convertible Preferred Stock resulting in gross proceeds of
$54,000. The Series D Stock provides for preferential dividends at an annual
rate of 8%. The preferred stock is convertible into shares of Common Stock at a
conversion price equal to $0.20 per share, subject to availability, at any time
during the two years following execution of the subscription agreements. Should
there be an insufficient number of shares of Common Stock available at the time
the preferred stock is offered for conversion, the conversion period shall be
extended by the number of days between the conversion date and the date common
shares become available. Two years from the original issuance date, the Company
shall offer to redeem such preferred shares then outstanding at a price equal to
the original issuance price plus accrued dividends if permitted by applicable
law.
On the date of issuance of the Series D Convertible Preferred Stock, the
effective conversion price was at a discount to the price of the Common Stock
into which it was convertible. The Company recorded a $54,000 dividend relative
to the beneficial conversion feature. In 2002, the Company converted the Series
D preferred stock into Common Stock.
Series E
In the first quarter of 2002, the Company consummated a private placement of 10
shares of Series E Convertible Preferred Stock resulting in gross proceeds of
$100,000. The Series E Convertible Preferred Stock provides for preferential
dividends at an annual rate of 8%. The preferred stock was convertible into
shares of Common Stock at a conversion price equal to $0.02 per share, subject
to availability, at any time during the two years following execution of the
subscription agreements. On the date of issuance of the Series E Convertible
Preferred Stock, the effective conversion price was at a discount to the price
of the Common Stock into which it was convertible. The Company recorded a
$100,000 dividend relative to the beneficial conversion feature. In 2003, the
Company converted the Series E preferred stock into 2,000,000 shares of Common
Stock.
Series F
On October 6, 2005, the Company issued 1,000,000 shares of Series F
Preferred Stock to Cornell Capital Partners, LP, ("Cornell Capital), a related
party, pursuant to a securities purchase agreement. Net proceeds from the
issuance amounted to $1,000,000 less costs of $154,277, or $845,723. The Series
F Preferred Stock provides for preferential dividends at an annual rate of 12%.
Also, the Series F Preferred Stock has a preferential liquidation amount of
$0.10 per share or $100,000. The preferred stock is convertible into shares of
Common Stock at a conversion price equal to $0.001 per share, subject to
availability, at any time after the termination of the Company's status as a
BDC. The stockholders voted to terminate the Company's election as a BDC in its
special meeting on December 30, 2005. Although not convertible until the
termination of the Company's status as a BDC, on the date of issuance of the
Series F Preferred Stock, the effective conversion price was at a discount to
the price of the Common Stock into which it was convertible. The Company
recorded a $1,000,000 dividend relative to the beneficial conversion feature. As
of December 31, 2005, none of the Series F Preferred Stock has been converted
into shares of Common Stock.
F-18
13. Stock Options
The Company established a stock option plan in 1995 to provide additional
incentives to its officers and employees. Eligible persons are all employees
employed on the date of grant. Management may vary the terms, provisions and
exercise price of individual options granted, with both incentive stock options
and non-qualified options authorized for grant. In 1995, the Board of Directors
approved the issuance of up to 8,946 options to acquire common shares of which
2,100 were outstanding at December 31, 2002. There were no outstanding options
at December 31, 2005 and 2004, respectively.
In 1997, the Company established an additional stock option plan under which
10,000 options to acquire common shares were reserved for issuance. There were
options to purchase 0, 250 and 3,627 shares outstanding under the 1997 plan at
December 31, 2004, 2003 and 2002, respectively. In 2001, the Company established
an additional stock option plan under which 500,000 options to acquire common
shares were reserved for issuance. There were options to purchase 0, 0 and
25,200 shares outstanding under the 2001 plan at December 31, 2005, 2004 and
2003, respectively.
In 2002, the Company established an additional stock option plan under which
10,000,000 options to acquire common shares were reserved for issuance. There
were options to purchase 0, 0 and 760,000 shares outstanding under the 2002 plan
at December 31, 2005, 2004 and 2003, respectively.
In 2005, the Company established an additional stock option plan under which
720,000,000 options to acquire common shares were reserved for issuance. There
are 580,000,000 options issued to C. Thomas McMillen, its President and CEO that
were outstanding at December 31, 2005. These options vested 116,000,000 at the
grant date (August 29, 2005) and 116,000,000 will vest each calendar quarter for
the next year.
Outside of the stock option plan, each of the directors was granted options to
purchase 72,000 shares of common stock. Of these options 8,000,000 at the grant
date (December 30, 2005) and 8,000,000 each quarter for eleven quarters
thereafter for a total of 72,000,000 options for each of these directors. These
options expire 10 years from the grant date.
2005 2004 2003
-------------------------- --------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------------ ------------ ------------ ------------ ------------ ------------
Outstanding at beginning of
Year -- $ -- 785,450 $ 0.04 7,105,727 $ 0.03
Granted 796,000,000 0.00096 -- -- -- --
Exercised -- -- -- -- -- --
Forfeited -- -- (785,450) 0.04 (6,320,277) 0.07
------------ ------------ ------------ ------------ ------------ ------------
Outstanding at end of year 796,000,000 $ 0.00096 -- $ -- 785,450 $ 0.04
============ ============ ============ ============ ============ ============
Options exercisable at year End 256,000,000 $ 0.00096 -- $ -- 397,818 $ 0.01
============ ============ ============ ============ ============ ============
14. Common Stock Warrants
2000 Warrants
In August 2000, the Company placed $410,000 of Series A convertible preferred
stock. In connection with this placement, the agent received warrants to
purchase 18,000 shares of Common Stock at $14.00 per share. The $202,800 fair
value of these warrants was recorded as a part of the offering. The fair value
of the warrants was determined using the Black-Scholes option pricing model with
the following assumptions: risk-free interest rate of 7.00%, expected dividends
of zero, volatility of 175.95% and expected lives of up to five years. These
warrants expired in August 2005.
2001 Warrants
F-19
In the first quarter of 2001, the Company consummated a private placement of 23
shares of Series B Redeemable Convertible Preferred Stock resulting in gross
proceeds of $230,000. The preferred stock was convertible into shares of Common
Stock at a conversion price equal to $0.50 per share, subject to availability,
at any time during the two years following execution of the subscription
agreements. Warrants to purchase one share of Common Stock for each two shares
of Common Stock issued upon conversion of this tranche of Series B Preferred
Stock were included. These warrants to purchase 230,000 shares of Common Stock
have an exercise price of $2.00 per share and are exercisable for a two year
period following the date that the last share of the Series B Redeemable
Convertible Preferred Stock is converted into Common Stock. The Company
allocated $132,000 of the proceeds to the warrants based on their relative fair
value. The value of the warrants was determined using the Black-Scholes option
pricing model with the following assumptions: risk-free interest rate of 6.77%,
expected dividends of zero, volatility of 219.79% and expected lives of up to
three years. As the last share of the Preferred Stock converted in March, 2003,
these warrants expired in March 2005.
On June 14, 2001, the Company entered into an Equity Line of Credit, which has
expired. In connection with the Equity Line of Credit, a consultant, who is also
a related party, received warrants to purchase 175,000 shares of Common Stock at
an exercise price of $2.00. The fair value of these warrants was recorded as an
equity placement fee. These warrants expire in June 2006.
In accordance with EITF 00-19, the Company recorded an equity warranty liability
of $1,363,975 in connection with these warrants. As the number of shares which
may be issued upon conversion of the convertible debentures is indeterminate, a
sufficient number of authorized but unissued shares may not be available. As a
result, the Company recorded a mark-to-market adjustment of $134,374 in 2002
which has been reflected as income on equity warrant liability.
In August 2001, the Company placed $1,586,000 of 4% convertible debentures. In
connection with this placement, the agent, who is also a related party, received
warrants to purchase 125,000 shares of Common Stock at $2.00 per share. The
warrants issued were for consulting fees in conjunction with the issuance of the
debentures and are accounted for as a cost of financing to be amortized over the
5 year life of the debentures. The value of the warrants, $344,951, was
determined using the Black-Scholes option pricing model with the following
assumptions: risk-free interest rate of 7.00%, expected dividends of zero,
volatility of 207.44% and expected lives of up to five years.
2002 Warrants
During 2002, the Company received $60,000 in proceeds from the issuance of
Common Stock for cash. In connection with these issuances, the individuals
received warrants to purchase up to 650,000 shares of Common Stock at between
$0.08 and $0.10 per share. The warrants expired in August 2004.
At December 31, 2004, there were 548,000 warrants outstanding with an exercise
price ranging from $2.00 to $14.00 with a weighted average price of $2.39. These
warrants expire at various dates from March 2005 through August 2006.
15. Stock Buyback Program
In September 2004, the Company was authorized to establish a stock buyback
program whereby the Company would acquire up to 500,000,000 shares of its Common
Stock over a twelve month period from the open market at favorable prices. There
was no obligation to acquire any specific number of shares or purchase at any
specific price. At December 31, 2004, the Company had acquired 226,843,599
shares at a cost of $561,334 and had accounted for the purchase as treasury
stock. The funding was provided primarily through a short term note of $500,000
from a related party. During 2005, the Company acquired 178,680,000 additional
shares at a cost of $417,966 funded from proceeds from the liquidation of its
Yorkville investment. The Company has retired all shares acquired under the
program in 2005.
16. Settlement of Trade Payable and Convertible Debentures
During 2005, the Company settled certain trade payables, convertible debentures,
and accrued interest of $3,055,000. Such settlement resulted in a gain on
forgiveness of approximately $33,300. In 2005, there was also a related-party
gain of $81,901, which was credited to APIC.
During 2004, the Company settled certain trade payables, convertible debentures
and accrued interest of $611,000. Such settlements resulted in a gain on
forgiveness of approximately $89,000.
17. Loss Per Share
Basic and diluted loss per share was computed by dividing net loss applicable to
Common Stock by the weighted average common shares outstanding during each
period. Potential common equivalent shares of 362,500,000, 2,470,119,429 and
1,623,420,188 at December 31, 2005 and 2004 and 2003, respectively, are not
included in the computation of per share amounts in the periods as the effect
would be antidilutive.
18. Cash Flows
Supplemental disclosure of cash flow information for the years ended December
31, 2005 and 2004 and 2003, are as follows:
F-20
2005 2004 2003
-------- -------- --------
Cash paid during the year for:
Interest $516,165 $120,343 $ 17,409
Taxes $ 0 $ 0 $ 0
Non Cash Investing and Financing activities include:
2005
The Company converted $10,724, including accrued interest, of the convertible
debentures into 7,149,333 shares of Common Stock.
On October 6, 2005, the Company entered into a Securities Purchase Agreement
with Cornell Capital, pursuant to which the Company issued to Cornell a total of
$1,000,000 of Series F Convertible Preferred stock, par value $0.01 per share
(the "Series F Preferred Stock"). Upon the termination of the Company's status
as a BDC under the Investment Company Act, the Series F Preferred Stock would
become convertible at the option of Cornell Capital into such number of fully
paid and non-assessable shares of our Common Stock, as is determined by dividing
(a) the sum of (i) $1,000,000 (the original purchase price for the Series F
Preferred Stock), plus (ii) all accrued but unpaid dividends thereon by (b) the
conversion price then in effect. As set forth in the Certificate of Designation
of the Series F Preferred Stock, the conversion price is $0.001, as adjusted
from time to time as provided in the Certificate of Designation. As of December
31, 2005, none of the Series F Preferred Stock has been converted into shares of
Common Stock.
2004
The Company issued 1,500,000 shares of Common Stock with a value of $2,250 as
payment for directors' fees.
The Company converted $247,125, including accrued interest, of the convertible
debentures into 241,727,920 shares of Common Stock.
2003
The Company issued 66,385,617 shares of Common Stock with a value of $70,623 as
payment for certain consulting and directors' fees, payroll and accounts payable
items.
The Company converted $2,703,932, including accrued interest, of the convertible
debentures into 1,088,283,880 shares of Common Stock.
The Company converted $322,500 of Series B Preferred Stock and $40,000 of Series
E Preferred Stock into 2,645,000 shares of Common Stock.
19. Commitments and Contingencies
In 2004, the Company has entered into several agreements to provide management
and other services to unrelated companies in 2005 and thereafter. One such
company, Sagamore Holdings, Inc., has issued 7,500,000 shares of stock to the
Company for those services. Because of senior securities issued by Sagamore, the
Common Stock received by the Company has been valued at nil and as of December
31, 2005, the Company had provided no services to Sagamore Holdings, Inc.
F-21
In December 2004 several prior employees brought an action against the Company
for back wages and benefits in a prior period. The Company had accrued $72,275
for potential damage awards at December 31, 2004. In January 2005, the Company
settled the claims and paid the awards in cash.
In addition, certain creditors, with debt aggregating approximately $160,000,
have threatened litigation if not paid. The Company is seeking to make
arrangements with these creditors. There can be no assurance that any claims, if
made, will not have an adverse effect on the Company.
As of December 31, 2004, the Company leased office space in Knoxville, Tennessee
under a lease agreement that expired in December 2007. Effective September 12,
2005, the Company moved its offices to Arlington, Virginia. The Company is in
the process of negotiating a cancellation agreement for the Knoxville location
that will reduce future rents. However, at December 31, 2005, the future minimum
lease payments by year, and in the aggregate, under this operating lease are as
follows:
2006 $ 9,600
2007 9,200
-------
$18,800
=======
Rent expense for operating leases was $14,400, $91,009 and $65,175 for 2005,
2004 and 2003, respectively.
In December 2001, EJA Electronics, Inc. (D/B/A Stack Electronics) sued the
Company for breach of contract and is seeking damages in excess of $106,000.
This action relates to amounts alleged to be owned from the cancellation of a
purchase order. During 2003, a judgement was rendered against the Company in the
amount of $71,000 which has been accrued as part of the judgements and defaults
payable at December 31, 2005.
20. Related Party Transactions
Revenue/Sales Concentrations
On March 5, 2001, the Company's subsidiary entered into a National Distributor
Agreement for the education market with Kidston Communications, a company
controlled by Edward Kidston, a director of the Company until October 30, 2002.
Pursuant to the terms of this Agreement, Kidston Communications is the exclusive
national distributor in the education market in the United States. The term of
the Agreement is through December 31, 2003 and will automatically renew for
additional three year periods unless one party notifies the other of its intent
not to renew at least 30 days prior to the end of the then current term. The
Agreement provides that Kidston Communications may purchase products from our
subsidiary, Celerity NV, at a five percent discount to list price, provided that
the price is not higher than the price paid by other customers for like
quantities of similar products and with similar terms and conditions. The
Company had sales of $626,597 to Kidston Communications in 2002, which
represented 96% of total sales. In Fourth Quarter 2004, the subsidiary decided
to close the interactive video business and have an orderly liquidation of its
business and assets.
21. Selected Quarterly Data-Unaudited
The following table sets forth certain quarterly information for each
of the eight quarters ended with the quarter ended December 31, 2005. This
information was derived from our unaudited consolidated financial statements.
Results for any quarter are not necessarily indicative of results for the full
year or any future quarter.
2005
---------------------------------------------------------
Quarter 1 Quarter 2 Quarter 3 Quarter 4
------------ ------------ ------------ ------------
Realized gain on investment $ -- $ 39,944 $ 2,016 $ 6,947
Dividend income -- -- -- --
Net sales -- -- -- --
Gross income (loss) -- 39,944 2,016 6,947
Net loss (300,781) (371,786) (211,155) (423,623)
Loss per common share-basic
and diluted $ -- $ -- $ -- $ --
2004
---------------------------------------------------------
Quarter 1 Quarter 2 Quarter 3 Quarter 4
------------ ------------ ------------ ------------
Unrealized loss on investment $ (103,383) $ (121,578) $ (8,141) $ (58,745)
Dividend income 345,000 350,000 260,000 300,000
Net sales -- -- -- --
Gross income (loss) 241,617 228,422 251,859 241,255
Net loss (214,714) 28,682 (68,632) (98,596)
Loss per common share-basic
and diluted $ -- $ -- $ -- $ --
F-22
22. Subsequent Events
Series G Preferred Stock
On February 6, 2006, the Company entered into an Investment Agreement with
Cornell Capital, pursuant to which the Company exchanged with Cornell Capital
1,000,000 shares of Series G Convertible Preferred Stock (the "Series G
Preferred Shares") for 450,000,000 shares of the Company's Common Stock owned by
Cornell Capital. Each share of Series G Preferred Shares may be converted, at
Cornell Capital's discretion, into 450 shares of the Common Stock. The Series G
Preferred Shares are senior to all Common Stock and all series of preferred
stock of the Company. Each share of Series G Preferred Share has a liquidation
preference of $0.10 plus any accrued and unpaid dividends. The holders of Series
G Preferred Shares are not entitled to receive any dividends. The Company paid a
$10,000 structuring fee to Yorkville Advisors Management, LLC in connection with
the transaction.
In connection with the Investment Agreement, the Company entered into an
Investor Registration Rights Agreement with the Cornell Capital pursuant to
which the company agreed to file a registration statement covering the resale of
shares of Common Stock issuable upon the conversion of the Series G Preferred
Shares. The Company also filed a Certificate of Designation with the State of
Delaware amending its certificate of incorporation to include the rights and
terms of the Series G Preferred Shares.
Sale of Convertible Debentures
On February 6, 2006, the Company entered into a Securities Purchase Agreement
with Cornell Capital, which provided for the purchase by Cornell Capital of a
Convertible Debenture (the "Debenture") in the amount of $4,000,000, which
debenture is convertible into Common Stock. The conversion price of the
Debenture shall be equal to the lesser of (1) $0.01 or (2) a ten percent
discount to the lowest daily volume weighted average price of the Common Stock
for the thirty days preceding conversion. Cornell Capital is entitled to convert
the Debenture at a conversion price into Common Stock, provided that Cornell
Capital cannot convert into shares of Common Stock that would cause Cornell
Capital to own more than 4.9% of the issued and outstanding Common Stock. The
Debenture has an interest at 5% per annum and the principal amount will be
payable on the third anniversary of the effective date of the Debenture. If the
Common Stock is trading below the conversion price, the Company may redeem the
Debenture at any time upon the payment of a redemption premium equal to twenty
percent of the amounts redeemed.
Pursuant to a Security Agreement between the Company and Cornell Capital, the
Company's obligations under the Debenture are secured by a pledge of all of its
assets. Pursuant to the Securities Purchase Agreement, the Company paid a
commitment fee of $400,000 and $20,000 in structuring fees and diligence fees,
all to Yorkville Advisors Management, LLC. Accordingly, the Company is entitled
to receive net proceeds of approximately $3,580,000 upon issuance of the
Debenture. The Company has also issued to Cornell Capital 50,000,000 shares of
the Common Stock pursuant to this transaction.
In connection with the Securities Purchase Agreement, the Company entered into
an Investor Registration Rights Agreement with Cornell Capital pursuant to which
Cornell Capital agreed to file a registration statement covering the resale of
shares of Common Stock issuable upon the conversion of the Debenture.
Acquisition of Nexus Technologies Group
On February 8, 2006, Nexus, a subsidiary of the Company, completed its
acquisition of Corporate Security Solutions, Inc., a Pennsylvania corporation
("CSS") pursuant to the terms of an Agreement and Plan of Merger (the "Merger
Agreement"), dated February 8, 2006, by and among Nexus, Corporate Security
Solutions, Inc., CSS Acquisition, Inc. and certain other persons named therein.
Pursuant to the Merger Agreement, CSS Acquisition, Inc., a wholly owned
subsidiary of Nexus, merged with and into CSS (the "Merger") with CSS surviving
the Merger. The stockholders of CSS received an aggregate of 3,675,000 shares of
Nexus common stock in exchange for all of the issued and outstanding CSS common
stock. Of these shares, 3,000,000 are deemed restricted stock and are subject to
vesting and performance provisions.
F-23
Upon the effectiveness of the Merger, the Company gained control of 82.1% of the
voting power of Nexus.
Acquistion of Nexus Preferred Shares
On February 8, 2006, the Company entered into a Series A Convertible Preferred
Stock Purchase Agreement (the "Purchase Agreement") with Nexus Technologies
Group, Inc. ("Nexus"). Pursuant to the Purchase Agreement, the Company purchased
3,400,000 shares of Nexus Series A Convertible Preferred Stock (the "Nexus
Preferred Shares") for an aggregate purchase price of $3,400,000. The Company
also committed to purchase an additional 6,400,000 Nexus Preferred Shares, in
one or more transactions, at a purchase price of $1.00 per share at any time
prior to February 8, 2008.
Each Nexus Preferred Share accrues dividends cumulatively at the rate of eight
percent (8%) per annum and is convertible into one (1) share of the Nexus common
stock at any time by the Company, subject to adjustment for stock dividends,
stock splits, and similar events. Each Nexus Preferred Share is entitled to one
vote as if converted into Nexus common stock. The holders of the outstanding
Nexus Preferred Shares, as a class, have the right to elect a majority of the
board of directors of Nexus. Each Nexus Preferred Share has a liquidation
preference of $1.00 per share plus any accrued and unpaid dividends.
Recent Option Issuances
In January 2006, the Company issued 60,000,000 options to purchase common stock
to James Maurer, its Vice President of Finance. The options vest quarterly pro
rata over three years and have an exercise price of $0.0017.
In January 2006, the Company issued 10,000,000 options to purchase common stock
to Mara Volcov, its Executive Assistant. The options vest quarterly pro rata
over three years and have an exercise price of $0.0017.
F-24
CELERITY SYSTEMS, INC.
2005 STOCK OPTION PLAN
1. Purpose of the Plan
The purpose of this Stock Option Plan (this "Plan") is to advance the interests
of Celerity Systems, Inc. (the "Company") by providing to directors of the
Company and to key employees of the Company who have substantial responsibility
for the direction and management of the Company additional incentives to exert
their best efforts on behalf of the Company, to increase their proprietary
interest in the success of the Company, to reward outstanding performance and to
provide a means to attract and retain persons of outstanding ability to the
service of the Company. Options granted under this Plan may qualify as incentive
stock options ("ISOs"), as defined in Section 422 of the Internal Revenue Code
of 1986, as amended (the "Code").
2. Administration
This Plan shall be administered by a committee (the "Committee") comprised of at
least two members of the Company's Board of Directors who each shall be (a) a
"non-employee director," as defined in Rule 16b-3 promulgated under the
Securities Exchange Act of 1934, as amended, unless administration of the Plan
by "non-employee directors" is not then required for exemptions under Rule 16b-3
to apply to transactions under the Plan, (b) not an "interested person," as
defined in Section 2(a)(19) of the Investment Company Act of 1940, as amended
(the "Act"), and (c) an "outside director" as defined under Section 162(m) of
the Code, unless the action taken pursuant to the Plan is not required to be
taken by "outside directors" to qualify for tax deductibility under Section
162(m) of the Code. The Committee shall interpret this Plan and, to the extent
and in the manner contemplated herein, shall exercise the discretion reserved to
it hereunder. The Committee may prescribe, amend and rescind rules and
regulations relating to this Plan and to make all other determinations necessary
for its administration. The decision of the Committee on any interpretation of
this Plan or administration hereof, if in compliance with the provisions of the
Act and regulations promulgated thereunder, shall be final and binding with
respect to the Company, any optionee or any person claiming to have rights as,
or on behalf of, any optionee.
3. Shares Subject to the Plan
The shares subject to option and the other provisions of this Plan shall be
shares of the Company's common stock, par value $.001 per share (the "shares").
Subject to the provisions hereof concerning adjustment, the total number of
shares that may be purchased upon the exercise or surrender of stock options
granted under this Plan shall not exceed 720,000,000 shares, which includes all
shares with respect to which options have been granted or surrendered for
payment in cash or other consideration pursuant to this Plan. In the event any
option shall cease to be exercisable in whole or in part for any reason, the
shares which were covered by such option, but as to which the option had been
exercised, shall again be available under this Plan. Shares may be made
available from authorized, unissued or reacquired stock or partly from each.
4. Participants
(a) Key Employees. The Committee shall determine and designate from time to time
those key employees of the Company who shall be eligible to participate in this
Plan. The Committee shall also determine the number of shares to be offered from
time to time to each optionee. In making these determinations, the Committee
shall take into account the past service of each such officer to the Company,
the present and potential contributions of such officer to the success of the
Company and such other factors as the Committee shall deem relevant in
connection with accomplishing the purposes of this Plan; provided that the
Committee shall determine that each grant of options to an optionee, the number
of shares offered thereby and the terms of such option are in the best interests
of the Company and its shareholders. The date on which the Committee approves
the grant of any option to an officer of the Company shall be the date of
issuance of such option. The agreement documenting the award of any option
granted pursuant to this paragraph 4(a) shall contain such terms and conditions
as the Committee shall deem advisable, including but not limited to being
exercisable only in such installments as the Committee may determine.
(b) Non-Employee Directors. Non-employee directors will be eligible to
participate in the Plan upon issuance of an order by the Securities and Exchange
Commission pursuant to Section 61(a)(3)(B)(i)(II) of the Act and then only in
accordance with the terms and conditions of such order.
(c) Option Agreements. Agreements evidencing options granted to different
optionees or at different times need not contain similar provisions. Options
that are intended to be ISOs will be designated as such; any option not so
designated will be treated as a nonqualified stock option.
5. Option Price
Each option agreement shall state the price at which the subject option may be
exercised, which shall not be less than the current fair market value of the
shares at the date of issuance of an option; provided, that the exercise price
of any option that is intended to be an ISO and that is granted to a holder of
10% or more of the Company's shares shall not be less than 110% of such current
fair market value.
6. Option Period
Each option agreement shall state the period or periods of time within which the
subject option may be exercised, in whole or in part, by the optionee as may be
determined by the Committee; provided, that the option period shall not exceed
10 years from the date of issuance of the option and, in the case of an option
that is intended to be an ISO and that is granted to a holder of 10% or more of
the Company's shares, shall not exceed five years.
7. Payment for Shares
Full payment for shares purchased shall be made at the time of exercising the
option in whole or in part. Payment of the purchase price shall be made in cash
(including check, bank draft or money order).
8. Transferability of Options
Options shall not be transferable other than by will, intestacy, or as otherwise
permitted by the Act, provided that a transfer will not be permitted to the
extent that it would result in adverse tax consequences for the optionee under
Section 83 or Section 422 of the Code.
9. Termination of Options
All rights to exercise options shall terminate one-hundred eighty days (180)
after any optionee ceases to be a director or a key employee of the Company
except as otherwise provided by the Committee in an option agreement, and no
options will vest after an optionee's termination date. Notwithstanding the
foregoing, however, where an optionee's service as a director or key employee of
the Company terminates as a result of the optionee's death or his total and
permanent disability, the optionee or the executors or administrators or
legatees or distributees of the estate, as the case may be, shall have the
right, from time to time within one (1) year after the optionee's total and
permanent disability or death and prior to the expiration of the term of the
option, to exercise any portion of the option not previously exercised, in whole
or in part, as provided in the respective option agreement.
10. Effect of Change in Stock Subject to the Plan
Subject to any required action by the shareholders of the Company and the
provisions of applicable corporate law, the number of shares represented by the
unexercised portion of an option, the number of shares which has been authorized
or reserved for issuance hereunder, and the number of shares covered by any
applicable vesting schedule hereunder, as well as the exercise price of a share
represented by the unexercised portion of an option, shall be adjusted as
determined by the Committee to reflect any merger, share exchange,
reorganization, consolidation, recapitalization, reclassification, distribution,
stock dividend, stock split, reverse stock split, split-up, spin-off, issuance
of rights or warrants or other similar transaction or event affecting the shares
after adoption of the Plan.
-2-
11. General Restriction
Each option shall be subject to the requirement that, if at any time the Board
of Directors shall determine, in its discretion, that the listing, registration
or qualification of the shares subject to such option upon any securities
exchange or under any state or federal law, or the consent or approval of any
government regulatory body, is necessary or desirable as a condition of, or in
connection with, the granting of such option or the issue or purchase of the
shares thereunder, such option may not be exercised in whole or in part unless
such listing, registration, qualification, consent or approval shall have been
effected or obtained free of any conditions not acceptable to the Company.
Subject to the limitations of paragraph 6, no option shall expire during any
period when exercise of such option has been prohibited by the Board of
Directors or the rules and regulations of the Securities and Exchange
Commission, including Regulation BTR, but shall be extended for such further
period so as to afford the optionee a reasonable opportunity to exercise his
option.
12. Miscellaneous Provisions
(a) No optionee shall have rights as a shareholder with respect to shares
covered by his option until the date of exercise of his option.
(b) The granting of any option shall not impose upon the Company any obligation
to appoint or to continue to appoint as a director or key employee any optionee,
and the right of the Company to terminate the employment of any key employee or
other employee, or service of any director, shall not be diminished or affected
by reason of the fact that an option has been granted to such optionee.
(c) Options shall be evidenced by stock option agreements in such form and
subject to the terms and conditions of this Plan as the Committee shall approve
from time to time, consistent with the provisions of this Plan. Such stock
option agreements may contain such other provisions, as the Committee in its
discretion may deem advisable. In the case of any discrepancy between the terms
of the Plan and the terms of any option agreement, the Plan provisions shall
control.
(d) For purposes of the Plan, the fair market value means, with respect to a
share, if the shares are then listed and traded on a national securities
exchange or quoted on a national securities association, the closing sales price
of a share on such exchange or association on the date of grant of an options.
If the shares are not traded on a national securities exchange or association,
then the fair market value, with respect to a share, shall mean the current net
asset value of a share.
(e) The aggregate fair market value (determined as of the date of issuance of an
option) of the shares with respect to which an option, or portion thereof,
intended to be an ISO is exercisable for the first time by any optionee during
any calendar year (under all incentive stock option plans of the Company) shall
not exceed $100,000.
(f) All options issued pursuant to this Plan shall be granted within 10 years
from the earlier of the date of adoption of this Plan (or any amendment thereto
requiring shareholder approval pursuant to the Code) or the date this Plan (or
any amendment thereto requiring shareholder approval pursuant to the Code) is
approved by the shareholders of the Company.
(g) The grant of any option under this Plan in violation of the Act shall be
null and void.
(h) A leave of absence granted to an employee does not constitute an
interruption in continuous employment for purposes of this Plan as long as the
leave of absence does not extend beyond one year.
(i) Any notices given in writing shall be deemed given if delivered in person or
by certified mail; if given to the Company addressed to the Company's Chief
Financial Officer, 122 Perimeter Park Drive, Knoxville, TN 37922; and, if to an
optionee, in care of the optionee at his or her last address on file with the
Company.
(j) This Plan and all actions taken by those acting under this Plan shall be
governed by the substantive laws of the State of Delaware without regard to any
rules regarding conflict-of-law or choice-of-law.
-3-
(k) All costs and expenses incurred in the operation and administration of this
Plan shall be borne by the Company.
13. Change of Control
In the event of a Change of Control (as hereinafter defined), all
then-outstanding options will become fully vested and exercisable as of the
Change of Control.
"Change in Control" means the occurrence of any of the following events:
(i) An acquisition in one or more transactions (other than directly from the
Company) of any voting securities of the Company by any Person (as defined
below) immediately after which such Person has Beneficial Ownership (as defined
below) of fifty percent or more of the combined voting power of the Company's
then outstanding voting securities; provided, however, in determining whether a
Change in Control has occurred, voting securities which are acquired in a
"Non-Control Acquisition" (as hereinafter defined) shall not constitute an
acquisition which would cause a Change in Control. A "Non-Control Acquisition"
shall mean an acquisition by (A) an employee benefit plan (or a trust forming a
part thereof) maintained by (I) the Company or (II) any corporation or other
Person of which a majority of its voting power or its voting equity securities
or equity interest is owned, directly or indirectly, by the Company (for
purposes of this definition, a "Subsidiary"), (B) the Company or its
Subsidiaries, or (C) any Person in connection with a "Non-Control Transaction"
(as hereinafter defined);
(ii) The individuals who, as of the date hereof are members of the Board (the
"Incumbent Board"), cease for any reason to constitute at least a majority of
the members of the Board or, following a Merger (as defined below), the board of
directors of the ultimate Parent Corporation (as defined below); provided,
however, that if the election, or nomination for election by the Company's
common stockholders, of any new director was approved by a vote of at least a
majority of the Incumbent Board (or, with respect to the directors who are not
"interested persons" as defined in Act, by a majority of the directors who are
not "interested persons" serving on the Incumbent Board), such new director
shall, for purposes of this Plan, be considered as a member of the Incumbent
Board; provided further, however, that no individual shall be considered a
member of the Incumbent Board if such individual initially assumed office as a
result of an actual or threatened solicitation of proxies or consents by or on
behalf of a Person other than the Board (a "Proxy Contest") including by reason
of any agreement intended to avoid or settle any Proxy Contest; or
(iii) The consummation of:
(A) A merger, consolidation or reorganization involving the Company (a
"Merger") or an indirect or direct subsidiary of the Company, or to which
securities of the Company are issued, unless:
(I) the stockholders of the Company, immediately before a Merger,
own, directly or indirectly immediately following the Merger, more than fifty
percent of the combined voting power of the outstanding voting securities of (1)
the corporation resulting from the Merger (the "Surviving Corporation") if fifty
percent or more of the combined voting power of the then outstanding voting
securities of the Surviving Corporation is not Beneficially Owned, directly or
indirectly, by another Person or group of Persons (a "Parent Corporation"), or
(2) if there is one or more Parent Corporations, the ultimate Parent
Corporation,
(II) the individuals who were members of the Incumbent Board
immediately prior to the execution of the agreement providing for a Merger
constitute at least a majority of the members of the board of directors of (1)
the Surviving Corporation or (2) the ultimate Parent Corporation, if the
ultimate Parent Corporation, directly or indirectly, owns fifty percent or more
of the combined voting power of the then outstanding voting securities of the
Surviving Corporation, and
(III) no Person other than (1) the Company, (2) any Subsidiary, (3)
any employee benefit plan (or any trust forming a part thereof) maintained by
the Company, the Surviving Corporation, any Subsidiary, or the ultimate Parent
Corporation, or (4) any Person who, together with its Affiliates (as defined
below), immediately prior to a Merger had Beneficial Ownership of fifty percent
or more of the then outstanding voting securities, owns, together with its
Affiliates, Beneficial Ownership of fifty percent or more of the combined voting
power of the then outstanding voting securities of (1) the Surviving Corporation
or (2) the ultimate Parent Corporation.
-4-
Each transaction described in clauses (I) through (III) above shall herein be
referred to as a "Non-Control Transaction."
(B) A complete liquidation or dissolution of the Company (other than where
assets of the Company are transferred to or remain with a Subsidiary or
Subsidiaries of the Company).
(C) The direct or indirect sale or other disposition of all or
substantially all of the assets of the Company to any Person (other than (1) a
transfer to a Subsidiary, (2) under conditions that would constitute a
Non-Control Transaction with the disposition of assets being regarded as a
Merger for this purpose, or (3) the distribution to the Company's stockholders
of the stock of a Subsidiary or any other assets).
Notwithstanding the foregoing, a Change in Control shall not be deemed to occur
solely because any Person (the "Subject Person") acquired Beneficial Ownership
of more than the permitted amount of the then outstanding voting securities as a
result of the acquisition of voting securities by the Company which, by reducing
the number of voting securities then outstanding, increases the proportional
number of shares Beneficially Owned by the Subject Persons, provided that if a
Change in Control would occur (but for the operation of this sentence) as a
result of the acquisition of voting securities by the Company, and after such
share acquisition by the Company, the Subject Person becomes the Beneficial
Owner of any additional voting securities which increases the percentage of the
then outstanding voting securities Beneficially Owned by the Subject Person,
then a Change in Control shall occur.
14. Amendment and Termination
The Board of Directors may modify, revise or terminate this Plan at any time and
from time to time. While the Board of Directors may seek shareholder approval of
an action modifying a provision of the Plan where it is determined that such
shareholder approval is advisable under the provisions of applicable law, the
Board of Directors shall be permitted to make any modification or revision to
any provision of this Plan without shareholder approval. This Plan shall
terminate when all shares reserved for issuance hereunder have been issued upon
the exercise of options, or by action of the Board of Directors pursuant to this
paragraph, whichever shall first occur.
15. Effective Date of the Plan
The Plan shall become effective upon the latest to occur of (1) adoption by the
Board of Directors, and (2) approval of this Plan by the shareholders of the
Company.
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