ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
The Company subleased approximately 2,260 square feet of office space, which served as its, and as of June 3, 2011 FRES’s, executive offices, at 1005 North Glebe Road, Suite 550, Arlington, Virginia 22201, through July 31, 2011. Lease payments were $7,756 per month from July 1, 2010 through December 31, 2010 and $7,503 per month from January 1, 2011 through July 31, 2011, including taxes and utilities. The Company and FRES moved offices on August 1, 2011, leasing approximately 750 square feet through July 31, 2012 at a cost of $99,216 through that date, including taxes and utilities.
Timios leases approximately 8,000 square feet of office space at 5716 Corsa Ave., Suite 102, Westlake Village, CA 91362, which serves as its executive and administrative offices. Lease payments are $14,157 per month. The lease payments are inclusive of taxes and utilities. The cumulative lease payment for the remainder of the lease will be approximately $346,000. The lease expires on August 31, 2013.
Timios also leases approximately 4,000 square feet of office space at 2201 West Plano Parkway, Suite 175, Plano, TX 75075, which serves as a regional administrative office. Lease payments are approximately $7,317 per month. The lease payments are inclusive of taxes and utilities. The cumulative lease payment for the remainder of the lease will be approximately $88,000. The lease expires on July 31, 2012.
Timios also leases approximately 4,000 square feet of office space at 16300 Katy Freeway, Suite 210, Houston, TX 77084, which is currently sublet to an unrelated company. Lease payments are approximately $1,848 per month. The lease payments are inclusive of taxes and utilities. The cumulative lease payment for the remainder of the lease will be approximately $30,000. The lease expires on December 31, 2012.
DSUSA leases approximately 5,908 square feet of office space at 5111 Commerce Crossing Drive, Suite 210, Louisville, KY 40229, which serves as its executive and administrative offices. Lease payments are approximately $7,691 per month. The lease payments are inclusive of taxes and utilities. The cumulative lease payment for the remainder of the lease will be approximately $184,582. The lease expires on September 30, 2013.
We believe that our existing facilities are adequate to accommodate our business needs.
From time to time, we may be involved in routine legal proceedings incidental to the conduct of our business. We are subject to certain claims and lawsuits typically filed against real estate services companies, alleging primarily professional errors or omissions. We carry professional liability insurance, subject to certain deductibles and policy limits, against such claims. However, in some actions, parties may seek damages that exceed our insurance coverage or for which we are not insured. Management’s opinion is that the resolution of any potential claim does not have a material adverse effect on our financial position, results of operations or cash flows.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is currently traded on the OTC Bulletin Board under the ticker symbol “HOMS.OB.” The following table sets forth, for the calendar quarters indicated, the high and low closing bid prices of our shares of common stock. 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 Bloomberg L.P.
Holders of our Common Stock
As of September 30, 2011, there were approximately 360 holders of record of our common stock.
Dividends
We have not paid dividends on our common stock since inception and do not intend to pay any dividends to our common stock holders in the foreseeable future. We currently intend to reinvest our earnings, if any, for the development and expansion of our business. Any declaration of dividends on any class of our stock 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.
Recent Sales of Unregistered Securities
None.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth certain information as of June 30, 2011, concerning our equity compensation plans:
Additional information regarding our stock-based compensation awards outstanding and available for future grants as of June 30, 2011 is presented in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
This item is not applicable to smaller reporting companies.
ITEM 7.
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 the Company and the Notes thereto appearing elsewhere in this Annual Report on Form 10-K. Statements in this Management’s Discussion and Analysis and Results of Operation and elsewhere in this Annual Report on form 10-K that are not statements of historical or current fact constitute “forward-looking statements.”
Overview
Homeland Security Capital Corporation was incorporated in Delaware on August 12, 1997 under the name “Celerity Systems, Inc.” In 2005, we changed our business plan to primarily seek acquisitions of and joint ventures and, since then, have operated solely as a provider of specialized technology-based radiological, nuclear, environmental, disaster relief and electronic security solutions to government and commercial customers. Our corporate headquarters is located in Arlington, Virginia.
In July 2011, we expanded the scope of operations to include companies operating in the real estate services industry through our acquisition of a majority interest in an intermediary holding company that owns, through another intermediary company, two companies, one engaged in title and escrow services for mortgage origination refinance, reverse mortgages and deed-in-lieu transactions, and the other in real estate-owned liquidation services to institutional real estate owned, or REO, customers.
In early 2011, we had announced that we were considering strategic alternatives to retire part or all of our debt, including the sale of one or all of our current subsidiaries. Accordingly, we developed a coordinated plan to dispose of our current operations and use the proceeds from the sale of our subsidiaries to retire our debt to YA. As part of this plan, we hired financial advisors to assist us in identifying solutions and these advisors identified possible buyers for Safety and CSS Management Corp. (formerly, Corporate Security Solutions, Inc.), or CSS, a wholly-owned subsidiary of NTG Management Corp. (formerly, Nexus Technologies Group, Inc.), or NTG, a majority-owned subsidiary of the Company.
Subsequent to year-end, the Company plans to conduct its continuing operations through one majority-owned subsidiary. On July 6, 2011, the Company formed Holdings and through Holdings on July 19, 2011 entered into a shareholder’s agreement to acquire eighty percent (80%) of FRES, a company involved in the real estate services industry. On July 5, 2011 and on July 29, 2011, FRES, through a newly formed subsidiary DSUSA, acquired substantially all the assets of Default Servicing, Inc and 100% of the stock of Timios, Inc., respectively.
The Company expects to grow these businesses both organically and by acquisitions. The Company continues to target growth companies that are generating revenues but face challenges in scaling their businesses to capitalize on growth opportunities. The Company will enhance the operations of these companies by helping them generate new business, grow revenues, develop superior management, build infrastructure and improve cash flows.
Results of Continuing Operations
The discussion below reflects the consolidated accounts of the Company’s continuing operations only as of June 30, 2011 and 2010. Safety, NTG and PMX are discussed below under Discontinued Operations. All intercompany balances and transactions related to discontinued operations have been eliminated.
The Company has measured the impact of inflation and changing prices on operating expenses and net income for 2011 and 2010, the financial periods included in this Annual Report on Form 10-K. We have concluded that there has not been a material impact to our financial position, results of operations or cash flows from inflation or changing prices during 2011 or 2010.
Year Ended June 30, 2011 as Compared to the Year Ended June 30, 2010
Operating expenses from continuing operations
For the twelve months ended June 30, 2011, the Company’s continuing operations recorded operating expenses of $2,947,395 as compared to $2,480,103 recorded for the twelve months ended June 30, 2010.
The increase of $467,292, or 18.8%, was primarily due to the increase in professional services, mainly legal expenses related to acquisition and disposal activities, offset by a decrease in non cash compensation in 2011.
Other income and expense from continuing operations
For the twelve months ended June 30, 2011, the Company’s continuing operations recorded net other expenses of $2,249,997 as compared to net other expenses of $2,291,004 recorded for the twelve months ended June 30, 2010. The decrease in net other expenses of $41,007 are further outlined below by functional line item:
The overall decrease in net other expenses of $41,007, or 1.8%, mainly reflects the increase in interest expense of $126,354, the increase of impairment losses of 203,216, offset by the absence in 2011 of the amortization for debt offering costs and debt discount which was fully amortized in 2010.
Net loss from continuing operations
As a result of the foregoing, the Company’s continuing operations recorded a net loss of $5,197,392 for the twelve months ended June 30, 2011 as compared to a net loss from continuing operations of $4,771,107 for the twelve months ended June 30, 2010.
Discontinued Operations
As previously indicated in this Annual Report on Form 10-K and as of the date of this filing, the Company has a single coordinated plan to dispose of Safety, NTG and PMX. The Company has either committed to sell, sold or transferred its entire interests in these operating subsidiaries related to its homeland security business segment. As a result of these pending or completed transactions, which had been previously contemplated, the Company has recorded the results of operations of these subsidiaries as discontinued operations, assets and liabilities have been separated on the balance sheet and cash flows have been separated on the statement of cash flows at June 30, 2011 and 2010, in accordance with Generally Accepted Accounting Principles in the U.S., or GAAP.
The table below reflects certain information regarding discontinued operations:
Liquidity and Capital Resources
From August 2005 through March 2008, the Company operated and acquired businesses using funding from issuance of its common stock, preferred stock and convertible debt to YA Global Investments, L.P. (YA) (formerly known as Cornell Capital, L.P.) totaling approximately $23,250,000. At June 30, 2011, the Company owed YA approximately $19,725,040, including accrued interest. In March 2008, the total debt was consolidated into three notes, each with a maturity date of March 14, 2010. This due date was initially extended to October 1, 2010 and it was subsequently extended to July 15, 2011, by which time the Company had expected to sell Safety, NTG and PMX and retire the debt. Since neither Safety, NTG nor PMX were sold by this date, YA agreed to a forbearance until August 31, 2011 and then subsequently agreed to an extension of the forbearance period until September 14, 2011. On August 19, 2011, $1,733,917 of the proceeds from the sale of NTG was paid to YA. Unless and until the Company sells Safety, it cannot repay this debt. Upon the expiration of the forbearance period, the Company is subject to foreclosure without notice. Since September 15, 2011 and until the date of this filing, YA has not notified the Company of its intention to foreclose on the assets of the Company, all of which are pledged as collateral for its debt. Such a foreclosure would have a material adverse effect on the Company’s continuing operations, its liquidity, its capital resources and its stockholders.
The Company had cash on hand of $3,494,256 at June 30, 2011 and $1,892,429 at June 30, 2010. Our primary needs for cash are to repay debt and fund our ongoing operations. Our secondary need for cash is to make additional acquisitions of businesses that provide products and services in our target industries. We do not have sufficient capital on hand to repay our debt nor are we able to internally generate sufficient capital to repay our debt at this time. We will require significant additional capital in order to repay our debt, fund our operations and to make additional acquisitions.
During the year ended June 30, 2011, the Company’s operations had a net increase in cash of $1,664,827. The Company’s continuing sources and uses of funds were as follows:
Cash Flows From Operating Activities
We provided net cash of $4,985,446 in our operating activities during the year ended June 30, 2010, primarily provided by our subsidiaries Safety and NTG in their ongoing operations.
Cash Flows From Investing Activities
We provided net cash of $831,863 in our investing activities during the year ended June 30, 2011, consisting of the proceeds from the disposal of fixed assets in the amount of $1,562,825, offset by the purchase of fixed assets of $730,962, mainly by Safety and NTG.
Cash Flows From Financing Activities
We used cash of $4,183,035 in financing activities during the year ended June 30, 2010, consisting of net repayments on Safety’s line of credit of $2,162,000, repayments of bank notes of $1,156,955, repayments of related party debt of $500,000, $216,200 for the repurchase of stock options outstanding at Safety and $147,880 for distributions to non-controlling interests.
As of June 30, 2011, the Holding Company had a net working capital deficit of $9,531,622.
Off-Balance Sheet Arrangements
Safety, in the normal course of business, is required to post a performance bond on certain projects. Typically, the bonding or surety company who posts the bond on Safety’s behalf will require collateralization of their potential liability for posting the bond. Through June 30, 2011, our President has guaranteed this potential liability.
The Company recognizes the potential exposure to our President and, on January 1, 2011, entered into an agreement with him and his spouse, indemnifying them against any liabilities they may endure as a result of collateralizing Safety’s bonding requirements. At June 30, 2011, the amount of possible indemnification to the President and his spouse was approximately $13,000,000.
Critical Accounting Policies and Estimates Used in Continuing and Discontinued Operations
Revenue Recognition - The Company recognizes revenue when it is realized or realizable and earned less estimated future doubtful accounts. The Company considers revenue realized or realizable and earned when all of the following criteria are met:
(i)
persuasive evidence of an arrangement exists,
(ii)
the services have been rendered and all required milestones achieved,
(iii)
the sales price is fixed or determinable, and
(iv)
collectability is reasonably assured.
Revenues are derived primarily from services performed under time and materials and fixed fee contracts and products sold. Revenues and costs derived from fixed price contracts are recognized using the percentage of completion (efforts expended) method. Revenue and costs derived from time and material contracts are recognized when revenue is earned and costs are incurred. Revenue and costs based on sale of products are derived when the products have been delivered and accepted by the customer.
Deferred Revenue - Revenue from service contracts, for which the Company is obligated to perform, is recorded as deferred revenue and subsequently recognized over the term of the contract.
Contract costs include all direct labor, material and other non-labor costs and those indirect costs related to contract support, such as depreciation, fringe benefits, overhead labor, supplies, tools, repairs and equipment rental. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability, including those arising from contract penalty provisions and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.
Foreign Operations - Safety and Ecology Corporation Limited, or SECL, a United Kingdom corporation, is wholly-owned by Safety. The financial statements of SECL are included in discontinued operations. The financial statements of SECL are translated into U.S. dollars using exchange rates in effect at period-end for assets and liabilities and average exchange rates during the period for results of operations. The related translation adjustments are reported as discontinued operations.
Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues and expenses and the 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.
Estimates are used when accounting for amounts recorded in revenue when applying percentage of completion accounting, fair value determination of assets and liabilities, impairment of long-lived assets (including goodwill and other intangible assets), collectability of accounts receivable, share based compensation assumptions and valuation allowance related to deferred tax assets.
The estimates we make are subject to several factors including management’s judgment, the industry in which we conduct our operations, the overall economy, market valuations concerning certain assets and liabilities and the government. Although we believe our estimates take into consideration the effect of these various factors, uncertainty still exists in such estimates and actual results may differ from our 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.
Recognition of Losses on Receivables - Trade accounts receivable are recorded at their estimated net realizable values using the allowance method. Management periodically reviews accounts for collectability, including accounts determined to be delinquent based on contractual terms. An allowance for doubtful accounts is maintained at the level management deems necessary to reflect anticipated credit losses. When accounts are determined to be uncollectible, they are charged off against the allowance for bad debts. Net accounts receivable are included in “Current assets related to discontinued operations.”
Investments in Assets Held for Sale - The Company classifies certain investments in marketable securities as “assets held for sale”. Under this classification securities are carried at fair value (period end market closing prices) with unrealized gains and losses excluded from earnings and reported as a separate component of shareholder’s equity until the gains or losses are realized or a provision for impairment is recognized.
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 recorded at the lower of cost or a value 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 the general market trends for businesses in the same industry. Because of the inherent uncertainty of valuations, management estimates of the value 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.
Periodically management makes an assessment as to impairment of the Company’s investment and accordingly adjusts the investment to record other than a temporary change in value.
Valuation of Stock Options and Warrants - The valuation of stock options and warrants granted to unrelated parties for services are measured at the earlier of: (i) the dates at which a commitment for performance by the counterparty to earn the equity instrument is reached, or (ii) the date the counterparty’s performance is complete.
Goodwill - Goodwill on acquisition is initially measured as the excess of the cost of the business acquired, including directly related professional fees, over the Company’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities. The Company’s acquisition of Safety in March of 2008 resulted in the recording of $6,403,982 as goodwill after the final allocation of the purchase price of the acquisition. All of the goodwill recorded on the Company’s consolidated balance sheet is allocated to Safety.
The Company performs impairment tests of goodwill at its operating segment level. Goodwill is tested for impairment at least annually, usually in the fourth quarter or more frequently if events or changes in circumstances indicate that the carrying amount may be impaired. The impairment test requires management to undertake certain judgments and consists of a two step process, if necessary. The first step is to compare the fair value of the operating segment to its carrying value, including goodwill. The Company typically uses a discounted cash model to determine the fair value of an operating segment, using assumptions in the model it believes to be consistent with those used by hypothetical market participants.
If the fair value of the operating segment is less than its carrying value, a second step of the impairment test must be performed in order to determine the amount of impairment loss, if any. The second step compares the implied fair value of the operating segment goodwill with the carrying amount of that goodwill. If the carrying amount of the operating segment’s goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal the carrying amount of the goodwill less its implied fair value.
Any impairment of goodwill based on the above calculations is recognized immediately in the income statement and is not subsequently reversed. At June 30, 2011, no goodwill impairment has been recognized.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This item is not applicable to smaller reporting companies.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required to be filed pursuant to this Item 8 are appended to this Annual Report on Form 10-K. A list of the financial statements filed herewith is found at “Item 15. Exhibits, Financial Statement Schedules.”
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation as of June 30, 2011, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, as well as other key members of our management, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, accumulated, processed, summarized, reported and communicated on a timely basis within the time periods specified in the Commission’s rules and forms, and is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure because of the material weakness described below under “Management’s Annual Report on Internal Control over Financial Reporting.”
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 defined in Rules 13A-15(f) and 15d-15(f) under the Securities Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes those policies and procedures that:
(1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect transactions involving our assets;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management, and
(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our Chief Executive Officer and Chief Financial Officer assessed the effectiveness of our internal control over financial reporting as of June 30, 2011. In making this assessment, management used the framework set forth in the reporting entitled Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was not effective as of June 30, 2011.
The Chief Executive Officer and the Chief Financial Officer determined that material information was omitted in determining whether contracts were in a loss position and such missing information would have caused a material misstatement within our financial statements.
The Chief Executive Officer and the Chief Financial Officer have undertaken a review of the current policies and procedures used in contract accounting and determined that changes to the policies and procedures, along with additional training of the employees responsible for applying such policies and procedures, will prevent such material weaknesses from occurring in the future.
Attestation Report of the Independent Registered Public Accounting Firm
This item is not applicable to smaller reporting companies.
Changes in Internal Control over Financial Reporting
In the ordinary course of business, we routinely enhance our information systems by either upgrading our current systems or implementing new systems. No change occurred in our internal controls over financial reporting during the year ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Executive Officers and Directors
Set forth below are, as of September 30, 2011, the names of our executive officers and directors, their ages, their positions, their principal occupations or employment for the past five years, the length of their tenure as directors and the names of other public companies in which such persons hold or have held directorships during the past five years. In addition, the following paragraphs include specific information about each director’s experience, qualifications, attributes or skills that led the Board of Directors to the conclusion that the individual is qualified to serve on the Board of Directors as of the time of this filing, in light of our business and structure.
C. Thomas McMillen. Mr. McMillen has served as the Company’s Chief Executive Officer and Chairman of the Board since August 30, 2005 and served as the Company’s President from August 30, 2005 until March 19, 2008. From December 2004 until January 2007, Mr. McMillen served as the Chairman of Fortress America Acquisition Corporation (now Fortress International Group, Inc., FIGI.PK), and from January 2007 until August 2009, he served as Vice Chairman and director. From October 2007 until October 2009, Mr. McMillen served as Chairman and Co-Chief Executive Officer of Secure America Acquisition Corporation, (now Ultimate Escapes, Inc. OTCBB: ULEIQ.PK) and from October 2009 to December 2010 as a director and from November 2009 to December 2010 as Vice Chairman. Ultimate Escapes, Inc. filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court in Wilmington, Delaware in September 2010. 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, 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. In addition, from 1987 through 1993, Mr. McMillen served three consecutive terms in the U.S. House of Representatives representing the 4th Congressional District of Maryland. Mr. McMillen received a Bachelor of Science in Chemistry from the University of Maryland and a Bachelor and Master of Arts from Oxford University as a Rhodes Scholar.
Mr. McMillen is qualified for service on our Board of Directors based on his many years of senior executive experience in the homeland security industry, including his experiences as a successful businessman, Congressman and Presidential appointee.
Christopher P. Leichtweis. Mr. Leichtweis has served as the Company’s President and as a director of the Company since March 19, 2008. In addition, Mr. Leichtweis has been serving as Chairman and Chief Executive Officer of Safety & Ecology Holdings Corporation since 1991. Mr. Leichtweis founded Safety in 1991 and over the last decade has grown the Company to its present state of over $70 million in revenue. Prior to founding Safety, Mr. Leichtweis served in various engineering and management positions at Bechtel National and Bechtel Environmental, Inc. a global engineering and construction Company starting in 1985 and was a key contributor to the environmental clean-up of major federal nuclear legacy programs. He currently serves on the board of directors of his undergraduate University’s Foundation Board (SUNY Brockport). Mr. Leichtweis received a Bachelor of Science in Physics from SUNY Brockport and a Masters of Business Administration from the University of Tennessee and is a Certified Industrial Hygienist. Mr. Leichtweis was nationally recognized as the Southeast United States 2005 Ernst & Young Entrepreneur of the Year award.
Mr. Leichtweis is qualified for service on our Board of Directors based on his 26 years of environmental remediation experience, including his extensive background in managing a growing company for 20 years.
Michael T. Brigante. Mr. Brigante has served as the Company’s Vice President of Finance since July 14, 2006 and the Company’s Chief Financial Officer since May 10, 2007. Mr. Brigante is a director of each of the Company’s subsidiary boards of directors. In January 2003, Mr. Brigante joined Sky Capital Enterprises, a venture firm, and Sky Capital Holdings, a FINRA registered broker dealer, which were both London Stock Exchange listed companies and served as their Chief Financial Officer until June 2006. From July 1999 until December 2002, Mr. Brigante was the Managing Partner of Pilot Rock Consulting, a diversified financial consulting practice to public and private companies, which he founded. From December 1995 until December 1996, Mr. Brigante served as the Controller and from January 1997 until June 1999 served as Chief Financial Officer of Complete Wellness Centers, Inc. a publicly held healthcare services company. Prior to his position with Complete Wellness Centers, Inc. Mr. Brigante served in a variety of Senior Financial positions with public and private companies. Mr. Brigante received a Bachelor of Science degree in Accounting and Economics from James Madison University and is a Certified Public Accountant.
Zev. E. Kaplan. Mr. Kaplan has served as a director of the Company since December 30, 2005. Mr. Kaplan is the founder of a law firm concentrating its practice in the areas of transportation, infrastructure, government relations, business and administrative law. Mr. Kaplan was Associate General Counsel to Global Cash Assess, Inc., a NYSE traded company from August 2008 to August 2009. Mr. Kaplan previously served as General Counsel to Cash Systems Inc., a publicly traded company in the financial services business, a position he has held from March 2005 to August 2008. 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 Juris Doctor from Southwestern University School of Law and attended Georgetown University for post-graduate legal studies; received a Masters Business Administration from the University of Nevada, Las Vegas; and received a Bachelor of Science from the Smith School of Business at the University of Maryland in 1974.
Mr. Kaplan is qualified for service on our Board of Directors based on his extensive legal experience, which includes various positions serving governmental agencies at the federal and state level.
Philip A. McNeill. Mr. McNeill has served as a director of the Company since December 30, 2005. Mr. McNeill is a Managing Partner and the Chief Investment Officer of SPP Mezzanine Partners II, LLC, the Manager of the SPP Mezzanine family of Funds, 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. From October 2007 until October 2009, Mr. McNeill also served as a director of Secure America Acquisition Corporation, (now Ultimate Escapes, Inc. OTCBB: ULEIQ.PK). Ultimate Escapes, Inc. filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court in Wilmington, Delaware in September 2010. Mr. McNeill graduated from Syracuse University in 1981 with a Bachelor of Science in Business Administration, with concentrations in Accounting, Finance, and Law & Public Policy. Mr. McNeill earned his Masters Business Administration from Harvard Business School in 1985.
Mr. McNeill is qualified for service on our Board of Directors based on his experience with middle-market companies, his financial background and his current position serving as managing partner and investment officer for an investment fund.
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.
Director Nominations
Generally, directors are recommended to the Company by senior management or currently serving directors. On occasion, as the Company enters an industry sector not familiar to the current management or directors, the Company will seek outside recommendations for industry experts to consider as potential director nominees.
Family Relationships
To our knowledge, there are no family relationships; as such term is defined in item 401(d) of Regulation S-K, among any of the directors or executive officers of the Company.
Involvement in Certain Legal Proceedings
To our knowledge, none of the Company’s directors or executive officers has been involved in legal proceedings over the past ten years that are material to an evaluation of his ability or integrity to serve as a director or executive officer of the Company.
Corporate Governance
Committees of the Board of Directors and Meetings
Audit Committee. Philip A. McNeill (Committee Chairman) and Zev E. Kaplan serve as members of the Audit Committee. They are independent members of the Board of Directors and our Board of Directors has determined that Mr. McNeill satisfies the criteria for an “audit committee financial expert” under Item 407 of Regulation S-K. Each Audit Committee member is able to read and understand fundamental financial statements, including our Company’s consolidated balance sheet, statement of operations and statement of cash flows. 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 quality of financial reporting, and (v) meet with the outside auditors to discuss the scope of the annual audit and to discuss the audited financial statements.
The charter for our Audit Committee can be found on our website at www.hscapcorp.com under the tab, “Investor Relations.”
AUDIT COMMITTEE REPORT
The members of the Audit Committee, which is comprised of two directors, have been appointed by the Board of Directors. The current members of the Committee are Messrs. Philip A. McNeill (Chairman) and Zev E. Kaplan.
The Audit Committee reviews the scope and timing of the independent registered public accounting firm’s audit and other services, and their report on our financial statements following completion of their audits. The Audit Committee also makes annual recommendations to the Board of Directors regarding the appointment of independent registered public accounting firms for the ensuing year. The Audit Committee operates under a written Audit Committee Charter.
Management is responsible for the preparation of our financial statements and the independent registered public accounting firm has the responsibility for the examination of those statements. The Audit Committee reviewed our audited financial statements for the year ended June 30, 2011 and met with both management and our external accountants to discuss those financial statements. Management and the independent registered public accounting firm have represented to the Audit Committee that the financial statements were prepared in accordance with generally accepted accounting principles. The Audit Committee also considered taxation matters and other areas of oversight relating to the financial reporting and audit process that the Audit Committee deemed appropriate.
The Audit Committee has received from the independent registered public accounting firm their written disclosure and letter regarding their independence from us as required by applicable requirements of the Public Company Accounting Oversight Board, and has discussed with the independent registered public accounting firm their independence. The Audit Committee also discussed with the independent registered public accounting firm any matters required to be discussed by Statement on Auditing Standards No. 61, as amended, as adopted by the Public Company Accounting Oversight Board in Rule 3200T, as may be modified or supplemented.
Based upon the reviews and discussions described in this Audit Committee Report, the Audit Committee has recommended to the Board of Directors that the audited financial statements be included in our Annual Report on Form 10-K for the year ended June 30, 2011 for filing with the Securities and Exchange Commission.
RESPECTFULLY SUBMITTED,
THE AUDIT COMMITTEE
Philip C. McNeill, Chairman
Zev E. Kaplan
Compensation Committee. Zev E. Kaplan (Committee Chairman) and Philip A. McNeill serve as members of the Compensation Committee. Both are independent members of the Board of Directors. The Compensation Committee met 9 times in fiscal year 2011.
Meeting Attendance. During the fiscal year ended June 30, 2011, there were seventeen meetings of our Board of Directors, and the various committees of the Board of Directors met a total of thirteen times. No director attended fewer than 75% of the total number of meetings of the Board of Directors and of committees on which he served during the fiscal year ended June 30, 2011.
Board Leadership Structure
Mr. McMillen serves as the Chairman of our Board of Directors and Chief Executive Officer and Mr. Leichtweis serves as our President. The Board of Directors does not have a policy regarding the separation of the roles of Chief Executive Officer and Chairman of the Board as the Board of Directors believes it is in the best interests of the Company to make that determination based on the position and direction of the Company and the membership of the Board of Directors. The Board of Directors has determined that having the Company’s Chief Executive Officer serve as Chairman is in the best interest of the Company’s stockholders at this time. This structure makes the best use of the Chief Executive Officer’s extensive knowledge of the Company and its industry, as well as fostering greater communication between the Company’s management and the Board of Directors. In addition, the Chairman can provide the President with guidance and feedback on his performance and allows the Chairman to focus on stockholder interests and corporate governance while providing Mr. Leichtweis with the ability to focus his attention on managing our day-to-day operations. As Mr. McMillen has significant senior level industry experience, he is particularly well-suited to serve as Chairman.
We recognize that different board leadership structures may be appropriate for companies in different situations. We will continue to re-examine our corporate governance policies and leadership structures on an ongoing basis to ensure that they continue to meet the Company’s needs.
Role in Risk Oversight
Management is responsible for managing the risks that we face. The Board of Directors is responsible for overseeing management’s approach to risk management that is designed to support the achievement of organizational objectives, including strategic objectives and risks associated with our growth strategy, to improve long-term organizational performance and enhance stockholder value. The involvement of the full Board of Directors in reviewing our strategic objectives and plans is a key part of the Board of Directors’ assessment of management’s approach and tolerance to risk. A fundamental part of risk management is not only understanding the risks a company faces and what steps management is taking to manage those risks, but also understanding what level of risk is appropriate for us. In setting our business strategy, our Board of Directors assesses the various risks being mitigated by management and determines what constitutes an appropriate level of risk for us.
While the Board of Directors has ultimate oversight responsibility for overseeing management’s risk management process, various committees of the Board of Directors assist it in fulfilling that responsibility.
The Audit Committee assists the Board of Directors in its oversight of risk management in the areas of financial reporting, internal controls and compliance with legal and regulatory requirements and the Compensation Committee assists the Board of Directors in its oversight of the evaluation and management of risks related to our compensation policies and practices.
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 our review of these forms and written representations from the executive officers and directors, we believe that all Section 16(a) filing filings were timely filed during the twelve-month period ended June 30, 2011, except that two reports on Form 4, covering an aggregate of two transactions were filed late by C. Thomas McMillen and Michael T. Brigante.
Code of Ethics
On March 16, 2004, the Board of Directors of the Company adopted a written Code of Ethics that applies, among others, to our principal executive officer and principal financial officer and is designed, among other things, 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. Our Code of Ethics can be found on our website at: www.hscapcorp.com. The Code of Ethics will be made available to our stockholders, without charge, upon request, in writing to the Corporate Secretary at 4601 North Fairfax Drive, Suite 1200, Arlington, Virginia 22203, Attention: Michael T. Brigante, Chief Financial Officer. Disclosure regarding any amendments to, or waivers from, provisions of the Code of Ethics will be included in a Current Report on Form 8-K within four business days following the date of the amendment or waiver.
Stockholder Communications to the Board of Directors
Generally, stockholders who have questions or concerns should contact the Chief Financial Officer at (703) 528-7073 or email at MBrigante@hscapcorp.com. Stockholders wishing to submit written communications directly to the Board of Directors should send their communications to our Chairman, Homeland Security Capital Corporation, 4601 North Fairfax Drive, Suite 1200, Arlington, Virginia, 22203. All stockholder communications will be considered by the independent members of our Board of Directors.
Summary Compensation Table
The following table shows the compensation paid or accrued during the last two fiscal years ended June 30, 2011 and 2010 to (1) our Chief Executive Officer, (2) our Vice President of Finance and Chief Financial Officer, and (3) our next most highly compensated executive officer, other than our Chief Executive Officer and our Vice President of Finance and Chief Financial Officer, who earned more than $100,000 during the year ended June 30, 2011.
Narrative Disclosure to Summary Compensation Table
C. Thomas McMillen Employment Agreement. On August 29, 2005, the Company and Mr. McMillen entered into an employment agreement pursuant to which Mr. McMillen agreed to serve as the Company’s Chief Executive Officer and President for a term of two years, such agreement being 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 this agreement, Mr. McMillen was also awarded options to acquire a total of 5,800,000 shares of common stock, as described below in more detail. Mr. McMillen also received a sign-on bonus of $125,000.
Effective September 1, 2007, the Company and Mr. McMillen agreed to a two-year extension of his employment agreement. Under the terms of the extension, Mr. McMillen’s annual salary was increased to $200,000 with the possibility of a performance bonus. Additionally, the base salary would be increased by $20,000, or pro rata, for every $10,000,000 of equity the Company sells during the term of the employment agreement (except for any equity securities (i) issued to employees or consultants as compensation, (ii) issued in acquisition or merger or (iii) purchased by employees, consultants or directors upon the exercise or conversion of any Company stock option or other security issued for compensatory purposes).
In connection with the successful completion of the Safety acquisition, Mr. McMillen’s base salary was increased to $300,000 effective March 1, 2008 and, on July 30, 2008, he was granted options to purchase 50,000,000 shares of common stock, as described below in more detail, without any changes to the remaining terms of his employment agreement as then in effect.
On September 1, 2009, Mr. McMillen’s employment agreement was automatically extended for a one-year period without any changes to the terms of the agreement then in effect. On September 1, 2010, Mr. McMillen’s employment agreement was again automatically extended for a one-year period without any change to the terms of the agreement as then in effect.
On June 15, 2011, the Company entered into a new employment agreement with Mr. McMillen (the “McMillen Agreement”). The McMillen Agreement has an initial term of one year and is automatically renewable for additional consecutive one year terms, unless at least ninety days written notice is given by either the Company or Mr. McMillen prior to the commencement of the next renewal term. The McMillen Agreement also provides that Mr. McMillen will continue to serve as Chairman of the Board of Directors of the Company so long as he is with the Company, with no additional compensation, subject to any required approvals.
The McMillen Agreement provides for an annual base salary of $350,000, effective June 1, 2011, and an annual discretionary bonus of up to 100% of Mr. McMillen’s base salary based upon the achievement of targeted annual performance objectives to be established by the Compensation Committee of the Board, in consultation with Mr. McMillen. In addition, Mr. McMillen is eligible for a one-time special bonus in an amount equal to $726,665 on the earlier of (i) December 31, 2011, and (ii) change of control of the Company (as such term is defined in the McMillen Agreement). The special bonus shall be reduced by the amount of principal and interest now owed by Mr. McMillen, as a result of his stepping in as guarantor of the obligations of Secure America Acquisition Holdings LLC pursuant to that certain promissory note, dated June 1, 2007, by and between the Company and Secure, which is now in default (the “Note”). The Company is also obligated to waive all events of default and amend the maturity date under the Note to the earlier of (i) December 31, 2011, (ii) a change of control of the Company, and (ii) the termination date of McMillen Agreement. Mr. McMillen has agreed to forfeit his pre-existing option to purchase 55,800,000 of the Company’s shares of common stock.
The McMillen Agreement also provides for a monthly automobile allowance in an amount equal to $1,000, a matching contribution to his 401(k) account consistent with the plan up to the maximum amount allowable under Section 401(k) of the Internal Revenue Code of 1986 (the “Code”), other benefits provided to other senior executives of the Company, actual and reasonable out-of-pocket expenses and reimbursement for attorney’s fees actually incurred by Mr. McMillen in connection with the review of his employment agreement of up to an amount equal to $10,000.
Michael T. Brigante Employment Agreement. On May 10, 2007, the Company and Mr. Brigante entered into an employment agreement pursuant to which Mr. Brigante agreed to serve as the Company’s Chief Financial Officer for a term of three years, such agreement being renewable by mutual agreement of the Company and Mr. Brigante. Mr. Brigante’s initial annual salary under this agreement was $190,000 with the possibility of a performance bonus. Pursuant to this agreement, Mr. Brigante was awarded options to acquire a total of 519,210 shares of common stock, as described in more detail below. Mr. Brigante also received a sign-on bonus of $5,000.
In connection with the successful completion of the Safety acquisition, Mr. Brigante’s base salary was increased to $217,500 effective March 1, 2008 and, on July 30, 2008, he was granted options to purchase 8,750,000 shares of common stock, as described in more detail below, without any changes to the remaining terms of his employment agreement as then in effect.
On February 1, 2010, Mr. Brigante’s base salary was increased to $227,500 effective January 1, 2010. The increase was in connection with Mr. Brigante’s continued service as Chief Executive Officer of NTG. No other terms in his employment agreement were changed as then in effect.
On May 10, 2010, Mr. Brigante’s employment agreement was automatically extended for a one-year period without any changes to the terms of the agreement as then in effect.
On June 15, 2011, the Company entered into a new employment agreement with Michael T. Brigante (the “Brigante Agreement”). The Brigante Agreement has an initial term of one year and is automatically renewable for additional consecutive one year terms, unless at least ninety days written notice is given by either the Company or Mr. Brigante prior to the commencement of the next renewal term.
The Brigante Agreement provides for an annual base salary of $250,000, effective June 1, 2011, and an annual discretionary bonus of up to 50% of Mr. Brigante’s base salary based upon the achievement of targeted annual performance objectives to be established by the Compensation Committee of the Board of Directors, in consultation with Mr. McMillen and Mr. Brigante. In addition, Mr. Brigante is eligible for a one-time special bonus in an amount equal to $124,462.66 on the earlier of (i) December 31, 2011, and (ii) change of control of the Company (as such term is defined in the Brigante Agreement). Mr. Brigante has agreed to forfeit his pre-existing option to purchase 9,500,000 of the Company’s shares of common stock.
The Brigante Agreement also provides for a monthly automobile allowance in an amount equal to $500 (provided that Mr. Brigante does not use a vehicle provided by the Company), a matching contribution to his 401(k) account consistent with the plan up to the maximum amount allowable under Section 401(k) of the Code, use of the Company’s corporate apartment in Washington D.C., and if the Company no longer maintains the apartment, a monthly housing allowance up to the amount that the Company paid to maintain the corporate apartment, other benefits provided to other senior executives of the Company, actual and reasonable out-of-pocket expenses and reimbursement for attorney’s fees actually incurred by Mr. Brigante in connection with the review of his employment agreement of up to an amount equal to $10,000.
Christopher Leichtweis Employment Agreement. On March 14, 2008, Safety and Mr. Leichtweis entered into an employment agreement pursuant to which Mr. Leichtweis agreed to serve as Safety’s Chief Executive Officer for a term of three years, such agreement being renewable by mutual agreement of Safety and Mr. Leichtweis. Mr. Leichtweis’ initial salary under this agreement was $300,000 annually, subject to annual cost of living increases and an annual minimum bonus of $100,000 if Safety’s annual revenues exceed $50,000,000. Mr. Leichtweis, at his discretion, may choose to receive less than the annual minimum bonus and allocate a portion thereof to any employee(s) he may choose. Additionally, Mr. Leichtweis serves as President of the Company, but on an at-will basis.
On March 14, 2011, Safety and Mr. Leichtweis agreed to extend the employment contract until July 15, 2011 under the same terms.
The 2005 Stock Option Plan. On August 29, 2005, the Board adopted a stock option plan, or the 2005 Plan, under which the Company reserved 7,200,000 shares of common stock for issuance. Participants eligible under the 2005 Plan are officers and key employees. There were a total of 250,000 options issued and outstanding under the 2005 Plan at June 30, 2011.
The 2008 Stock Option Plan. On July 30, 2008, the Board adopted a stock option plan, or the 2008 Plan, under which the Company reserved 75,000,000 shares of common stock for issuance. Participants eligible under the 2008 Plan are officers, key employees and directors. There were a total of 10,000,000 options issued and outstanding under the 2008 Plan at June 30, 2011.
The table below reflects the activity and assumptions with respect to the 2005 Plan and the 2008 Plan through June 30, 2011:
Mr. McMillen and Mr. Brigante forfeited 5,800,000 and 750,000 options in the 2005 Plan, respectively, in connection to signing their employment agreements on June 15, 2011. Mr. McMillen and Mr. Brigante forfeited 50,000,000 and 8,750,000 options in the 2008 Plan, respectively, in connection to signing their employment agreements on June 15, 2011. Mr. Griffin, our former director, forfeited 5,000,000 options in the 2008 Plan upon his resignation as a Director on May 27, 2011. For additional information on the Company’s option plans, please refer to Note 11 to Consolidated Financial Statements.
Outstanding Equity Awards at Fiscal Year-End
At June 30, 2011, the Company did not have any outstanding equity awards, including non-performance based awards, to each of the executive officers named in the Summary Compensation Table.
Nonqualified Deferred Compensation
The Company does not have any non-qualified deferred compensation plans.
Potential Payments Upon Termination or Change-In-Control
We have entered into agreements that require us to make payments and/or provide benefits to certain of our executive officers in the event of a termination of employment or change-in-control.
The following summarizes the potential payments to each named executive officer with whom we have entered into such an agreement, assuming that one of the events identified below occurs.
C. Thomas McMillen
On June 15, 2011, the Company and Mr. McMillen entered into an employment agreement. The agreement is terminable by the Company for cause or upon ninety days prior written notice without cause and by Mr. McMillen for good reason (as such terms are defined in the agreement) or upon ninety days prior written notice without good reason. If the Company terminates Mr. McMillen without cause or Mr. McMillen terminates his employment for good reason during the term of employment, then the Company will pay Mr. McMillen: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, (ii) the base salary that the Mr. McMillen would have received had he remained employed through the expiration date of his agreement, (iii) a pro-rated bonus, if any, (iv) the special bonus described above and the bonus from the prior year, if unpaid, (v) health and/or dental insurance coverage pursuant to COBRA until the date that is one year following the termination date or until Mr. McMillen is eligible for comparable coverage with a subsequent employer, whichever occurs first, and (vi) any accrued, but unpaid compensation prior to the termination. If the Company terminates Mr. McMillen without cause or Mr. McMillen terminates his employment for good reason following the expiration date, then the Company will pay Mr. McMillen: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, and (ii) any accrued, but unpaid compensation prior to the termination.
The agreement is terminable by the Company for cause or upon ninety days prior written notice without cause and by Mr. McMillen for good reason (as such terms are defined in the agreement) or upon ninety days prior written notice without good reason. If the Company terminates Mr. McMillen without cause or Mr. McMillen terminates his employment for good reason during the term of employment, then the Company will pay Mr. McMillen: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, (ii) the base salary that the Mr. McMillen would have received had he remained employed through the expiration date of his agreement, (iii) a pro-rated bonus, if any, (iv) the special bonus and the bonus from the prior year, if unpaid, (v) health and/or dental insurance coverage pursuant to COBRA until the date that is one year following the termination date or until Mr. McMillen is eligible for comparable coverage with a subsequent employer, whichever occurs first, and (vi) any accrued, but unpaid compensation prior to the termination. If the Company terminates Mr. McMillen without cause or Mr. McMillen terminates his employment for good reason following the expiration date, then the Company will pay Mr. McMillen: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, and (ii) any accrued, but unpaid compensation prior to the termination.
In addition, Mr. McMillen is eligible for a one-time special bonus in an amount equal to $726,665 on the earlier of (i) December 31, 2011, and (ii) change of control of the Company. The special bonus shall be reduced by the amount of principal and interest now owed by Mr. McMillen, as a result of his stepping in as guarantor of the obligations of SAAH pursuant to that certain promissory note, dated June 1, 2007, by and between the Company and SAAH, which is now in default. “Change in control” is defined as the earlier of December 31, 2011, or a change in control, which is defined as the date (i) that any one person (for purposes herein, “person” includes an individual or entity), or more than one person acting as a group, acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons), assets from the Company that have a total gross fair market value equal to or more than forty percent (40%) of the total gross fair market value of all of the assets of the Company immediately before such acquisition or acquisitions (which, for the sake of clarity, includes the sale of the Company’s Safety and Ecology Corporation subsidiary); (ii) that any one person, or more than one person acting as a group, is or becomes the beneficial owner, directly or indirectly, of forty percent (40%) or more of the voting stock of the Company; or (iii) of a consummation of a merger, consolidation, share exchange or similar form of corporate reorganization (a “Business Combination”) of the Company with or into any other entity other than a Business Combination in which the shares of the Company outstanding immediately before such Business Combination are exchanged or converted into or constitute shares which represent sixty (60%) or more of the surviving entity’s voting capital stock after such Business Combination. Notwithstanding the foregoing, under no circumstances shall a Change of Control occur under this Agreement if it results from the sale of the Company’s assets to an entity in which more than fifty percent (50%) of the total voting power is owned by the Company’s shareholders (individually or in the aggregate) who own (individually or in the aggregate), more than fifty percent (50%) of the total voting power of the Company.
Michael T. Brigante
On June 15, 2011, the Company and Mr. Brigante entered into an employment agreement. The agreement is terminable by the Company for cause or upon ninety days prior written notice without cause and by Mr. Brigante for good reason (as such terms are defined in the agreement) or upon ninety days prior written notice without good reason. If the Company terminates Mr. Brigante without cause or Mr. Brigante terminates his employment for good reason during the term of employment, then the Company will pay Mr. Brigante: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, (ii) the base salary that the Mr. Brigante would have received had he remained employed through the expiration date of his agreement, (iii) a pro-rated bonus, if any, (iv) the special bonus and the bonus from the prior year, if unpaid, (v) health and/or dental insurance coverage pursuant to COBRA until the date that is one year following the termination date or until Mr. Brigante is eligible for comparable coverage with a subsequent employer, whichever occurs first, and (vi) any accrued, but unpaid compensation prior to the termination. If the Company terminates Mr. Brigante without cause or Mr. Brigante terminates his employment for good reason following the expiration date, then the Company will pay Mr. Brigante: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, and (ii) any accrued, but unpaid compensation prior to the termination.
In addition, Mr. Brigante is eligible for a one-time special bonus in an amount equal to $124,462.66 on the earlier of (i) December 31, 2011, and (ii) change of control of the Company (as such term is defined in the agreement).
The following table outlines the potential payments that would be made to Messrs. McMillen and Brigante, assuming separation from the Company on June 30, 2011 under the following circumstances:
Golden Parachute Compensation
The table below sets the potential golden parachute compensation that Christopher P. Leichtweis would have received, assuming the consummation of the sale of Safety occurred on June 30, 2011:
(1)
Mr. Leichtweis, together with two additional executives and certain key employees, are entitled to a retention bonus of an aggregate of $100,000.00, as described above, if they remain employed until the closing of the Purchase Agreement.
Director Compensation
The following table shows the total compensation paid or accrued during the fiscal year ended June 30, 2011 to each of our non-employee directors:
Each director of the Company, except Mr. McMillen and Mr. Leichtweis, is entitled to receive a quarterly fee for his service as a director. Each director of the Company will be reimbursed for reasonable expenses incurred in connection with their service on the Board of Directors. The following table reflects each director’s fee per quarter during the year ended June 30, 2011:
In addition to the quarterly payment of fees listed above, each Messer’s McNeill and Kaplan received a $25,000 director’s fee adjustment in the fourth quarter and Mr. Griffin received a $50,000 director’s fee adjustment in the fourth quarter.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information with respect to the beneficial ownership of our Common Stock as of September 30, 2011 for (a) our named executive officers, (b) each of our directors, (c) all of our current directors and executive officers as a group, and (d) each stockholder known by the us to own beneficially more than 5% of each class of our shares of Common Stock, relying solely upon the amounts and percentages disclosed in their public filings.
Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. We deem shares of common stock that may be acquired by an individual or group within 60 days of September 30, 2011 pursuant to the exercise or conversion of options or warrants to be outstanding for the purpose of computing the percentage ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table. Except as indicated in footnotes to this table, we believe that the stockholders named in this table have sole voting and investment power with respect to all shares of stock shown to be beneficially owned by them based on information provided to us by these stockholders.
Percentage of ownership is based on 55,159,022 shares of Common Stock outstanding as of September 30, 2011.
The address for each of the directors and named executive officers is c/o Homeland Security Capital Corporation., 4601 North Fairfax Road, Suite 1200, Arlington, Virginia 22203. Addresses of other beneficial owners are noted in the table.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
On June 1, 2007, the Company loaned $500,000 to SAAH, an entity controlled by two of our directors, and the initial stockholder and founder of SAAC. SAAC was formed for the purpose of acquiring, or acquiring control of, through a merger, capital stock exchange, asset acquisition, stock purchase or other similar business combination, one or more domestic or international operating businesses. SAAH, in turn, loaned the $500,000 to SAAC. SAAC ultimately consummated its initial business combination with UEI and changed its name to UEI. The loan is evidenced by a note bearing 5% interest per annum, which was due on or before May 31, 2011, with no prepayment penalties. The loan is guaranteed in its entirety by our Chairman and Chief Executive Officer. The Company expected repayment of the loan from the proceeds of the sale by SAAH of its founder warrants and ultimately by UEI. On September 20, 2010, UEI filed for bankruptcy protection. At June 30, 2011 and 2010, the balance of the note, including interest, was $449,127 and $444,515, respectively. As guarantor of this note, our Chairman and Chief Executive Officer has the intent and ability to satisfy any obligations under this note.
Safety leases approximately 21,000 square feet of office space from a company controlled by our President. The space, in Knoxville, Tennessee, serves as the headquarters for Safety. The total rent paid during the twelve months ended June 30, 2011 and 2010 was $344,000, respectively.
Safety, in the normal course of business, is required to post a performance bond on certain projects. Typically, the bonding or surety company who posts the bond on Safety’s behalf will require collateralization of their potential liability for posting the bond. Through June 30, 2011, our President and his spouse have guaranteed this potential liability.
The Company recognizes the potential exposure to our President and his spouse and, on January 1, 2011, entered into an agreement with him and his spouse, indemnifying them against any liabilities they may endure as a result of collateralizing Safety’s bonding requirements and agreed to pay them a standard fee for this collateralization. Through June 30, 2011, the Company paid our President and his spouse $61,958 under the indemnity agreement. Through June 30, 2011, the amount of possible indemnification to the President and his spouse was approximately $13,000,000.
On July 29, 2011, the Company’s Chief Executive Officer and the Company’s Chief Financial Officer purchased 15 and 5 Class B membership units of Holdings, respectively, both for nominal amounts. The limited liability operating agreement of Holdings provides, among other things, that Class B members cannot participate in or receive any financial benefit from their Class B membership units if and until the Company’s total purchase price of the Class A membership units ($1,800,000) is fully repaid, including any interest thereon, and any other loans or advances made by the Company to Holdings are repaid, including any interest thereon, at which time the will be entitled to a 20% carry and a pro rata participation in any distributions made by Holdings thereafter.
We believe that each of the above referenced transactions was made on terms not materially less favorable to us than could have been obtained from an unaffiliated third party. Furthermore, any future transactions between us and officers, directors, principal stockholders or affiliates, will be on terms not materially 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.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents fees for professional audit services rendered by Coulter & Justus, P.C. for the audit of our annual financial statements for the fiscal years ended June 30, 2011 and 2010. And fees billed for other services rendered by Coulter & Justus P.C. during those periods.
(1)
Audit fees represent fees of Coulter & Justus P.C. for the audit of the Company’s annual consolidated financial statements; review of the Company’s quarterly results of operations and reports on Form 10-Q; and the services that an independent registered public accounting firm would customarily provide in connection with subsidiary audits, other regulatory filings, and similar engagements for each fiscal year shown, such as consents and assistance with review of documents filed with the Commission.
Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors
Effective May 6, 2003, the Commission adopted rules that require that before an independent registered public accounting firm is engaged by us to render any auditing or permitted non-audit related service, the engagement must first be:
•
approved by our audit committee; or
•
entered into pursuant to pre-approval policies and procedures established by the audit committee, provided the policies and procedures are detailed as to the particular service, the audit committee is informed of each service, and such policies and procedures do not include delegation of the audit committee’s responsibilities to management.
Our audit committee was formed in February 2006, and has assumed responsibility for the pre-approval of audit and permitted non-audit services to be performed by our Company’s independent auditor. The audit committee will, on an annual basis, consider and, if appropriate, approve the provision of audit and non-audit services by Counter & Justus, P.C. Thereafter, the audit committee will, as necessary, consider and, if appropriate, approve the provision of additional audit and non-audit services by Coulter & Justus, P.C. which are not encompassed by the audit committee’s annual pre-approval and are not prohibited by law. The audit committee has delegated to the chair of the audit committee the authority to pre-approve, on a case-by-case basis, non-audit services to be performed by Coulter & Justus, P.C.
Since we did not have an audit committee in 2005, our full board of directors considered the nature of services performed by HJ & Associates, LLC, our audit firm at that time, and found them to be compatible with maintaining HJ & Associates’ independence. Subsequently, following the acquisition of Safety, our full board of directors considered the nature of services performed by Coulter & Justus, P.C. and found them to be compatible with maintaining Coulter & Justus, P.C.’s independence.
Prior to engagement of an independent registered public accounting firm for the next year’s audit, management will submit an aggregate of services expected to be rendered during that year for each of four categories of services to the Audit Committee for approval.
1. Audit services include audit work performed in the preparation of financial statements, as well as work that generally only an independent registered public accounting firm can reasonably be expected to provide, including comfort letters, statutory audits, and attest services and consultation regarding financial accounting and/or reporting standards.
2. Audit-Related services are for assurance and related services that are traditionally performed by an independent registered public accounting firm, including due diligence related to mergers and acquisitions, employee benefit plan audits, and special procedures required to meet certain regulatory requirements.
3. Tax services include all services performed by an independent registered public accounting firm’s tax personnel except those services specifically related to the audit of the financial statements, and includes fees in the areas of tax compliance, tax planning, and tax advice.
4. Other Fees are those associated with services not captured in the other categories. The Company generally does not request such services from our independent registered public accounting firm.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) (1) and (2) The following documents are filed as part of this Annual Report on Form 10-K:
Reference is made to the Index to Consolidated Financial Statements on Page. Other financial statement schedules have not been included because they are not applicable or the information is included in the financial statements or notes thereto.
(a) (3) Exhibits:

Indicates management compensatory plan, contract or arrangement.
*
Filed herewith.
**
Furnished herewith.
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
Chief Executive Officer
(Principal Executive Officer)
October 6, 2011
/s/ Michael T. Brigante
Michael T. Brigante
Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
October 6, 2011
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.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Homeland Security Capital Corporation
We have audited the accompanying consolidated balance sheets of Homeland Security Capital Corporation and subsidiaries (the “Company”) as of June 30, 2011 and 2010, and the related consolidated statements of operations, stockholders’ deficit and comprehensive loss, and cash flows for each of the years in the two-year period ended June 30, 2011. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we perform the audits 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 audits 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 financial statements referred to above present fairly, in all material respects, the financial position of Homeland Security Capital Corporation and subsidiaries as of June 30, 2011 and 2010, and the results of its operations and its cash flows for each of the two-year period ended June 30, 2011 in conformity with accounting principles generally accepted in the United States of America.
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, Related Party Senior Notes Payable totaling $19,725,040 are due and payable, the Company has incurred a loss from operations for year ended June 30, 2011 and has a net capital deficiency in addition to a working capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters are described in Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Coulter & Justus, P.C.
Knoxville, Tennessee
September 30, 2011
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
The accompanying notes are an integral part of these consolidated financial statements.
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
The accompanying notes are an integral part of these consolidated financial statements.
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these consolidated financial statements.
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Changes in Stockholders’ Deficit and Comprehensive Loss
The accompanying notes are an integral part of these consolidated financial statements.
HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Organization and Nature of Business
Homeland Security Capital Corporation (together with any subsidiaries shall be referred to as the “Company,” “we,” “us” and “our”) is a consolidator of companies, whose current operating companies provide title, escrow and asset management real estate services. We are focused on creating long-term value by taking a controlling interest in and developing our subsidiary companies through superior operations and management. We intend to operate businesses that provide real estate services, growing organically and by acquisitions. The Company is targeting emerging companies that are generating revenues but face challenges in scaling their businesses to capitalize on growth opportunities.
The Company was incorporated in Delaware in August 1997 under the name “Celerity Systems Inc.” In December 2005, the Company amended its Certificate of Incorporation to change its name to “Homeland Security Capital Corporation.”
In fiscal year 2011, the Company announced it was considering strategic alternatives to retire part or all of its debt, including the sale of one or all of its current subsidiaries. Accordingly, the Company developed a coordinated plan to dispose of its operations and use the proceeds from the sale of its subsidiaries to retire debt. On July 15, 2011, the Company signed a definitive agreement to sell its wholly owned Safety subsidiary. On August 19, 2011, the Company sold the assets and related operations of its majority owned Nexus subsidiary.
On July 6, 2011, the Company, through a newly formed subsidiary, Fiducia Holdings, LLC (Holdings), acquired 80% of Fiducia Real Estate Solutions, Inc. (FRES). This acquisition along with the decision to sell its current subsidiaries initiated a change in the Company’s business plan by effectively changing our overall focus to pursuing new lines of business outside of the homeland security sector. Although the Company has not dismissed future acquisitions in the homeland security sector or other business sectors, its primary focus will be in the real estate services industry sector.
The Company’s primary business plan will continue to be the owner of a majority of the outstanding capital stock of any of its subsidiaries, to control each of its subsidiary boards of directors and to provide extensive management and advisory services to its subsidiaries. Accordingly, the Company believes it will exercise sufficient control over the operations and financial results of each of its subsidiaries and will consolidate the results of operations, eliminating minority interests when such minority interests have a basis in the consolidated entity.
2. Summary of Significant Accounting Policies
Fiscal Year-End - The Company’s fiscal year ends on June 30. All references in these consolidated financial statements refer to the fiscal year end (June 30), unless otherwise specified.
Principles of Consolidation - The consolidated financial statements in this Annual Report include the continuing operations of the holding company and the segregated discontinued operations of wholly owned subsidiary Safety (including Safety’s wholly owned United Kingdom subsidiary SECL and majority owned subsidiary Radcon Alliance, LLC) and majority owned subsidiaries Nexus (including its wholly owned subsidiary CSS) and PMX. All significant inter-company transactions and balances have been eliminated in consolidation.
Foreign Operations (related to discontinued operations) - SECL, a United Kingdom corporation, which is wholly owned by Safety, has total assets of $128,353 and $214,137, total liabilities of $11,720 and $752,711 and a net loss of $119,121 and $442,788 as of and for the periods ending June 30, 2011 and 2010, respectively, which are included in the Company’s discontinued operations for those periods.
The financial statements of SECL are translated using exchange rates in effect at year-end for assets and liabilities and average exchange rates during the year for results of operations. The related translation adjustments are reported as a separate component of shareholders’ equity.
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.
Estimates are used when accounting for amounts recorded in revenue when applying percentage of completion accounting, fair value determination of assets and liabilities, impairment of long-lived assets (including goodwill and other intangible assets), collectability of accounts receivable, share based compensation assumptions and valuation allowance related to deferred tax assets.
The estimates we make are subject to several factors including management’s judgment, the industry in which we conduct our operations, the overall economy, market valuations concerning certain assets and liabilities and the government. Although we believe our estimates take into consideration the effect of these various factors, uncertainty still exists in such estimates and actual results may differ from our estimates.
Fair Value of Financial Instruments - The carrying amount of items included in working capital approximate fair value as a result of the short maturity of those instruments. The carrying value of the Company’s debt from 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.
Revenue Recognition (related to discontinued operations) - The Company recognizes revenue when it is realized or realizable and earned less estimated future doubtful accounts. The Company considers revenue realized or realizable and earned when all of the following criteria are met:
(i)
persuasive evidence of an arrangement exists,
(ii)
the services have been rendered and all required milestones achieved,
(iii)
the sales price is fixed or determinable, and
(iv)
collectability is reasonably assured.
Revenues are derived primarily from services performed under time and materials and fixed fee contracts and products sold. Revenues and costs derived from fixed price contracts are recognized using the percentage of completion (efforts expended) method. Revenue and costs derived from time and material contracts are recognized when revenue is earned and costs are incurred. Revenue and costs based on sale of products are derived when the products have been delivered and accepted by the customer.
Deferred Revenue (related to discontinued operations) - Revenue from service contracts, for which the Company is obligated to perform, is recorded as deferred revenue and subsequently recognized over the term of the contract.
Contract costs from discontinued operations include all direct labor, materials, and other non-labor costs and those indirect costs related to contract support, such as depreciation, fringe benefits, overhead labor, supplies, tools, repairs and equipment rental. General and administrative costs from continuing and discontinued operations are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts for discontinued operations are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability, including those arising from contract penalty provisions, and final contract settlements for discontinued operations may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Because of inherent uncertainties in estimating costs for discontinued operations, it is at least reasonably possible the estimates used will change within the near term.
Cash and Cash Equivalents - The Company considers all investments with a maturity of three months or less when purchased to be cash equivalents. Cash consists of cash on hand and deposits in banks.
Recognition of Losses on Receivables (related to discontinued operations) - Trade accounts receivable are recorded at their estimated net realizable values using the allowance method. The Company generally does not require collateral from customers. Management periodically reviews accounts for collectability, including accounts determined to be delinquent based on contractual terms. An allowance for doubtful accounts is maintained at the level management deems necessary to reflect anticipated credit losses. When accounts are determined to be uncollectible, they are charged off against the allowance for bad debts. At June 30, 2011 and 2010 the Company had a consolidated bad debt allowances reported in discontinued operations of approximately $248,840 and $229,340, respectively.
Property and Equipment - 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 improvements 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 amortized on a straight line basis over the term of the related debt, most of which is in the form of senior secured notes. Should there be an early extinguishment of the debt prior to the stated maturity date; the remaining unamortized cost is expensed. Amortization expense amounted to $0 and $378,210 in 2011 and 2010, respectfully. At June 30, 2010 all debt offering costs were fully amortized.
Investments in Assets Held for Sale - As of June 30, 2011 and 2010 the shares in Vuance Ltd. held by the Company were classified as assets held for sale. Under this classification, securities are carried at fair value (period end market closing prices) with unrealized gains and losses excluded from earnings and reported in a separate component of shareholder’s equity until the gains or losses are realized or a provision for impairment is recognized.
At June 30, 2011, the discontinued operations of Safety, Nexus and PMX are also classified as assets held for sale. The combined results of their operations, assets and liabilities and are reported as separate line items within our financial statements. The assets are measured at the lower of their carrying amount or fair value, with the fair value based upon recent offers received for the assets. Depreciation expense associated with the assets has ceased and no impairment loss has been recorded associated with the assets.
Investment Valuation (related to continuing operations) - Investments in equity securities are recorded at fair value. The fair value of investments that have no ready market, are recorded at the lower of cost or a value determined in good faith by management and approved by the Board of Directors, based on assets and revenues of the underlying investee companies as well as the general market trends for businesses in the same industry. Because of the inherent uncertainty of valuations, management’s estimates of the value of our investments may differ significantly from the values that would have been used had a ready market for the investment existed and the differences could be material.
Income Taxes - Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates as of the date of enactment.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income.
Stock Based Compensation - Share based payments are measured at fair value on the awards’ grant date, based on the estimated number of awards that are expected to vest and are reflected as compensation cost in the financial statements.
Valuation of Options and Warrants - The valuation of options and warrants granted to unrelated parties for services are measured as of the earlier of: (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. The options and warrants will continue to be revalued in situations where they are granted prior to the completion of the performance.
Employee Benefit Plans - Safety has a 401(k) profit sharing plan covering substantially all its employees. Employees are allowed to make before-tax contributions to the plan, through salary reductions, up to the legal limits as described under the Internal Revenue Code. Any company match is discretionary. Safety contributed $432,532 and $332,307 to its plan during 2011 and 2010, respectively.
SECL, a wholly owned subsidiary of Safety, has a group stakeholder pension scheme for the benefit of its employees. The plan covers substantially all SECL employees and provides for SECL to contribute at least three percent of the eligible employee’s compensation to the plan. SECL contributed $0 and $582 to their plan during 2011 and 2010, respectively.
Nexus has a salary deferral plan covering substantially all its employees. Employees are allowed to make before-tax contributions to the plan, through salary reductions, up to the legal limits as described under the Internal Revenue Code. Any company match is discretionary. Nexus did not contribute any amount to its plan during 2011 and 2010, respectively.
The holding company has a salary deferral plan covering all its employees. Employees are allowed to make before-tax contributions to the plan, through salary reductions, up to the legal limits as described under the Internal Revenue Code. Any company match is discretionary. The holding company contributed $40,809 and $0 to its plan during 2011 and 2010, respectively.
Impairment of Long-Lived Assets - The Company reviews long-lived assets 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.
Net Earnings (Loss) Per Share - The Company computes basic earnings (loss) per share by dividing net income (loss) attributable to common stockholders, by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share are computed by dividing net income attributable to common stockholders, by diluted weighted average shares outstanding. Potentially dilutive shares include the assumed exercise of stock options and warrants, the assumed conversion of preferred stock and the assumed vesting of stock option grants (using the treasury stock method), if dilutive.
Reclassifications - As a result of classifying certain of its operations as discontinued, certain prior year’s balances have been reclassified to conform to the current year presentation.
Recent Accounting Pronouncements
In September 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-08, Intangibles - Goodwill and Other (Topic 350). This Accounting Standards Update amends FASB ASC 350. This amendment specifies the change in method for determining the potential impairment of goodwill. It includes examples of circumstances and events that the entity should consider in evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company is currently assessing the impact on its consolidated financial statements.
In December 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-29, Business Combinations (Topic 805). This amendment specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined period as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in this ASU also expand the supplemental pro forma disclosures under FASB ASC 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments of this ASU are effective prospectively for business combinations for which the acquisition date in on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company is currently assessing the impact on its consolidated financial statements.
3. Going Concern
The primary source of financing for the Company since its inception has been through the issuance of equity and debt securities. The accompanying financial statements have been prepared assuming the Company will continue as a going concern which contemplates the realization of assets and liquidation of liabilities in the normal course of business. As of June 30, 2011, the Company has a stockholders’ deficit of $6,791,297. Management recognizes it will be necessary to continue to generate positive cash flow from operations and have availability to other sources of capital to continue as a going concern and has implemented measures to increase profitability and has committed to sell certain operations, using such sale proceeds to re-pay debt. Additionally, management believes the acquisition of new, more profitable operations in new lines of business and the further reduction of certain operating expenses will have positive impact on cash flow. Management also recognizes that its inability to repay outstanding debt could result in foreclosure on the assets of the Company.
As mentioned above, the Company intends to sell its subsidiaries using the proceeds to repay debt. On August 19, 2011, the Company closed the sale of Nexus and used $1,733,917 from the sale proceeds to repay debt. On July 15, 2011, the Company entered into an agreement to sell Safety and as of the date of this filing an agreement on the terms of this sale has not been reached and there can be no assurance an agreement will be reached. The Company will be unable to repay its debt if a sale of Safety is not completed.
Forbearance Agreement with YA
On July 29, 2011, the Company, entered into a Forbearance Agreement by and among YA Global Investments, L.P., as lender (Lender), Homeland Security Advisory Services, Inc., Celerity Systems, Inc. and Nexus Technology Group, Inc. (the “Agreement”), pursuant to which the Lender agreed to forbear from exercising its rights and remedies under the Financing Documents (as defined therein) and applicable law with respect to one or more Events of Default (as defined in the Financing Documents) that have occurred and are continuing as a consequence of the Company having failed to pay, when due at maturity, all outstanding principal and accrued and unpaid interest under the Company’s outstanding debt with the Lender (the “Existing Defaults”). The forbearance period ends on the earlier of (i) August 31, 2011 and (ii) the occurrence of a “Termination Event,” defined in the Agreement as (a) the failure of the Company or any Guarantor (as defined in the Agreement) to perform or comply with any term or condition of the Agreement; (b) the determination by the Lender that any warranty or representation made by the Company or any Guarantor in connection with the Agreement was false or misleading; (c) the occurrence of a materially adverse change in or to the collateral granted to the Lender under the Financing Documents and/or pursuant to the Agreement, as determined by the Lender in its sole and exclusive discretion; and (d) the occurrence of any default and/or Event of Default (other than the Existing Defaults) under the Financing Documents.
As a condition to the entry to the Agreement, the Company has undertaken to grant to the Lender a security interest in its Class A membership interests in its new subsidiary, Fiducia Holdings LLC (“Holdings”) (see note 18), and to cause Holdings to guarantee the Company’s obligations to the Lender and grant a security interest in the capital stock it owns in its subsidiary, Fiducia Real Estate Holdings, Inc.
On September 7, 2011, the Company, entered into the First Amendment (the “Amendment”) to the Forbearance Agreement entered into by and among YA Global Investments, L.P., as lender (“Lender”), the Company, Homeland Security Advisory Services, Inc., Celerity Systems, Inc. and Nexus Technologies Group, Inc. (the “Agreement”), pursuant to which the Lender agreed to extend the Forbearance Period (as defined in the Agreement) by amending the definition of “Termination Date” to September 14, 2011. As amended, the Forbearance Period now ends on the earlier of (i) September 14, 2011 and (ii) the occurrence of a “Termination Event,” defined in the Agreement, as (a) the failure of the Company or any Guarantor (as defined in the Agreement) to perform or comply with any term or condition of the Agreement; (b) the determination by the Lender that any warranty or representation made by the Company or any Guarantor in connection with the Agreement was false or misleading; (c) the occurrence of a materially adverse change in or to the collateral granted to the Lender under the Financing Documents and/or pursuant to the Agreement, as determined by the Lender in its sole and exclusive discretion; and (d) the occurrence of any default and/or Event of Default (other than the Existing Defaults) under the Financing Documents.
Upon the expiration of the Forbearance Agreement mentioned above (September 14, 2011), the Company is subject to foreclosure without notification. As of the date of this filing the Lender has not notified the Company it intends to exercise any of its rights or remedies under the Financing Documents or applicable law with respect to our default under the agreement.
During the course of fiscal year 2012, it remains management’s intention to continue to explore all options available to the Company, which include among other things, sale of subsidiaries, additional profitable acquisitions, private placements and significant expense reductions where ever possible.
4. Discontinued Operations
During fiscal year 2011, the Company considered the sale of one or all of its current subsidiaries and using the proceeds from any sale of a subsidiary to re-pay debt. Accordingly, the Company developed a coordinated plan to dispose of its subsidiaries and retained advisors to assist it in the marketing and sale of subsidiary operations. On July 15, 2011, the Company signed a definitive agreement to sell its wholly owned Safety subsidiary. On August 19, 2011, the Company sold its majority owned Nexus subsidiary. The results of operations of these subsidiaries, along with PMX, are reported as “discontinued operations” and assets and liabilities have been separated on the balance sheet.
Contract revenues of approximately $105,000,000 in 2011 and $98,000,000 in 2010 are included in discontinued operations. Included in contract revenues are approximately $2,400,000 in 2011 and $1,400,000 in 2010 of unbilled claims for costs incurred in excess of contracted amounts for which Safety believes they have a legal right to recover. However the ultimate realization is subject to change in the near term.
Revisions in contract profits are made in the period in which circumstances requiring the revision become known. The effect of changes in estimates of contract profits was to decrease net income by approximately $3,100,000 in 2011 from that which would have been reported had the revised estimates been used as the bases of recognition of contract profits in the proceeding period.
5. Fair Value Measurements
The Company follows Topic 820 - Fair Value Measurements and Disclosures (“FASB ASC 820”), formerly known SFAS 157 Fair Value Measurements, which, among other things, requires enhanced disclosures about assets and liabilities carried at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. We primarily apply the market approach for recurring fair value measurements and attempt to utilize the best available information. FASB ASC 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and lowest priority to unobservable inputs (level 3 measurements). The three levels of fair value hierarchy are as follows:
Level 1 - Quoted prices are available in active markets for identical assets or liabilities as of the reporting date.
Level 2 - Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.
Level 3 - Unobservable inputs for the asset or liability.
As of September 30, 2010, the Company reduced the carrying value of its securities available for sale in Vuance, Ltd (692,058 ordinary shares of Vuance, Ltd; OTCQB - VUNCF, the “Vuance Shares”) to zero as a result of inactive and illiquid markets for the Vuance Shares. The Company does not believe the quoted prices represent the actual value appurtenant to Vuance Shares. Consequently, the Company regards the value of the Vuance Shares available for sale as permanently impaired and has recorded a loss in the amount of $263,210 for the year ended June 30, 2011.
Additionally, as of March 31, 2011, the Company reduced the carrying value of its securities available for sale in Ultimate Escapes, Inc. (NYSE Amex: UEI; formerly known as Secure America Acquisition Corporation, or “SAAC;” referred to herein as “UEI”) as a result of inactive and illiquid markets and filing for bankruptcy protection by UEI on September 20, 2010. The Company is the beneficial owner of 40,912 shares of common stock of UEI through its membership interests in Secure America Acquisition Holdings, LLC (“SAAH”). Accordingly, the Company considers its investment in SAAH’s membership units permanently impaired and has recorded a loss in the amount of $45,004 for the year ended June 30, 2011.
6. Goodwill
Goodwill on acquisition is initially measured at cost being the excess of the cost of the business acquired including directly related professional fees over the Company’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities.
Following initial recognition, goodwill is measured at cost less any accumulated impairment losses. Goodwill is entirely related to Safety and is tested for impairment annually or more frequently if events or changes in circumstances indicate that the carrying amount may be impaired. The impairment review requires management to undertake certain judgments, including estimating the recoverable value of the business acquired to which the goodwill relates, based on either fair value less costs to sell or the value in use, in order to reach a conclusion on whether it deems the goodwill to be recoverable. Estimating the fair value less costs to sell is based on the best information available, and refers to the amount at which the business acquired could be sold in a current transaction between willing parties. The valuation methods are based on an earnings multiple approach. The earnings multiple approach uses transaction multiples, obtained from comparable businesses in the industry sector in which the acquired business operates. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects management’s estimate of return on capital employed, which is subject to a value in use calculation.
Any impairment is recognized immediately in the income statement and is not subsequently reversed. No goodwill impairment has been recognized in 2011 or in 2010.
7. Minority Interest in Ultimate Escapes, Inc.
The Company has indirectly acquired a minority equity interest in Ultimate Escapes, Inc., a luxury destination club (“UEI”) (formerly known as Secure America Acquisition Corporation, or “SAAC”), as a result of the business combination between SAAC and Ultimate Escapes Holdings, LLC, which was consummated on October 29, 2009. Through its membership interests in Secure America Acquisition Holdings, LLC (“SAAH”), the original investor in SAAC, the Company was deemed to beneficially own 40,912 shares, or approximately 1.5% of the outstanding capital stock of UEI, at June 30, 2010, and was entitled to receive such shares of common stock in UEI upon the release of SAAH’s shares from escrow, which was expected in October 2010.
On September 20, 2010, UEI filed for protection under Chapter 11 of the U.S. Bankruptcy Code. Since the date of UEI’s Chapter 11 filing and through the date of this filing, no plan of reorganization has been made public and the Company’s believes the value in its indirect interest is zero. Additionally, the Company cannot determine with any degree of certainty if its loan to SAAH in the amount of $449,127 including interest, at June 30, 2011 is collectable under the circumstances, but believes its interests are secured by alternate means of payment (see Note 16 to the Consolidated Financial Statements).
8. Income Taxes
The Company and certain of its subsidiaries file income tax returns in the US and in various state jurisdictions. With few exceptions, the Company is no longer subject to US federal, state and local, or non-US income tax examinations by tax authorities for years before 2007.
The Internal Revenue Service (IRS) has not notified the Company of any scheduled examination of the Company’s US income tax returns for 2006 through 2010. As of June 30, 2011, the IRS has proposed no adjustments to the Company’s tax positions.
There are no amounts included in the balance at June 30, 2011 or 2010 for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.
It is the Company’s policy to recognize any interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. During 2011 and 2010, the Company recognized no interest or penalties.
The tax effects of temporary differences giving rise to the Company’s deferred tax assets (liabilities) are as follows:
As a result of significant historical pretax losses, management cannot conclude that it is more likely than not that the deferred tax asset will be realized. Accordingly, a full valuation allowance has been established against the total net deferred tax asset. Approximately $874,000 of the valuation allowance was allocated to reduce the goodwill of discontinued operations. Because the benefit of the deferred tax assets offset any provision for income tax purposes, the entire provision for income tax expense, if any, represents amounts currently due state tax jurisdictions for continuing operations. The valuation allowance increased by $1,058,354 to $17,633,225 in 2011 and decreased by $1,140,055 to $16,574,871 in 2010.
The Company’s income tax provision (benefit) differs from that obtained by using the federal statutory rate of 34% as a result of the following:
At June 30, 2011, the Company had an available net operating loss carryforward of approximately $42,330,392. This amount is available to reduce the Company’s future taxable income and expires in the years 2014 through 2031 as follows:
9. Related Party Senior Notes Payable
In June 2009 the Company entered into an agreement with YA extending the due date on its three senior notes payable, and accrued interest, to YA from March 14, 2010 until October 1, 2010 with respect to $2,500,000 and April 1, 2011 for the balance of the principal and accrued interest through that date. In exchange for the extension agreement, the Company agreed to an increase in the interest rate, from 13% to 15%, on the senior notes payable and certain other debt due to YA, effective January 1, 2010, if the Company failed to secure a certain contract by March 2010. In December 2009, the Company was informed that it had been eliminated from the award process for this contract. Accordingly, the Company began recording interest expense at the increased rate effective January 1, 2010.
In September 2010, the Company entered into a debt extension agreement with YA to extend the due dates for all senior notes payable and all accrued interest to July 15, 2011. As part of the agreement, the Company agreed to prepay $500,000 of the accrued interest due at June 30, 2010. On July 29, 2011, the Company entered into a forbearance agreement with YA whereby YA agreed to not exercise its rights or remedies under previous financing agreements or applicable law with respect to our default under the agreements. On September 7, 2011, YA agreed to an amendment to the forbearance agreement moving the default date to September 14, 2011. Upon expiration of this extension of the Forbearance Agreement, the Company is subject to foreclosure without notification. The debt is secured by all the assets of the Company. As of the date of this filing the debt due YA has not been repaid and YA has not discussed with the Company its future intentions.
The table below reflects the elements of the Company’s outstanding senior notes payable.
On August 19, 2011, the Company paid $1,733,917 from the proceeds of the sale of Nexus to reduce accrued interest.
10. Convertible Preferred Stock
At June 30, 2011, the Company had three series of convertible preferred stock outstanding. The information below sets out certain information about each series.
Series F
On October 6, 2005, the Company issued 1,000,000 shares of Series F Convertible Preferred Stock, par value $0.01 per share (the “Series F Preferred Stock”), to YA, a related party, pursuant to a securities purchase agreement. 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 liquidating 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 Series F Preferred Stock is convertible into shares of common stock at a conversion price equal to $0.10 per share, subject to availability. In 2005, the Company recorded a $1,000,000 dividend relative to the beneficial conversion feature. As of June 30, 2011, none of the Series F Preferred Stock has been converted into shares of common stock.
Series H
On March 17, 2008, the Company issued 10,000 shares of Series H Convertible Preferred Stock, par value $0.01 per share (the “Series H Preferred Stock”), to YA, a related party, pursuant to a securities purchase agreement. Proceeds from the issuance amounted to $10,000,000. The Series H Preferred Stock provides for preferential dividends at an annual rate of 12%. Also, the Series H Preferred Stock has a preferential liquidation amount of $1,000 per share or $10,000,000, plus all accumulated and unpaid dividends, which at June 30, 2011 amounted to $3,935,147. Each share of Series H Preferred Stock is initially convertible into 33,334 shares of common stock at a conversion price equal to $0.03 per share, subject to availability. In 2008, the Company recorded a $2,740,540 dividend relative to the beneficial conversion feature. As of June 30, 2011, 101 shares of the Series H Preferred Stock have been converted into 3,366,734 shares of common stock and 9,899 shares of Series H Preferred Stock are outstanding.
As described above, the Series H Stock was convertible into shares of common stock at an initial ratio of 33,334 shares of common stock for each share of Series H Stock, subject to adjustments, including achieving certain earnings milestones, as defined, for the calendar years ending December 31, 2009 and 2008. The second financial milestone for the calendar year ended December 31, 2009, was not satisfied, resulting in a potential adjustment to the conversion ratio yielding approximately 56,300 shares of common stock for each share of Series H Stock, or approximately a potential additional 224,000,000 shares of our common stock in the aggregate.
Management continues to discuss with YA the possibility of a waiver or amendment of any adjustment to the Series H Stock conversion ratio, however there can be no assurances YA will waive or amend the adjustment, if any, to the Series H Stock conversion ratio. YA has not exercised any of its conversion rights pertaining to the adjusted conversion ratio as of the date of this filing.
Series I
On March 13, 2008, the Company issued 550,000 shares of Series I Convertible Preferred Stock, par value $0.01 per share (the “Series I Preferred Stock”), to Safety and certain named individuals pursuant to a merger agreement. The initial value of the stock issued as merger consideration was $3,300,000. Upon issuance, a portion of the Series I Preferred Stock was placed in escrow to offset any indemnification claims or purchase price adjustments pursuant to the merger agreement. As of June 30, 2011, all of the Series I Preferred Stock has been released from escrow. The Series I Preferred Stock provides for preferential dividends at an annual rate of 12%. Also, the Series I Preferred Stock has a preferential liquidation amount of $6.00 per share or $3,303,300, plus all accumulated and unpaid dividends, which at June 30, 2011 amounted to $1,115,901. Each share of Series I Preferred Stock is convertible into 200 shares of common stock at a conversion price of $0.03 per share, subject to availability. As of June 30, 2011, none of the Series I Preferred Stock has been converted into shares of common stock.
The table below reflects the number of shares of common stock that would potentially be outstanding if: i) all series of preferred stock were to be converted into common stock; and ii) the Company was unable to obtain a waiver or amendment in the Series H Preferred Stock conversion ratio for the years ended June 30, 2011 and 2010, respectively, including accrued but unpaid dividends as of those dates.
11. Stock Options
Stock Options Awarded Under the 2005 Plan
There are 7,200,000 shares of common stock reserved for issuance upon exercise of options under the Company’s 2005 stock option plan (the “2005 Plan”). From August 2005 through October 2006, 6,800,000 options were granted under the 2005 Plan at strike prices ranging from $0.08 to $0.17. Of the options granted, all have fully vested, 6,550,000 have been forfeited through June 30, 2011, and $629,096 of total compensation expense has been recognized in the financial statements of the Company through that date. During the years ended June 30, 2011 and 2010, the Company recorded $0 and $2,500 as compensation expense, respectively, under the 2005 Plan. At June 30, 2011, there were 6,950,000 options available for award under the 2005 Plan. There have been no exercises of vested options under the 2005 Plan.
Stock Options Awarded Under the 2008 Plan
There are 75,000,000 shares of common stock reserved for issuance upon exercise of options under the Company’s 2008 stock option plan (the “2008 Plan”). In July 2008, 73,850,000 options were granted under the 2008 Plan at a strike price of $0.05. Of the options granted, all have fully vested, 33,360 have been exercised, 63,750,000 have been forfeited through June 30, 2011 and $2,669,709 of total compensation expense has been recognized in the financial statements of the Company through that date. During the years ended June 30, 2011 and 2010, the Company recorded $0 and $1,000,575 as compensation expense, respectively, under the 2008 Plan. At June 30, 2011, there are 64,966,640 options available for award under the 2008 Plan.
Stock Options Awarded Outside of the 2005 Plan and the 2008 Plan
From December 2005 through May 2007, the Company granted 2,760,000 options to three directors and one consultant outside of the 2005 Plan and the 2008 Plan at strike prices ranging from $0.12 to $0.17. All of these options have vested, 1,320,000 have been forfeited through June 30, 2011 and $390,000 of total compensation expense has been recognized in the financial statements of the Company through that date.
As of June 30, 2011, the Company has a total of 11,690,000 options outstanding at strike prices ranging from $0.05 to $0.17. A total of $3,688,805 in compensation expense has been recognized in the financial statements of the Company through that date.
Additional information about the Company’s stock option plans is summarized below:
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: risk-free interest rate of between 4.0% and 4.95%, volatility between 60% and 456% and expected lives of ten years. All options granted have a maximum three year service period.
Not included in the table above, but included in discontinued operations compensation expense, are options issued by our subsidiaries to purchase shares of the subsidiaries’ common stock in the future or accept cash settlements in exchange for the increased value of any vested options. Compensation expense for these options is calculated by comparing our discontinued operations to comparable publicly traded companies in their industry for stock volatility purposes and using the Black-Scholes option-pricing model.
12. Common Stock Warrants
On March 14, 2008, in connection with a securities purchase agreement with YA, the Company issued to YA a warrant to purchase up to 81,166,666 shares of its common stock. The YA warrant vested when granted and has an exercise price equal to $0.03 with a term of five years from the date of issuance of March 14, 2008. On July 19, 2011, YA exercised 5,041,181 warrants on a cashless basis and received 964,754 shares of common stock. As of September 23, 2011, YA has 76,125,485 warrants remaining, expiring on March 13, 2013.
On March 17, 2008, the Company issued warrants to purchase up to 22,000,000 shares of its common stock as part of the purchase consideration in the acquisition of Safety. A portion of the warrants were held in escrow, along with the Series I Preferred Stock to offset any indemnification claims or purchase price adjustments. As of June 30, 2011, all of the warrants have been released from escrow. The warrants have an exercise price of $0.03 with a term of five years from the date of issuance of March 17, 2008.
During 2006 and 2007, the Company issued 800,000 and 1,400,000 warrants, respectively, to two entities and one consultant. These warrants vested when granted and were issued in connection with our debenture financing, financial advisory services and investor relations consultation. The exercise price of these warrants range from $0.11 to $1.00. Of these warrants, 800,000 issued in 2006 have expired.
All warrants were valued using the Black Scholes pricing model with the following assumptions; risk-free interest rate of between 2.2% and 4.95%, volatility of between 60% and 456% and expected life of five years.
13. Earnings (Loss) Per Share
The basic earnings (loss) per share was computed by dividing the net income or loss applicable to common stockholders by the weighted average shares of common stock outstanding during each period.
Diluted earnings per share are computed using outstanding shares of common stock plus the Convertible Preferred Shares, common stock options and warrants that can be exercised or converted, as applicable, into common stock at June 30, 2011 and 2010.
The reconciliations of the basic and diluted income (loss) per share for income (loss) attributable to the Company’s stockholders are as follows:
14. Cash Flows
Supplemental disclosure of cash flow information for the twelve months ended June 30, 2011 and 2010 are as follows:
15. Commitments and Contingencies
Leases
The Company’s continuing operations did not have any long term lease commitments at June 30, 2011.
Rent expense related to continuing operations for the years ended June 30, 2011 and 2010 was $137,390 and $69,308, respectively.
Commitments
The Company, in the normal course of business, routinely enters into consulting agreements for services to be provided to the Company. These agreements are generally short term and are terminable by either party on sixty (60) days notice. As a result, the Company does not believe it has any material commitments to consultants. At June 30, 2011 and 2010, the Company has not recognized any material liabilities for loss contingencies.
Claims
During the ordinary course of business, the Company is subject to various disputes and claims and there are uncertainties surrounding the ultimate resolutions of these matters. Because of the uncertainties, it is at least reasonably possible that any amount recorded may change within the near term.
16. Related Party Transactions
Safety leases approximately 21,000 square feet of office space from a company controlled by our President. The Company recognized rent expense (in discontinued operations) under this agreement of $344,000 in 2011 and 2010.
Safety, in the normal course of business, is required to post a performance bond on certain projects. Typically, the bonding or surety company who posts the bond on Safety’s behalf will require collateralization of their potential liability for posting the bond. Through June 30, 2011, Our President has guaranteed this potential liability.
The Company recognizes the potential exposure to our President and, on January 1, 2011, entered into an agreement with him and his spouse, indemnifying them against any liabilities they may endure as a result of collateralizing Safety’s bonding requirements and agreed to pay them a standard fee for this collateralization. Through June 30, 2011, the Company paid our President and his spouse $61,958 under the indemnity agreement. Through June 30, 2011, the amount of possible indemnification to the President and his spouse was approximately $13,000,000.
On June 1, 2007, the Company loaned $500,000 to SAAH, an entity controlled by two of our directors, and the initial stockholder and founder of SAAC. SAAC was formed for the purpose of acquiring, or acquiring control of, through a merger, capital stock exchange, asset acquisition, stock purchase or other similar business combination, one or more domestic or international operating businesses. SAAH, in turn, loaned the $500,000 to SAAC. SAAC ultimately consummated its initial business combination with UEI.
The loan is evidenced by a note bearing 5% interest per annum and is due on or before May 31, 2011, with no prepayment penalties (see discussion below concerning CEO special bonus). The loan is guaranteed in its entirety by our Chairman and Chief Executive Officer. The Company expected repayment of the loan from the proceeds of the sale by SAAH of its founder warrants and ultimately by UEI. On September 20, 2010, UEI filed for bankruptcy protection. At June 30, 2011 and 2010, the balance of the note, including interest, was $449,127 and $430,627, respectively. Interest income related to this note was $18,500 for each of the years ended June 30, 2011 and 2010. Our Chairman and Chief Executive Officer intends to fulfill his guarantee has the ability to satisfy any obligations under this note.
We have entered into employment agreements that require us to make payments and/or provide benefits to certain of our executive officers in the event of a termination of employment or change-in-control.
The following summarizes the potential payments to each named executive officer with whom we have entered into such an agreement, assuming that one of the events identified below occurs.
On June 15, 2011, the Company and our CEO entered into an employment agreement. The agreement is terminable by the Company for cause or upon ninety days prior written notice without cause and by our CEO for good reason (as such terms are defined in the agreement) or upon ninety days prior written notice without good reason. If the Company terminates the agreement without cause or the CEO terminates his employment for good reason during the term of employment, then the Company will pay the CEO: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, (ii) the base salary that the CEO would have received had he remained employed through the expiration date of his agreement, (iii) a pro-rated bonus, if any, (iv) the special bonus described below and the bonus from the prior year, if unpaid, (v) health and/or dental insurance coverage pursuant to COBRA until the date that is one year following the termination date or until the CEO is eligible for comparable coverage with a subsequent employer, whichever occurs first, and (vi) any accrued, but unpaid compensation prior to the termination. If the Company terminates the agreement without cause or the CEO terminates his employment for good reason following the expiration date, then the Company will pay the CEO: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, and (ii) any accrued, but unpaid compensation prior to the termination.
In addition, the CEO is eligible for a one-time special bonus in an amount equal to $726,665 on the earlier of (i) December 31, 2011, and (ii) change of control of the Company (as such term is defined in the agreement). The special bonus shall be reduced by the amount of principal and interest now owed by our Chairman and CEO, as a result of his stepping in as guarantor of the obligations of SAAH pursuant to that certain promissory note, dated June 1, 2007, by and between the Company and SAAH, which is now in default.
On June 15, 2011, the Company and our CFO entered into an employment agreement. The agreement is terminable by the Company for cause or upon ninety days prior written notice without cause and by our CFO for good reason (as such terms are defined in the agreement) or upon ninety days prior written notice without good reason. If the Company terminates the agreement without cause or the CFO terminates his employment for good reason during the term of employment, then the Company will pay the CFO: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, (ii) the base salary that the CFO would have received had he remained employed through the expiration date of his agreement, (iii) a pro-rated bonus, if any, (iv) the special bonus described below and the bonus from the prior year, if unpaid, (v) health and/or dental insurance coverage pursuant to COBRA until the date that is one year following the termination date or until the CFO is eligible for comparable coverage with a subsequent employer, whichever occurs first, and (vi) any accrued, but unpaid compensation prior to the termination. If the Company terminates the agreement without cause or the CFO terminates his employment for good reason following the expiration date, then the Company will pay the CFO: (i) an amount equal to one year of his base salary at the rate in effect as of the termination date, and (ii) any accrued, but unpaid compensation prior to the termination.
In addition, the CFO is eligible for a one-time special bonus in an amount equal to $124,462 on the earlier of (i) December 31, 2011, and (ii) change of control of the Company (as such term is defined in the agreement).
On July 6, 2011, the Company formed a wholly owned subsidiary, Fiducia Holdings, LLC (Holdings), and purchased Class A membership units of Holdings. The Company’s CEO and the Company’s CFO purchased Class B membership units of Holdings for nominal amounts. The Class B membership interests can be deemed to own twenty percent (20%) of Holdings, but only after the Company receives its initial purchase price, plus any accrued interest.
17. Subsequent Events
Acquisitions
On July 5, 2011, the Company completed the acquisition of all of the assets and properties of, and the assumption of certain liabilities (Assets) from, Default Servicing, LLC, (Servicing) pursuant to the previously announced Asset Purchase Agreement the Company entered into on June 22, 2011 with Default Servicing USA, Inc. (Default), an indirect and majority-owned subsidiary of the Company, Default and DAL Group, LLC (Seller), the sole member of Default.
Default is engaged in the business of providing real estate-owned, liquidation-related services, including property inspection, eviction and broker assignment services. The Assets acquired include, among other things, certain contract rights of Servicing, certain office furniture and equipment located at their offices in Kentucky, and other rights and interests of Servicing.
In consideration for the Assets, the Company paid at closing an aggregate purchase price of $480,700 in cash. In addition, the Company may pay up to an additional amount of approximately $2.9 million in contingent payments, if any, subject to the achievement of specified net revenue measurement metrics during each calendar month through 2014. The purchase price was allocated by applying $33,455 to office furniture and equipment, $15,000 toward a non-compete agreement with the Chief Operating Officer and $432,245 to certain contract rights that were acquired.
Simultaneously with the completion of the acquisition of the Assets, the employment agreement between Default and its Chief Operating Officer became effective.
On July 29, 2011, the Company completed the acquisition of all of the issued and outstanding capital stock (Shares) of Timios, Inc. (Timios), pursuant to a Stock Purchase Agreement (Purchase Agreement) dated May 27, 2011, by and among the Company, Timios Acquisition Corp., an indirect and majority-owned subsidiary of the Company, DAL Group, LLC (Seller) and Timios, a wholly-owned subsidiary of Seller.
Timios and its subsidiaries are engaged in the business of providing settlement services and asset valuation, including title insurance and escrow services.
In consideration for the Shares, the aggregate purchase price consists of: (a) $1,150,000 in cash, subject to working capital adjustment to be determined within 60 days following the closing as set forth in the Purchase Agreement, and (b) an aggregate of up to an additional $1,350,000 in contingent payments, if any, subject to the achievement of specified net revenue measurement metrics, as set forth in the Purchase Agreement. The final purchase price of $2.183.238, after a reduction for working capital deficiency of $316,762, was allocated by applying $119,087 to office furniture and equipment, computer hardware and software and leasehold improvements, a total of $45,000 toward a non-compete agreements with each of the Chief Executive Officer, the Chief Financial Officer and the Vice President of Sales, $344, 909 to intangible assets and $1,674,242 to goodwill.
Simultaneously with the completion of the acquisition of the Shares, the employment agreements between Timios and each of its Chief Executive Officer, Chief Financial Officer and Senior Vice President became effective.
The Company, through Fiducia Holdings, LLC owns eighty percent (80%) of Fiducia Real Estate Solutions, Inc. (FRES), the parent company and one hundred percent (100%) owner of Default and Timios. Accordingly, the Company believes it will exercise sufficient control over the operations and financial results of each of its subsidiaries and will consolidate the results of operations, eliminating minority interests when such minority interests have a basis in the consolidated entity.