ITEM 1A. RISK FACTORS
The following section should be read in light of our Form 8-K filed with the SEC on November 15, 2007 and Definitive Proxy Statement on Schedule 14A filed with the SEC on December 4, 2007, regarding the Purchase Agreement. Should the transactions contemplated by the Purchase Agreement be consummated as anticipated, we will cease our current operations. In such event, we plan to pursue the acquisition of an attractive operating business that seeks to become publicly traded through a reverse merger, which will likely result in an entirely different business and associated risks from the ones described below.
Pending Asset Purchase and Sale Agreement
As mentioned in the preceding paragraph, we have entered into an agreement to sell substantially all of our operating assets to Corporate Technologies, LLC. Although the transaction is expected to be approved by the shareholders and subsequently completed, there can be no assurances that the transaction will be completed.
Because we have notified our customers, vendors and employees of the contemplated transaction, failure to complete the transaction for any reason could have a material adverse effect on our results of operations or financial condition.
Customer Concentration and Lack of Recurring Revenue
During 2007, two customers, Hackensack University Medical Center and GAF Materials Corporation accounted for 25% and 21% of our revenue, respectively. Additionally, Hackensack University Medical Center, US Bank Corp., and GAF Material Corporation comprised 39%, 11% and 10% of our accounts receivable as of September 30, 2007. The loss of these customers or the loss of significant orders from these customers or the inability of these customers to meet their financial obligations in a timely manner could have a material adverse effect on our results of operations or financial condition.
Less than 10% of our revenue is recurring revenue based on contracts or annual renewals. As a result, failure to receive orders from existing or new customers on a continuous basis in the future could have a material adverse effect on our results of operations or financial condition.
Key Personnel
Our ability to attract and retain employees is crucial to meeting our business objectives, particularly in the sales and technical areas of our company. As a relatively small company, we rely heavily on our key employees and managers to achieve our financial goals. In order for us to grow, it is necessary for us to have the ability to hire additional key personnel. We offer competitive compensation and benefit packages to attract and retain employees; however, we do not have employment agreements and there can be no assurance that we will be able to retain or attract the employees required to meet our business goals. The loss of key sales, technical or management personnel could have a material adverse effect on our results of operations or financial condition.
Changing Technology and Technical Certifications
We compete in the IT market space, which is constantly faced with changing technology. This environment presents a number of challenges that must be met in order for us to achieve our business goals. Failure to keep pace with changing technology or failure to develop the proper technology strategy that will result in a portfolio of technology solutions that will satisfy our customers’ needs could adversely affect our ability to maintain and grow our current customer base. This could have a material adverse effect on our results of operations or financial condition.
Additionally, our stated objective of continuing to sell high-end technical solutions is dependent on our ability to acquire and maintain certain technical certification levels required by the manufacturers we represent. These certifications must be held by the technical and engineering personnel as well as the sales personnel in order to be authorized to sell and service our manufacturers’ high-end products. Failure to acquire and maintain the technical certifications required could cause us to lose our authorization to sell certain high-end products, which could have a material adverse effect on our results of operations or financial condition.
Cyclical Nature of IT Markets
Historically, the IT market space has been subject to cyclical market upturns and downturns. In the past few calendar years, the IT market has enjoyed a relatively favorable economic climate allowing for growth and expansion. However IT markets experienced a significant downturn during the years of 2001 through much of 2003. These downturns resulting from the cyclical nature of IT could have a material adverse effect on our results of operations or financial condition.
Competition
The IT marketplace is highly competitive, particularly in the New York City metropolitan area where we compete. As a result, there are many competitors in our geographic area vying for customers as well as experienced IT sales and technical personnel. Certain of our current and potential competitors have greater financial, technical, marketing and other resources than we do. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and sales of their services than we can. No assurance can be given that we will be able to compete successfully against current or future competitors.
Financing and Ability to Raise Capital
Our long-term capital needs may require additional sources of credit. There can be no assurances that we will
be successful in negotiating additional sources of credit for our long-term capital needs. Our inability to have continuous access to such financing at reasonable costs could materially and adversely impact our financial condition, results of operations and cash flows.
In the second and fourth quarters of fiscal year 2006, and in the fourth quarter of fiscal year 2007 we were not in compliance with certain of the financial covenants contained in our credit agreement with our primary lender, Wells Fargo. In connection with the Purchase Agreement, we plan to terminate our current credit agreements upon the consummation of the transactions contemplated thereby. In the event that the transactions contemplated by the Purchase Agreement are not consummated for any reason and our agreement with Wells Fargo remains in place, we may have difficulty maintaining compliance with our financial covenants throughout the remainder of fiscal year 2008. If it appears likely that such non-compliance may occur, we will seek to obtain a waiver or amendment to such financial covenants. There can be no assurance, however, that we would be successful in negotiating such waiver or amendment or that such waiver or amendment would be granted on terms that are favorable to us. In the absence of a waiver or amendment to the financial covenants, such non-compliance would constitute an event of default under the credit agreement, and Wells Fargo would be entitled to accelerate the maturity of all amounts outstanding. This could materially and adversely impact our financial condition, results of operations and cash flows.
We are a publicly traded company and our stock is traded on the over-the-counter Bulletin Board, where there is limited visibility in the investment community. Moreover, our share volume averaged less than 5,000 shares per day during fiscal year 2007. Raising equity capital could therefore be challenging for us. Any limitations on our ability to raise equity capital could significantly impact our ability to fund our operations or undertake future growth through expansion or acquisition.
Operating Losses
For the years ended September 30, 1999 through 2007, we experienced operating losses and as of September 30, 2007 our accumulated deficit was $4,408,000. If the transactions contemplated by the Purchase Agreement are consummated, we will cease our current operations and seek to acquire a business that may be in an entirely different industry. While we continue to change our business model and strategic direction to improve our results, we cannot make any assurances that we will be able to achieve profitability on a consistent basis.
Majority Stockholder
Our majority stockholder, ADS owns approximately 51% of our outstanding shares. As a result, ADS is able to exercise significant influence over our company that could affect major transactions we contemplate and is able to elect our entire Board of Directors. This influence has the potential to delay, prevent, change or initiate a change in control, acquisition, merger or other transaction, such as a transaction to take the company private. Additionally, as our majority shareholder, ADS has the ability to approve the transactions contemplated by the Purchase Agreement, which it has indicated that it intends to do.
We lease 180 square feet of general office space in New York City at a monthly rental of $2,709 pursuant to a month to month lease effective November 1, 2007. The lease requires a thirty day notice for termination. This location adequately serves our needs and is approximately 100% utilized.
We lease 9,661 square feet of general office space in Fairfield, New Jersey at an annual rental of $162,435 pursuant to a five year lease. Effective November 1, 2007 the lease was amended per an oral agreement, reducing the rent by $4,200 annually in exchange for sharing a portion of the space with other tenants in the building. This lease expires on December 31, 2010; however, we have a renewal option for an additional five-year period. This location adequately serves our needs and is approximately 75% utilized.
We are not party to any legal proceedings or claims at this time. Accordingly, we do not anticipate any material adverse impact on our financial position, results of operations or cash flows as a result of legal proceedings or claims.
We are not subject to any environmental or governmental proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our stockholders during the fourth quarter of fiscal 2007.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the over-the-counter bulletin board under the symbol “IFTH”. The following table shows, for the periods indicated, the high and low bid quotations per share of the common stock based on published financial sources. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
High
Low
First Quarter
$ 0.45
$ 0.39
Second Quarter
0.77
0.33
Third Quarter
0.57
0.36
Fourth Quarter
0.41
0.28
First Quarter
$ 0.40
$ 0.20
Second Quarter
0.28
0.20
Third Quarter
0.25
0.20
Fourth Quarter
0.28
0.18
Dividends
We have never paid cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future. The decision whether to apply legally available funds to the payment of dividends on our common stock may be made by our Board of Directors from time to time in the exercise of its business judgment. Our financing agreement with Wells Fargo contains restrictions on our ability to declare and pay dividends.
Holders
As of December 19, 2007, there were 52 holders of record of our common stock. We believe that there are a substantially greater number of beneficial owners of shares of our common stock.
Information regarding equity compensation plans is set forth under Part III, Item 12 of this Form 10-K and is incorporated herein by reference.
Issuer Purchases of Equity Securities
We did not make any common stock repurchases during the fiscal year ended September 30, 2007.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below, insofar as they relate to each of the five years ended September 30, 2007, are derived from, and are qualified by reference to, our audited consolidated financial statements and should be read in conjunction with those consolidated financial statements and the notes thereto. The selected consolidated financial data as of September 30, 2005, 2004 and 2003 and for the years ended September 30, 2004 and 2003 are derived from audited consolidated financial statements not included herein. Results for past periods are not necessarily indicative of results that may be expected for future periods, particularly if the transactions contemplated by the Purchase Agreement are consummated. Pursuant to such transactions, we will cease our current operations and seek to acquire a business that may be in an entirely different industry.
(1) In the fourth quarter of 2006, we recorded an impairment charge of $924 related to goodwill.
(2) In the fourth quarter of 2005, we recorded an impairment charge of $529 related to goodwill.
(3) In the fourth quarter of 2004, we recorded an impairment charge of $701 related to goodwill.
(4) In the fourth quarter of 2004, we recorded an impairment charge of $1,550 related to deferred taxes.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We operate in a highly competitive industry, which in turn places constant pressures on maintaining gross profit margins. The following table sets forth, for the periods indicated, the percentage relationship to net sales of certain items in our consolidated statements of operations.
Fiscal Year 2007 Highlights
(in $’000s)
•
Sales for 2007 were down $4,112 or 25.7% compared to 2006 and gross profit decreased $202, or 7.5%, from last year.
•
Product sales were down $4,044 or 27.8% compared to 2006 primarily due to a combination of a decrease in sales to our larger customers and a $2.6 million sale in the quarter ended December 31, 2006 to one of our major customers for which we acted as a sales agent, only recognizing the sales agent fee as revenue. Product gross profit was down $304 or 13.1% from 2006 primarily due to the decrease in product sales.
•
Service sales were down slightly, $68 or 4.6% compared to 2006, primarily due to a decline in installation and deployment services. Service gross profit increased $102 or 28.3% compared to 2006 primarily due to lower service costs resulting from the reduction in our workforce in our service department. Those cost reductions increased service margins from 24.3% in 2006 to 32.6% in 2007.
•
The goodwill associated with the acquisition of our wholly-owned subsidiary InfoTech USA, Inc. was fully impaired at September 30, 2006. Accordingly, there was no impairment charge in 2007. The impairment charges in 2006 and 2005 were $924 and $529, respectively.
•
Our loss from operations was $477 for fiscal year 2007, compared to losses of $2,061 and $707 in fiscal years 2006 and 2005, respectively.
Fiscal Year 2007 Compared to Fiscal Year 2006
(in $’000s)
As disclosed in our Definitive Proxy Statement on Schedule 14A filed with the SEC on December 4, 2007, our strategy will shift in the event that the transactions contemplated by the Purchase Agreement are consummated. The Purchase Agreement contemplates that Corporate Technologies LLC (“Corporate Technologies”) will purchase substantially all of the assets of InfoTech with certain exceptions as set forth in the Purchase Agreement, in exchange for up to $1,000. We will retain all net current assets. This is likely to
result in a gain estimated to be between $500 to $700. We estimate that we will receive $900 in cash. We anticipate that these transactions will be consummated in December 2007. In such event, we will cease our current operations and seek to acquire a business that may be in an entirely different industry. In such event, any forward looking statements in the management discussion and analysis below will be inapplicable to our business.
Revenue for fiscal year 2007 decreased $4,112 or 25.7% to $11,898 from $16,010 in 2006. The decrease in revenue was primarily due to a decrease in product sales. Product sales decreased from $14,522 in 2006 to $10,478, a decrease of $4,044 or 27.8% and service sales decreased slightly by $68 or 4.6%. The decrease in product sales of $4,044 or 27.8% compared to 2006 was primarily due to a combination of a decrease in sales to our larger customers and a $2.6 million sale in the quarter ended December 31, 2006 to one of our major customers for which we acted as a sales agent, only recognizing the sales agent fee as revenue. The decrease in service sales was primarily due to a decrease in installation and deployment services which was somewhat offset by an increase in time and material services. In the event that the transactions contemplated by the Purchase Agreement are not consummated, we cannot predict whether our sales volume for the coming fiscal year will remain at current sales volume levels.
Gross profit decreased by $202, or 7.5% in fiscal year 2007 to $2,475 from $2,677 in fiscal year 2006. The decrease in gross profit was due to a decrease in product gross profit which was partially offset by an increase in service gross profit. Product gross profit was down $304 or 13.1% from 2006 primarily due to the decrease in product sales while service gross profit increased $102 or 28.3% compared to 2006 primarily due to lower service costs resulting from the reduction in our workforce in our service department. Total gross margin increased to 20.8% in 2007 from 16.7% in 2006 as a result of improved margins on both product and services sales. The improvement in product margins to 19.2% in fiscal year 2007 from 15.9% in fiscal year 2006 was mainly attributable to an agency fee earned in the quarter ended December 31, 2006. The improvement in our service margins from 24.3% in 2006 to 32.6% in 2007 was primarily due to lower service costs resulting from the reduction in our workforce in our service department. In the event that the transactions contemplated by the Purchase Agreement are not consummated, we cannot predict whether our overall margins will be steady in the coming fiscal year.
Selling, general and administrative expenses decreased $845, or 22.4%, to $2,925 in fiscal year 2007, compared to $3,770 in fiscal year 2006 due a combination of factors. In fiscal year 2006 we had one time charges of $99 for stock-based compensation expense stemming from the adoption of SFAS 123(R) and $40 of severance paid to InfoTech’s former Chief Operating Officer and Acting President and Chief Executive Officer, Sebastian Perez. Additionally, in fiscal year 2007 we had reductions in expenses related to a reduced headcount, commissions, insurance, recruiting and the reversal of a portion of our allowance for doubtful accounts. We expect compensation expense to continue to be impacted as a result of the adoption of SFAS 123(R), although not to the level experienced in 2006. In the event that the transactions contemplated by the Purchase Agreement are not consummated, we cannot predict whether our management and administrative staff will be sufficient in the coming fiscal year and we may need to add or remove personnel in the administrative, sales and technical areas of the business as sales volume dictates.
Depreciation and amortization expense for fiscal year 2007 decreased $17, or 38.6%, to $27 from $44 in fiscal year 2006. The decrease was primarily a result of certain assets being fully depreciated as of the end of fiscal year 2006.
Our operating loss for fiscal year 2007 was $477 compared to an operating loss of $2,061 in fiscal year 2006. The loss from operations in 2006 was significantly impacted by the asset impairment charge incurred for the remaining balance of goodwill of $924.
Other expense, net, in fiscal year 2007 decreased $11, or 55.0% to $9 from $20 in fiscal year 2006 and in 2007 we had a loss on sale of securities resulting from the sale of a portion of the shares of ADS stock that were issued to us in payment of a $1,000 loan. We may incur further losses resulting from the sale of the shares of ADS. Based on the closing price of the ADS stock at September 30, 2007 we had an unrealized loss of approximately $228. We believe the recent pressure on ADS's stock price is due to general market conditions, especially in the microcap sector, and is temporary. ADS has recently taken steps to restructure their operations via a proposed merger and discontinuing certain operations. Our intention is to hold the ADS shares in anticipation of a recovery in price. We have not sold any of these shares since July 11, 2007.
Net interest expense increased $48 or 78.7% to $109 in fiscal year 2007, from $61 in 2006 primarily due to the ceasing of interest income from ADS in June of 2007 when the loan was fully satisfied. The interest expense for 2007 and 2006 was a result of interest expense incurred in connection with the Wells Fargo credit facility of $210 and $220, respectively, as well as interest expense incurred in connection with the IBM Credit facility of $19 and $3, respectively. The interest income of $120 and $162 for 2007 and 2006, respectively, was earned in connection with the loan made to our majority stockholder, ADS.
Our net loss for fiscal year 2007 was $618, compared to a net loss $2,142 in fiscal year 2006, based on the factors asserted above.
Fiscal Year 2006 Compared to Fiscal Year 2005
(in $’000s)
Revenue for fiscal year 2006 decreased $456 or 2.8% to $16,010 from $16,466 in 2005. The decrease in revenue was due to a decrease in service sales. Product sales increased slightly from $14,457 in 2005 to $14,522, an increase of $65 or 0.4% while service sales decreased $521 or 25.9%. The decrease in services sales was due to a combination of decreases in project work and service contract revenue.
Gross profit decreased by $643, or 19.4% in fiscal year 2006 to $2,677 from $3,320 in fiscal year 2005. The decrease in gross profit was due to a combination of lower product gross margins and the decline in service revenue. The product margins fell from 19.4% in fiscal year 2005 to 15.9% in fiscal year 2006 primarily due to a decrease in sales of high-end products in 2006 compared to 2005 and favorable pricing from vendors experienced in 2005 that was not available in fiscal year 2006. Total gross margin declined to 16.7% in 2006 from 20.2% in 2005.
Selling, general and administrative expenses increased $370, or 10.9%, to $3,770 in fiscal year 2006, compared to $3,400 in fiscal year 2005 due a combination of factors. In 2005 we recorded a $168 reversal of an estimated accrual in accrued litigation expense following the settlement of a lawsuit with InfoTech’s former President, Chief Executive Officer and director, Anat Ebenstein, which was settled for less than what was originally recorded, and in 2006 we incurred compensation expense of $124 related to the adoption of SFAS 123(R), as well as compensation expense in connection with the severance agreement with InfoTech’s former Chief Operating Officer, acting President and Chief Executive Officer, Sebastian Perez. These factors were somewhat offset by reduced commissions related to lower gross profit.
Depreciation and amortization expense for fiscal year 2006 decreased $54, or 55.1%, to $44 from $98 in fiscal year 2005. The decrease was primarily a result of certain assets being fully depreciated as of the end of fiscal year 2005.
Following the annual independent valuation of the goodwill of our subsidiary, InfoTech USA, Inc., we determined that there has been a full impairment of our long-lived assets, which resulted in an impairment charge of $924 which was recorded in the fourth quarter of 2006. The impairment was calculated using projections we compiled based on estimates of our future cash flows derived from our existing business, taking into account our history of operating losses and the overall volatility in the IT industry.
Our operating loss for fiscal year 2006 was $2,061 compared to an operating loss of $707 in fiscal year 2005. The loss from operations in both 2006 and 2005 was significantly impacted by the asset impairment charges incurred in both years of $924 and $529, respectively.
Other expense, net, in fiscal year 2006 increased $7, or 53.8% to $20 from $13 in fiscal year 2005.
Net interest expense was $61 in fiscal year 2006, compared to $57 in 2005. The net interest expense in both years was interest expense incurred in 2006 and 2005 of $223 and $219, respectively which was largely offset by the interest income of $162 earned in 2006 and 2005, from the loan made to our majority stockholder, ADS.
Our net loss for fiscal year 2006 was $2,142, compared to a net loss $768 in fiscal year 2005, based on the factors asserted above.
Liquidity and Capital Resources
(in $’000s)
Cash used in operating activities in fiscal 2007 was $276 compared to $654 in 2006 and cash provided by operating activities of $1,572 in 2005. The cash used in operating activities in 2007 was primarily due to our operating loss and a decrease in our accounts payable, these were largely offset by the decrease in our accounts receivable. The decrease in accounts receivable was due to lower sales and improved collections. The cash used in operating activities in 2006 was primarily a result of our operating loss which was somewhat offset by decreases in accounts receivable and other current assets, and an increase in accounts payable and accrued liabilities. The cash provided by operating activities in 2005 was primarily a result of a decrease in accounts receivable and an increase in accounts payable and accrued expenses. These were somewhat offset by our operating loss.
Cash provided by investing activities in 2007 was $328 compared to cash used in investing activities in fiscal year 2006 and 2005 of $36. The cash provided by investing activities in 2007 was a result of the proceeds from the sale of a portion of the shares issued to us by ADS in payment of a loan and the cash used in investing activities in 2006 and 2005 was a result of capital expenditures.
Net cash used in financing activities in 2007 was $19 and was due to net payments on our lines of credit with Wells Fargo and ADS. Net cash provided by financing activities in 2006 was $36 and was primarily due to proceeds from the issuance of common stock and an increase in borrowings on the ADS line of credit. Net cash used in financing activities in 2005 was $801 and was primarily due to net payments on the Wells Fargo line of credit.
As disclosed in our Definitive Proxy Statement on Schedule 14A filed with the SEC on December 4, 2007, our strategy will shift in the event that the transactions contemplated by the Purchase Agreement are consummated. We anticipate that these transactions will be consummated in December 2007. In such event, we will cease our current operations and seek to acquire a business that may be in an entirely different industry. In such event, any forward looking statements in the liquidity and capital resources discussion below will be inapplicable to our business. Furthermore, management expects that the transactions will generate sufficient cash to repay all our loans and all of our financial arrangements with Wells Fargo, IBM Credit and Ingram will be terminated upon completion of the proposed sale of our operating assets to Corporate Technologies.
Our business activities are capital intensive and, consequently, we finance our operations through arrangements with Wells Fargo and IBM Credit. Our current financing agreement with Wells Fargo, entered into on June 30, 2004, provides us with a $4,000 credit facility. Amounts borrowed under the credit facility bear interest at Wells Fargo’s prime rate plus 3%. Unless earlier terminated, the credit facility matures on June 29, 2008 and automatically renews for successive one-year periods thereafter unless terminated by Wells Fargo or us. Our wholesale financing agreement with IBM Credit provides for inventory financing up to $600 and is secured by a letter of credit issued under our Wells Fargo credit agreement in the amount of $600.
Under the current terms of the credit agreement, Wells Fargo may, at its election, make advances from time to time in the amounts requested by us up to an amount equal to the difference between the borrowing base and the sum of (i) the amount outstanding under the credit facility; and (ii) the $600 letter of credit outstanding under the credit facility which secures our obligations to IBM Credit under the wholesale financing agreement. The borrowing base is equal to the lesser of (x) $4,000 or (y) the amount equal to (a) 85% of our eligible accounts receivable plus (b) the amount of available funds in our deposit account with Wells Fargo minus (c) certain specified reserves. As of September 30, 2007 and 2006, we had a borrowing base of approximately $386 and $598, respectively, and availability under the credit facility as of September 30, 2007 and 2006 of approximately $384 and $585, respectively.
In connection with the execution of the credit agreement, we paid Wells Fargo an origination fee of $40. Each year, we will pay Wells Fargo a facility fee of $15 and an unused line fee of 0.5% of the daily, unused amount under the credit facility. In addition, we must pay Wells Fargo minimum monthly interest based on minimum borrowings of $1,500. We will incur additional fees if Wells Fargo terminates the credit facility upon default or if we terminate the credit facility prior to its termination date. These fees are $120 during the first year of the credit facility, $60 during the second year of the credit facility and $20 after the second year of the credit facility.
The obligations under the credit agreement have been guaranteed by both of our subsidiaries and by us. In addition, we have pledged the stock of our subsidiaries. The credit facility is further secured by a first priority security interest in substantially all of our assets.
As amended as of November 16, 2006, the credit facility requires us to maintain certain financial covenants, including a book net worth of at least $1,575 as of September 30, 2007 and $1,575 plus an amount equal to 50% of the aggregate consolidated net income as of the end of each quarter for all fiscal years commencing with the fiscal year 2007 provided that if the consolidated net income is negative such net income will be equal to zero. We were also limited to a net loss, as defined in the credit agreement, of $570 for the year ended September 30, 2007. As of the end of each quarter ended after September 30, 2007, we must maintain a net income on a cumulative quarterly basis of not less than 80% of the projected cumulative net income or worse than 100% of the projected cumulative net loss for the period. A debt to book net worth ratio of not more than 2.10 to 1.00 must also be maintained by us. The credit facility also prohibits us from incurring or contracting to incur capital expenditures exceeding $50 in the aggregate during any fiscal year or more than $10 in any one transaction. The credit agreement contains other standard covenants related to our operations, including prohibitions on the creation of additional liens, the incurrence of
additional debt, the payment of dividends, the sale of certain assets and other corporate transactions by us, without Wells Fargo’s consent.
Borrowing under the Wells Fargo line of credit amounted to $2 at September 30, 2007 and $13 at September 30, 2006. Borrowing under the IBM Credit financing arrangement amounted to $273 and $513 at September 30, 2007 and 2006, respectively, and are included in either accounts payable or accrued expenses and other liabilities.
In addition to the above lines of credit we have an agreement with one of our primary suppliers, Ingram Micro Inc., which, as amended September 28, 2007, provides us with a credit line of up to $250. Payments for purchases under this credit line are due and payable within 30 days from the date of invoice. Amounts not repaid within 10 days past due bear interest at a rate of 1½% per month. Our obligations under this credit line have been guaranteed by us and our subsidiary, Information Technology Services, Inc. The credit line will remain in effect until terminated by either party. The amounts outstanding under the Ingram line of credit were $97 and $103 as of September 30, 2007 and 2006, respectively. The borrowings are included in either accounts payable or accrued expenses and other liabilities.
We cannot provide any assurances that our present financing arrangements with Wells Fargo, IBM Credit and Ingram Micro, our current cash position and the proceeds from the sale, if necessary or determined to be appropriate by management, of some or all of the remaining Applied Digital Solutions stock we received as payment of the loan to Applied Digital Solutions, will be sufficient to fund our operations and capital expenditures through September 30, 2008 in the event that the transactions contemplated by the Purchase Agreement are not consummated.
Additionally, in the event that the transactions contemplated by the Purchase Agreement are not consumated, our long-term capital needs may require additional sources of credit. There can be no assurances that we will be successful in negotiating additional sources of credit for our long-term capital needs. Our inability to have continuous access to such financing at reasonable costs may materially and adversely impact our financial condition, results of operations and cash flows.
On November 3, 2006, we notified Wells Fargo that we did not expect to be in compliance with the covenants for cumulative net income and minimum book net worth contained in the credit facility with Wells Fargo as of and for the fiscal year ended September 30, 2006. Wells Fargo agreed to waive the anticipated non-compliance and, on November 16, 2006, we and our subsidiaries entered into an amendment and waiver with Wells Fargo.
On November 8, 2007, we notified Wells Fargo that we did not expect to be in compliance with the covenants for cumulative net income and minimum book net worth contained in the credit facility with Wells Fargo as of and for the fiscal year ended September 30, 2007. Wells Fargo agreed to waive the anticipated non-compliance and, on November 14, 2007, we and our subsidiaries entered into a letter agreement with Wells Fargo pursuant to which Wells Fargo waived such non-compliance.
In connection with the Purchase Agreement, we plan to terminate our current credit agreements upon the consummation of the transactions contemplated thereby. In the event that the transactions contemplated by the Purchase Agreement are not consummated for any reason and our agreement with Wells Fargo remains in place, we may have difficulty maintaining compliance with our financial covenants throughout the remainder of fiscal year 2008. If it appears likely that such non-compliance may occur, we will seek to obtain a waiver or amendment to such financial covenants. There can be no assurance, however, that we would be successful in negotiating such waiver or amendment or that such waiver or amendment would be granted on terms that are favorable to us. In the absence of a waiver or amendment to the financial covenants, such non-compliance would constitute an event of default under the credit agreement, and Wells Fargo would be entitled to accelerate the maturity of all amounts outstanding.
The table below summarizes our known contractual obligations, consisting of our operating lease commitments and our consulting agreements, as of September 30, 2007:
Impact of Recently Issued Accounting Standards
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No. 3 “Reporting Accounting Changes in Interim Financial Statements.” The statement applies to all voluntary changes in accounting principle and all changes required by an accounting pronouncement that does not include specific transition provisions. Previously, APB Opinion No. 20 required that most voluntary changes in accounting principle be recognized by including in the net income or loss of the period of change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires retrospective application of the change in accounting principle to financial statements of prior periods’ unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When a pronouncement includes specific transition provisions, those provisions should be followed. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 has not had a material impact on our financial statements.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of SFAS No. 109, “Accounting for Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax returns. The Interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating whether the adoption of FIN 48 will have a material effect on our financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value and establishes a framework for measuring fair value in accordance with generally accepted accounting principles (GAAP). The statement also expands the disclosures related to the fair value measurements used to value assets and liabilities. SFAS 157 is currently effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We are currently evaluating whether the adoption of SFAS 157 will have a material impact on our financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”). In SFAS 141(R), the FASB retained the fundamental requirements of Statement No. 141 to account for all business combinations using the acquisition method (formerly the purchase method) and for an acquiring entity to be identified in all business combinations. However, the new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS 141(R) is effective for annual periods beginning on or after December 15, 2008. We are currently evaluating whether the adoption of SFAS 141(R) will have a material impact on our financial statements.
No other recently issued accounting pronouncements that became effective during the year ended September 30, 2007 or that will become effective in a subsequent period is expected to have a material impact on our consolidated financial statements.
Inflation
In the opinion of management, inflation has not had a material effect on our operations.
Critical Accounting Policies
The SEC has previously issued disclosure guidance for “critical accounting policies.” The Commission defines
“critical accounting policies” as those that require the application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.
Our significant accounting policies are described in Note 1 to our consolidated financial statements, contained elsewhere in this report. We believe that the following accounting policies or estimates require the application of management’s most difficult, subjective or complex judgments:
Estimating Allowances for Doubtful Accounts Receivable
We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. A significant change in the liquidity or financial position of any of our significant customers could have a material adverse effect on the collectibility of our accounts receivable and our future operating results.
Valuation of Deferred Tax Assets
We regularly evaluate our ability to recover the reported amount of our deferred income taxes considering several factors, including our estimate of the likelihood that we will generate sufficient taxable income in future years in which temporary differences reverse. Presently we believe it is not likely that we will be able to realize a substantial portion of the benefit of our deferred tax assets. This is primarily based on the combination of our historical losses, our loss incurred in fiscal year ended September 30, 2007, and the overall volatility of the IT industry, resulting in an expectation of marginal profitability in the future. As a result we recorded an increase in our valuation allowance of $193 for the year ended September 30, 2007, and as a result, did not record any deferred tax asset as of September 30, 2007.
Valuation of Long-Lived Assets
We assess the recoverability of intangible assets with indefinite lives at least annually and all long-lived tangible and intangible assets whenever we determine that events or changes in circumstances indicate that their carrying amount may not be recoverable. Our assessment is primarily based upon our estimate of future cash flows associated with these assets. Due to our historical losses, including the loss incurred in fiscal year ended September 30, 2006, and the overall volatility of the IT industry, we project marginal profitability in the future. Accordingly, we have determined that as of September 30, 2006, there has been a full impairment of our long-lived intangible asset, goodwill, resulting in an impairment charge of $924.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We presently do not use any derivative financial instruments to hedge our exposure to adverse fluctuations in interest rates, foreign exchange rates, fluctuations in commodity prices or other market risks, nor do we invest in speculative financial instruments. For InfoTech USA, borrowings under the financing agreement with Wells Fargo are at Wells Fargo’s prime rate plus 3%. We do not have any investments in any instruments that are sensitive to changes in the general level of U.S. interest rates.
Due to the nature of our borrowings, we have concluded that there is no material market risk exposure and, therefore, no quantitative tabular disclosures are required.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and supplementary data included in this Annual Report are listed in Item 15 and begin immediately after Item 15.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(t).
ITEM 9A(t). CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management, including our principal executive officer and
principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures with respect to the information generated for use in our reporting system. Based upon, and as of the date of that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the Commission’s rules and forms.
There was no change in our internal control over financial reporting during the quarter ended September 30, 2007 that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.
It should be noted that our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding our directors and executive officers is set forth under the captions “Election of Director and Ratification of Appointment of Director - Board of Directors,” “ - Legal Proceedings and Indemnification,” “ - Directorships,” “ - Board Committees and Meetings,” “ - Code of Ethics,” “ - Section 16(a) Beneficial Ownership Reporting Compliance” and “ - Executive Officers and Significant Employees” in the Proxy Statement for our 2008 Annual Meeting of Stockholders, which information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation is set forth under the captions “Election of Director and Ratification of Appointment of Director - Executive Compensation,” “ - Option Grants in Last Fiscal Year,” “ - Aggregate Option Exercises in Last Fiscal Year and Year-End Values,” “ - Compensation of Directors” and “ - Compensation Committee Interlocks and Insider Participation in Compensation Decisions” in the Proxy Statement for our 2008 Annual Meeting of Stockholders, which information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners and management is set forth under the captions “Election of Director and Ratification of Appointment of Director - Ownership of Equity Securities,” and “- Principal Stockholders” in the Proxy Statement for our 2008 Annual Meeting of Stockholders, which information is incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information regarding our compensation plans (including individual compensation arrangements) under which shares of our common stock are authorized for issuance as of September 30, 2007:
Number of Securities to be
Issued upon Exercise of
Outstanding Options,
Weighted Average Exercise
Price of Outstanding
Options, Warrants
Number of Securities
Remaining Available for
Future Issuance under Equity
Compensation Plans
(Excluding Securities
Plan Category
Warrants and Rights
(a)
and Rights
(b)
Reflected in Column (a)
(c)
Equity compensation plans approved by security holders
3,325,000
$ 0.304
7,369,000
Equity compensation plans not approved by securities holders
1,050,000(1)
$ 0.699(2)
-
Total
4,375,000
$ 0.392(2)
7,369,000
(1) The 1,050,000 shares consist of, 950,000 shares subject to outstanding options and 100,000 shares of restricted stock. The restricted shares were granted in January 2006 to our chairman of the board and chief executive officer in the amount of 100,000 shares each. In January 2007, on the first anniversary date of the grant, 50% of the restricted stock, or 50,000 shares each, vested and was issued, the remaining 50% will vest on the second anniversary date of the grant.
(2) The restricted stock does not affect and is not reflected in the weighted average exercise price.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information regarding certain relationships and related transactions is set forth under the caption “Election of Director and Ratification of Appointment of Director - Certain Relationships and Related Transactions” in the Proxy Statement for our 2008 Annual Meeting of Stockholders, which information is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding our principal accountant fees and services is set forth under the caption “Ratification of Selection of Independent Registered Public Accounting Firm - Principal Accountant Fees and Services” in the Proxy Statement for our 2008 Annual Meeting of Stockholders, which information is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1)
The financial statements and financial statement schedules listed below are included in this report
Report of Independent Registered Public Accounting Firm
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Financial Statement Schedule
Schedule of Valuation and Qualifying Accounts
(a)(2)
Financial statement schedules have been included in Item 15(a)(1) above.
(a)(3)
Exhibits
See Index to Exhibits filed as part of this annual report on Form 10-K.
(c)
Exhibits - Included in Item 15(a)(3) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Scott R. Silverman
Chairman of the Board of Directors
December 26, 2007
(Scott R. Silverman)
/s/ Jonathan F. McKeage
President, Chief Executive Officer and Director
(Principal Executive Officer)
December 26, 2007
(Jonathan F. McKeage)
/s/ J. Robert Patterson
Vice President, Chief Financial Officer, Treasurer, Secretary and Director (Principal Financial Officer and Principal Accounting Officer)
December 26, 2007
(J. Robert Patterson)
/s/ Charles L. Doherty
Director
December 26, 2007
(Charles L. Doherty)
/s/ Jeffrey S. Cobb
Director
December 26, 2007
(Jeffrey S. Cobb)
LIST OF EXHIBITS
(Item 14 (c))
Exhibit
Number
Description
3.1
Amended and Restated Certificate of Incorporation dated April 21, 1997 (incorporated by reference to Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 14, 2003)
3.2
Certificate of Amendment of Certificate of Incorporation dated March 22, 2002 (incorporated by reference to Exhibit 3.2 to the registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 14, 2003)
3.3
Certificate of Amendment of Certificate of Incorporation dated April 9, 2004 (incorporated by reference to Exhibit 3.3 to the registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 14, 2003)
3.4
Amended and Restated By-Laws (incorporated by reference to Exhibit 3.4 to the registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 14, 2003)
4.1
Non-Qualified Stock Option Award Granted to David A. Loppert dated January 1, 2001 (incorporated by reference to Exhibit 4.1 to the registrant's Annual Report on Form 10-K filed with the Commission on December 20, 2002)
10.1
Credit and Security Agreement, dated June 29, 2004, by and among InfoTech USA, Inc., InfoTech USA, Inc., Information Technology Services, Inc. and Wells Fargo Business Credit, Inc. (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed with the Commission on July 8, 2004)
10.2
Guaranty by Corporations, dated June 29, 2004, by and among InfoTech USA, Inc., Information Technology Services, Inc. and Wells Fargo Business Credit, Inc. (incorporated by reference to Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed with the Commission on July 8, 2004)
10.3
Stock Pledge Agreement, dated June 29, 2004, by and between InfoTech USA, Inc. and Wells Fargo Business Credit, Inc. (incorporated by reference to Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed with the Commission on July 8, 2004)
10.4
Collateral Assignment of Note, dated June 29, 2004, by and between InfoTech USA, Inc. and Wells Fargo Business Credit, Inc. (incorporated by reference to Exhibit 10.4 to the registrant’s Current Report on Form 8-K filed with the Commission on July 8, 2004)
10.5
First Amendment and Waiver, dated as of December 24, 2004, among InfoTech USA, Inc., the registrant, Information Technology Services, Inc. and Wells Fargo Business Credit, Inc. (incorporated by reference to Exhibit 10.5 to the registrant’s Annual Report on Form 10-K filed with the Commission on December 29, 2004)
10.6
Agreement for Wholesale Financing, dated June 30, 2004, by and between IBM Credit, LLC and InfoTech USA, Inc. (incorporated by reference to Exhibit 10.5 to the registrant’s Current Report on Form 8-K filed with the Commission on July 8, 2004)
10.7
Commercial Loan Agreement, dated June 27, 2003, between InfoTech USA, Inc. and Applied Digital Solutions, Inc. (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K, dated June 27, 2003, filed with the Commission on July 11, 2003)
10.8
Term Note, dated June 27, 2004, issued by Applied Digital Solutions, Inc. in favor of InfoTech USA, Inc. (incorporated by reference to Exhibit 10.2 to the registrant’s Current Report on Form 8-K, dated June 27, 2004, filed with the Commission on July 11, 2004)
10.9
Stock Pledge Agreement, dated June 27, 2004, between Applied Digital Solutions, Inc. and InfoTech USA, Inc. (incorporated by reference to Exhibit 10.3 to the registrant’s Current Report on Form 8-K, dated June 27, 2004, filed with the Commission on July 11, 2004)
10.10
First Amendment to Loan Documents, dated June 28, 2004, by and between Applied Digital Solutions, Inc. and InfoTech USA, Inc. (incorporated by reference to Exhibit 10.6 to the registrant’s Current Report on Form 8-K filed with the Commission on July 8, 2004)
10.11*
1998 Incentive Stock Option Plan, as Amended (incorporated herein by reference to Exhibit 99 to the registrant’s definitive Proxy Statement filed with the Commission on December 27, 1999)
10.12*
1999 Employee Stock Purchase Plan (incorporated herein by reference to Exhibit A to the registrant’s definitive Proxy Statement filed with the Commission on December 28, 1998)
10.13*
2001 Flexible Stock Plan (incorporated herein by reference to Exhibit B to the Company's definitive Proxy Statement filed with the Commission on February 28, 2001)
10.14
Sublease Agreement dated as of May 25, 2000 by and between Sungard Portfolio Solutions and Information Products Center, Inc. (incorporated by reference to Exhibit 10.13 to the registrant’s Annual Report on Form 10-K filed with the Commission on December 23, 2003)
10.15
Second Amendment and Waiver, dated as of November 4, 2005, among InfoTech USA, Inc., the registrant, Information Technology Services, Inc. and Wells Fargo Business Credit, Inc. (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed with the Commission on November 7, 2005)
10.16
Settlement Agreement and General Release, effective as of April 13, 2005, by and among SysComm International Corp., Applied Digital Solutions, Inc., Jerome Artigliere, Richard Sullivan, Scott Silverman, Kevin McLaughlin and Anat Ebenstein (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed with the Commission on April 19, 2005)
10.17
Office Lease Agreement, dated as of April 15, 2005, by and between Faircorp Associates, L.L.C. and InfoTech USA, Inc. (incorporated by reference to Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed with the Commission on April 19, 2005)
10.18
Letter Agreement, dated May 13, 2005, from Ingram Micro Inc. to InfoTech USA, Inc. (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed with the Commission on May 19, 2005)
10.19
Security Agreement, dated May 16, 2005, by and between InfoTech USA, Inc. and Ingram Micro Inc. (incorporated by reference to Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed with the Commission on May 19, 2005)
10.20
Guaranty, dated May 16, 2005, by and between InfoTech USA, Inc. and Ingram Micro Inc. (incorporated by reference to Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed with the Commission on May 19, 2005)
10.21
Guaranty, dated May 16, 2005, by and between Information Technology Services, Inc. and Ingram Micro Inc. (incorporated by reference to Exhibit 10.4 to the registrant’s Current Report on Form 8-K filed with the Commission on May 19, 2005)
10.22
Intercreditor and Subordination Agreement, dated May 16, 2005, by and between Ingram Micro Inc. and Wells Fargo Business Credit, Inc. (incorporated by reference to Exhibit 10.5 to the registrant’s Current Report on Form 8-K filed with the Commission on May 19, 2005)
10.23
Second Amendment to Loan Documents, dated June 28, 2005, by and between Applied Digital Solutions, Inc. and InfoTech USA, Inc. (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed with the Commission on June 28, 2005)
10.24*
Summary of the salaries for the Company’s named executive officers (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K/A filed with the Commission on October 4, 2005)
Contents
Page
Report of Independent Registered Public Accounting Firm
Financial Statements
Consolidated Balance Sheets
September 30, 2007 and 2006
Consolidated Statements of Operations
Years ended September 30, 2007, 2006 and 2005
Consolidated Statements of Stockholders’ Equity
Years ended September 30, 2007, 2006 and 2005
Consolidated Statements of Cash Flows
Years ended September 30, 2007, 2006 and 2005
Notes To Consolidated Financial Statements
/22
Schedule II - Valuation and Qualifying Accounts
S-1
Years ended September 30, 2007, 2006 and 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
InfoTech USA, Inc.
Fairfield, New Jersey
We have audited the accompanying consolidated balance sheets of InfoTech USA, Inc. and Subsidiaries as of September 30, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years ended September 30, 2007, 2006 and 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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 plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of InfoTech USA, Inc. and Subsidiaries as of September 30, 2007 and 2006, and their results of operations and cash flows for the years ended September 30, 2007, 2006 and 2005, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation in fiscal 2006.
Our audits referred to above included the information in Schedule II, which presents fairly, in all material respects, the information required to be set forth therein when read in conjunction with the consolidated financial statements.
/s/ J. H. Cohn LLP
Roseland, New Jersey
December 21, 2007
INFOTECH USA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
See the accompanying notes to consolidated financial statements.
INFOTECH USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
See the accompanying notes to consolidated financial statements.
INFOTECH USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For The Years Ended September 30, 2007, 2006 and 2005
(In thousands)
See the accompanying notes to consolidated financial statements.
INFOTECH USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See the accompanying notes to consolidated financial statements.
INFOTECH USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands Except Per Share Amounts)
Note 1 - Summary Of Significant Accounting Policies
Business Organization And Basis Of Presentation
InfoTech USA, Inc. (the “Company”) was incorporated on September 30, 1987 as a Delaware corporation. The Company has two subsidiaries: Information Technology Services, Inc. (doing business as InfoTech), a New York Corporation since 1980, and InfoTech USA, Inc., a New Jersey corporation since 1983. The Company is controlled by its 51% majority stockholder, Applied Digital Solutions, Inc. (“ADS”, “Applied Digital” or the “Parent Company”).
The Company, through its subsidiaries, is a supplier and systems integrator of a broad range of computer services and related products. The Company conducts business in the New York City Metropolitan area and New Jersey. The Company’s customers are generally medium to large size entities.
Basis Of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.
Use Of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition
For product sales, the Company recognizes revenue upon delivery in accordance with the applicable product’s shipping terms. The Company has no obligation for warranties on new hardware sales, because the manufacturer provides the warranties. For consulting and other services, the Company recognizes revenue based on the direct labor hours incurred for services rendered times the standard billing rate, adjusted to realizable value, if necessary. Revenues from sales contracts involving both products and consulting and other services are allocated to each element based on amounts that would have been charged if each element was sold separately and, accordingly, are allocated to each element and accounted for as if they have been sold separately. The Company does not offer a warranty policy for services to customers. Revenues are not recognized unless prices are fixed or determinable and collectibility is reasonably assured.
The Company does not require any collateral in connection with sales of products or services. It provides an allowance for doubtful accounts equal to the estimated collection losses based on historical experience coupled with a review of the current status of existing receivables.
Investment in Marketable Equity Securities
Investments in marketable equity securities classified as “available for sale” are recorded at fair value based on quoted market prices and unrealized gains and losses are reported as accumulated other comprehensive income (loss) within stockholders’ equity. The cost of securities sold is based on the first in first out method.
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
Inventories
Inventories consist principally of computer hardware and software and are valued at the lower of cost (first-in, first-out) or market. Substantially all inventory items are finished goods.
The Company reviews the movement of inventories on an item-by-item basis to determine the value of items which are slow moving. After considering the potential for near term product engineering changes and/or technological obsolescence and current realizability due to changes in returns and price protection policies, the Company determines the need for an inventory valuation allowance. The allowance was $23, $56 and $28 as of September 30, 2007, 2006 and 2005, respectively.
Equipment And Improvements
Equipment and improvements are stated at cost, net of accumulated depreciation and amortization. Expenditures for maintenance and repairs are charged against operations as incurred. Upon retirement or sale, any assets disposed of are removed from the accounts and any resulting gain or loss is reflected in the results of operations. Capitalized values of property under leases are amortized over the life of the lease or the estimated life of the asset, whichever is less.
Depreciation and amortization are computed using straight-line and accelerated methods over the following estimated useful lives:
Estimated
Useful Life
Computer equipment
5 years
Furniture and fixtures
7 years
Leasehold improvements
5 years
Impairment losses on long-lived assets, such as equipment and improvements, are recognized when events or changes in circumstances indicate that the undiscounted cash flows estimated to be generated by such assets are less than their carrying value and, accordingly, all or a portion of such carrying value may not be recoverable. Impairment losses are then measured by comparing the fair value of assets to their carrying amounts.
Goodwill
The cost in excess of fair value of net assets of businesses acquired is recorded as goodwill. Prior to the adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (“SFAS 142”) in fiscal 2002, goodwill was amortized on a straight-line basis over 10 years. Goodwill is no longer amortized. Instead, it is tested at least annually for impairment utilizing a two-step methodology. The initial step requires the Company to determine the fair value of the business acquired (reporting unit) and compare it to the carrying value, including goodwill, of such reporting unit. If the fair value exceeds the carrying value, no impairment loss would be recognized. However, if the carrying value of the reporting unit exceeds its fair value, the goodwill of the unit may be impaired. The amount, if any, of the impairment is then measured in the second step based on the excess, if any, of the reporting unit’s carrying value over its fair value.
The Company determines the fair value of the acquired reporting unit for purposes of the initial test primarily by using a discounted cash flow valuation technique. Significant estimates used in the valuation include estimates of future profitability, cash flows, both future short-term and long-term growth rates, and estimated cost of capital for purposes of arriving at a discount factor. The company performs its annual impairment test during the fourth quarter absent any interim impairment indicators. See Note 5 for the impact of charges for impairment in 2006 and 2005.
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” (“SFAS 109”) which requires the use of the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The income tax provision or credit is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
Net Income (Loss) Per Common Share
The Company presents “basic” income (loss) per common share and, if applicable, “diluted” income per common share, pursuant to the provisions of Statement of Financial Accounting Standards No. 128, “Earnings per Share” (“SFAS 128”). Basic income (loss) per common share is calculated by dividing net income or loss by the weighted average number of common shares outstanding during each period. The calculation of diluted income per common share is similar to that of basic income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, such as those issuable upon the exercise of stock options and warrants, were issued during the period.
Since the Company had net losses in 2007, 2006 and 2005, the assumed effects of the exercise of employee stock options for the purchase of 3,975, 3,975 and 4,105 common shares and 300 warrants outstanding at September 30, 2007, 2006 and 2005, respectively, would have been anti-dilutive and, accordingly, dilutive per share amounts are not presented.
Cash And Cash Equivalents
The Company considers all liquid instruments with a maturity of three months or less at the date of purchase to be cash equivalents.
Fair Value Of Financial Instruments
The carrying values of financial instruments including cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the relatively short maturity of these instruments. The carrying value of the note receivable from the Parent Company and the line of credit borrowings approximate fair values because they bear interest at market interest rates and have relatively short maturities.
Stock-based compensation
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123(R), “Share-Based Payments” (“SFAS 123(R)”) which establishes standards of accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment arrangements including stock options and compensatory employee stock purchase plans. SFAS 123(R) requires that the fair value of such equity instruments be measured based on the fair value of the instruments on the date they are granted and that an estimate of the portion of the fair value that will vest be recognized in the financial statements as an expense over the period during which the employees are required to provide services in exchange for the equity instruments.
The Company adopted SFAS 123(R) effective October 1, 2005 and has selected the Black-Scholes method of valuation for share-based compensation. The Company has elected the modified prospective application transition method which requires that the provisions of SFAS 123(R) be
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
applied going forward from the date of adoption to new share-based payments, and to all unvested stock options outstanding at the beginning of the first quarter of adoption of SFAS 123(R). The Company did not grant any stock options during 2007 or 2006 and all outstanding options were fully vested as of September 30, 2005. However, in January 2006, the Company modified certain existing stock option agreements and granted restricted stock. Accordingly, there was $136 of compensation expense recognized in 2006 as a result of the adoption of SFAS 123(R). To calculate the excess tax benefits available as of the date of adoption for use in offsetting future tax shortfalls, the Company followed the alternative transition method discussed in Financial Accounting Standards Board Staff Position No. 123(R) - 3.
Prior to the adoption of SFAS 123(R), the Company measured compensation cost related to stock options issued to employees using the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued To Employees” which only required charges to expense over the service period if the fair value of the stock options exceeded their exercise price on the date of grant. To use this method, the Company was required to adopt the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosures” (“SFAS 148”) and to present pro forma net income or loss as if the Black-Scholes option pricing model, which was also an acceptable fair value-based method of accounting for stock options under SFAS 123, had been applied if such pro forma amounts differed materially from the historical amounts. As permitted by SFAS 123, the Company elected to continue to apply the intrinsic value method of accounting described above and adopted only the disclosure requirements of SFAS 123, as amended, which resulted in pro forma charges that were similar in most respects to those computed under SFAS 123(R). Accordingly the Company did not restate prior years for pro forma expense amounts.
The Company’s net loss and net loss per common share determined under SFAS 123(R) for 2007 and 2006 and pro forma net loss and net loss per common share (assuming compensation cost had been determined based on the fair value at the grant date for all awards issued by the Company and amortized over the vesting period consistent with the provisions of SFAS 123) for the year ended 2005 are set forth below:
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
Net loss - as reported
$
(618
)
$
(2,142
)
$
(768
)
Deduct total stock-based employee
compensation expense determined
under a fair value based method for all
awards, net of related tax effects
(178
)
Net loss - pro forma
$
(946
)
Net Loss Per Common Share:
Basic - as reported
$
(0.12
)
$
(0.44
)
$
(0.16
)
Basic - pro forma
$
(0.19
)
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted-average assumptions were used for determining the fair value of options granted in 2005:
Risk-free interest rates
4.2%
Expected option lives
8 years
Expected volatilities
78%
Expected dividend yields
0%
A summary of option activity under the Company’s stock option plans as of September 30, 2007 and changes during the year then ended is presented below:
Stock
Options
Weighted
Average
Exercise Price
Weighted
Average
Contractual
Term
Aggregate
Intrinsic Value
Outstanding at October 1, 2006
3,975
$
0.38
4.4
Granted
-
-
-
Exercised
-
-
-
Forfeited or Expired
-
-
-
Outstanding at September 30, 2007
3,975
$
0.38
3.4
-*
Exercisable at September 30, 2007
3,975
$
0.38
3.4
-*
* The intrinsic value of a stock option is the amount by which the fair value of the underlying stock exceeds the exercise price of the option. The fair value of InfoTech’s stock was $0.18 per share at September 30, 2007 based upon its closing price on the OTC.
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
No options were exercised during 2007 and 2005. The total intrinsic value of options exercised during 2006 was $16.
As of September 30, 2007, there was $13 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Company’s stock option plans. That cost is expected to be recognized over a weighted-average period of .25 years. The total fair value of shares vested during 2007 was $50.
In January 2006, the Company granted its chairman of the board and its chief executive officer 100 shares of its restricted stock each. In January 2007, on the first anniversary date of the grant, 50% of the restricted stock, or 50 shares each, vested and was issued. The remaining 50% will vest on the second anniversary date of the grant. The Company determined the fair value of the stock to be $100 based on the closing price of its stock on the date of grant. The fair value of the restricted stock is being recognized as compensation expense over the vesting period. Compensation expense was recorded in connection with the restricted stock during 2007 and 2006 in the amount of $50 and $37, respectively.
Note 2 - Marketable Securities
As explained in Note 12 below, on May 15, 2007, the Company entered into an Agreement whereby Applied Digital issued 704 shares of its common stock to the Company with a fair value of $1,000 in payment of a loan due to the Company in that amount. At September 30, 2007, the Company has classified the shares as available for sale marketable equity securities and in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” is recording unrealized changes in their fair value as part of its comprehensive income. During the year ended September 30, 2007, the Company sold 249 shares and realized a loss of $23. The remaining shares had a cost of $646 and a market value of $418 at September 30, 2007 and, accordingly, the Company has included its $228 of unrealized loss in accumulated comprehensive loss, a separate component of stockholders’ equity, as of September 30, 2007. At September 30, 2007, the Company believes the decrease in the fair value of these shares to be temporary and no charge for impairment in the statement of operations is required. Management believes the recent pressure on the stock price of the Applied Digital stock is due to general market conditions, especially the high volatility in the microcap stock sector. Applied Digital has recently taken steps to restructure via a proposed merger and discontinuing certain operations that are not related to to its current core products and strategy. Management intends to hold these shares in anticipation of a recovery in price, and has not sold any of these shares since July 11, 2007. Management believes it has the ability to hold these shares for the forseeable future.
Note 3 - Other Current Assets
Vendor receivables (rebates and returns)
$
$
Prepaid expenses
Miscellaneous receivable
-
Other
-
Totals
$
$
Note 4 - Equipment And Improvements
Computer equipment
$
$
1,532
Furniture and fixtures
Leasehold improvements
1,880
Less accumulated depreciation and amortization
(389
)
(1,767
)
Totals
$
$
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
Included above are computer equipment and furniture and fixtures acquired under capital lease obligations and related accumulated depreciation in the total amount of $64 at September 30, 2007 and 2006, respectively.
Depreciation and amortization charged to operations amounted to $27, $44 and $98 for 2007, 2006 and 2005, respectively.
Note 5 - Goodwill
Goodwill consisted of the unamortized excess of cost over fair value of tangible and identifiable intangible assets net of liabilities of InfoTech USA, Inc. at the date of acquisition. The Company applied APB No. 16, “Business Combinations,” and used the purchase method of accounting for this acquisition in 2001. Goodwill was fully written off at September 30, 2006 as shown below:
Original balance
$
2,339
Less accumulated amortization
(185)
Less impairment charges
(2,154)
Carrying value
$
-
Effective October 1, 2001, the Company adopted SFAS 142. Under SFAS 142, goodwill amortization ceased upon the adoption of the standard. SFAS 142 also required an initial goodwill impairment assessment in the year of adoption and annual impairment tests thereafter. As of September 30, 2006 following the valuation analysis it was determined that due to the Company’s historical losses, including the loss incurred in fiscal year ended September 30, 2006, the overall volatility of the IT industry and the Company’s projected marginal profitability in the future, the goodwill was fully impaired, resulting in a carrying value of $0 as of the end of fiscal year 2006. Accordingly no valuation analysis was performed at September 30, 2007. Valuation analysis testing for goodwill impairment as of September 30, 2006 and 2005 resulted in a charge for goodwill impairment of $924 and $529 respectively.
Note 6 - Financing Arrangements
The Company’s financing agreement with Wells Fargo Business Credit, Inc. (“Wells Fargo”), entered into on June 30, 2004, provides financing up to $4,000. Amounts borrowed under the credit facility bear interest at Wells Fargo’s prime rate plus 3%. Unless earlier terminated, the credit facility matures on June 29, 2008 and automatically renews for successive one-year periods thereafter unless terminated by Wells Fargo or the Company. The Company also has a wholesale financing agreement with IBM Credit in effect as of September 30, 2007 that provides for inventory financing up to $600 and is secured by a letter of credit in the amount of $600.
Under the current terms of the credit agreement, Wells Fargo may, at its election, make advances from time to time in the amounts requested by the Company up to an amount equal to the difference
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
between the borrowing base and the sum of (i) the amount outstanding under the credit facility; and (ii) the $600 letter of credit outstanding under the credit facility which secures the Company’s obligations to IBM Credit under the wholesale financing agreement. The borrowing base is equal to the lesser of (x) $4,000 or (y) the amount equal to (a) 85% of our eligible accounts receivable plus (b) the amount of available funds in our deposit account with Wells Fargo minus (c) certain specified reserves. As of September 30, 2007 and 2006, the Company had a borrowing base of approximately $386 and $598, respectively, and availability under the credit facility as of September 30, 2007 and 2006 of approximately $384 and $585, respectively.
In connection with the execution of the credit agreement, the Company paid Wells Fargo an origination fee of $40. Each year, the Company must pay Wells Fargo a facility fee of $15 and an unused line fee of 0.5% of the daily, unused amount under the credit facility. Additionally, there is minimum monthly interest based on minimum borrowings of $1,500. The Company will incur an additional fee of $20 if Wells Fargo terminates the credit facility upon default or if the Company terminates the credit facility prior to its termination date of June 29, 2008.
The obligations under the credit agreement have been guaranteed by the Company and by both of the Company’s subsidiaries. In addition, the Company has pledged the stock of its subsidiaries. The credit facility is further secured by a first priority security interest in substantially all of the Company’s assets.
As amended as of November 16, 2006, the credit facility requires the Company to maintain certain financial covenants, including a book net worth of at least $1,575 as of September 30, 2007 and $1,575 plus an amount equal to 50% of the aggregate consolidated net income as of the end of each quarter for all years commencing with 2007 provided that if the consolidated net income is negative such net income will be equal to zero. The Company was also limited to a net loss, as defined in the credit agreement, of $570 for the year ending September 30, 2007. As of the end of each quarter after September 30, 2007, the Company must have a net income on a cumulative quarterly basis of not less than 80% of the projected cumulative net income or worse than 100% of the projected cumulative net loss for the period. A debt to book net worth ratio of not more than 2.10 to 1.00 must also be maintained by the Company. The credit facility also prohibits the Company from incurring or contracting to incur capital expenditures exceeding $50 in the aggregate during any fiscal year or more than $10 in any one transaction. The credit agreement contains other standard covenants related to the Company’s operations, including prohibitions on the creation of additional liens, the incurrence of additional debt, the payment of dividends, the sale of certain assets and other corporate transactions by the Company, without Wells Fargo’s consent.
Borrowings under the Wells Fargo line of credit amounted to $2 and $13 at September 30, 2007 and 2006, respectively. Borrowings under the IBM Credit financing arrangement amounted to $273 and $513 at September 30, 2007 and 2006, respectively, and are included in either accounts payable or accrued expenses and other liabilities.
On May 19, 2005, the Company entered into an arrangement, which was amended September 28, 2007, with one of its primary suppliers, Ingram Micro Inc. (“Ingram”), pursuant to which Ingram provides the Company with a credit line of up to $250. Payments for purchases under this credit line are due and payable within 30 days from the date of invoice. Amounts not repaid within 10 days past due bear interest at 1½% per month. The credit line is secured by a security interest in substantially all of the Company’s equipment, inventory and accounts receivable. Advances under the credit line are subordinate and junior in right of payment to borrowings under the Company’s credit facility with Wells Fargo. The Company had $97 and $103 outstanding with Ingram as of September 30, 2007 and 2006,
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
respectively, and the borrowings are included in either accounts payable or accrued expenses and other liabilities.
As disclosed in Note 14, the Company has entered into a purchase agreement (“Purchase Agreement”) with Corporate Technologies LLC (“Corporate Technologies”). In the event that the sale of the Company's operating assets and other transactions contemplated by the Purchase Agreement are consummated in December 2007 as anticipated, the Company will cease its current operations and seek to acquire a business that may be in an entirely different industry. In such event, management expects that the transactions will generate sufficient cash to repay all of the Company’s loans and all of the Company’s financial arrangements with Wells Fargo, IBM Credit and Ingram will be terminated upon completion of the proposed sale of the operating assets to Corporate Technologies.
Management cannot provide any assurances that the Company’s present financing arrangements with Wells Fargo, IBM Credit and Ingram Micro, the Company’s current cash position and the proceeds from the sale, if necessary or determined to be appropriate by management, of some or all of the remaining Applied Digital Solutions stock received as payment of the loan to Applied Digital, will be sufficient to fund the Company’s operations and capital expenditures through September 30, 2008 in the event that the transactions contemplated by the Purchase Agreement are not consummated.
On November 3, 2006, the Company notified Wells Fargo that the Company did not expect to be in compliance with the covenants for cumulative net income and minimum book net worth contained in the credit facility with Wells Fargo as of and for the year ended September 30, 2006. Wells Fargo agreed to waive the anticipated non-compliance and, on November 16, 2006, the Company and its subsidiaries entered into an amendment and waiver with Wells Fargo. In connection therewith, the Company agreed to pay Wells Fargo a $25 waiver fee in three installments, $5 on December 1, 2006, $10 on January 2, 2007 and $10 on February 6, 2007.
On November 8, 2007, the Company notified Wells Fargo that the Company did not expect to be in compliance with the covenants for cumulative net income and minimum book net worth contained in the credit facility with Wells Fargo as of and for the fiscal year ended September 30, 2007. Wells Fargo agreed to waive the anticipated non-compliance and, on November 14, 2007, the Company and the Company's subsidiaries entered into a letter agreement with Wells Fargo. The Company did not incur any fees in connection with the waiver of the non-compliance.
As previously discussed, in connection with the Purchase Agreement, the Company plans to terminate the Company's current credit agreements upon the consummation of the transactions contemplated thereby. In the event that the transactions contemplated by the Purchase Agreement are not consummated for any reason and the Company’s agreement with Wells Fargo remains in place, the Company may have difficulty maintaining compliance with its financial covenants throughout the remainder of fiscal year 2008. If it appears likely that such non-compliance may occur, the Company will seek to obtain a waiver or amendment to such financial covenants. There can be no assurance, however, that the Company will be successful in negotiating such waiver or amendment or that such waiver or amendment would be granted on terms that are favorable to the Company. In the absence of a waiver or amendment to the financial covenants, such non-compliance would constitute an event of default under the credit agreement, and Wells Fargo would be entitled to accelerate the maturity of all amounts outstanding.
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
Note 7 - Income Taxes
Income tax benefit consists of the following:
The reconciliation of the effective tax rate with the statutory Federal income tax rate is as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows:
Deferred Tax Assets:
Asset reserves
$
$
Property and equipment
Stock options
Net operating loss carryforwards
2,799
2,576
Gross deferred tax assets
2,876
2,683
Valuation allowance
(2,876
)
(2,683
)
Net Deferred Tax Assets
$
-
$
-
At September 30, 2007, the Company has net operating loss carryforwards of approximately $6,803, which will expire in varying amounts through 2026. Utilization of the Company’s net operating losses may be subject to a substantial annual limitation due to ownership change limitations provided by the Internal Revenue Code and similar state provisions. Realization of deferred tax assets is dependent upon future earnings, the timing and amount of which are uncertain.
A portion of the Company’s net operating loss carryforwards arose prior to a change of control during December 2000. As a result, these net operating loss carryforwards are subject to the annual limitations. Therefore, management believed the Company was not likely to realize the tax benefits associated with the net operating loss carryforwards that arose prior to the change of control and,
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
accordingly, the Company recorded a valuation allowance of $574 in 2001, which did not change in 2002 and 2003. As of September 30, 2004, management believed the Company was not likely to realize a substantial portion of the tax benefits from its deferred tax assets in subsequent years. This was based primarily on the Company’s history of losses and the Company’s susceptibility to the volatile conditions that exist in the IT market, making the likelihood of the Company generating taxable income in future years uncertain. Accordingly, the Company’s management determined that it was appropriate to record a valuation allowance of $2,124, the full amount of its net deferred tax assets as of September 30, 2004 and as a result, the Company increased the valuation allowance by $976 in 2004. As of September 30, 2007 and 2006, management continued to believe the Company was not likely to realize a substantial portion of the tax benefits from any of its deferred tax assets and, accordingly, the Company increased the valuation allowance by $193 and $472 to $2,876 and $2,683 the full amount of its net deferred tax assets, as of September 30, 2007 and 2006, respectively.
Note 8 - Stock-Based Compensation and Warrants
Stock Option Plans
In February 1998, a stock option plan (the “1998 Plan”) was approved by the stockholders. The 1998 Plan was amended in January 2000. Under the revised plan, 1,000 shares of common stock are reserved for issuance upon the exercise of options designated as either incentive stock options or non-qualified stock options. The 1998 Plan will terminate in February 2008. Options granted under the 1998 Plan will expire not more than ten years from the date of grant. Options granted under the plan generally have a vesting period of four years. At September 30, 2007, 1,000 options remain available for issuance under the 1998 Plan.
In March 2001, the stockholders approved the 2001 Flexible Stock Plan (the “2001 Plan”). Under the 2001 Plan, the number of shares which may be issued or sold, or for which options, Stock Appreciation Rights (“SARs”) or Performance Shares may be granted to certain directors, officers and employees of the Company is 2,500 per year, plus an annual increase, effective as of the first day of each calendar year, commencing with 2002, equal to 25% of the number of outstanding shares as of the first day of such calendar year, but in no event more than 10,000 shares in the aggregate. A total of 9,844 and 8,620 shares were subject to grants outstanding under the 2001 Plan at September 30, 2007 and 2006, respectively. The options outstanding as of September 30, 2007 were granted with various vesting schedules and as of September 30, 2007 all outstanding options were fully vested. The options are exercisable over a period ranging from eight to ten years from the date of grant.
On May 12, 2005, the Board of Directors approved a grant of a total of 200 stock options in varying amounts to each of the two Independent Directors of the Company at an exercise price of $.31 per share. The options became exercisable on May 12, 2006 and expire on May 12, 2012. On September 26, 2005, the Board of Directors approved a grant of a total of 300 stock options in varying amounts to each of the four Directors of the Company at an exercise price of $.41. The options became exercisable on September 26, 2006 and expire on September 26, 2013.
A summary of stock option activity related to the Company’s stock option plans is as follows:
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
Employee Stock Purchase Plan
On December 17, 1998, the Company adopted the 1999 Employee Stock Purchase Plan (the “1999 Plan”) whereby 200 shares of common stock were reserved for issuance to eligible employees. A participant may have up to 10% of their earnings withheld during a period of approximately six months commencing on the first trading day on or after April 1 and terminating on the last trading day ending the following September 30, or commencing on the first trading day on or after October 1 and terminating on the last trading day ending the following March 31. The purchase price shall be an amount equal to 85% of the fair market value of a share of common stock on the enrollment date, or on the exercise date, whichever is lower. There were no purchases under the 1999 Plan during 2007, 2006 and 2005.
Warrants
As of September 30, 2007, 2006 and 2005, the Company had 300 warrants outstanding at an exercise price of $0.58 per share. The warrants expire on December 31, 2010.
Note 9 - 401(k) Plan
The Company has a 401(k) Savings Plan (the “Plan”) for the benefit of all eligible employees. An employee would become a participant after the completion of three months of service and the attainment of 20 years of age.
Participants may elect to contribute from their compensation any amount up to the maximum deferral allowed by the Internal Revenue Code. Employer contributions are a discretionary percentage match. The Company may make optional contributions for any Plan year at its discretion.
During 2007, 2006 and 2005, there were no Company contributions to the Plan.
Note 10 - Concentration Of Credit Risk
Cash
The Company places most of its temporary cash investments with one financial institution. Balances normally exceed the Federal Deposit Insurance Corporation limit. At September 30, 2007, amounts in excess of the Federally insured limit totaled approximately $234. The Company has not experienced any loss to date as a result of the practice.
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
Major Customers
Computer sales encompass markets wherein the demands of any one customer may vary greatly due to changes in technology. For 2007, the two largest customers, Hackensack University Medical Center and GAF Material Corporation, accounted for 25% and 21% of the Company’s revenue, respectively. Additionally, as of September 30, 2007, Hackensack University Medical Center, US Bank Corp., and GAF Material Corporation comprised 39%, 11% and 10% of the Company’s accounts receivable, respectively. For 2006, the three largest customers comprised 49% of sales. The three customers with the largest accounts receivable balances comprised 46% of accounts receivable at September 30, 2006. For 2005, the three largest customers comprised 57% of sales.
Note 11 - Commitments And Contingencies
Operating Leases And Consulting Contract
The Company has operating leases on real property expiring through the year 2010. In addition to fixed rentals, the real property leases have escalation clauses that require the Company to pay a percentage of common area maintenance, real estate taxes and insurance.
Rent expense and other related charges totaled $211, $228 and $241 in 2007, 2006 and 2005, respectively.
The approximate minimum payments required under operating leases, that have initial or remaining terms in excess of one year at September 30, 2007, are:
Minimum
Year Ending
Rental
September 30,
Payments
$ 168
Totals
$ 533
Purchases
The Company purchases a majority of its products from a small number of suppliers. Approximately 70%, 70% and 71% of purchases were from the four largest vendors for 2007, 2006 and 2005, respectively.
Legal Proceedings
On April 13, 2005, the Company entered into a Settlement Agreement and General Release with its former President, Chief Executive Officer and director, Anat Ebenstein. Ms. Ebenstein filed a complaint against the Company, Applied Digital and certain of Applied Digital’s officers and directors, on October 22, 2002 in the Superior Court of New Jersey, Mercer County. Ms. Ebenstein’s complaint sought compensatory and punitive damages of $1,000 arising from an alleged improper termination of her employment.
Under the terms of the settlement agreement, Ms. Ebenstein agreed to release the Company and the other defendants from any and all claims. Without admitting any wrongdoing, the Company agreed to forgive a $20 loan payable by Ms. Ebenstein to the Company and to pay Ms. Ebenstein $600, a portion of which was in the form of an annuity. The Company’s employment practices liability insurance provider has agreed to cover 90% of the amount
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
payable by the Company under the settlement agreement less any remaining deductible under the policy that has not been satisfied through the payment of defense costs.
In prior periods, the Company accrued for anticipated legal and settlement costs, based on estimates, which were in excess of the final legal and settlement costs. Accordingly, the Company reversed the over-accrual in the quarter ended March 31, 2005, which resulted in a favorable adjustment to the statement of operations for 2005 of approximately $168.
The Company was not party to any legal proceedings or claims as of September 30, 2007. Accordingly, management does not anticipate any material adverse impact on the Company’s financial position, results of operations or cash flows as a result of legal proceedings or claims.
The Company is not subject to any environmental or governmental proceedings.
Note 12 - Related Party Transactions
The Parent Company incurs certain expenses on behalf of the Company. In 2007, 2006 and 2005, these costs included accounting fees, various business insurance coverages and miscellaneous business expenses. Additionally in 2007 and 2006 these costs included the salary, payroll taxes and benefits of personnel assigned to the Company in those years. The Company reimbursed $213, $287 and $110 of these costs to the Parent Company in 2007, 2006 and 2005, respectively.
In 2007 and 2006 the Company charged the Parent Company $24 and $4, respectively, for services rendered by its Chief Financial Officer at the Parent Company’s wholly owned subsidiary, Computer Equity, Inc
At September 30, 2007 and 2006, amounts due to the Parent Company were $105 and $113 respectively. These amounts arose out of inter-company expenses.
There were no borrowings from the Parent Company in 2007 or 2006.
On June 27, 2003, the Company loaned $1,000 to the Parent Company. Under the terms of the loan, interest, which accrued at an annual rate of 16%, was due and payable on a monthly basis beginning July 31, 2003. Interest income paid or accrued on the loan to the Parent Company amounted to $120, $162 and $162 in 2007, 2006 and 2005, respectively.
On May 15, 2007, the Company entered into a Satisfaction of Loan Agreement (“Agreement”) with Applied Digital with respect to the Commercial Loan Agreement. Under the Agreement, Applied Digital issued to the Company 833,333 shares (the “Shares”) of its common stock, having an aggregate fair value of approximately $1,000 as explained below. On June 11, 2007, the registration statement covering the Shares was declared effective by the Securities and Exchange Commission (“SEC”) (the “Effective Date”) and on June 22, 2007 the shares became freely tradeable. In accordance with the Agreement, once the registration statement covering the Shares was declared effective by the SEC and the Shares became freely tradeable by the Company, Applied Digital was in full satisfaction of all principal, interest and other amounts owed to the Company under the Loan Documents. Additionally, in accordance with the Agreement, on the Effective Date, the exact number of shares to be delivered to the Company was determined to be 703,730 which was calculated by dividing the outstanding principal amount of the note of $1,000 by the average daily closing prices for a share of Applied Digital’s common stock on each trading day occurring during the ten trading day period ending on and including the trading day immediately preceding the Effective Date of the Registration Statement of $1.421.
INFOTECH USA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Continued)
Note 13 - Summarized Quarterly Data (Unaudited)
The following table sets forth the unaudited summarized operating data for each of the quarters in 2007 and 2006:
First
Second
Third
Fourth
Full
Quarter
Quarter
Quarter
Quarter
Year
Total revenue
$
4,305
$
3,040
$
2,819
$
1,734
$
11,898
Gross profit
1,039
2,475
Income (loss) from operations
(214)
(126)
(198)
(477)
Net income (loss)
(234)
(164)
(256)
(618)
Income (loss) per common share -
basic and diluted
0.01
(0.05)
(0.03)
(0.05)
(0.12)
Total revenue
$
5,216
$
3,918
$
3,642
$
3,234
$
16,010
Gross profit
2,677
Loss from operations
(174)
(346)
(240)
(1,301)
(1)
(2,061)
(1)
Net loss
(188)
(366)
(267)
(1,321)
(1)
(2,142)
(1)
Net loss per common share - basic
(0.04)
(0.07)
(0.05)
(0.27)
(0.44)
(1) In the fourth quarter of 2006, the Company recorded impairment charges of $924 related to goodwill.
Net income (loss) per share is calculated independently for each of the quarters presented. Therefore, the sum of the quarterly amounts of net income (loss) per common share will not necessarily equal the total for the year.
Note 14 - Subsequent Event
On December 4, 2007, the Company entered into the Purchase Agreement with Minneapolis, MN based Corporate Technologies to sell substantially all of its operating assets to Corporate Technologies with certain exceptions as set forth in the Purchase Agreement, in exchange for up to $1,000. The Company will retain all net current assets. However, the Company will also be required to recognize certain compensation and other costs as a result of the sale. The transactions contemplated by the Purchase Agreement are likely to result in a material gain that management estimates will be between $500 to $700. Management anticipates that these transactions will be consummated in December 2007. Should the transactions contemplated by the Purchase Agreement be consummated as anticipated, the Company plans to pursue the acquisition of an attractive operating business that seeks to become publicly traded through a reverse merger. Such an acquisition could result in an entirely different business from the one in which the Company is currently engaged.
The transaction is subject to the approval of the majority of the stockholders of the Company and, accordingly, the Company filed a Definitive Proxy Statement on Schedule 14A with the SEC on December 4, 2007. The Special meeting of the shareholders of the Company is scheduled for December 27, 2008. The Company anticipates that the transaction will be approved as the Parent Company’s vote is sufficient to adopt the proposals and the Parent Company has indicated that it intends to vote for the ratification and adoption of the purchase agreement.
INFOTECH USA, INC. AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(In Thousands)
Deducted from Assets
Balance at Beginning of Period
Additions (Deductions)Charged to Costs and Expenses
Other
(Additions)
Deductions
Balance at End of Period
Allowance for Doubtful Accounts:
Year ended September 30, 2005
$ 97
$ -
$ (6)
(a)
$ 103
Year ended September 30, 2006
(a)
Year ended September 30, 2007
(24)
Allowance for Inventory Obsolescence:
Year ended September 30, 2005
-
Year ended September 30, 2006
-
Year ended September 30, 2007
(20)
Deferred Tax Valuation Allowance:
Year ended September 30, 2005
2,124
-
(87)
2,211
Year ended September 30, 2006
2,211
-
(472)
2,683
Year ended September 30, 2007
2,683
-
(193)
2,876
(a)
Amounts written off, net of recoveries.
See Report of Independent Registered Public Accounting Firm.
S-1