Form 10-QSB
UNITED STATES SECURITIES AND EXCHANGE COMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-9129
EPICEDGE, INC.
Exact name of Registrant as specified in its charter
TEXAS 75-1657943
State or other jurisdiction of IRS Employer Identification Number
Incorporation or organization
3200 Wilcrest
Suite 370
Houston, Texas 77042-3366
713-784-2374
Address and telephone number of principal executive offices
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to filing
requirements for the past 90 days.
X Yes No
--- ---
The number of shares of common stock of the Registrant outstanding at November
7, 2000 was 29,505,222.
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EPICEDGE, INC.
FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
INDEX
Page No.
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PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited) 1
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Operations
Condensed Consolidated Statements of Cash Flows
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
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<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
EPICEDGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2000 1999
----------------- ------------------
ASSETS
Current Assets:
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Cash and cash equivalents $ 3,245,275 $ 1,517,065
Trade receivable, less allowance for doubtful accounts of
$294,334 and $37,000, respectively 6,804,914 4,551,736
Unbilled revenue 1,654,377 -
Inventory 410,610 16,931
Other current assets 486,765 230,686
----------------- ------------------
Total current assets 12,601,941 6,316,418
Property and equipment, net 4,480,148 485,261
Goodwill, net 50,942,404 8,508,128
Discontinued operations, net - 365,878
Restricted cash and other assets 1,667,489 -
----------------- ------------------
$ 69,691,982 $ 15,675,685
================= ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Revolving line of credit $ 3,870,934 $ 1,866,471
Notes payable 3,649,904 1,375,000
Accounts payable 4,446,439 5,096,439
Accrued expenses and other current liabilities 4,639,156 1,316,866
----------------- ------------------
Total current liabilities 16,606,433 9,654,776
Notes payable 4,373,958 -
Other long term liabilities 9,101 -
----------------- ------------------
Total liabilities 20,989,492 9,654,776
----------------- ------------------
Shareholders' Equity:
Preferred stock, par value $0.01; 5,000,000 shares authorized;
no shares issued and outstanding - -
Common stock, par value $0.01; 50,000,000 shares authorized;
29,505,222 and 23,081,486 shares issued and
outstanding, respectively 295,052 230,815
Additional paid-in capital 85,676,847 12,353,567
Treasury stock (372,946) -
Accumulated deficit (27,371,249) (6,563,473)
Unearned ESOP shares (9,151,980) -
Unearned compensation (373,234) -
----------------- ------------------
Total shareholders' equity 48,702,490 6,020,909
----------------- ------------------
$ 69,691,982 $ 15,675,685
================= ==================
</TABLE>
The accompanying notes are in integral part
of these condensed consolidated financial
statements.
1
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<TABLE>
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EPICEDGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
--------------- --------------- --------------- ---------------
REVENUES:
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Professional services $ 8,054,290 $ 1,454,703 $ 14,453,477 $ 2,189,009
Technology integration 369,823 3,408,185 12,252,780 17,045,606
--------------- --------------- --------------- ---------------
8,424,113 4,862,888 26,706,257 19,234,615
--------------- --------------- --------------- ---------------
COST OF REVENUES:
Professional services 4,593,225 1,100,191 8,425,942 1,661,390
Technology integration 659,163 3,125,838 10,741,966 15,335,812
--------------- --------------- --------------- ---------------
5,252,388 4,226,029 19,167,908 16,997,202
--------------- --------------- --------------- ---------------
Gross margin 3,171,725 636,859 7,538,349 2,237,413
--------------- --------------- --------------- ---------------
OPERATING EXPENSES:
Selling, general and administrative
(excluding stock-based compensation and
costs shown below) 8,366,555 1,233,077 17,008,937 2,864,640
Depreciation and amortization 1,832,058 185,207 3,217,016 295,195
Stock-based compensation and costs 453,126 - 7,398,760 -
--------------- --------------- --------------- ---------------
10,651,739 1,418,284 27,624,713 3,159,835
--------------- --------------- --------------- ---------------
Loss from operations (7,480,014) (781,425) (20,086,364) (922,422)
Interest and other income (expense), net (369,347) (21,525) (355,534) 35,481
--------------- --------------- --------------- ---------------
Loss from continuing operations before (7,849,361) (802,950) (20,441,898) (886,941)
income taxes
Benefit (provision) for income taxes - (6,040) - (5,000)
--------------- --------------- --------------- ---------------
Net loss from continuing operations (7,849,361) (808,990) (20,441,898) (891,941)
Income (loss) from discontinued operations (383,885) (60,448) (365,878) (106,926)
--------------- --------------- --------------- ---------------
Net loss $ (8,233,246) $ (869,438) $ (20,807,766) $ (998,867)
=============== =============== =============== ===============
Basic and diluted loss per share:
Continuing operations $ (0.29) $ (0.01) $ (0.79) $ (0.04)
Discontinued operations (0.01) - (0.01) (0.01)
--------------- --------------- --------------- ---------------
$ (0.30) $ (0.01) $ (0.80) $ (0.05)
=============== =============== =============== ===============
Basic and diluted weighted average shares
outstanding 27,461,466 21,483,986 25,944,197 20,812,836
=============== =============== =============== ===============
</TABLE>
The accompanying notes are an integral part
of these condensed consolidated financial
statements.
2
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<TABLE>
<CAPTION>
EPICEDGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended
September 30,
2000 1999
----------------- ------------------
Cash flows from operating activities:
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Net loss from continuing operations $ (20,807,776) $ (998,867)
Adjustments to reconcile net loss to net cash
provided by (used in) in operating activities:
Depreciation and amortization 3,790,478 295,195
Provision for doubtful accounts 285,152 -
Provision for excess and obsolete inventory 350,000 -
Stock-based compensation and costs 7,398,760 -
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable 526,089 1,157,953
Unbilled receivables (1,654,377) -
Inventory (743,679) (76,698)
Prepaid expenses and other 234,320 -
Accounts payable (1,097,128) (1,365,425)
Accrued expenses and other current liabilities 336,617 (288,863)
Other, net - (116,280)
----------------- ------------------
Net cash used in operating activities (11,381,544) (1,392,985)
----------------- ------------------
Cash flows from investing activities:
Purchase of property and equipment (3,582,449) (161,803)
Net cash used in business acquisitions (3,110,702) (420,342)
Increase in other assets (349,062) -
----------------- ------------------
Net cash used in investing activities (7,042,213) (582,145)
----------------- ------------------
Cash flows from financing activities:
Net proceeds from notes payable 6,315,529 1,131,492
Proceeds from revolving line of credit 940,631 -
Net proceeds from private placement of stock and warrants 12,895,807 -
----------------- ------------------
Net cash provided by financing activities 20,151,968 1,131,492
----------------- ------------------
Net increase (decrease) in cash and cash equivalents 1,728,210 (843,638)
Cash and cash equivalents, beginning of period 1,517,065 850,925
----------------- ------------------
Cash and cash equivalents, end of period $ 3,245,275 $ 7,287
================= ==================
</TABLE>
3
The accompanying notes are in integral part
of these condensed consolidated financial
statements.
<PAGE>
EPICEDGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared by EpicEdge, Inc. (the "Company" or "EpicEdge") pursuant to
the rules and regulations of the Securities and Exchange Commission
regarding interim financial reporting. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements and should be read in
conjunction with the consolidated financial statements and notes thereto
for the year ended December 31, 1999 included in the Company's Annual
Report on Form 10-KSB/A. The accompanying condensed consolidated financial
statements reflect all adjustments (consisting solely of normal, recurring
adjustments) that are, in the opinion of management, necessary for a fair
presentation of results for the interim periods presented. The results of
operations for the three and nine months ended September 30, 2000 are not
necessarily indicative of the results to be expected for any future period
or the full fiscal year.
Certain amounts from the three and nine months ended September 30, 2000
have been reclassified to conform to the current year presentation.
2. Business Combinations
In March 2000, the Company acquired all of the issued and outstanding stock
of The Growth Strategy Group, Inc. (Growth Strategy), an e-marketing and
strategy consulting firm, for 277,000 unregistered shares of the Company's
common stock valued at $6,076,800 and $375,000 in cash. The three
stockholders of Growth Strategy entered into employment agreements with the
Company. These employment agreements terminate in February 2003 and include
a non-compete provision for the term of the agreement and one year
thereafter.
In June 2000, the Company acquired all of the issued and outstanding stock
of IPS Associates, Inc. (IPS), a project management firm, for $3,000,000 in
cash, 1,472,585 unregistered shares of Company's common stock and options
to purchase 1,082,060 shares of the Company's common stock and the
assumption of net liabilities of $2,242,000. The aggregate value of the
shares and stock options issued in connection with the transaction was
$36,405,139. The Company also assumed an employee stock ownership plan
(ESOP) from IPS. The Company recorded unearned compensation of $9,445,240
related to 493,224 shares of common stock issued to the ESOP in connection
with the transaction that will be amortized over a period of approximately
three to five years. These shares will be periodically revalued in
accordance with Statement of Position 93-6, "Employers' Accounting for
Employee Stock Ownership Plans." In connection with the assumption of the
ESOP, the Company assumed a note payable to a financial institution for
ESOP financing of approximately $4.5 million. The note bears annual
interest of 8.02% and is due in monthly installments of principal and
interest as detailed in the agreements payable through July 2005. The note
is secured by the accounts receivable, investments, and property and
equipment of IPS.
Certain key employees of IPS entered into employment agreements with the
Company. These employment agreements terminate in June 2003 and include a
non-compete provision for the term of the agreement and one year
thereafter. In connection with the transaction, the Company paid a
commission to an individual who facilitated the execution of the
transaction that consisted of a cash payment of $300,000 and the issuance
of 25,065 unregistered shares of the Company's common stock valued at
$576,495 and recorded as part of the cost of the IPS acquisition.
The acquisitions of Growth Strategy and IPS were accounted for under the
purchase method of accounting and resulted in the Company recording
goodwill of $39,712,863, subject to final purchase price adjustments, which
will be amortized over a period of eight years. The selling shareholders
may request registration rights for the shares received in the transactions
under certain circumstances at the Company's expense.
4
<PAGE>
The results of operations of Growth Strategy and IPS have been included in
the Company's financial statements commencing on April 1, 2000 and June 1,
2000, respectively, the effective dates of the transactions for accounting
purposes. The unaudited pro forma consolidated results of operations for
the current year up to September 30, 2000 as though the companies had
combined at the beginning of the period being reported on are as follows:
Revenues $32,782,074
Net loss from continuing operations (21,481,081)
Loss per share (0.80)
Weighted average shares outstanding 27,018,253
In July 2000, the Company acquired substantially all of the assets of
Tumble Interactive Media, Inc. (Tumble), a creative and design firm, for
250,000 unregistered shares of the Company's common stock valued at
$4,937,500, and $325,000 in cash. The principal selling shareholder entered
into an employment agreement with the Company. The agreement terminates in
July 2003 and includes a non-compete provision for the term of the
agreement and one year thereafter. The transaction was accounted for under
the purchase method of accounting and resulted in the goodwill of
$5,432,901, which will be amortized over a period of eight years. The
results of operations of Tumble would not have a material affect on the pro
forma financial information presented and therefore has been excluded from
the pro forma financial information.
3. Inventory
The Company's inventory at September 30, 2000 and December 31, 1999
consists of hardware and software products related to the Company's value
added reseller (VAR) operations that are being phased out. The Company
recorded a reserve for potentially excess and obsolete inventory of
$350,000 during the three months ended September 30, 2000, related to
inventory held by the Company at September 30, 2000, as a result of the
Company substantially transitioning out of this business.
4. Earnings per share
The Company reports earnings per share in accordance with Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." Under
SFAS No. 128, basic earnings per share is based on the weighted effect of
all common shares issued and outstanding during the period and is
calculated by dividing net income available to common stockholders by the
weighted average shares of common stock outstanding during the period.
Diluted earnings per share is calculated by dividing net income available
to common stockholders by the weighted average number of common shares used
in the basic earnings per share calculation plus the number of common
shares that would be issued assuming conversion of all potentially dilutive
shares outstanding. Stock options and warrants of approximately 2,945,000
and 2,568,000 for the three and nine months ended September 30, 2000 and
approximately 332,000 and 148,000 for the three and nine months ended
September 30, 1999 were excluded from the calculation of loss per share for
these periods because the effect of these shares would have been
anti-dilutive.
5
<PAGE>
5. Financing Transactions
In February 2000, the Company sold 2,260,000 unregistered shares of its
common stock to a group of private investors led by Edgewater Private
Equity Fund III, L.P. and Fleck T.I.M.E. Fund, L.P. for $11.3 million
($5.00 per share). The transaction resulted in certain shareholder rights
being granted to the investors including a right to request registration of
the shares at the Company's expense. In August 2000, the investor group
exercised its right to request registration of the shares. In connection
with the transaction, the Company paid a commission to an individual who
facilitated the execution of the transaction that consisted of a cash
payment of $395,000 and a warrant to purchase 22,000 shares of the
Company's common stock at an exercise price of $15.00 per share. The
warrants are exercisable for a period of three years from the date of
issuance.
In July 2000, the Company completed a $5.0 million convertible debt
offering with certain private investors, Edgewater Private Equity Fund III,
L.P. and Fleck T.I.M.E. Fund, L.P. The convertible debt bears annual
interest of 9.5%. Principal and interest are due at maturity on December
30, 2000, if not converted earlier. The principal and accrued and unpaid
interest is convertible at the option of the holder into common stock of
the Company at a 25% discount from the per share price of a Qualified
Financing consummated prior to the maturity date. A Qualified Financing is
defined as an equity financing in which the Company raises at least $7.0
million. If a Qualified Financing is not consummated prior to the maturity
date, then the principal and accrued and unpaid interest is convertible at
the option of the holder into common stock of the Company at a conversion
price of $5.00 per share. During the remainder of fiscal 2000, the Company
will record a non-cash charge of approximately $5.0 million as incremental
interest expense related to the beneficial conversion feature in accordance
with EITF Issue No. 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios," based on the quoted market price of the Company's common stock of
$19.50 per share on the date of issuance. At September 30, 2000, the
balance of the convertible note is $5,000,000 and is offset by a discount
of $5,000,000 related to the beneficial conversion feature resulting in a
net carrying amount of zero.
In September 2000, the Company sold 2,000,000 shares of unregistered common
stock to certain private equity investors, Edgewater Private Equity Fund
III, L.P. and Fleck T.I.M.E. Fund, L.P., for $2 million ($1.00 per share).
The stock purchase agreement provides for two additional board members to
be appointed by the investors. Such appointments were made in September and
October 2000. The purchase agreement also requires the Company to
immediately register the shares of common stock that were issued. The
investors have agreed to a six month lock-up period which prevents them
from selling the shares of common stock acquired in this transaction during
the lock-up period.
6. Other Stock Transactions
In November 1999, the Company granted 190,000 unregistered shares of the
Company's common stock to two of its board members as compensation for
their participation on the Company's Board of Directors. The shares are
issued to each board member in equal installments at the end of each
quarter through the quarter ended September 30, 2000. The Company records
the value of the shares issued each quarter by multiplying the quoted
market price of the stock on the issuance date times the number of shares
issued for that period. The Company recorded stock-based compensation
related to the shares issued of $414,635 and $1,891,093, respectively, for
the three and nine months ended September 30, 2000. The Company has issued
95,000 shares to these board members during the nine months ended September
30, 2000.
6
<PAGE>
In March 2000, the Company issued warrants for the purchase of 40,000
shares of the Company's common stock to two advisory board members for
services to be rendered from April 2000 to March 2002. The warrants have an
exercise price of $21.88 and are exercisable for five years from the date
of grant. One third of the warrants vest upon grant, and the remaining
two-thirds vest in one half increments on the first and second anniversary
of the grant date. The Company recorded the initial value of these warrants
based on the Black-Scholes model, totaling $346,465, as unearned
compensation on the date of grant. The Company is amortizing this amount as
compensation expense over the consulting period, and will revalue the
warrants over the consulting period. The Company revalued the warrants
during the quarter ended September 30, 2000, and based on a lower stock
price during the quarter, reduced the amount of the unearned compensation
by $187,671. The Company recorded no stock-based compensation related to
the warrants for the three months ended September 30, 2000 and $158,973 of
stock-based compensation related to the warrants for the nine months ended
September 30, 2000.
In April 2000, the Company issued to its client's venture capital affiliate
a warrant to purchase 500,000 shares of the Company's common stock at an
exercise price of $22.00 per share. The warrant is exercisable at any time
after the earlier of (i) 60 days after the consummation of a registered
public offering and (ii) October 3, 2001 (such earlier date being the
vesting date), through the third anniversary of the vesting date. The
Company determined the value of the warrant to be $4,843,195 based on the
Black-Scholes model. The warrant was issued contemporaneously with the
negotiation of a consulting agreement between the Company and the client,
under which the Company could receive estimated fees totaling $3.1 million
over the next three years. However, the agreement provides the client with
the right of cancellation for convenience. Therefore, at June 30, 2000,
there was no assurance that the client would continue to engage the Company
under the agreement or would enter into any additional agreements in the
future. Accordingly, the Company recorded the estimated value of the
warrant as a stock-based compensation and costs charge of $4,843,195 during
the three months ended June 30, 2000.
In June 2000, the Company entered into a severance agreement with one of
its employees that provided, among other things, for the modification of
the employee's stock options allowing a cashless exercise of vested and
unexercised stock options. As a result, the Company accounted for the stock
options as variable options and recorded a stock-based compensation charge
on the exercise date during the three months ended June 30, 2000 of
$467,188 based on the difference between the exercise price and the quoted
market price of the underlying stock. The Company issued 22,353 shares of
its common stock to the former employee as a result of the cashless
exercise.
7. Certain Non-recurring Expenses
During the quarter ended September 30, 2000, the Company also announced
plans to move its headquarters from Houston, Texas to Austin, Texas during
the fourth quarter ending December 31, 2000. The Company has recorded a
charge totaling approximately $297,292, during the quarter ended September
30, 2000 related to severance and transition costs for affected employees.
During the quarter ended September 30, 2000, the Company's Chief Executive
Officer and Vice Chairman resigned his positions with the Company. As part
of his resignation, this individual was given a separation package which
includes the payment of one year's base salary in periodic installments
over the ensuing year and the issuance of shares of the Company's common
stock with a total value at the time of issuance of $450,000 only upon the
successful completion of a secondary offering by the Company. The Company
has recorded a severance expense during the quarter ended September 30,
2000 of $300,000 related to the separation agreement. An additional charge
of $450,000 will be recorded by the Company in the period in which it
becomes probable that the Company will complete a secondary offering.
During the quarter ended September 30, 2000, the Company irrevocably
transferred its investment in the remaining shares of Loch Energy to a
designated trustee of Loch Exploration, Inc. Since the Company was unable
to achieve its original plan of distributing these shares as registered
stock to its chareholders who were former shareholders of Loch Exploration,
Inc., the Company has recorded a write-off of $383,885 related to the
disposal of the remaining assets of the discontinued operations related to
Loch Energy during the quarter ended September 30, 2000.
7
<PAGE>
In October 2000, the Company announced a company-wide streamlining of its
business operations. This initiative is expected to reduce future operating
expenses through the elimination of 43 full-time positions, or 14% of the
company's workforce. The Company expects to record a charge related to this
activity during the fourth quarter ending December 31, 2000 of
approximately $825,000.
8. Subsequent Events
The Company has two lines of credit totaling $6.0 million with two
financial institutions. The Company may draw on the lines of credit based
on a borrowing base which is 85% of eligible accounts receivable. Amounts
outstanding under the lines of credit bear interest ranging from the prime
rate plus 0.5% to the prime rate plus 2.5%. The lines of credit are secured
by accounts receivables, inventory, investments and property and equipment.
The outstanding balance on the lines of credit was $3,870,934 at September
30, 2000. No additional amounts were available at September 30, 2000 under
the lines of credit. The Company also is the guarantor on a note payable to
a financial institution for a loan made to an Employee Stock Ownership Plan
sponsored by the Company (the "ESOP loan"). The ESOP loan bears annual
interest at 8.02% and is secured by accounts receivables, inventory,
investments, property and equipment, and the personal guarantees of certain
employees and stockholders of the Company. The outstanding balance of the
ESOP loan at September 30, 2000 was $5,132,291. The Company is in technical
default of its lines of credit and the ESOP loan and the creditors have
asserted the default under the loan agreements. The financial institutions
have agreed to temporarily standstill and forbear accelerating the
outstanding balances through approximately January 20, 2001 to allow the
Company time to either replace the lines of credit with new creditors or
repay the outstanding balances. There is no assurance that the Company will
be able to replace the lines of credit with new creditors on terms
acceptable to the Company or that the Company will be able to repay the
outstanding balances. These uncertainties could have a material adverse
affect on the Company.
In November 2000, the Company's Chairman and principal shareholder provided
a $1,000,000 line of credit to the Company in the form of a convertible
note. The Company may draw upon the line of credit from time to time as
needed. To date, the Company has drawn $900,000 on the line of credit. The
convertible note is payable in November 2001, unless converted earlier at
the Chairman's option. The note bears annual interest at the rate of 8%.
The Chairman may convert the note into shares of the Company's common stock
in connection with the next round of financing closed by the Company on the
same terms as the next round of financing closed by the Company. The note
is secured by a first lien position on all assets of the Company not
already pledged to other creditors and a second lien position on all assets
of the Company that are pledged to other creditors.
9. New Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes standards for
measuring, classifying and reporting all derivative financial instruments
in the financial statements. SFAS No. 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. The Company will
adopt SFAS No. 133 beginning the first quarter of fiscal year 2001. The
Company does not expect the adoption of this standard to have a material
impact on the Company's financial position or results of operations.
In March 2000, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of Accounting Principles Board (APB) Opinion No.
25 and among other issues clarifies the following: the definition of an
employee for purposes of applying APB Opinion No. 25; the criteria for
determining whether a plan qualifies as a non-compensatory plan; the
accounting consequences of various modifications to the terms of previously
fixed stock options or awards; and the accounting for an exchange of stock
compensation awards in a business combination. FIN 44 is effective July 1,
2000, but certain conclusions in FIN 44 cover specific events that occurred
after either December 15, 1998 or January 12, 2000. The Company does not
expect the application of FIN 44 to have a material impact on the Company's
financial position or results of operations.
* * *
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The following analysis of the results of operations and financial
condition of the Company should be read in conjunction with the condensed
financial statements, including the notes thereto, contained elsewhere in this
Form 10-QSB.
The Company was originally incorporated under the name Loch
Exploration, Inc. in 1979 and historically engaged in the oil and gas business.
The Company was an inactive SEC registrant with operations that had
substantially ceased (a shell company with a listing on a public stock exchange)
when in December 1998 the Company entered into a reverse merger with Design
Automation Systems, Inc. The reverse merger was executed such that the Company
was the surviving company but the shareholders of Design Automation Systems,
Inc. acquired a controlling interest in the combined company. As such, the
operations of Design Automation Systems, Inc. were the on-going operations of
the combined company after the combination and the remaining operations of Loch
Exploration, Inc. (which became Loch Energy, Inc.) were reflected as
discontinued operations after the combination. Therefore, all financial
information in this prospectus reflects the operations of Design Automation
Systems, Inc.
Design Automation Systems, Inc.'s historical operations were as a
value-added reseller (VAR) and system integrator of hardware and software
products. After the reverse merger, the new combined company, which was renamed
EpicEdge, Inc. in March 2000, transformed its operations to primarily provide
professional services. The Company now engages in the business of enabling
clients to advance their competitive edge by transforming their internet vision
into an effective e-business solution. The Company's professional services
support customers through the phases of an e-business implementation including
strategy development and creative services, information architecture and design,
e-commerce application development, legacy system integration, project
management and training, and site hosting services. The Company offers flexible
consulting and technology solutions that address emerging needs and help clients
to focus on performance improvement through measurement and assessment. The
Company substantially completed the transition of its operations to a
professional services company in the second quarter of 2000 and the Company
expects substantially all of its future revenues to be derived from delivering
professional services to its clients.
The Company's ability to successfully provide professional services to
its clients is dependent upon its ability to obtain the necessary skills,
resources and capabilities required to render such professional services. As a
result, the Company completed a series of strategic acquisitions to acquire the
skills, resources and capabilities necessary to create a professional service
offering that would enable it to provide the appropriate professional services
to support customers through all phases of an e-business implementation. The
acquisitions that the Company completed are as follows:
9
<PAGE>
<TABLE>
<CAPTION>
Acquisition Date Company Name Service Capability Nature of Acquisition Consideration Paid
<S> <C> <C> <C> <C>
March 1999 COAD Solutions, Inc. e-business consulting We acquired all of the issued 600,000 shares of
("COAD") and ERP implementation and outstanding shares of COAD unregistered common stock
services and $200,000 in cash
May 1999 Dynamic Professional ERP implementation and We acquired all of the issued 524,000 shares of
Services, Inc. public sector consulting and outstanding shares of unregistered common stock
("Dynamic") services Dynamic and $200,000 in cash
July 1999 Connected Software e-business consulting We acquired all of the issued 300,000 shares of
Solutions LLC and trainaing services and outstanding shares of unregistered common stock
("Connected") Connected and $300,000 in cash
November 1999 Net Information Systems, e-business development We acquired all of the assets 350,000 shares of
Inc. ("Net Information") and consulting services of Net Information unregistered common stock,
$180,000 in cash, and a
$50,000 note payable
March 2000 The Growth Strategy, e-marketing and strategy We acquired all of the issued 277,000 shares of
Inc. ("Growth consulting services and outstanding shares of unregistered common stock
Strategy") Growth Strategy and $375,000 in cash
June 2000 IPS Associates, Inc. Project management and We acquired all of the issued 1,472,585 shares of
("IPS") corporate development and outstanding shares of IPS unregistered common stock,
anda training services $3,000,000 in cash, and
conversion of outstanding
IPS stock options to
purchase 1,082,060 shares
of IPS stock
July 2000 Tumble Interactive Creative and design We acquired all of the assets 250,000 shares of
Media, Inc. ("Tumble") services of Tumble unregistered common stock
and $325,000 in cash
</TABLE>
Business Combinations
In March 2000, the Company acquired all of the issued and outstanding
stock of The Growth Strategy Group, Inc. (Growth Strategy), an e-marketing and
strategy consulting firm, for 277,000 unregistered shares of the Company's
common stock valued at $6,076,800 and $375,000 in cash. The three stockholders
of Growth Strategy entered into employment agreements with the Company. These
employment agreements terminate in February 2003 and include a non-compete
provision for the term of the agreement and one year thereafter.
10
<PAGE>
In June 2000, the Company acquired all of the issued and outstanding
stock of IPS Associates, Inc. (IPS), a project management firm, for $3,000,000
in cash, 1,472,585 unregistered shares of Company's common stock and options to
purchase 1,082,060 shares of the Company's common stock and the assumption of
net liabilities of $2,242,000. The aggregate value of the shares and stock
options issued in connection with the transaction was $36,405,139. The Company
also assumed an employee stock ownership plan (ESOP) from IPS. The Company
recorded unearned compensation of $9,445,240 related to 493,224 shares of common
stock issued to the ESOP in connection with the transaction that will be
amortized over a period of approximately 3 to 5 years. These shares will be
periodically revalued in accordance with Statement of Position 93-6, "Employers'
Accounting for Employee Stock Ownership Plans." In connection with the
assumption of the ESOP, the Company assumed a note payable to a financial
institution for ESOP financing of approximately $4.5 million. The note bears
annual interest of 8.02% and is due in monthly installments of principal and
interest as detailed in the agreements payable through July 2005. The note is
secured by the accounts receivable, investments, and property and equipment of
IPS.
Certain key employees of IPS entered into employment agreements with
the Company. These employment agreements terminate in June 2003 and include a
non-compete provision for the term of the agreement and one year thereafter. In
connection with the transaction, the Company paid a commission to an individual
who facilitated the execution of the transaction that consisted of a cash
payment of $300,000 and the issuance of 25,065 unregistered shares of the
Company's common stock valued at $576,495 and recorded as part of the cost of
the IPS acquisition.
The acquisitions of Growth Strategy and IPS were accounted for under
the purchase method of accounting and resulted in the Company recording goodwill
of $40,248,229, subject to final purchase price allocations, which will be
amortized over a period of eight years. The selling shareholders may request
registration rights for the shares received in the transactions under certain
circumstances at the Company's expense.
The results of operations of Growth Strategy and IPS have been included
in the Company's financial statements commencing on April 1, 2000 and June 1,
2000, respectively, the effective dates of the transactions for accounting
purposes. The unaudited pro forma consolidated results of operations for the
current year up to September 30, 2000 as though the companies had combined at
the beginning of the period being reported on are as follows:
Revenues $32,782,074
Net loss from continuing operations (21,481,081)
Loss per share (0.80)
Weighted average shares outstanding 27,018,253
In July 2000, the Company acquired substantially all of the assets of
Tumble Interactive Media, Inc. (Tumble), a creative and design firm, for
250,000 unregistered shares of the Company's common stock valued at
$4,937,500, and $325,000 in cash. The principal selling shareholder entered
into an employment agreement with the Company. The agreement terminates in
July 2003 and includes a non-compete provision for the term of the agreement
and one year thereafter. The transaction was accounted for under the purchase
method of accounting and resulted in the goodwill of $5,432,901, which will be
amortized over a period of eight years. The results of operations of Tumble
would not have a material affect on the pro forma financial information
presented and therefore has been excluded from the pro forma financial
information.
11
<PAGE>
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS
The following table sets forth certain condensed consolidated statement of
operations data expressed as a percentage of total revenues for the periods
indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
----------------------- ------------------------
<S> <C> <C> <C> <C>
Revenues 100% 100% 100% 100%
Cost of revenues 62% 87% 72% 88%
----------------------- ------------------------
Gross margin 38% 13% 28% 12%
----------------------- ------------------------
Operating expenses:
Selling, general and administrative 99% 25% 63% 15%
Depreciation and amortization 22% 4% 12% 2%
Stock-based compensation and costs 5% 0% 28% 0%
----------------------- ------------------------
126% 29% 103% 17%
----------------------- ------------------------
Loss from operations -88% -16% -75% -5%
Interest and other income (expense), net -4% 0% -1% 0%
----------------------- ------------------------
Loss from continuing operations before income taxes -92% -16% -76% -5%
Benefit (provision) for income taxes 0% 0% 0% 0%
----------------------- ------------------------
Net loss from continuing operations -92% -16% -76% -5%
Income (loss) from discontinued operations -5% -1% -1% -1%
----------------------- ------------------------
Net loss -97% -17% -77% -6%
======================= ========================
</TABLE>
REVENUES
Professional Services Revenues
Total revenues increased 71% from $4.9 million to $8.4 million for the
three months ended September 30, 1999 and 2000, respectively. Total revenues
increased 39% from $19.2 million to $26.7 million for the nine months ended
September 30, 1999 and 2000, respectively.
Professional service revenues increased 440% from $1.5 million for the
three months ended September 30, 1999 to $8.1 million for the three months ended
September 30, 2000, representing 31% and 96% of total revenues in the respective
periods. Professional service revenues increased 559% from $2.2 million for the
nine months ended September 30, 1999 to $14.5 million for the nine months ended
September 30, 2000, representing 11% and 54% of total revenues in the respective
periods.
12
<PAGE>
Total revenues and professional services revenues increased from the
three and nine months ended September 30, 1999 to the three and nine months
ended September 30, 2000 as a result of the completion of several acquisitions
of professional services businesses during the nine months ended September 30,
2000 which resulted in increased revenues generated from the Company's
professional services business as the Company executes its business strategy of
migrating from a value-added reseller (VAR) of hardware and software to a
professional services company. The Company has substantially completed this
migration in the second quarter of fiscal 2000 and expects substantially all of
its future revenues to be derived from professional services. As a result, the
Company expects total revenues to decline from the fourth quarter of fiscal 1999
to the fourth quarter of fiscal 2000.
Technology Integration Revenues
Technology integration revenues decreased 88% from $3.4 million for the
three months ended September 30, 1999 to $0.4 million for the three months ended
September 30, 2000, representing 69% and 4% of total revenues in the respective
periods. Technology integration revenues decreased 28% from $17.0 million for
the nine months ended September 30, 1999 to $12.3 million for the nine months
ended September 30, 2000, representing 89% and 46% of total revenues in the
respective periods. The nine month trend in technology integration revenues is
reflective of the Company's strategy to migrate from a value-added reseller
(VAR) of hardware and software to a professional services company which has
resulted in the phasing out of its VAR operations. The Company does not expect
to generate substantial additional revenues from its VAR business in the fourth
quarter of fiscal 2000.
COST OF REVENUES
Total cost of revenues increased 26% from $4.2 million for the three
months ended September 30, 1999 to $5.3 million for the three months ended
September 30, 2000. Total cost of revenues increased 13% from $17.0 million for
the nine months ended September 30, 1999 to $19.2 million for the six months
ended September 30, 2000.
Cost of Professional Service Revenues
Cost of professional service revenues consists primarily of salaries
and employee costs for personnel dedicated to client projects, sub-contractor
costs related to client projects, and direct expenses incurred to complete
projects that were not reimbursed by clients. Cost of professional service
revenues increased 318% from $1.1 million for the three months ended September
30, 1999 to $4.6 million for the three months ended September 30, 2000,
representing 22% and 55% of total revenues in the respective periods. Cost of
professional service revenues increased 394% from $1.7 million for the nine
months ended September 30, 1999 to $8.4 million for the nine months ended
September 30, 2000, representing 9% and 32% of total revenues in the respective
periods. The increases are the result of the Company being engaged on larger and
more numerous client projects during the three and nine months ended September
30, 2000 in comparison with the same periods in fiscal 1999.
The gross margin on professional service revenues was 43% and 42%,
respectively, for the three and nine months ended September 30, 2000 and was 24%
for the three and nine months ended September 30, 1999.
Cost of Technology Integration Revenues
Cost of technology integration revenues consists primarily of hardware
and software costs associated with product sales. Cost of technology integration
revenues decreased 77% from $3.1 million for the three months ended September
30, 1999 to $0.7 million for the three months ended September 30, 2000,
representing 63% and 8% of total revenues in the respective periods. Cost of
technology integration revenues decreased 30% from $15.3 million for the nine
months ended September 30, 1999 to $10.7 million for the nine months ended
September 30, 2000, representing 80% and 40% of total revenues in the respective
periods. The changes in the cost of technology integration revenues are the
result of related increases or decreases in product sales. Additionally, the
Company recorded a reserve for potentially excess and obsolete inventory during
the three months ended September 30, 2000 of $350,000 as the Company has
substantially transitioned out of the hardware and software VAR business. The
gross margin on technology integration revenues was 8% and (78)% for the three
months ended September 30, 1999 and 2000, respectively. The technology
integration margin was 10% and 12% for the nine months ended September 30, 1999
and 2000, respectively.
13
<PAGE>
OPERATING EXPENSES
Selling, General and Administrative
Selling, general and administrative expenses (SG&A) increased 600% from
$1.2 million for the three months ended September 30, 1999 to $8.4 million for
the three months ended September 30, 2000, representing 25% and 99% of total
revenues in the respective periods. SG&A expenses increased 486% from $2.9
million for the nine months ended September 30, 1999 to $17.0 million for the
nine months ended September 30, 2000, representing 15% and 63% of total revenues
in the respective periods. The increase in SG&A expenses reflects the
acquisition of certain businesses which brought additional SG&A expenses to the
Company and an increase in staffing and related expenses to support the growth
in the business. The Company also recorded a provision for doubtful accounts of
$285,152 during the three months ended September 30, 2000, related primarily to
accounts receivable associated with the former hardware and software VAR
business.
Depreciation and Amortization
Depreciation and amortization increased 800% from $0.2 million for the
three months ended September 30, 1999 to $1.8 million for the three months ended
September 30, 2000, representing 4% and 22% of total revenues in the respective
periods. Depreciation and amortization increased 967% from $0.3 million for the
nine months ended September 30, 1999 to $3.2 million for the nine months ended
September 30, 2000, representing 2% and 12% of total revenues in the respective
periods. Depreciation and amortization increased during the three and nine
months ended September 30, 2000 as a result of amortization of goodwill recorded
in connection with the acquisition of certain businesses. Amortization of
goodwill and unearned ESOP share deferral at September 30, 2000 will be
approximately $2.0 million per quarter in future quarters.
Stock-based Compensation and Costs
Stock-based compensation and costs was $0.5 million and $7.4 million
for the three and nine months ended September 30, 2000, representing 5% and 28%
of total revenues in the respective periods. No stock-based compensation was
recorded during the three and nine months ended September 30, 1999. The
stock-based compensation charges during the three and nine months ended
September 30, 2000 were based on certain transactions as follows:
In November 1999, the Company granted 190,000 unregistered shares of
the Company's common stock to two of its board members as compensation for their
participation on the Company's Board of Directors. The shares are issued to each
board member in equal installments at the end of each quarter through the
quarter ended September 30, 2000. The Company records the value of the shares
issued each quarter by multiplying the quoted market price of the stock on the
issuance date times the number of shares issued for that period. The Company
recorded stock-based compensation related to the shares issued of $130,625 and
$1,607,083, respectively, for the three and nine months ended September 30,
2000. The Company has issued 95,000 shares to these board members during the
nine months ended September 30, 2000.
14
<PAGE>
In March 2000, the Company issued warrants for the purchase of 40,000
shares of the Company's common stock to two advisory board members for services
to be rendered from April 2000 to March 2002. The warrants have an exercise
price of $21.88 and are exercisable for five years from the date of grant. One
third of the warrants vest upon grant, and the remaining two-thirds vest in one
half increments on the first and second anniversary of the grant date. The
Company recorded the initial value of these warrants based on the Black-Scholes
model, totaling $346,465, as unearned compensation on the date of grant. The
Company is amortizing this amount as compensation expense over the consulting
period, and will revalue the warrants over the consulting period. The Company
revalued the warrants during the quarter ended September 30, 2000, and based on
a lower stock price during the quarter, reduced the amount of the unearned
compensation by $187,671. The Company recorded no stock-based compensation
related to the warrants for the three months ended September 30, 2000 and
$158,973 of stock-based compensation related to the warrants for the nine months
ended September 30, 2000.
In April 2000, the Company issued to its client's venture capital
affiliate a warrant to purchase 500,000 shares of the Company's common stock at
an exercise price of $22.00 per share. The warrant is exercisable at any time
after the earlier of (i) 60 days after the consummation of a registered public
offering and (ii) October 3, 2001 (such earlier date being the vesting date),
through the third anniversary of the vesting date. The Company determined the
value of the warrant to be $4,843,195 based on the Black-Scholes model. The
warrant was issued contemporaneously with the negotiation of a consulting
agreement between the Company and the client, under which the Company could
receive estimated fees totaling $3.1 million over the next three years. However,
the agreement provides the client with the right of cancellation for
convenience. Therefore, at June 30, 2000, there was no assurance that the client
would continue to engage the Company under the agreement or would enter into any
additional agreements in the future. Accordingly, the Company recorded the
estimated value of the warrant as a stock-based compensation and costs charge of
$4,843,195 during the three months ended June 30, 2000.
In June 2000, the Company entered into a severance agreement with one
of its employees that provided, among other things, for the modification of the
employee's stock options allowing a cashless exercise of vested and unexercised
stock options. As a result, the Company accounted for the stock options as
variable options and recorded a stock-based compensation charge on the
exercise date during the three months ended June 30, 2000 of $467,188 based on
the difference between the exercise price and the quoted market price of the
underlying stock. The Company issued 22,353 shares of its common stock to the
former employee as a result of the cashless exercise.
Certain Non-recurring Expenses
During the quarter ended September 30, 2000, the Company also announced
plans to move its headquarters from Houston, Texas to Austin, Texas during the
fourth quarter ending December 31, 2000. The Company has recorded a charge
totaling $297,292 during the quarter ended September 30, 2000 related to
severance and transition costs for affected employees.
During the quarter ended September 30, 2000, the Company's Chief
Executive Officer and Vice Chairman resigned his positions with the Company. As
part of his resignation, this individual was given a separation package which
includes the payment of one year's base salary in periodic installments over the
ensuing year and the issuance of shares of the Company's common stock with a
total value at the time of issuance of $450,000 only upon the successful
completion of a secondary offering by the Company. The Company has recorded a
severance expense during the quarter ended September 30, 2000 of $300,000
related to the separation agreement. An additional charge of $450,000 will be
recorded by the Company in the period in which it becomes probable that the
Company will complete a secondary offering.
In October 2000, the Company announced a company-wide streamlining of
its business operations. This initiative is expected to reduce future operating
expenses through the elimination of 43 full-time positions, or 14% of the
company's workforce. The Company expects to record a charge related to this
activity during the fourth quarter ending December 31, 2000 of approximately
$825,000. As such, the Company expects SG&A expenses to increase during the
fourth quarter of fiscal 2000 as a result of the reduction in workforce.
15
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2000, the Company's primary sources of liquidity
were cash and cash equivalents of $3,245,275, and net accounts receivable of
$6,804,914. The Company also relies on amounts available under lines of credit
totaling $6,000,000 with two financial institutions. There were no amounts
available under the lines of credit at September 30, 2000.
Net cash used in operating activities was $11,381,544 for the nine
months ended September 30, 2000 and is the result of the net loss incurred
during the period in addition to increases in unbilled receivables and
inventories and a decrease in accounts payable, partially offset by decreases in
accounts receivables and increases in accrued expenses. Net cash used in
operations was $1,239,589 for the nine months ended September 30, 1999 and is
primarily the result of the net loss for the period and decreases in accounts
payable and accrued expenses, partially offset by a decrease in accounts
receivable.
Net cash used in investing activities was $7,042,213 for the nine
months ended September 30, 2000 and is the result of net purchases of property
and equipment as well as cash used to acquire certain businesses. Net cash used
in investing activities was $735,541 for the nine months ended September 30,
1999 and is the result of net purchases of property and equipment as well as
cash used to acquire certain businesses
Net cash provided by financing activities was $20,151,968 for the nine
months ended September 30, 2000 and reflects the sale of the Company's common
stock to a group of private equity investors netting approximately $12,900,000
to the Company, the completion of a $5,000,000 convertible debt offering and net
borrowings under the line of credit of $940,631. Net cash provided by financing
activities was $1,131,492 for the nine months ended September 30, 1999 and
reflects net borrowings under the Company's revolving line of credit.
In February 2000, the Company sold 2,260,000 unregistered shares of its
common stock to a group of private equity investors for $11.3 million ($5.00 per
share). The transaction resulted in certain shareholder rights being granted to
the investors including a right to request registration of the shares at the
Company's expense. In August 2000, the investor group exercised its right to
request registration of the shares. In connection with the transaction, the
Company paid a commission to an individual who facilitated the execution of the
transaction that consisted of a cash payment of $395,000 and the issuance of
22,000 shares of the Company's common stock.
In July 2000, the Company completed a $5.0 million convertible debt
offering with certain private investors. The convertible debt bears annual
interest of 9.5%. Principal and interest are due at maturity on December 30,
2000, if not converted earlier. The principal and accrued and unpaid interest is
convertible at the option of the holder into common stock of the Company at a
25% discount from the per share price of a Qualified Financing consummated prior
to the maturity date. A Qualified Financing is defined as an equity financing in
which the Company raises at least $7.0 million. If a Qualified Financing is not
consummated prior to the maturity date, then the principal and accrued and
unpaid interest is convertible at the option of the holder into common stock of
the Company at a conversion price of $5.00 per share. During the remainder of
fiscal 2000, the Company will record a non-cash charge of approximately $5.0
million as incremental interest expense related to the beneficial conversion
feature in accordance with EITF Issue No. 98-5, "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios," based on the quoted market of the Company's common stock of
$19.50 per share price on the date of issuance.
In September 2000, the Company sold 2,000,000 shares of unregistered
common stock to certain private equity investors, Edgewater Private Equity Fund
III, L.P. and Fleck T.I.M.E. Fund, L.P., for $2 million. The stock purchase
agreement provides for two additional board members to be appointed by the
investors. Such appointments were made in September and October 2000. The
purchase agreement also requires the Company to immediately register the shares
of common stock that were issued. The investors have agreed to a six month
lock-up period which prevents them from selling the shares of common stock
acquired in this transaction during the lock-up period.
During the quarter ended September 30, 2000, the Company irrevocably
transferred its investment in the remaining shares of Loch Energy to a
designated trustee of Loch Exploration, Inc. Since the Company was unable to
achieve its original plan of distributing these shares as registered stock to
its shareholders who were former shareholders of Loch Exploration, Inc., the
Company has recorded a write-off of $383,885 related to the disposal of the
remaining assets of the discontinued operations related to Loch Energy during
the quarter ended September 30, 2000.
16
<PAGE>
The Company has two lines of credit totaling $6.0 million with two
financial institutions. The Company may draw on the lines of credit based on a
borrowing base which is 85% of eligible accounts receivable. Amounts outstanding
under the lines of credit bear interest ranging from the prime rate plus 0.5% to
the prime rate plus 2.5%. The lines of credit are secured by accounts
receivables, inventory, investments and property and equipment. The outstanding
balance on the lines of credit was $3,870,934. No additional amounts were
available at September 30, 2000 under the lines of credit. The Company also is
the guarantor on a note payable to a financial institution for a loan made to an
Employee Stock Ownership Plan sponsored by the Company (the "ESOP loan"). The
ESOP loan bears annual interest at 8.02% and is secured by accounts receivables,
inventory, investments, property and equipment, and the personal guarantees of
certain employees and stockholders of the Company. The outstanding balance of
the ESOP loan at September 30, 2000 was $5,132,291. The Company is in technical
default of its lines of credit and the ESOP loan and the creditors have asserted
the default under the loan agreements. The financial institutions have agreed to
temporarily standstill and forbear accelerating the outstanding balances through
approximately January 20, 2000 to allow the Company time to either replace the
lines of credit with new creditors or repay the outstanding balances. There is
no assurance that the Company will be able to replace the lines of credit with
new creditors on terms acceptable to the Company or that the Company will be
able to repay the outstanding balances. These uncertainties could have a
material adverse affect on the Company.
In November 2000, the Company's Chairman and principal shareholder
provided a $1,000,000 line of credit to the Company in the form of a convertible
note. The Company may draw upon the line of credit from time to time as needed.
To date, the Company has drawn $900,000 on the line of credit. The convertible
note is payable in November 2001, unless converted earlier at the Chairman's
option. The note bears annual interest at the rate of 8%. The Chairman may
convert the note into shares of the Company's common stock in connection with
the next round of financing closed by the Company on the same terms as the next
round of financing closed by the Company. The note is secured by a first lien
position on all assets of the Company not already pledged to other creditors and
a second lien position on all assets of the Company that are pledged to other
creditors.
At September 30, 2000, the Company had negative working capital of
$4,229,077. Additionally, the Company has completed several acquisitions that
may place an additional strain on the Company's cash resources as the operations
of the acquired businesses are integrated with the Company's operations.
Furthermore, the Company will require additional cash to meet its short- and
long-term liquidity requirements and to execute its current business plan.
Management is currently in the process of raising additional financing to meet
planned working capital requirements. In the event that the Company is unable to
obtain additional financing on terms that are acceptable to the Company, then
the Company will have to modify its business plan to reduce future cash outflows
to enable it to meet its liquidity requirements for the remainder of the current
fiscal year. There is no assurance that the Company will be able to successfully
obtain the additional financing required to execute its current business plan or
that the Company will be able to modify its business plan sufficiently to reduce
future cash outflows to a level that would enable it to meet its liquidity
requirements for the remainder of the current fiscal year. These uncertainties
could have a material adverse affect on the Company's future operations.
The Company currently has term sheets from several different investors
for different financings. The form and amounts of the investments vary; however,
all of the financings involve significant dilution to current shareholders. The
Company is evaluating the alternative financing options and expects to reach a
decision during the fourth quarter of fiscal 2000. The Company expects that
closing one or more of these financings will provide the working capital
necessary to enable it to continue to implement its business plan in the near
term. There can be no assurance that the Company will be able to close any of
the proposed financings. These uncertainties could have a material adverse
affect on the Company's ability to continue as a going concern.
17
<PAGE>
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes standards for measuring,
classifying and reporting all derivative financial instruments in the financial
statements. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. The Company will adopt SFAS No. 133 beginning the
first quarter of fiscal year 2001. The Company does not expect the adoption of
this standard to have a material impact on the Company's financial position or
results of operations.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and among other issues clarifies
the following: the definition of an employee for purposes of applying APB
Opinion No. 25; the criteria for determining whether a plan qualifies as a
non-compensatory plan; the accounting consequences of various modifications to
the terms of previously fixed stock options or awards; and the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 is
effective July 1, 2000, but certain conclusions in FIN 44 cover specific events
that occurred after either December 15, 1998 or January 12, 2000. The Company
does not expect the application of FIN 44 to have a material impact on the
Company's financial position or results of operations.
CERTAIN FACTORS THAT MAY AFFECT OUR BUSINESS
We Are Currently in Default of Senior Debt Securities
The Company has two lines of credit totaling $6 million with two
financial institutions. The lines of credit are secured by accounts receivables,
inventory, investments and property and equipment. The outstanding balance on
the lines of credit was $3,870,934 at September 30, 2000. No additional amounts
were available at September 30, 2000 under the lines of credit. The Company also
is the guarantor on a note payable to a financial institution for a loan made to
an Employee Stock Ownership Plan sponsored by the Company (the "ESOP loan"). The
ESOP loan is secured by accounts receivables, inventory, investments, property
and equipment, and the personal guarantees of certain employees and stockholders
of the Company. The outstanding balance of the ESOP loan at September 30, 2000
was $5,132,291. The Company is in technical default of its lines of credit and
the ESOP loan and the creditors have asserted the default under the loan
agreements. The financial institutions have agreed to temporarily standstill and
forbear accelerating the outstanding balances through approximately January 20,
2000 to allow the Company time to either replace the lines of credit with new
creditors or repay the outstanding balances. There is no assurance that the
Company will be able to rreplace the lines of credit with new creditors on terms
acceptable to the Company or that the Company will be able to repay the
outstanding balances. These uncertainties could have a material adverse affect
on the Company.
We Need to Raise Additional Capital, Which May Not Be Available.
We must raise additional funds to continue to operate, and it is
uncertain that we will be able to obtain additional financing on favorable terms
or at all. Additionally, we have experienced a sharp decline in our stock price
and as a result, any financing equity transaction will likely be highly dilutive
to existing shareholders. If we cannot raise additional capital on acceptable
terms, we will not be able to implement our current operating plan or continue
to operate in our existing form. Issuance of debt may require us to agree to
restrictive covenants which could hamper our business and operations. These
uncertainties could have a material adverse affect on the Company.
We Face Intense Competition in Our Market
Our services are targeted at the new and rapidly evolving market for
e-commerce solutions. Although the competitive environment in this market has
yet to develop fully, we anticipate that it will be intensely competitive,
subject to rapid change and significantly affected by new service and product
introductions and other market activities of industry participants.
Increased competition could result in pricing pressures, reduced
margins or the failure of our services to achieve or maintain market acceptance,
any of which could have a serious adverse effect on our business, financial
condition and results of operations.
Our Industry is Subject to Rapid Technological Change
The emerging market for e-commerce solutions and related services is
characterized by rapid technological developments and services and evolving
industry standards. The emerging nature of this market and its rapid evolution
will require us to improve existing services as well as be first to market new
services in the e-commerce environment. Our failure to develop and introduce new
and existing services successfully and on a timely basis could have a
significant adverse effect on our business, financial condition and result of
operations.
We Must Manage Our Growth
We are currently experiencing tremendous growth which places a
significant strain on our management and other resources. Our business has grown
significantly in size and complexity over the past year. The growth in size and
complexity of our business as well as its customer base has placed, and is
expected to continue to place, a significant strain on our management and
operations. We anticipate that continued growth will require us to recruit and
hire a substantial number of new managerial, finance, sales and marketing and
support personnel. Our ability to compete effectively and to manage future
growth will depend on, among other things: (1) our ability to continue to
implement and improve operational, financial and management information systems
on a timely basis and (2) our ability to expand, train, motivate and manage our
work force.
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Possible Future Acquisitions Could Impact Our Expected Results
As part of our future growth strategy, it is possible that we will
acquire or make investments in companies, technologies, or professional services
offerings. With respect to these acquisitions, we would face the difficulties of
assimilating their personnel and operations with our present business, and the
problems of retaining and motivating key personnel from acquired businesses. In
addition, these acquisitions may disrupt ongoing operations, divert management
from day-to-day business, and adversely impact our results of operations.
Certainly, these types of transactions often result in charges to earnings for
items such as amortization of goodwill.
Our Stock Price May be Volatile in the Future
The trading price of our common stock has been, and is expected to
continue to be, highly volatile and may be significantly and adversely affected
by factors such as: (1) actual or anticipated fluctuations in our operating
results, (2) new services, products or contracts offered by us or our
competitors, (3) developments with respect to patents, copyrights and propriety
rights, (4) conditions and trends in the e-commerce industry, (5) changes in
financial estimates by securities analysts, (6) private placement transactions
completed to raise needed capital and (7) general market conditions and other
factors.
The public markets have from time-to-time experienced significant price
and volume fluctuations that have particularly affected the market prices for
the stock of technology companies as a group but have been unrelated to the
performance of particular companies. The market price of our common stock may be
adversely affected by these broad market fluctuations as well as: (1) shortfalls
in sales or earnings as compared with securities analysts' expectations, (2)
changes in such analysts' recommendations or projections, and (3) general
economic and market conditions.
Cautionary Statement Regarding Risks and Uncertainties That May Affect
Future Results
The report contains "forward-looking statements" within the meaning of
section 27(a) of the Securities Act of 1933 and section 21(e) of the Securities
Exchange Act of 1934 and are subject to the safe harbor provisions of those
sections and The Private Securities Litigation Reform Aact of 1995. These
forward-looking statements relate to expected reductions in the company's
operating expenses, to expected increases in the company's revenues and earnings
before non-cash and interest expenses, and to the company's ability to continue
providing a complete range of services. These forward-looking statements are
based on management's current views and assumptions and are not guarantees of
future performanace. Actual results may vary materially from those set out in
the forward-looking statements. Furthermore, such statements are subject to
risks and uncertainties, including the following: the company's ability to raise
additional capital to continue operations, the continued development of the
internet as a means for commerce; unauthorized access or computer viruses
affecting the company's information systems; the company's ability to keep pace
with rapidly changing technologies; general economic conditions; the company's
ability to successfully manage its growth and to integrate acquired businesses;
increased competition from competitors with greater financial and other
resources; the company's ability to attract and retain qualified employees; the
company's dependence on principal clients and the effects of governmental
regulation, all as more fully described in our SEC filings. The foregoing
important factors should not be construed as exhaustive. The Company undertakes
no obligation to update the forward-looking statements, whether as a result of
new information, future events or otherwise.
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PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(c) Sale of Unregistered Securities
In February 2000, the Company sold 2,260,000 unregistered shares
of its common stock to a group of private investors led by Edgewater
Private Equity Fund III, L.P. and Fleck T.I.M.E. Fund, L.P. for $11.3
million ($5.00 per share). The transaction resulted in certain
shareholder rights being granted to the investors including a right to
request registration of the shares at the Company's expense. In August
2000, the investor group exercised its right to request registration of
the shares. In connection with the transaction, the Company paid a
commission to an individual who facilitated the execution of the
transaction that consisted of a cash payment of $395,000 and a warrant
to purchase 22,000 shares of the Company's common stock at an exercise
price of $15.00 per share. The warrants are exercisable for a period of
three years from the date of issuance.
In July 2000, the Company completed a $5.0 million convertible
debt offering with certain private investors, Edgewater Private Equity
Fund III, L.P. and Fleck T.I.M.E. Fund, L.P. The convertible debt bears
annual interest of 9.5%. Principal and interest are due at maturity on
December 30, 2000, if not converted earlier. The principal and accrued
and unpaid interest is convertible at the option of the holder into
common stock of the Company at a 25% discount from the per share price
of a Qualified Financing consummated prior to the maturity date. A
Qualified Financing is defined as an equity financing in which the
Company raises at least $7.0 million. If a Qualified Financing is not
consummated prior to the maturity date, then the principal and accrued
and unpaid interest is convertible at the option of the holder into
common stock of the Company at a conversion price of $5.00 per share.
During the remainder of fiscal 2000, the Company will record a non-cash
charge of approximately $5.0 million as incremental interest expense
related to the beneficial conversion feature in accordance with EITF
Issue No. 98-5, Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios." At
September 30, 2000, the balance of the convertible note is $5,000,000
and is offset by a discount of $5,000,000 related to the beneficial
conversion feature resulting in a net carrying amount of zero.
In September 2000, the Company sold 2,000,000 shares of
unregistered common stock to certain private equity investors,
Edgewater Private Equity Fund III, L.P. and Fleck T.I.M.E. Fund, L.P.,
for $2 million ($1.00 per share). The stock purchase agreement provides
for two additional board members to be appointed by the investors. Such
appointments were made in September and October 2000. The purchase
agreement also requires the Company to immediately register the shares
of common stock that were issued. The investors have agreed to a six
month lock-up period which prevents them from selling the shares of
common stock acquired in this transaction during the lock-up period.
None of the securities sold by the Company in the transactions
described above were registered under federal securities laws upon
reliance under Rule 144A. The net proceeds from the sales of the
securities were used for the consummation of certain business
combinations and for general corporate purposes.
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Item 3. Defaults Upon Senior Securities
The Company has two lines of credit totaling $6 million with two
financial institutions. The Company may draw on the lines of credit based on a
borrowing base which is 85% of eligible accounts receivable. Amounts outstanding
under the lines of credit bear interest ranging from the prime rate plus 0.5% to
the prime rate plus 2.5%. The lines of credit are secured by accounts
receivables, inventory, investments and property and equipment. The outstanding
balance on the lines of credit was $3,870,934. No additional amounts were
available at September 30, 2000 under the lines of credit. The Company also is
the guarantor on a note payable to a financial institution for a loan made to an
Employee Stock Ownership Plan sponsored by the Company (the "ESOP loan"). The
ESOP loan bears annual interest at 8.02% and is secured by accounts receivables,
inventory, investments, property and equipment, and the personal guarantees of
certain employees and stockholders of the Company. The outstanding balance of
the ESOP loan at September 30, 2000 was $5,132,291. The Company is in technical
default of its lines of credit and the ESOP loan and the creditors have asserted
the default under the loan agreements. The financial institutions have agreed to
temporarily standstill and forbear accelerating the outstanding balances through
approximately January 20, 2000 to allow the Company time to either replace the
lines of credit with new creditors or repay the outstanding balances. There is
no assurance that the Company will be able to replace the lines of credit with
new creditors on terms acceptable to the Company or that the Company will be
able to repay the outstanding balances. These uncertainties could have a
material adverse affect on the Company.
Item 5. Other Information
In June 2000, the Company's Chairman and principal shareholder entered
into a transaction with the Company's Chief Executive Officer and its President
and Chief Operating Officer whereby the Chairman executed the private sale of
1,000,000 shares of the Company's common stock held by him to each of the two
officers for a purchase price of $7.50 per share. The Company obtained an
independent valuation of the unregistered shares related to this private sale
that considered, among other things, two private placements by the Company of
unregistered common stock, negotiations for other private placement offerings
which were in process at the date of the valuation opinion, large block factors
and illiquidity factors in determining the fair value of the shares sold. The
independent valuation determined that the value of the shares sold were $7.50
per share. As such, the transaction had no effect on the Company's financial
position or results of operations as the shares were sold at estimated fair
value.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
2.11 Asset Purchase Agreement among the Company, Tumble Interactive
Media, Inc. and Charles C. Vornberger
10.27 Convertible Bridge Loan Agreement
10.28 Jeffrey Sexton Employment Agreement
10.29 Warrant Purchase Agreement between the Company and FINOVA Capital
Corporation
10.30 FINOVA Warrant
27.1 Financial Data Schedule
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(b) Reports on Form 8-K
A Current Report on Form 8-K was filed on January 26, 2000, reporting a change
in accountants from Hein + Associates, LLP to Deloitte & Touche, LLP.
A Current Report on Form 8-K was filed on February 28, 2000, reporting a Stock
Purchase Agreement by and among the Company, Edgewater Private Equity Fund III,
LP, Aspen Finance Investors I, LLC, Fleck T.I.M.E. Fund, LP, Fleck Family
Partnership II, LP, LJH Partners, LP, Wain Investment, LLC, Gerald C. Allen and
John Paul DeJoria.
A Current Report on Form 8-K was filed on March 15, 2000, and amended by the
Company's Current Report on Form 8-K/A dated May 15, 2000, reporting the
acquisition of The Growth Strategies Group, Inc.
A Current Report on Form 8-K was filed on July 14, 2000, and amended by the
Company's Current Report on Form 8-K/A dated September 13, 2000, reporting the
acquisition of IPS Associates, Inc.
A Current Report on Form 8-K was filed on October 16, 2000 reporting the sale of
a $2,000,000 of unregistered common stock, the appointment of a new Board
member, the resignation of the Company's Chief Executive Officer and Vice
Chairman, and the appointment of Jenkens & Gilchrist P.C. as the Company's
general counsel.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
EpicEdge, Inc.
Date: November 20, 2000 By /s/ Paul Ruiz
-----------------------------
Paul Ruiz
Chief Financial Officer
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