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Thursday, April 06, 2006 11:04:06 PM
Form 10KSB/A for ELINEAR INC
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6-Apr-2006
Annual Report
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion and analysis of the Company's financial condition as of December 31, 2004, and the Company's results of operations for the years in the two-year period ended December 31, 2004 and 2003, should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included elsewhere in this report.
Overview
The Company currently consists of four operating segments:
· Consulting services. The Company offers consulting services, creative web site design, web site content management software and technical project management and development services.
· Product fulfillment and network and storage solutions. Through NetView the Company offers a complete solution to its customers for the acquisition, management and configuration of complex storage and network server installations.
· Communications deployment. Through NewBridge the Company provides structured cabling, which is a set of cabling and connectivity products that integrate voice, data, video and various management systems, cabling infrastructure design and Implementation, which is the design and implementation of the structured cabling systems, security installation and monitoring and digital services of voice, data and video over fiber optic networks to its residential and commercial customers.
· Security solutions. Through TanSeco the Company has business centered on premise security solutions which includes a three-year contract with RadioShack Corporation to install kiosks throughout the United States, 24X7 security monitoring contracts with a variety of commercial customers and project work installing security devices and fiber/cable in client locations across the US.
The Company operated as a technology consulting business from December 1999 until its acquisition of NetView in April 2003. It acquired its Internet consulting business as a result of a reverse merger with Imagenuity, Inc. (Imagenuity) in 1999. Since 1999 to date, its Internet consulting business consisted of Internet consulting services, creative web site design, web site content management and software and technical project management and development services. For the fiscal year ended December 31, 2004, the consulting segment contributed less than 1% of its revenue. Immediately prior to acquiring the business of Imagenuity, eLinear, which at the time was named Kinetiks.com, Inc. (Kinetiks.com") did not engage in any business activities except for negotiating and compromising debt and searching for merger candidates. While Kinetics.com was the survivor in the merger, from an accounting standpoint the transaction was accounted for as though it was a recapitalization of Imagenuity and a sale of shares by Imagenuity in exchange for the net assets of Kinetics.com. On July 31, 2000, the Company changed its name to eLinear, Inc.
The Company completed the acquisitions of NetView and NewBridge during 2003. In April 2003, the Company issued 12,961,979 shares of common stock for all of the outstanding common stock of NetView. After the merger the stockholders of NetView owned approximately 90% of eLinear.
Although NetView became a wholly-owned subsidiary, for accounting purposes this transaction was treated as an acquisition of eLinear and a recapitalization of NetView using the purchase method of accounting. The acquisition resulted in goodwill of $451,920. Since NetView is deemed to be the acquiring company for accounting purposes, the financial information for the year ended December 31, 2003 is information derived from the financial statements of NetView.
In July 2003, the Company completed the acquisition of all the outstanding shares of NewBridge. Pursuant to the transaction, eLinear issued 850,000 shares of its common stock valued at $935,000, using the market price on July 31, 2003, and options to purchase 300,000 shares of common stock valued at $274,000 using the Black-Scholes option pricing model, to the shareholders of NewBridge. The acquisition was accounted for using the purchase method of accounting resulting in goodwill of $1,491,102, as restated.
In November 2004, the Company acquired all of the outstanding and issued stock of TanSeco from RadioShack. As a result, TanSeco became a wholly-owned subsidiary of eLinear. The Company purchased the stock with cash and acquired inventory, fixed assets and security monitoring contracts. Concurrent with this transaction, TanSeco entered into a three-year services agreement with RadioShack whereby TanSeco will provide the installation, service, repair and inspection of security, closed circuit television and fire systems used by RadioShack for the security of its more than 5,000 company-owned stores, kiosks and other physical locations.
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Recent Developments
On February 28, 2005, the Company entered into financing arrangements for a total principal amount of $12 million with Laurus, Iroquois Capital LP (Iroquois), RHP Master Fund (RHP), Basso Private Opportunity Holding Fund Ltd. (Basso Private), and Basso Multi-Strategy Holding Fund Ltd. (Basso Multi), collectively, the (Investors) in which it issued to: (i) Laurus a convertible secured note in the principal amount of $5,000,000 and a common stock purchase warrant to purchase up to 750,000 shares of Company common stock at an exercise price of $1.25 per share; (ii) Iroquois a convertible secured note in the principal amount of $5,000,000 and a common stock purchase warrant to purchase up to 750,000 shares of Company common stock at an exercise price of $1.25 pre share; (iii) RHP a convertible secured note in the principal amount of $1,000,000 and a common stock purchase warrant to purchase up to 150,000 shares of Company common stock at an exercise price of $1.25 per share; (iv) Basso Private a convertible secured note in the principal amount of $220,000 and a common stock purchase warrant to purchase up to 33,000 shares of Company common stock at an exercise price of $1.25 per share; and (v) Basso Multi a convertible secured note in the principal amount of $780,000 and a common stock purchase warrant to purchase up to 117,000 shares of Company common stock at an exercise price of $1.25 per share. The terms between the Company and each of the respective Investors are substantially similar and the Company has agreed to treat each of the Investors pro rata with respect to this financing, including conversion, redemption and payments thereto.
These notes are secured by all of the Company and its subsidiaries' assets. The payment of interest and principal, under certain circumstances, may be made with shares of the Company common stock at a conversion price of no less than $1.00 per share. The Company has agreed to register the resale of the shares of the Company common stock underlying the Investor Notes and the shares issuable upon exercise of the Warrants. The Investor Notes will accrue interest at a rate per annum equal to the prime rate published in the Wall Street Journal plus seventy five basis points, as may be adjusted. The Company has the ability to prepay any amounts owed under these Investors Notes at 110% of the principal amount.
Under the terms of the Investor Notes and related documents, 20% (including applicable fees) of the principal amount of the Investor Notes was provided to Company for immediate use upon the closing of the Investor Notes (Amortizing Principal), the remaining 80% (net of applicable fees) is held in restricted accounts for each respective Investors (Restricted Account). The Company is obligated to make monthly payments, either in cash or stock as determined by the Investor Notes, beginning on June 1, 2005 for the Amortizing Principal, plus applicable interest (the Monthly Payment). The Monthly Payment will be made (i) automatically by a conversion in stock at a Fixed Conversion Price, (ii) at the discretion of the Company at a reduced conversion price, or (iii) in cash paid by the Company at 110% of the Monthly Payment. The Monthly Payments shall be automatically made in Company common stock at the Fixed Conversion Price if (i) the shares of the Company common stock underlying the shares of the Investor Notes are registered; and (ii) the average trading price of the Company common stock for the five days preceding the Monthly Payment is greater than 110% of the Fixed Conversion Price. If the Monthly Payment is not automatically converted into shares of Company common stock because the average trading price of the Company common stock for the five trading days prior to the due date of the Monthly Payment is less than 110% of the Fixed Conversion Price, the Company may, at its discretion, make the Monthly Payment in Company common stock at a conversion price equal to 85% of the average trading price of the Company common stock for the five lowest closing days for the 22 trading days prior to the Company's notice, but in no case shall the conversion price be less than $1.00. As of February 28, 2005 the Fixed Conversion Price is $1.00, subject to adjustment, but in no case less than $1.00.
The Company will receive cash disbursements (less applicable accrued interest) for the amounts held in the Restricted Account after (i) the Amortizing Principal, plus interest, is paid in full, (ii) the shares of the Company common stock underlying the Investor Notes are registered; and (iii) either the Company or the Investor converts any amounts held in the Restricted Accounts into shares of the Company's common stock. If the Company converts the amounts held in the Restricted Account, the amounts shall be converted at either (i) a price equal to 85% of the average of the five lowest closing prices of the Company common stock during the 22 trading days immediately prior to the date of a respective repayment notice if the average closing price of the Company common stock is less than 110% of the Fixed Conversion Price, but in no instance may such shares by converted for less than $1.00; or (ii) at the Fixed Conversion Price, if the average closing price of the Company common stock for the five consecutive trading days immediately preceding the respective repayment notice is greater than or equal to 115% of the Fixed Conversion Price.
The Investors may convert all or any portion of the principal amounts of their respective Investor Notes, including any accrued interest or fees thereon at the Fixed Conversion Price.
Notwithstanding the foregoing, the Company's right to issue shares of its common stock in payment of obligations under the Investor Notes shall be subject to the limitation that the number of aggregate shares of common stock issued to each Investor shall not exceed 25% of the aggregate dollar trading volume of the Company common stock for the 22 trading days immediately preceding the date on which the conversion is to occur. Furthermore, the Investors are not entitled to convert their respective Investor Notes; if the aggregate Investors beneficial ownership of the Company's common stock would exceed pro rata 19.99% of the outstanding shares of common stock of the Company at the time of the conversion.
The warrants issued pursuant to this funding are exercisable by the Investors until February 28, 2012, at $1.25 per share of Company common stock. The Warrants are exercisable immediately.
The Company has agreed to file a registration statement with the Securities and Exchange Commission within a definitive period of time not to exceed 45 days from February 28, 2005, in order to register the resale of the shares of common stock underlying the Investor Notes and the shares issuable upon exercise of the Warrants. If the Company fails to meet this deadline, if the registration statement is not declared effective prior to 105 days from February 28, 2005, if the registration statement ceases to remain effective, or certain other events occur, the Company has agreed to pay the Investors liquidated damages of 1.25% of the principal amount of the Investor Notes per month.
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Critical Accounting Policies
General
The Consolidated Financial Statements and Notes to Consolidated Financial Statements contain information that is pertinent to this management's discussion and analysis. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of any contingent assets and liabilities. Management believes these accounting policies involve judgment due to the sensitivity of the methods, assumptions and estimates necessary in determining the related asset and liability amounts. Management believes it has exercised proper judgment in determining these estimates based on the facts and circumstances available to its management at the time the estimates were made. The significant accounting policies are described in the Company's financial statements (See Note 2 in Notes to Consolidated Financial Statements).
Revenue Recognition
The Company's revenue recognition policy is objective in that it recognizes revenue when products are shipped or services are delivered. Accordingly, there are no estimates or assumptions that have caused deviation from its revenue recognition policy. Additionally, the Company has a limited amount of sales returns which would affect its revenue earned.
The Company accounts for arrangements that contain multiple elements in accordance with EITF 00-21, "Revenue Arrangements with Multiple Deliverables". When elements such as hardware, software and consulting services are contained in a single arrangement, or in related arrangements with the same customer, the Company allocates revenue to each element based on its relative fair value, provided that such element meets the criteria for treatment as a separate unit of accounting. The price charged when the element is sold separately generally determines fair value. In the absence of fair value for a delivered element, the Company allocates revenue first to the fair value of the undelivered elements and allocates the residual revenue to the delivered elements. In the absence of fair value for an undelivered element, the arrangement is accounted for as a single unit of accounting, resulting in a delay of revenue recognition for the delivered elements until the undelivered elements are fulfilled. The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services or subject to customer-specified return or refund privileges.
The Company recognizes revenue from the sale of manufacturer's maintenance and extended warranty contracts in accordance with EITF 99-19 net of its costs of purchasing the related contracts.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts, which reflects the estimate of losses that may result from the inability of some of the Company's customers to make required payments. The estimate for the allowance for doubtful accounts is based on known circumstances regarding collectability of customer accounts and historical collections experience. If the financial condition of one or more of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Material differences between the historical trends used to estimate the allowance for doubtful accounts and actual collection experience could result in a material change to the Company's consolidated results of operations or financial position.
Goodwill
As of December 31, 2004, the Company had $1,100,000 of goodwill, as restated, resulting from the acquisition of NewBridge. Goodwill represents the excess of cost over the fair value of the net tangible assets acquired and is not amortized. However, goodwill is subject to an impairment assessment at least annually which may result in a charge to operations if the fair value of the reporting segment in which the goodwill is reported declines. In September 2004, the Company performed a valuation analysis of the discounted projected estimated future cash flows of NewBridge and the Company elected to write down a portion of the goodwill related to NewBridge. Due to the large amount of goodwill presently on the Company's financial reports, if an impairment is required, the Company's financial condition and results of operations would be negatively affected. During March 2004, the Company recorded an impairment charge of approximately $451,000 related to the goodwill associated with the NetView acquisition.
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Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation based on the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, as amended by the Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation Accounting Principles Board Opinion No. 25 and Financial Accounting Standards Board Interpretation No. 44 state that no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value per share of the company's common stock on the grant date. The Company adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which requires compensation expense to be disclosed based on the fair value of the options granted at the date of the grant.
In December 2002, the Financial Accounting Standards Board issued its Statement No. 148, Accounting for Stock-Based Compensation -- Transition and Disclosure--an amendment of Financial Accounting Standards Board Statement No.
123. This Statement amends Statement of Financial Accounting Standards No. 123, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of Statement of Financial Accounting Standards No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. The transition and annual disclosure provisions of Statement of Financial Accounting Standards No. 148 are effective for fiscal years ending after December 15, 2002, and the interim disclosure provisions were effective for the first interim period beginning after December 15, 2002. The Company did not voluntarily change to the fair value based method of accounting for stock-based employee compensation, therefore, the adoption of Statement of Financial Accounting Standards No. 148 did not have a material impact on its operations and/or financial position.
Derivative Financial Instruments
The Company accounts for all derivative financial instruments in accordance with SFAS No. 133. Derivative financial instruments are recorded as liabilities in the consolidated balance sheet, measured at fair value. When available, quoted market prices are used in determining fair value. However, if quoted market prices are not available, the Company estimates fair value using either quoted market prices of financial instruments with similar characteristics or other valuation techniques.
The value of the derivative liabilities relating to the Convertible Note in the financial statements are subject to the changes in the trading value of the Companys common stock and other assumptions. As a result the Companys financial statements may fluctuate from quarter to quarter based on factors such as trading value of the Companys Common Stock, the amount of shares converted by Laurus in connection with the Laurus Convertible Note and exercised in connection with the Warrant outstanding. Consequently, the Company's consolidated financial position and results of operations may vary from quarter to quarter based on conditions other than the Companys operating revenue and expenses. See note 6 and 9 regarding valuation methods used for derivative liabilities.
Derivative financial instruments that are not designated as hedges or that do not meet the criteria for hedge accounting under SFAS No. 133 are recorded at fair value, with gains or losses reported currently in earnings. All derivative financial instruments held by the Company as December 31, 2004 were not designated as hedges.
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Results of Operations and Financial Condition
The Company's primary business focus is on solving well-defined customer problems or providing a need-proven service. It is focused on delivering reliable and effective IT solutions, managed services, software, security solutions, Internet telephony solutions and network and storage solutions that enable enterprises to restructure and integrate entire business processes while extending them across enterprise boundaries to customers, employees and suppliers. As its arsenal of products, services and solutions grows through internal and external initiatives, its sales force will be required to leverage its cross-selling potential. The Company earns its revenue through the sales efforts of its four distinct business segments. When products and/or services are purchased, the Company invoices its customers and subsequently receives payment for those products and/or services, which generates the cash needed to pay for those products and/or services. Due to its growth, the Company has been required to obtain various lines of credit to finance the purchase of these products.
Prior to the acquisitions of NetView, NewBridge and TanSeco, the Company was a technology consulting services firm providing strategic consulting solutions, creative web site design, web site content management software and technical project management and development services to companies seeking to increase productivity or reduce costs through investing in technology. In order to diversify its business plan, the Company began seeking merger candidates. eLinear selected NetView due to its list of customers and management with the view toward cross-selling its consulting services with NetView's network and storage solutions customers. Its acquisition of NewBridge was determined by its desire to provide a total IT solutions product to its customers, which NewBridge provided the ability to expand its business in the area of communications deployment. The acquisition of TanSeco provided the Company an opportunity to enter the security solutions business segment. In addition to its consulting services it previously provided, it now offers a full range of IT solutions. These acquisitions have in fact expanded its customer base and provided additional sales opportunities, which were not previously available to it. The Company intends to expand its business in all four segments of which it operates.
eLinear is specifically focused on growing its business across all offerings. This growth will, in some instances, be pursued internally and in others, externally via acquisitions.
Internal Growth
The primary focus internally will be on making strategic hires for its network solutions, IP Telephony solutions and security solutions. This has and will continue to include:
1) account executives that bring to eLinear established relationships with customers; and
2) technical resources and engineers that can assess, architect, design, implement, support and maintain all the different aspects required by the Company's solutions.
Much of the Company's internal growth will also come from leveraging its ability to cross-sell its diverse offerings to its entire customer base. The Company also plans to expand into the geographies that its current customers have presences in, and hence, would be relatively easier than expanding into other geographies without any inroads into them. More specifically, below are some current initiatives being developed:
1) IP Telephony - the design, architecting, implementation and roll-out of corporate Voice Over Internet Protocol (VOIP) telephone systems integrated with data networks, eliminating the need for traditional switching telephone systems. The Company has identified several account executives and engineers that would enable broader customer coverage. Concurrently, the Company is in the process of upgrading its certification levels with partners in order to provide it with better services, pricing and opportunities, primarily with Cisco Systems;
2) Network Solutions - the Company continually hires account executives and engineers that enable broader customer coverage by bringing new customers and skills to eLinear. During 2004, the Company hired nearly 25 people in Dallas as an extension of its Houston presence; and
3) Security Solutions - the Company is now focused on growing its security system sales to its customers, with the solutions being enabled via strategic partnerships with such companies as Cisco Systems, Netscreen and others.
All of its solutions are distributed through its internal sales and engineering forces.
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External Growth
The primary focus externally will be on making strategic acquisitions into areas that the Company feels it wants to compete, but will not be able to establish and grow a competitive presence internally. The security systems arena is an area where the Company's acquisitions will be targeted. Intrusion technology firms and security consulting firms that can perform vulnerability assessments, penetration testing and security policy creation represent areas that the Company feels it can be more effective by acquiring into.
Financing Growth
Currently, the Company has enough cash on hand and credit through its lines of credit to fund its internal working capital needs, which include internal growth initiatives over the next twelve months, and evaluating acquisitions. Moving forward, should the Company determine that it is strategically important to make multiple acquisitions, then the Company may need to pursue additional funding for those acquisitions.
Purchase of New Products
From a procurement perspective, the Company has lines of credit with Textron, Ingram Micro and GE Financial that are needed in order to fund the purchase of hardware required for its solutions offerings. Its new products are purchased primarily through one of the following four vendors: Ingram Micro, GE Financial, Synnex and Tech Data. If the credit line at each vendor becomes over extended, then that vendor gets paid by Textron immediately upon invoicing of the product. eLinear then has 30 days to pay the vendor and 45 days to pay Textron. This enables eLinear to maintain liquidity and rapid procurement on behalf of its customers.
NetView Acquisition
The acquisition of NetView brought to eLinear customers that need services in the network solutions market, including the design, procurement, implementation, support and maintenance of corporate networks. NetView's customer base ranges from the likes of the Fortune 2000 to Small to Medium Businesses (SMB). Industry verticals that Netview customers are in, and hence are new markets to eLinear, include energy, healthcare, state and local governments, finance and several others. The opportunities acquired are general in nature and there was not any specific opportunity that was deemed material in making this acquisition. Network solutions will be selectively expanded through the hiring of key account executives with long-term, well-established client relationships.
NewBridge Acquisition
The acquisition of NewBridge brought to eLinear customers that need services in the network infrastructure market, including the design, procurement, implementation, support and maintenance of physical network infrastructure such as structured cabling, network access points (drops), secure card access, closed circuit TV, and other services. NewBridge's customer base includes Houston based . . .
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6-Apr-2006
Annual Report
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion and analysis of the Company's financial condition as of December 31, 2004, and the Company's results of operations for the years in the two-year period ended December 31, 2004 and 2003, should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included elsewhere in this report.
Overview
The Company currently consists of four operating segments:
· Consulting services. The Company offers consulting services, creative web site design, web site content management software and technical project management and development services.
· Product fulfillment and network and storage solutions. Through NetView the Company offers a complete solution to its customers for the acquisition, management and configuration of complex storage and network server installations.
· Communications deployment. Through NewBridge the Company provides structured cabling, which is a set of cabling and connectivity products that integrate voice, data, video and various management systems, cabling infrastructure design and Implementation, which is the design and implementation of the structured cabling systems, security installation and monitoring and digital services of voice, data and video over fiber optic networks to its residential and commercial customers.
· Security solutions. Through TanSeco the Company has business centered on premise security solutions which includes a three-year contract with RadioShack Corporation to install kiosks throughout the United States, 24X7 security monitoring contracts with a variety of commercial customers and project work installing security devices and fiber/cable in client locations across the US.
The Company operated as a technology consulting business from December 1999 until its acquisition of NetView in April 2003. It acquired its Internet consulting business as a result of a reverse merger with Imagenuity, Inc. (Imagenuity) in 1999. Since 1999 to date, its Internet consulting business consisted of Internet consulting services, creative web site design, web site content management and software and technical project management and development services. For the fiscal year ended December 31, 2004, the consulting segment contributed less than 1% of its revenue. Immediately prior to acquiring the business of Imagenuity, eLinear, which at the time was named Kinetiks.com, Inc. (Kinetiks.com") did not engage in any business activities except for negotiating and compromising debt and searching for merger candidates. While Kinetics.com was the survivor in the merger, from an accounting standpoint the transaction was accounted for as though it was a recapitalization of Imagenuity and a sale of shares by Imagenuity in exchange for the net assets of Kinetics.com. On July 31, 2000, the Company changed its name to eLinear, Inc.
The Company completed the acquisitions of NetView and NewBridge during 2003. In April 2003, the Company issued 12,961,979 shares of common stock for all of the outstanding common stock of NetView. After the merger the stockholders of NetView owned approximately 90% of eLinear.
Although NetView became a wholly-owned subsidiary, for accounting purposes this transaction was treated as an acquisition of eLinear and a recapitalization of NetView using the purchase method of accounting. The acquisition resulted in goodwill of $451,920. Since NetView is deemed to be the acquiring company for accounting purposes, the financial information for the year ended December 31, 2003 is information derived from the financial statements of NetView.
In July 2003, the Company completed the acquisition of all the outstanding shares of NewBridge. Pursuant to the transaction, eLinear issued 850,000 shares of its common stock valued at $935,000, using the market price on July 31, 2003, and options to purchase 300,000 shares of common stock valued at $274,000 using the Black-Scholes option pricing model, to the shareholders of NewBridge. The acquisition was accounted for using the purchase method of accounting resulting in goodwill of $1,491,102, as restated.
In November 2004, the Company acquired all of the outstanding and issued stock of TanSeco from RadioShack. As a result, TanSeco became a wholly-owned subsidiary of eLinear. The Company purchased the stock with cash and acquired inventory, fixed assets and security monitoring contracts. Concurrent with this transaction, TanSeco entered into a three-year services agreement with RadioShack whereby TanSeco will provide the installation, service, repair and inspection of security, closed circuit television and fire systems used by RadioShack for the security of its more than 5,000 company-owned stores, kiosks and other physical locations.
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Recent Developments
On February 28, 2005, the Company entered into financing arrangements for a total principal amount of $12 million with Laurus, Iroquois Capital LP (Iroquois), RHP Master Fund (RHP), Basso Private Opportunity Holding Fund Ltd. (Basso Private), and Basso Multi-Strategy Holding Fund Ltd. (Basso Multi), collectively, the (Investors) in which it issued to: (i) Laurus a convertible secured note in the principal amount of $5,000,000 and a common stock purchase warrant to purchase up to 750,000 shares of Company common stock at an exercise price of $1.25 per share; (ii) Iroquois a convertible secured note in the principal amount of $5,000,000 and a common stock purchase warrant to purchase up to 750,000 shares of Company common stock at an exercise price of $1.25 pre share; (iii) RHP a convertible secured note in the principal amount of $1,000,000 and a common stock purchase warrant to purchase up to 150,000 shares of Company common stock at an exercise price of $1.25 per share; (iv) Basso Private a convertible secured note in the principal amount of $220,000 and a common stock purchase warrant to purchase up to 33,000 shares of Company common stock at an exercise price of $1.25 per share; and (v) Basso Multi a convertible secured note in the principal amount of $780,000 and a common stock purchase warrant to purchase up to 117,000 shares of Company common stock at an exercise price of $1.25 per share. The terms between the Company and each of the respective Investors are substantially similar and the Company has agreed to treat each of the Investors pro rata with respect to this financing, including conversion, redemption and payments thereto.
These notes are secured by all of the Company and its subsidiaries' assets. The payment of interest and principal, under certain circumstances, may be made with shares of the Company common stock at a conversion price of no less than $1.00 per share. The Company has agreed to register the resale of the shares of the Company common stock underlying the Investor Notes and the shares issuable upon exercise of the Warrants. The Investor Notes will accrue interest at a rate per annum equal to the prime rate published in the Wall Street Journal plus seventy five basis points, as may be adjusted. The Company has the ability to prepay any amounts owed under these Investors Notes at 110% of the principal amount.
Under the terms of the Investor Notes and related documents, 20% (including applicable fees) of the principal amount of the Investor Notes was provided to Company for immediate use upon the closing of the Investor Notes (Amortizing Principal), the remaining 80% (net of applicable fees) is held in restricted accounts for each respective Investors (Restricted Account). The Company is obligated to make monthly payments, either in cash or stock as determined by the Investor Notes, beginning on June 1, 2005 for the Amortizing Principal, plus applicable interest (the Monthly Payment). The Monthly Payment will be made (i) automatically by a conversion in stock at a Fixed Conversion Price, (ii) at the discretion of the Company at a reduced conversion price, or (iii) in cash paid by the Company at 110% of the Monthly Payment. The Monthly Payments shall be automatically made in Company common stock at the Fixed Conversion Price if (i) the shares of the Company common stock underlying the shares of the Investor Notes are registered; and (ii) the average trading price of the Company common stock for the five days preceding the Monthly Payment is greater than 110% of the Fixed Conversion Price. If the Monthly Payment is not automatically converted into shares of Company common stock because the average trading price of the Company common stock for the five trading days prior to the due date of the Monthly Payment is less than 110% of the Fixed Conversion Price, the Company may, at its discretion, make the Monthly Payment in Company common stock at a conversion price equal to 85% of the average trading price of the Company common stock for the five lowest closing days for the 22 trading days prior to the Company's notice, but in no case shall the conversion price be less than $1.00. As of February 28, 2005 the Fixed Conversion Price is $1.00, subject to adjustment, but in no case less than $1.00.
The Company will receive cash disbursements (less applicable accrued interest) for the amounts held in the Restricted Account after (i) the Amortizing Principal, plus interest, is paid in full, (ii) the shares of the Company common stock underlying the Investor Notes are registered; and (iii) either the Company or the Investor converts any amounts held in the Restricted Accounts into shares of the Company's common stock. If the Company converts the amounts held in the Restricted Account, the amounts shall be converted at either (i) a price equal to 85% of the average of the five lowest closing prices of the Company common stock during the 22 trading days immediately prior to the date of a respective repayment notice if the average closing price of the Company common stock is less than 110% of the Fixed Conversion Price, but in no instance may such shares by converted for less than $1.00; or (ii) at the Fixed Conversion Price, if the average closing price of the Company common stock for the five consecutive trading days immediately preceding the respective repayment notice is greater than or equal to 115% of the Fixed Conversion Price.
The Investors may convert all or any portion of the principal amounts of their respective Investor Notes, including any accrued interest or fees thereon at the Fixed Conversion Price.
Notwithstanding the foregoing, the Company's right to issue shares of its common stock in payment of obligations under the Investor Notes shall be subject to the limitation that the number of aggregate shares of common stock issued to each Investor shall not exceed 25% of the aggregate dollar trading volume of the Company common stock for the 22 trading days immediately preceding the date on which the conversion is to occur. Furthermore, the Investors are not entitled to convert their respective Investor Notes; if the aggregate Investors beneficial ownership of the Company's common stock would exceed pro rata 19.99% of the outstanding shares of common stock of the Company at the time of the conversion.
The warrants issued pursuant to this funding are exercisable by the Investors until February 28, 2012, at $1.25 per share of Company common stock. The Warrants are exercisable immediately.
The Company has agreed to file a registration statement with the Securities and Exchange Commission within a definitive period of time not to exceed 45 days from February 28, 2005, in order to register the resale of the shares of common stock underlying the Investor Notes and the shares issuable upon exercise of the Warrants. If the Company fails to meet this deadline, if the registration statement is not declared effective prior to 105 days from February 28, 2005, if the registration statement ceases to remain effective, or certain other events occur, the Company has agreed to pay the Investors liquidated damages of 1.25% of the principal amount of the Investor Notes per month.
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Critical Accounting Policies
General
The Consolidated Financial Statements and Notes to Consolidated Financial Statements contain information that is pertinent to this management's discussion and analysis. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of any contingent assets and liabilities. Management believes these accounting policies involve judgment due to the sensitivity of the methods, assumptions and estimates necessary in determining the related asset and liability amounts. Management believes it has exercised proper judgment in determining these estimates based on the facts and circumstances available to its management at the time the estimates were made. The significant accounting policies are described in the Company's financial statements (See Note 2 in Notes to Consolidated Financial Statements).
Revenue Recognition
The Company's revenue recognition policy is objective in that it recognizes revenue when products are shipped or services are delivered. Accordingly, there are no estimates or assumptions that have caused deviation from its revenue recognition policy. Additionally, the Company has a limited amount of sales returns which would affect its revenue earned.
The Company accounts for arrangements that contain multiple elements in accordance with EITF 00-21, "Revenue Arrangements with Multiple Deliverables". When elements such as hardware, software and consulting services are contained in a single arrangement, or in related arrangements with the same customer, the Company allocates revenue to each element based on its relative fair value, provided that such element meets the criteria for treatment as a separate unit of accounting. The price charged when the element is sold separately generally determines fair value. In the absence of fair value for a delivered element, the Company allocates revenue first to the fair value of the undelivered elements and allocates the residual revenue to the delivered elements. In the absence of fair value for an undelivered element, the arrangement is accounted for as a single unit of accounting, resulting in a delay of revenue recognition for the delivered elements until the undelivered elements are fulfilled. The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services or subject to customer-specified return or refund privileges.
The Company recognizes revenue from the sale of manufacturer's maintenance and extended warranty contracts in accordance with EITF 99-19 net of its costs of purchasing the related contracts.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts, which reflects the estimate of losses that may result from the inability of some of the Company's customers to make required payments. The estimate for the allowance for doubtful accounts is based on known circumstances regarding collectability of customer accounts and historical collections experience. If the financial condition of one or more of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Material differences between the historical trends used to estimate the allowance for doubtful accounts and actual collection experience could result in a material change to the Company's consolidated results of operations or financial position.
Goodwill
As of December 31, 2004, the Company had $1,100,000 of goodwill, as restated, resulting from the acquisition of NewBridge. Goodwill represents the excess of cost over the fair value of the net tangible assets acquired and is not amortized. However, goodwill is subject to an impairment assessment at least annually which may result in a charge to operations if the fair value of the reporting segment in which the goodwill is reported declines. In September 2004, the Company performed a valuation analysis of the discounted projected estimated future cash flows of NewBridge and the Company elected to write down a portion of the goodwill related to NewBridge. Due to the large amount of goodwill presently on the Company's financial reports, if an impairment is required, the Company's financial condition and results of operations would be negatively affected. During March 2004, the Company recorded an impairment charge of approximately $451,000 related to the goodwill associated with the NetView acquisition.
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Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation based on the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, as amended by the Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation Accounting Principles Board Opinion No. 25 and Financial Accounting Standards Board Interpretation No. 44 state that no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value per share of the company's common stock on the grant date. The Company adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which requires compensation expense to be disclosed based on the fair value of the options granted at the date of the grant.
In December 2002, the Financial Accounting Standards Board issued its Statement No. 148, Accounting for Stock-Based Compensation -- Transition and Disclosure--an amendment of Financial Accounting Standards Board Statement No.
123. This Statement amends Statement of Financial Accounting Standards No. 123, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of Statement of Financial Accounting Standards No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. The transition and annual disclosure provisions of Statement of Financial Accounting Standards No. 148 are effective for fiscal years ending after December 15, 2002, and the interim disclosure provisions were effective for the first interim period beginning after December 15, 2002. The Company did not voluntarily change to the fair value based method of accounting for stock-based employee compensation, therefore, the adoption of Statement of Financial Accounting Standards No. 148 did not have a material impact on its operations and/or financial position.
Derivative Financial Instruments
The Company accounts for all derivative financial instruments in accordance with SFAS No. 133. Derivative financial instruments are recorded as liabilities in the consolidated balance sheet, measured at fair value. When available, quoted market prices are used in determining fair value. However, if quoted market prices are not available, the Company estimates fair value using either quoted market prices of financial instruments with similar characteristics or other valuation techniques.
The value of the derivative liabilities relating to the Convertible Note in the financial statements are subject to the changes in the trading value of the Companys common stock and other assumptions. As a result the Companys financial statements may fluctuate from quarter to quarter based on factors such as trading value of the Companys Common Stock, the amount of shares converted by Laurus in connection with the Laurus Convertible Note and exercised in connection with the Warrant outstanding. Consequently, the Company's consolidated financial position and results of operations may vary from quarter to quarter based on conditions other than the Companys operating revenue and expenses. See note 6 and 9 regarding valuation methods used for derivative liabilities.
Derivative financial instruments that are not designated as hedges or that do not meet the criteria for hedge accounting under SFAS No. 133 are recorded at fair value, with gains or losses reported currently in earnings. All derivative financial instruments held by the Company as December 31, 2004 were not designated as hedges.
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Results of Operations and Financial Condition
The Company's primary business focus is on solving well-defined customer problems or providing a need-proven service. It is focused on delivering reliable and effective IT solutions, managed services, software, security solutions, Internet telephony solutions and network and storage solutions that enable enterprises to restructure and integrate entire business processes while extending them across enterprise boundaries to customers, employees and suppliers. As its arsenal of products, services and solutions grows through internal and external initiatives, its sales force will be required to leverage its cross-selling potential. The Company earns its revenue through the sales efforts of its four distinct business segments. When products and/or services are purchased, the Company invoices its customers and subsequently receives payment for those products and/or services, which generates the cash needed to pay for those products and/or services. Due to its growth, the Company has been required to obtain various lines of credit to finance the purchase of these products.
Prior to the acquisitions of NetView, NewBridge and TanSeco, the Company was a technology consulting services firm providing strategic consulting solutions, creative web site design, web site content management software and technical project management and development services to companies seeking to increase productivity or reduce costs through investing in technology. In order to diversify its business plan, the Company began seeking merger candidates. eLinear selected NetView due to its list of customers and management with the view toward cross-selling its consulting services with NetView's network and storage solutions customers. Its acquisition of NewBridge was determined by its desire to provide a total IT solutions product to its customers, which NewBridge provided the ability to expand its business in the area of communications deployment. The acquisition of TanSeco provided the Company an opportunity to enter the security solutions business segment. In addition to its consulting services it previously provided, it now offers a full range of IT solutions. These acquisitions have in fact expanded its customer base and provided additional sales opportunities, which were not previously available to it. The Company intends to expand its business in all four segments of which it operates.
eLinear is specifically focused on growing its business across all offerings. This growth will, in some instances, be pursued internally and in others, externally via acquisitions.
Internal Growth
The primary focus internally will be on making strategic hires for its network solutions, IP Telephony solutions and security solutions. This has and will continue to include:
1) account executives that bring to eLinear established relationships with customers; and
2) technical resources and engineers that can assess, architect, design, implement, support and maintain all the different aspects required by the Company's solutions.
Much of the Company's internal growth will also come from leveraging its ability to cross-sell its diverse offerings to its entire customer base. The Company also plans to expand into the geographies that its current customers have presences in, and hence, would be relatively easier than expanding into other geographies without any inroads into them. More specifically, below are some current initiatives being developed:
1) IP Telephony - the design, architecting, implementation and roll-out of corporate Voice Over Internet Protocol (VOIP) telephone systems integrated with data networks, eliminating the need for traditional switching telephone systems. The Company has identified several account executives and engineers that would enable broader customer coverage. Concurrently, the Company is in the process of upgrading its certification levels with partners in order to provide it with better services, pricing and opportunities, primarily with Cisco Systems;
2) Network Solutions - the Company continually hires account executives and engineers that enable broader customer coverage by bringing new customers and skills to eLinear. During 2004, the Company hired nearly 25 people in Dallas as an extension of its Houston presence; and
3) Security Solutions - the Company is now focused on growing its security system sales to its customers, with the solutions being enabled via strategic partnerships with such companies as Cisco Systems, Netscreen and others.
All of its solutions are distributed through its internal sales and engineering forces.
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External Growth
The primary focus externally will be on making strategic acquisitions into areas that the Company feels it wants to compete, but will not be able to establish and grow a competitive presence internally. The security systems arena is an area where the Company's acquisitions will be targeted. Intrusion technology firms and security consulting firms that can perform vulnerability assessments, penetration testing and security policy creation represent areas that the Company feels it can be more effective by acquiring into.
Financing Growth
Currently, the Company has enough cash on hand and credit through its lines of credit to fund its internal working capital needs, which include internal growth initiatives over the next twelve months, and evaluating acquisitions. Moving forward, should the Company determine that it is strategically important to make multiple acquisitions, then the Company may need to pursue additional funding for those acquisitions.
Purchase of New Products
From a procurement perspective, the Company has lines of credit with Textron, Ingram Micro and GE Financial that are needed in order to fund the purchase of hardware required for its solutions offerings. Its new products are purchased primarily through one of the following four vendors: Ingram Micro, GE Financial, Synnex and Tech Data. If the credit line at each vendor becomes over extended, then that vendor gets paid by Textron immediately upon invoicing of the product. eLinear then has 30 days to pay the vendor and 45 days to pay Textron. This enables eLinear to maintain liquidity and rapid procurement on behalf of its customers.
NetView Acquisition
The acquisition of NetView brought to eLinear customers that need services in the network solutions market, including the design, procurement, implementation, support and maintenance of corporate networks. NetView's customer base ranges from the likes of the Fortune 2000 to Small to Medium Businesses (SMB). Industry verticals that Netview customers are in, and hence are new markets to eLinear, include energy, healthcare, state and local governments, finance and several others. The opportunities acquired are general in nature and there was not any specific opportunity that was deemed material in making this acquisition. Network solutions will be selectively expanded through the hiring of key account executives with long-term, well-established client relationships.
NewBridge Acquisition
The acquisition of NewBridge brought to eLinear customers that need services in the network infrastructure market, including the design, procurement, implementation, support and maintenance of physical network infrastructure such as structured cabling, network access points (drops), secure card access, closed circuit TV, and other services. NewBridge's customer base includes Houston based . . .
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