Form 10QSB/A for ELINEAR INC
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4-Apr-2006
Quarterly Report
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion and analysis of the Company's financial condition as of September 30, 2004, and its results of operations for the nine month periods ended September 30, 2004 and 2003, should be read in conjunction with the audited consolidated financial statements and notes included in eLinear's Form 10-KSB/A (Fourth Amendment) filed with the Securities and Exchange Commission.
OVERVIEW
The Company's business currently consists of three operating segments:
· Product fulfillment and network and storage solutions. Through its wholly owned subsidiary, NetView Technologies, Inc.("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 its wholly owned subsidiary, NewBridge Technologies, Inc. ("NewBridge"), the Company provides: (a) structured cabling, which is a set of cabling and connectivity products that integrate the voice, data, video and various management systems of a structure,(b)cabling infrastructure design and implementation, which is the design and implementation of the structured cabling systems,(c)security installation and monitoring, and (d) digital services of voice, data and video over fiber optic networks to residential and commercial customers.
· Consulting services. The Company offers: (a) consulting services,(b)creative web site design,(c)web site content management software, and (d) technical project management and development services.
The Company has operated as a technology consulting business since December 1999. It acquired its Internet consulting business as a result of a reverse merger with 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 six months ended June 30, 2004, the consulting segment contributed less than 1% of the Companys revenue. From 1995, its inception, the Company, which at the time was named Kinetics.com, was engaged in marketing proprietary software programs for use on the world wide web of the Internet. Kinetics.com marketed two software programs designed for use on the Web in 1995 and 1996. During 1996, several creditors of Kinetics.com obtained court judgments against it as a result of non-payment of financial obligations and in 1997, Kinetics.com transferred all of its assets to an unaffiliated third party. Subsequent to the asset transfer, the only activities of Kinetics.com consisted of negotiating settlements with its creditors and attempting to identify a suitable acquisition or merger candidate. 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, it changed its name to eLinear, Inc.
The Company completed the acquisitions of NetView and NewBridge during the last fiscal year. In April 2003, eLinear 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 its 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. In March 2004, the Company recorded impairment expense totaling $451,920 related to 100% of the goodwill related to the 2003 eLinear acquisition. In March 2004, the consulting services reporting unit lost its largest consulting contract and the other operations that had been acquired in the eLinear purchase had declined due to the loss of key employees after the acquisition. During the three months ended June 30, 2004, the Company recognized only $220 of revenue from the consulting services business segment. Based on projected estimated future cash flows from the reporting unit purchased in 2003, management determined a full impairment charge was required. NetView contributed 92% of eLinears revenue for the nine months ended September 30, 2004.
In July 2003, eLinear completed the acquisition of all the outstanding shares of NewBridge. Pursuant to the transaction, eLinear issued 850,000 shares of common stock valued at $1,062,500, using the average of the bid and asked prices on July 31, 2003, and options to purchase 300,000 shares of common stock valued at $274,000, using Black-Scholes, 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 September 2004, the Company recorded impairment expense totaling $391,114 related to a portion of the goodwill related to the NewBridge acquisition. The Company performed a valuation analysis of the discounted projected estimated future cash flows from the reporting unit. Based on the valuation analysis, the Company elected to write down the goodwill for NewBridge to $1,100,000 resulting in the impairment charge. NewBridge contributed 9% of eLinear's revenue for nine months ended September 30, 2004.
The financial information for the nine months ended September 30, 2003 is information derived from the consolidated financial statements of NetView for the nine months ended September 20, 2003, eLinear for the six months ended September 30, 2003 , and NewBridge for the three months ended September 30, 2003.
The Company's strategy is to expand its operations along the above three reporting segments through internal growth and through acquisitions. Whereas the Company has added two distinct reporting segments through the above listed acquisitions, it intends to expand its operations from all three reporting segments through the addition of personnel to increase sales. The changes in its business strategy have not affected its relationship with any of its customers. eLinear intends to utilize the proceeds from its recent offerings discussed below, as well as through additional offerings, to finance its internal growth and for any acquisitions. The Company does not have any commitments to raise additional funds, and it may be unable to do so in the future. If it does raise additional funds, it may do so at below market prices, which would cause dilution to its shareholders.
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RECENT DEVELOPMENTS
On November 3, 2004, eLinear acquired all of the outstanding and issued stock of TanSeco Systems, Inc. a Delaware Corporation (TanSeco), from RadioShack corporation, a Delaware corporation (Radioshack). TanSeco is a nation wide security solutions company, established over 35 years ago, that provides single source integrated life safety and physical security systems and security monitoring services to commercial customers. Pursuant to this transaction, eLinear offered employment to over 35 RadioShack employees. Concurrently with this transaction, TanSeco entered into a three year services agreement with RadioShack, pursuant to which, TanSeco will provide the installation, service, repair and inspection of security, closed circuit television, and fire systems used by RadioShack for the security systems of its more than 5,000 company-owned stores located in the continental United States, Puerto Rico and the U.S. Virgin Islands, Kiosks and other physical locations. In addition to providing services to RadioShack in connection with the service agreement, TanSeco plans to do the following: (i) continue to provide installation, service, repair, and inspection of security, closed circuit television and fire systems to existing customers of TanSeco (ii) seek out and obtain, either independently or through the use of third parties, new customers for TanSecos installation, service, repair, and inspection of security closed circuit television and fire systems services; and
(iii) either independently or through the use of third parties, provide monitoring services which may include monitoring fire alarms and burglar alarms, to new and existing customers of TanSeco
In January 2004, the Company completed a private offering in which it raised gross proceeds of $2,533,850. In February 2004, the Company completed a private offering in which it raised gross proceeds of $2,460,000. Both of these agreements included warrants, which if exercised would bring in an additional $8,029,621. In each of these offerings the Company issued its common stock at prices below the then market price.
The Company has filed a registration statement with the Securities and Exchange Commission which is registering the resale of 3,194,225 shares of the Companys common stock and 3,944,737 shares of the Companys common stock underlying the warrants pursuant to the above listed financings. The registration statement was declared effective on September 10, 2004.
In February 2004, the Company obtained a secured revolving note with Laurus Master Fund, Ltd. ("Laurus"). Under the terms of the agreement, the Company can borrow up to $5,000,000 at an annual interest rate of prime plus .75% (with a minimum rate of 4.75%). The agreement contains two notes: a minimum secured revolving note totaling $2,000,000 and a revolving credit facility totaling $3,000,000 based on eligible accounts receivable. See Note 3 to the unaudited financial statements included herein.
As part of the above credit facility, the Company agreed to file a registration statement with the SEC in order to register the resale of any shares issuable upon conversion of up to $2 million of the credit facility and upon the exercise of the warrants. In consideration for the issuance of seven-year warrants to purchase 150,000 shares of the Companys common stock at $1.90 per share and the forgiveness of penalties owed to Laurus in the approximate amount of $153,000 as of October 2004, the Company agreed in October 2004 to reduce the conversion price of the credit facility from $2.91 to $1.00 per share. At the option of the holder, the outstanding balance on the credit facility can be converted into shares of Company common stock at a conversion price of $1.00 per share. In connection with the execution of this credit facility, and in connection with the October 2004 amendment, the Company issued Laurus seven-year warrants to purchase a total of 440,000 shares of Company common stock at exercise prices ranging from $1.90 to $3.32 per share. Laurus is limited to owing or beneficially owning a maximum of 4.99% of the Companys outstanding shares of common stock. In addition, each time the Company borrows $2 million under the credit facility, the Company will be required to file an additional registration statement covering the possible conversion of that amount of the nor. The Company is not obligated at any time to repurchase any portion of the Laurus conversion shares nor the shares underlying the warrants. The Company filed a registration statement to register the aforementioned shares and shares underlying the warrants with the SEC on November 5, 2004
CRITICAL ACCOUNTING POLICIES
General
The consolidated financial statements and notes included in this Form10-QSB/A (First Amendment) 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 the Company to make estimates and assumptions that affect the reported amounts of its assets and liabilities, and affect the disclosure of any contingent assets and liabilities. The Company 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. The significant accounting policies are described in its financial statements and notes included in its Form 10-KSB/A (Fourth Amendment) filed with the Securities and Exchange Commission.
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 underlying 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 future delivery of products or services or subject to customer-specified return of refund privileges.
The Company recognizes revenue from the sale of manufacturers maintenance and extended warranty contracts in accordance with EITF 99-19 net of its costs of purchasing the related contracts.
Goodwill
As of September 30, 2004, the Company had $1,100,000 of goodwill resulting from the acquisition of NewBridge Technologies, Inc. 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. Due to the newness of the NewBridge acquisition, the Company has not performed an impairment assessment of the NewBridge acquisition. Due to the large amount of goodwill presently included in its financial reports, if impairment is required, its financial condition and results would be negatively affected.
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." These rules 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 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 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 financial position. The Company recorded $3,246 of stock-based compensation expense for employee stock options which was reflected in the net loss for the nine-month period ended September 30, 2004.
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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 its 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 its 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 its consolidated results of operations or financial position. As of September 30, 2004, the Company maintained an allowance for doubtful accounts of $137,288, which allowance was 2% of total accounts receivable as of that date.
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 credit facilities in the quarterly financial statements are subject to the changes in the trading value of the Companys common stock and other assumptions. As a result the Companys quarterly 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 credit facilities 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 7 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 September 30, 2004 were not designated.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
eLinear's primary business focus is on solving well-defined customer problems or providing a need-proven service. The Company 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 three 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 and NewBridge, eLinear 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. The information technology outsourcing and consulting industry in which the Company operates has declined drastically with substantial overall reductions in information technology investments. This has resulted in a dramatic reduction in spending for information technology services overall, and a significant decrease in the amount of services the Company is able to sell. In order to reduce costs the Company closed its offices in Denver during 2002 and has concentrated its marketing efforts in the Houston market. However, due to the failure of Enron Corp. and weakening financial conditions of companies such as Dynegy Energy and Reliant Resources, the Houston market for information technology services in 2003 and 2004 has been hit particularly hard.
In order to diversify its business plan, eLinear began seeking merger candidates. It selected NetView due to its list of customers and management with the view toward cross-selling its consulting services with its network and storage solutions customers. The Company's 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. In addition to consulting services the Company previously provided, eLinear 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. eLinear intends to expand its business in all three segments of which it operates.
Revenue Total revenue for the nine months ended September 30, 2004 was $16,960,375 which was an increase of 60% over the prior year period of $10,581,583. Revenue from the consulting services business segment for the nine months ended September 30, 2004 was $88,990 which was less than 1% of total revenue. The consulting services business segment has seen a significant decline in customer utilization during 2004 and 2003. Due to the significant reduction in customers in consulting services business segment, the Company significantly reduced its number of full-time employees and contract personnel during the 2004 period in order to reduce costs and conserve its limited resources. In addition, the former CEO and primary consultant of the Company resigned in May 2003 and the Company lost its primary consulting customer in March 2004. During February 2004, the Company hired a primary consultant and several consulting engineers and the Company intends to concentrate its efforts on building additional consulting services customer relationships during the current fiscal year and, if successful, add additional personnel to increase its sales. However, there are no guarantees that the Company will be successful in this endeavor. Revenue generated from the network and storage solutions business segment for the nine months ended September 30, 2004 was $15,416,359, which was an increase of $5,437,164 or 54% over the prior year period. The network and storage solutions business segment contributed 91% of total revenue for the current nine month period. The Company was able to increase its revenue over the 2003 period primarily by the addition of sales personnel who had previous customer relationships and has opened a sales office in Dallas, Texas with satellite offices in Austin, Texas and Oklahoma City, Oklahoma. The increase in revenue was due to an increase in the amount of products sold and was not affected by an increase in pricing. The Company intends to focus on adding additional customers and personnel to service these customers. Revenue from the communications deployment business segment for the nine months ended September 30, 2004 was $1,455,026 which was 9% of total revenue. As the acquisition of NewBridge did not occur until July 31, 2003, there was only $88,444 of revenue from the communications deployment segment recognized in the 2003 period.
Of the revenue generated for the three and nine months period ended September 30, 2004, one customer provided in excess of 10% of the Company's revenue with The Methodist Hospital contributing 21% of the revenue. No other customer provided more than 10% of the Companys revenue for the 2004 period. If the Company were to lose any of these customers, its financial results may be negatively affected.
Cost of sales. Total cost of sales for the and nine months ended September 30, 2004 was $14,647,673 an increase of $5,843,473 or 66%, over the prior year period of $8,804,200. The Company hired a consulting manager to replace its former CEO and added several consulting engineers during the quarter ended March 31, 2004 to begin growing its business through selling these services to its existing client base. Additionally for the network and storage solutions business segment, the cost of hardware and software as a percent of revenue increased from 84% fro the 2003 period to 90% for the 2004 period which was a result of the addition of a major customer which received favorable pricing from the Company. In order to obtain and retain this customer, the Company lowered its standard pricing for resale of computer hardware and software to this customer. The Company was unable to obtain a reduction in the cost of hardware and software purchased from it vendors, resulting in a decrease in its gross margin. This customer became a customer of the Company during the three months ended June 30, 2003. The Company does not anticipate the favorable pricing it has granted this customer will change in the future.
For the network and storage solutions business segment, cost of sales is comprised of the costs associated with acquiring hardware and software to fill customer orders. For the consulting services business segment, cost of sales consists of full-time personnel and contract employee costs associated with projects eLinear provides to its customers for a fee. For the communications deployment business segment, cost of sales consists of materials and personnel to build the customer infrastructure. The increase in cost of sales was due to the cost of procuring hardware and software to fill an expanded number of customer orders. The Companys principal suppliers of hardware and software products are Hewlett Packard and Cisco Systems. The Company anticipates they will continue to be its principal suppliers in the future. Total hardware and software costs amounted to $13,602,289 for the nine months ended September 30, 2004. The Company anticipates that cost of sales will increase as revenues increases.
Gross profit. Total gross profit increased from $1,177,383 for the nine months ended September 30, 2003, to $2,312,702 for the nine month ended September 30, 2004. Total gross profit as a percentage of revenue decreased from 16.8% for the nine months and ended September 30, 2004 to 13.6% for the current year period. As previously described, the Company has hired additional personnel in its consulting services business segment in order to market those services to its existing customer base and granted favorable pricing to a major customer which resulted in the decrease in gross profit as a percent of revenue. The Company had not experienced any significant increase in revenue associated with the increased staffing costs during the nine months ended September 30, 2004, but anticipates its revenue and profit margin will improve in the future from this business segment.
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