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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON D.C. 20549




FORM10-K

| | (Mark One) |  |                                                                                      | 
| | ---------- |  | ------------------------------------------------------------------------------------ | 
| | [X]        |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
| |            |  | FOR THE FISCAL YEAR ENDED: MARCH 31, 2005                                           
| | [  ]       |  | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934  
| |            |  | FOR THE TRANSITION PERIOD FROM                        TO                            
| |            |  | COMMISSION FILE NUMBER: 0-22122                                                     




MTM TECHNOLOGIES, INC.(Exact name of registrant as specified in its charter)




|New York(State or other jurisdiction of
incorporation or organization) |  | 13-3354896(I.R.S. Employer Identification No.)
|---------------------------------------------------------------------- |  | ----------------------------------------------
|850 Canal Street
Stamford, CT(Address of principal executive offices)  |  | 06902(Zip Code)                               

Registrant's telephone number, including area code: (203) 975-3700




Securities registered under Section 12(b) of the Exchange Act:None

Securities registered under Section 12(g) of the Exchange Act:Common stock, par value $0.001 per share

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 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]      No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

Indicate by check mark whether the registrant is an accelerated filer. Yes [  ]      No [X]

The aggregate market value of the 3,210,816 shares of voting and non-voting common equity stock held by non-affiliates (all shareholders other than directors, executive officers and 5% or greater shareholders) of the registrant was $5,972,118 as of September 30, 2004, based on the average bid and asked prices of the registrant's common stock on such date of $1.86 per share, as reported by The Nasdaq Stock Market, Inc.

There were a total of 7,392,317 shares of the registrant's common stock outstanding as of June 15, 2005.

Documents Incorporated by Reference:None



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MTM TECHNOLOGIES, INC.FORM 10-KFor the Fiscal Year Ended March 31, 2005
Number



PagePART IItem 1.

Business


1Item 2.

Properties


8Item 3.

Legal Proceedings


8Item 4.

Submission of Matters to a Vote of Security Holders


8PART IIItem 5.

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities


9Item 6.

Selected Financial Data


10Item 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations


11Item 7A.

Quantitative and Qualitative Disclosures about Market Risk


17Item 8.

Financial Statements and Supplementary Data


17Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure


18Item 9A.

Controls and Procedures


18PART IIIItem 10.

Directors and Executive Officers of the Registrant


19Item 11.

Executive Compensation


22Item 12.

Security Ownership of Certain Beneficial Owners and Management


26Item 13.

Certain Relationships and Related Transactions


32Item 14.

Principal Accountant Fees and Services


32PART IVItem 15.

Exhibits and Financial Statement Schedules


34

Introductory Comment—Terminology
Throughout this Annual Report on Form 10-K, the terms “we,” “us,” “our” and “our company” refers to MTM Technologies, Inc. (formerly, Micros-to-Mainframes, Inc.) ( “MTM” ) and, unless the context indicates otherwise, our subsidiaries on a consolidated basis.
“Pequot Fund” refers to Pequot Private Equity Fund III, L.P., “Pequot Partners” refers to Pequot Offshore Private Equity Partners III, L.P., and collectively with Pequot Fund, “Pequot,” “Constellation Venture” refers to Constellation Venture Capital II, L.P., “Constellation Offshore” refers to Constellation Venture Capital Offshore II, L.P., “BSC” refers to The BSC Employee Fund VI, L.P., “CVC” refers to CVC Partners II, LLC, and collectively with Constellation Venture, Constellation Offshore and BSC, “Constellation,” and together with Pequot, the “Investors.”
Introductory Comment—Forward-Looking Statements
Statements contained in this Annual Report on Form 10-K include “forward-looking statements” within the meaning of such term in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause actual financial or operating results, performances or achievements expressed or implied by such forward-looking statements not to occur or be realized. Forward-looking statements made in this Form 10-K generally are based on our best estimates of future results, performances or achievements, predicated upon current conditions and the most recent results of the companies involved and their respective industries. Forward-looking statements may be identified by the use of
forward-looking terminology such as “may,” “will,” “could,” “should,” “project,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” “potential,” “opportunity” or similar terms, variations of those terms or the negative of those terms or other variations of those terms or comparable words or expressions. Potential risks and uncertainties include, among other things, such factors as:
•
the market acceptance, revenues and profitability of our current and future products and services;•
our ability to acquire additional companies and ability to successfully integrate such acquirees, if any, into our operations;•
general economic conditions in the United States and elsewhere, as well as the economic conditions affecting the industries in which we operate;•
the competitive environments within the industries in which we operate;•
our ability to raise additional capital, if and as needed;•
the cost-effectiveness of our product and service development activities;•
the extent that our sales network and marketing programs achieve satisfactory response rates;•
political and regulatory matters affecting the industries in which we operate; and•
the other risks detailed in this Form 10-K and, from time to time, in our other filings with the Securities and Exchange Commission.Readers are urged to carefully review and consider the various disclosures made by us in this Annual Report on Form 10-K and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this Form 10-K speak only as of the date hereof and we disclaim any obligation to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.

PART I
Item 1.Description of Business
We are a leading national computer and communications technology management company providing information technology (“IT”) networking, communications, software applications and data center services, including secure access, voice over internet protocol (“VOIP”), storage, security and messaging solutions. We serve as a single source provider of advanced technology solutions to support our clients’ mission-critical business processes. Our clients consist of divisions of Fortune 100 and Fortune 500 corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipal, state and federal government agencies, and educational institutions. We serve clients in most major US metropolitan markets.
We provide services to our clients that address the full life cycle of a business solution from needs analysis, through planning, solution development, deployment, and testing, to on-going maintenance and support. We act a single-source provider of business technology solutions to our clients, an increasingly mandated requirement in today’s marketplace.
Business Strategy
There is a rapidly growing trend among companies to outsource their computer services requirements. This entails client companies obtaining all or a portion of their data processing and related requirements from solution providers, such as us, that specialize in the technology service, product or application required by these client companies. Our strategy is to be the national leader in providing sophisticated network solutions to the middle market using a combination of carefully managed internal growth and acquisitions. We offer our clients selective outsourced infrastructure solutions at competitive prices. We are focusing our efforts on developing our higher margin recurring service offerings, while maintaining control over our expenses and improving our balance sheet. These services include our outsourced support
services; contract programming; voice over internet protocol (VOIP) solutions; network consulting; network management and monitoring; security solutions; collaboration solutions focused primarily on Microsoft Exchange; data storage (including disaster recovery and data back-up) and IT staff augmentation.
Since 1991, we have evolved to become a provider of IT managed solutions. We are focusing our current marketing efforts in accelerating growth in such areas. Services accounted for approximately 28% of our revenues for the fiscal year ended March 31, 2005, as compared to approximately 25% in the fiscal year ended March 31, 2004, with a small portion of these revenues derived from maintenance and repair services. The trend toward services revenue has accelerated, however as a result of our acquisition program, with service revenue accounting for approximately 30% of our revenue in the quarter ended March 31, 2005.
Our acquisition program is an important part of our business strategy.
Acquisition Program
One of our principal goals is to grow our business through the acquisition of additional companies. These acquisitions would expand our business into geographic regions where we do not yet have a strong presence, strengthen our technical capabilities and provide new service offerings. These benefits would enable us to better service the needs of middle market business and divisions of large enterprises. To fund the cash portions of the acquisitions which we have made to date, we have relied on private institutional financing.
On January 29, 2004 we entered into an agreement (the “Pequot Purchase Agreement”) with Pequot to sell to Pequot an aggregate of up to $25 million of Series A Convertible Preferred Stock, together with warrants to purchase additional shares of common stock. We subsequently sold shares of Series A-1 Convertible Preferred Stock and Series A-2 Convertible Preferred Stock, in each case together with common stock warrants, to Pequot, to fund the cash portions of the
1

purchase prices for our acquisitions of DataVox Technologies, Inc. and Network Catalyst, Inc., respectively, referred to below.
On December 7, 2004, Pequot assigned to Constellation all of Pequot’s rights and obligations under the Pequot Purchase Agreement to purchase a portion of the shares of the Series A-3 Convertible Preferred Stock and common stock warrants covered by that agreement. On that date we also entered into a purchase agreement (the “Pequot/Constellation Purchase Agreement”) with Pequot and Constellation for up to $40 million (or in certain limited circumstances, up to $47.5 million) of additional financing in the form of 7% convertible secured notes in three tranches. We subsequently sold to Pequot and Constellation shares of Series A-3 Preferred Stock and common stock warrants under the Pequot Purchase Agreement, and Series A-4 First Tranche Notes under the Pequot/Constellation Agreement, to fund
the cash portion of the purchase price for our acquisition of the Vector ESP entities; and Series A-4 Second Tranche Notes under the latter agreement to fund the cash portion of our purchase price for our acquisition of Info Systems, Inc. The Series A-4 First Tranche Notes and Series A-4 Second Tranche Notes were converted into shares of our Series A-4 Preferred Stock upon approval of such convertibility by our shareholders on June 23, 2005.
We believe that there is an opportunity to consolidate similar businesses throughout the United States. We will focus our acquisition strategy on businesses providing secure access, voice over internet protocol (VOIP), storage, networking and messaging solutions. The acquisition targets will include companies providing IT services and products, as well as certain managed solutions. We intend to seek acquisitions to enhance our current service offerings and extend our geographic presence. We seek to identify businesses which will add technical expertise and service offerings, customers, sales capabilities and/or geographic coverage while generating a positive rate of return on investment. Furthermore, we intend to capitalize on the business practices of acquired companies that we believe will best maintain or strengthen
our competitive advantage and ensure ongoing delivery of high quality IT solutions to our customers. The acquisition candidates we may investigate can be large, and their acquisition by us could have a significant and lasting impact on our business.
In executing our growth-through-acquisition strategy during our 2005 fiscal year, we have acquired the businesses and operating assets of the first three of the following four companies, and all of the outstanding capital stock of the fourth one:
•
DataVox Technologies, Inc., a Cisco AVVID (Architecture for Voice, Video and Integrated Data) authorized partner, offering advanced technology solutions, including IP telephony, security, storage, networking and wireless technologies solutions, as well as network facilities engineering and data center technology consulting and services.•
Network Catalyst, Inc., a provider of advanced technology solutions in the VOIP (voice over internet protocol), infrastructure and security fields to clients located throughout the Southern California region.•
Vector ESP, Inc. and Vector ESP Management, Inc., providers of secure access, consulting services, information technology products, technology solutions, applications, messaging and collaboration products and services, remote connectivity and workforce mobility products and services.•
Info Systems, Inc., a provider of VOIP, security and storage solutions, as well as telecommunications and structured cabling services, outsourced information technology (IT), staff augmentation and remote network monitoring, management and support services through its Network Operations Center.Business Services
We are a leading national computer and communications technology management company providing IT networking, communications, software applications and data center services, including secure access, voice over internet protocol (VOIP), storage, security and messaging solutions. We serve as a single source provider of advanced technology solutions to support our clients’ mission-
2

critical business processes. Our clients consist of divisions of Fortune 100 and Fortune 500 corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipal, state and federal government agencies, and educational institutions. We serve clients in most major US metropolitan markets.
We provide services to our clients that address the full life cycle of a business solution, from needs analysis, through planning, solution development, deployment, and testing, to on-going maintenance and support. We act a single-source provider of business technology solutions to our clients, an increasingly mandated requirement in today’s marketplace.
Our services can be broadly categorized into the following:
•
Managed services•
Consulting, integration and professional services•
IT outsourcing (including staff outsourcing)•
Product provisioning (including on-line purchasing)•
Repair and restorative servicesManaged Services
We provide our clients with a suite of managed services through the use of our Pivot Technology system which includes our proprietary network management and monitoring software system. Our Pivot Technology system provides our clients with real-time monitoring of their computing and storage systems, VOIP systems and network infrastructure to immediately detect component failures, critical security events (such as, for example, hacking attempts), deteriorating performance and also to report on the health of these systems. The Pivot Technology system is a combination of our proprietary network management and monitoring software and best-of-breed third party licensed software. Monitoring of our clients’ networks is performed by our certified engineering staff operating on a 24x7x365 basis from two of our network operations
centers (“NOC”). Our NOCs are located in Delaware and California.
In addition to monitoring, our managed services include managed hosting and a suite of hosted applications, including VOIP and e-mail. We offer our customers a choice of two collocation facilities to host their computing systems. Our field engineering resources are available in each of our regions to provide field support and technical resources in connection with our managed services.
Consulting, Integration and Professional Services
Our staff of certified technology professionals provide our clients with a full suite of services ranging from advanced configurations and complex project management, project logistics and planning. We provide design, consulting, implementation and support services in our seven areas of core competence. These are network infrastructure (including LAN, WAN and Wireless), VOIP, storage solutions, operating systems, security, facilities design and access infrastructure.
Our capability to address all phases of technology projects, from needs analysis and definition through implementation and support, allows us to offer our customers a single point of accountability for a broad range of technology projects. As technology infrastructure becomes progressively more sophisticated and complex, our clients demand total project accountability from a single vendor. With our national presence, engineering expertise, and extensive relationships with top tier vendors, we are able to undertake most technology infrastructure projects for our clients and provide them that critical single point of accountability.
We provide professional consulting services for most of the infrastructure technologies that our clients utilize. These include expertise in the technology of a number of leading manufactures of infrastructure technology. For example, we are a Cisco Gold partner, a Citrix Platinum Solutions Advisor, a Hewlett Packard Gold and Enterprise Storage Elite partner, Microsoft Gold partner, an Avaya Gold partner, a Captaris Platinum partner, and a Nortel Elite partner. For those
3

manufactures that we believe are critical to our client’s technology infrastructure we generally hold the highest level of certification granted by such manufacturers.
In many of our regions we operate large project staging facilities, where technology systems associated with of our clients’ complex projects are staged, configured, tested and verified prior to delivery to the clients’ premise. We also provide accredited and topic-specific professional training services for our clients at several training facilities across the United States. Each of these facilities is fully equipped with the necessary equipment and lab facilities specific to the curriculum being delivered. In addition, we frequently offer seminars and technology awareness events for the benefit of our existing and prospective clients.
IT Outsourcing
Many of our potential clients have adopted an approach to technology of focusing on their core business competencies, while outsourcing non-core technology systems. These clients, however, often find it more cost effective to outsource than to fund the cost of a full-time internal IT staff to operate the sophisticated technology systems necessary which support their core business. Additionally, some clients are faced with extensive legal and regulatory compliance mandates that require sophisticated technology solutions. Again, for some of these clients, maintaining a full-time internal staff to operate those systems is not feasible.
Our IT outsourcing solutions provide a cost effective solution to such clients by providing targeted support to fill gaps in their technology staffing on a project basis. We also offer solutions which allow clients to adopt a “pay-as-you-go” approach for supporting their IT requirements by providing hosted systems solutions that do not require substantial upfront capital investments. We believe that our technology outsourcing solutions allow our clients to achieve productivity enhancements, meet their legal and regulatory compliance requirements and improve financial performance by deploying advanced technologies on an outsourced basis. These solutions range from outsourcing of specific targeted business functions (such as application hosting, help desk operations) to strategy definition and execution on a virtual
CIO basis.
For clients with defined staff augmentation needs, our IT outsourcing provides cost-effective staffing alternatives in connection with both long and short term client projects by maintaining an extensive staff of highly trained consultants meeting many of the same qualifications as those which our clients demand of our own professional staff resources.
Product Provisioning Services and On-line Sourcing
We provide all aspects of infrastructure technology product delivery to our clients. Through our relationships as a certified partner with most of the key top tier infrastructure technology product manufacturers and with key infrastructure technology distributors, we are able to provide our clients with cost-effective product sourcing solutions to meet their requirements for managed, timely and competitive product procurement.
We offer an on-line, web-based and secure product purchasing option for those clients who prefer a self-service alternative. Our eCommerce portal allows our clients to obtain product pricing, place unit or volume orders, and track the delivery process of their orders on line.
For clients who require their purchased products to be staged, pre-configured, field tested, assembled or integrated, we provide these services in one of two extensive staging facilities (in California and Connecticut). Staging can be provided with or without the client’s participation, as directed by the client.
Repair and Restorative Services
Many of our clients require a guaranteed response to their system outages. Through our national staff of certified technicians and related field resources, we provide service level guarantees to our customers in response to problems with their infrastructure technology outages that are communicated to us, or that are detected through our Pivot Technology monitoring
4

systems as part of a managed services solution. We offer our clients various degrees of guaranteed response depending on the severity of the outage or the client’s specific response requirements. Our technical staff providing these services is fully trained in and accredited with each of the vendors’ technology systems.
Industry
The network computer industry has become a multi-billion dollar industry since its development in the late 1970’s. Today, industry participants face intense competition, the challenge of constant technological advancement and the ongoing need for business process optimization. The outsourcing of computer solutions is a rapidly growing trend in which a client company obtains all or a portion of its data processing requirements from a systems integrator, such as us, that specializes in the computer service, product or application required by the client.
We believe the strongest demand for our IT services is among companies which typically lack the time and technical resources to satisfy all of their IT needs internally. These companies typically require sophisticated, experienced IT assistance to achieve their business objectives. These companies often rely on IT service providers to help implement and manage their systems. However, many of these companies rely on multiple providers for their IT needs. Generally, we believe that this reliance on multiple providers results from the fact that larger IT service providers do not target these companies, while smaller IT service providers lack sufficient breadth of services or industry knowledge to satisfy all of these companies’ needs.
Companies have recognized the importance of IT systems in supporting their business processes and are turning to IT solutions to complete more effectively. At the same time the process of designing, developing and implementing IT solutions has become increasingly complex. The accelerated rate of development of new technologies is placing increasing demand on our clients to understand the opportunity and impact which these technologies can have on their business. IT services organizations like ours are faced with an increasing demand to keep up with these developments so as to effectively serve as consultants and advisors to our clients.
During the period 2001 to 2004 following the burst of the “internet bubble,” the technology industry was impacted by a dramatic slowdown in IT spending. Companies refrained from funding critical technology projects necessary to keep up with the advances in IT, and often those necessary for the basic upkeep and maintenance of their installed technology base. Companies used the period of economic slowdown to reassess the return on investment associated with their past IT spending; and, we believe, concluded that past levels of IT spending can not be sustained at historical levels in today’s competitive marketplace. As such, future spending may increasingly be targeted and scrutinized from the standpoint of necessity and business impact. Importantly, companies have indicated that their intent is to focus
on the effectiveness of IT solutions, not merely on the level of IT spending. This important development may result in the differentiation between technology providers who focus on offering total solutions versus those who focus on product resales.
Advances in virtualization at the device and application level have suggested a trend toward a centralized computing model. This cycle, which started with mainframes, then workgroup mini-computers, then highly distributed applications running on micro-computers and PCs, may now be returning to a model where an increasing portion of business applications are implemented in a centralized computing model, using increasingly sophisticated terminal services to access these applications. This shift may be one of the most significant developments driving the re-definition by IT service providers of product and service solutions for the foreseeable future.
Sales and Marketing
Our marketing efforts are focused on divisions of large corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipalities and educational institutions.Except for major corporate accounts, these customers generally do not have internal computer support personnel. We believe that the increasing complexity of computer
5

systems, increased usage of computers in the workplace and the trend toward network interconnecting will cause business and institutional customers to require significant levels of outsourced customer support services, such as those provided by us. We believe that these customers are increasingly relying on their dealers and suppliers to provide, in addition to competitive pricing, a one-stop solution-based approach to their data processing requirements. We use such an approach, which addresses purchasing, compatibility, maintenance, support, training and obsolescence.
Our customers are diversified in such industries as securities, financial institutions, pharmaceuticals, manufacturing, distribution, law and accounting firms as well as municipalities and educational institutions. For the years ended March 31, 2005, 2004 and 2003, approximately 20%, 34%, and 18% of our revenue was from one customer, Verizon Wireless. We entered into a three-year desktop maintenance and support contract with Verizon Wireless, which expired in April 2005. We continue to provide services to Verizon and are currently negotiating an extension to the agreement.
As of May 31, 2005, we employed 122 salespersons, sales assistants and marketing persons who are paid salaries, commissions and/or a combination of both. Our sales executives regularly call on management at companies seeking solutions for their computer problems.
We also make joint sales presentations with certain of our major suppliers to existing and prospective customers. Certain of these suppliers’ customer fulfillment option programs allow customers who purchase directly from the supplier to apply purchases from us to their purchase obligations under those agreements. As a result, these customers have the flexibility of purchasing products from us to take advantage of our added services and our ability to integrate multiple manufacturers’ products. Most major manufacturers have instituted either a moratorium or a selective authorization procedure on the approval of additional authorized dealership locations. While in effect, such policies may preclude us and certain of our competitors from becoming authorized dealers for new vendors.
Suppliers
We purchase software,computers and related products directly from numerous suppliers as either an authorized dealer or a value added reseller. We have entered into authorization agreements with our major suppliers. Typically, these agreements provide that we have been appointed, on a non-exclusive basis, as an authorized dealer and systems integrator of specified products of the supplier at specified locations. Most of the authorization agreements provide that the supplier may terminate the agreement with or without cause upon 30 to 90 days notice or immediately upon the occurrence of certain events. We believe that we have excellent relationships with our major suppliers; however, there can be no assurance that the aforementioned agreements will be renewed.
If these agreements are not renewed, we may have difficulty in obtaining inventory at a sufficiently low cost to allow for resale at a competitive price.
Distributors and integrators in the computer industry currently face a number of adverse business conditions, including price and gross profit margin pressures and market consolidation. In recent years, major hardware vendors have instituted aggressive price reductions in response to lower component costs and discount pricing by certain computer manufacturers. The increased price competition among major hardware vendors has resulted in declining gross margins for many computer distributors and may result in a reduction in existing vendor subsidies. We believe that these current conditions, which are forcing certain of our direct competitors out of business, may present us with opportunities to expand our business. There can be no assurance, however, that we will be able to continue to compete effectively in this industry.
Pursuant to the terms of most of our authorized dealership agreements, we furnish firm purchase orders 30 to 90 days in advance of shipment. Under the terms of these agreements, we are generally liable for up to a 5% restocking fee to many manufacturers and suppliers for the return of previously received merchandise. We have not experienced any significant cancellation penalties or restocking fees to date.
6

We receive certain discretionary cost subsidies, typical for the industry, from certain major suppliers to promote sales and support activities relating to their products. We have used these funds to subsidize marketing, advertising and our connectivity and communication laboratory.
Our suppliers permit us to pass through to its customers all warranties and return policies applicable to the suppliers’ products. To date, we have experienced few returns of product and have been reimbursed by the suppliers for most warranty work done for its customers. All service work after the expiration of the warranty period is at the customer’s expense. We offer service contracts of varying lengths under which we agree to be responsible for all service costs for a fixed term in exchange for a set fee paid by the customer.
Software and other related products are purchased from numerous industry suppliers. As is customary, we do not have any long-term agreements or commitments with these suppliers, because competitive sources of supply are generally available for such products.
Competition
The markets in which we operate are highly competitive with respect to performance, quality and price. In our professional services business our competition ranges from small, specialty integrators, to other service providers of comparable size and profile to us, as well as large national and global professional services firms and integrators. Our smaller competitors generally are highly focused on their immediate market segment and can respond more quickly to changes in customer needs. Our larger competitors generally have greater financial resources and may be able to compete more effectively than we can on prices and payment terms offered to potential customers. In our product provisioning business we directly compete with local, regional and national distributors and mail order providers of computer and IT products
and services, including network integrators and corporate divisions of retail superstores.
In addition, the computer and IT products and services industries have each experienced a significant amount of consolidation through mergers and acquisitions. In the future, we may face further competition from new market entrants and possible alliances between existing competitors. Further, certain computer superstores have expanded their marketing efforts to target segments of our customer base, which could have a material adverse impact on our operations and financial results. Some of our competitors have, or may have, greater financial, marketing and other resources than us. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements, benefit from greater purchasing economies, offer more aggressive hardware and service pricing to customers, or devote greater
resources to the promotion of their products and services. There can be no assurance that we will be able to compete successfully in the future with such competitors. We also compete with manufacturers, including those serving as our vendors, which market through direct sales forces and distributors. More aggressive competition by principal manufacturers of computer and IT products, such as offering a full range of services in addition to products, could have a material adverse effect on our operations and financial results.
We believe that we will continue to be able to compete effectively against our various competitors by combining fair pricing with a wide range of customer support services designed to provide our customers with high-end technological services, multi-vendor technical support, maintenance of their computer product needs, a dedicated, trained staff of salespersons and technicians, complete solutions for single user, multi-user or network systems and specialized vertical market software.
We believe that our backlog of unfilled customer orders is not material.
Proprietary Information
We do not hold any patents, but have several trademarks and service marks. We also may affix copyright notices on our support service, training and service manuals. While such protection may become important to use, it is not considered essential to the success of our business. We rely
7

on the know-how, experience and capabilities of our management, sales and service personnel. We require our employees to sign confidentiality or non-competition agreements.
Employees
Our growth-through-acquisition strategy has resulted in a substantial increase in the number of employees. As of May 31, 2004, prior to commencing our acquisition strategy, we employed 151 persons and as of May 31, 2005, after completing four acquisitions, we employed 616 persons, all but 30 of whom are full-time personnel. Of these employees, 15 were in management, 122 were in sales and marketing, 388 were in technical support, 91 were in operations, finance and administration.
As of June 29, 2005, none of our personnel was represented by a union. We consider our employee relations to be good. On May 21, 2005, we received a Notice of Filing of Petition for Union Representation Election for the cabling unit of our Info Systems, Inc. subsidiary. This unit comprises approximately 25 employees. An election with respect to union representation is scheduled for July 15, 2005.
Incorporation
We were incorporated on May 12, 1986 in the State of New York.
Item 2.Properties
Our principal executive offices are currently located at 850 Canal Street, Stamford, Connecticut. We occupy approximately 6,500 square feet at this location. The lease for this location expires in September, 2009. The monthly base rent for this location is approximately $11,800.
We are also responsible for real estate taxes, insurance, utilities and maintenance expenses relating to all of our other leased facilities. These expenses for all of our leased facilities including the Stamford, Connecticut facility totaled approximately $1.4 million for the year ended March 31, 2005.
Item 3.Legal Proceedings
None.
Item 4.Submission of Matters to a Vote of Security Holders.
None.
8

PART II
Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities.
Market for Our Common Stock
Our common stock is traded on The Nasdaq SmallCap Market under the symbol “MTMC.” Set forth in the following table is the range of the high and low bid quotations for our common stock for each of the quarters during our last two completed fiscal years, based upon data provided by Nasdaq. These quotations reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions, and may not represent actual transactions.
Fiscal Year Ended March 31, 2004

High Bid

Low BidQuarter ended June 30, 2003

$
1.07


$
0.49Quarter ended September 30, 2003


1.76



0.75Quarter ended December 31, 2003


1.73



1.02Quarter ended March 31, 2004


2.17



1.02Fiscal Year Ended March 31, 2005Quarter ended June 30, 2004

$
1.62


$
1.55Quarter ended September 30, 2004


2.20



1.52Quarter ended December 31, 2004


5.35



5.03Quarter ended March 31, 2005


4.46



4.03Record Holders
As of June 15, 2005, there were 143 record holders of our common stock. We believe that there are approximately 1,100 beneficial holders of our common stock, based on information gathered in connection with the recently held special meeting of our shareholders.
Dividends
We have never declared or paid any dividends to the holders of our common stock and we do not expect to pay cash dividends in the foreseeable future. We currently intend to retain all earnings for use in connection with the further development of our business and for general corporate purposes. Our board of directors will have the sole discretion in determining whether to declare and pay dividends in the future. The declaration of dividends will depend on our profitability, financial condition, cash requirements, future prospects and other factors deemed relevant by our board of directors. In addition, provisions contained in our certificate of incorporation governing the terms of our Series A Convertible Preferred Stock, as well as our financing agreements with The CIT Group/Business Credit, Inc. (“CIT”) and
Textron Financial Corporation (“Textron”), place restrictions on our ability to declare or make any cash dividends on our common stock. In addition, our ability to pay cash dividends on our common stock in the future could be further limited or prohibited by the terms of future financing agreements that we may enter into or by the terms of any preferred stock that we may authorize and issue.
Equity Compensation Plan Information
The following table sets forth, as of March 31, 2005:
•
the number of shares of our common stock issuable upon exercise of outstanding options, warrants and rights, separately identified by those granted under equity incentive plans approved by our shareholders and those granted under plans, including individual compensation contracts, not approved by our shareholders (column A),•
the weighted average exercise price of such options, warrants and rights, also as separately identified (column B), and the number of shares remaining available for future issuance under such plans, other than those shares issuable upon exercise of outstanding options, warrants and rights (column C).9

Column A

Column B

Column CNumber of shares
to be issued
upon exercise of
outstanding
options, warrants
and rights

Weighted average
exercise price of
outstanding
options warrants
and rights

Number of shares
remaining
available for
future issuance
under equity
compensation
plans (excluding
shares reflected
in column A)Equity incentive plans approved by shareholders


4,739,416


$
3.10



1,185,450Equity incentive plans not approved by shareholders


30,000


$
5.00



Not applicableTotals


4,769,416


$
3.11



1,185,450The shares issuable upon exercise of outstanding options, warrants and rights granted under plans not approved by shareholders consist of:
•
warrants to purchase 30,000 shares of our common stock at an exercise price of $5.00 per share that we issued to the placement agent for a private placement we conducted in 2000. These warrants expire on September 25, 2005.Equity Compensation Plan Information excludes warrants issued in connection with our Series A-4 First Tranche Notes and Series A-4 Second Tranche Notes as these warrants were not exercisable as of March 31, 2005. A total of 984,617 such warrants were issued as of March 31, 2005 with an exercise price of $4.06 per share.
Item 6.Selected Financial Data
The following selected financial data for the fiscal years ended March 31, 2005, 2004, 2003, 2002, and 2001 have been derived from our consolidated financial statements. This data should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K.
10

Income Statement Data:
Year Ended March 31,2005

2004

2003

2002

2001(In thousands of dollars, except per share amounts)Net revenues:Products

$
73,161


$
38,976


$
34,471


$
55,141


$
57,804Services


28,033



13,288



20,985



20,309



22,367Total Revenue


101,194



52,264



55,456



75,450



80,171Cost of Products


64,246



37,757



32,139



50,662



53,674Cost of Services


18,160



12,103



13,272



13,017



14,900Gross profit—products


8,915



1,219



2,332



4,479



4,130Gross profit—services


9,873



1,185



7,713



7,292



7,467Gross profit—total


18,788



2,404




10,045



11,771



11,597Selling, general and administrative(a)


21,770



10,025



11,484



11,077



13,431Severance and other costs of terminated employees


















677Operating (loss) income


(2,982
)


(7,621
)


(1,439
)


694



(2,511
)Interest expense(b)


(4,686
)


(494
)


(286
)


(459
)


(439
)Other income






6



98



37



69Net (loss) income before benefit for income taxes


(7,668
)


(8,109
)


(1,627
)


272



(2,880
)Net (loss) income


(7,681
)


(8,109
)


(1,211
)


389



(2,279
)Net (loss) income per common share:Basic


(1.34
)


(1.72
)


(0.26
)


0.08



(0.45
)Diluted


(1.34
)


(1.72
)


(0.26
)


0.08



(0.45
)Weighted average number of common and common equivalent shares used in calculation:Basic


5,714



4,723



4,734



5,033



5,013Diluted


5,714



4,723



4,734



5,043



5,013
(a)

Includes $1.1 million of expenses in the year ended March 31, 2005, for payments made to two officers of the Company in connection with the Pequot Investment.(b)

Includes $4.1 million of non cash interest related to convertible debt.Balance Sheet Data:
As of March 31,2005

2004

2003

2002

2001(In thousands of dollars)Total assets

$
93,214



$
19,475


$
22,954


$
26,386


$
30,248Total liabilities


64,698



14,311



9,713



11,581



15,584Long Term Obligations


948







110



485



4Working capital deficiency


(18,792
)


(1,277
)


(6,256
)


(8,409
)


(7,832
)Accumulated Deficit


(17,886
)


(10,205
)


(2,096
)


(885
)


(1,273
)Shareholders’ equity


28,516



5,164



13,242



14,806



14,664Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The following discussion and analysis of our results of operations and financial condition should be read in conjunction with our updated consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
11

Use of Estimates
The preparation of financial statements in conformity with accounting principals generally accepted in the United States of America requires management to make estimates and assumptions that effect the amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Overview
We are a leading national computer and communications technology management company providing IT networking, communications, software applications and data center services, including secure access, voice over internet protocol (VOIP), storage, security and messaging solutions. We serve as a single source provider of advanced technology solutions to support our clients’ mission-critical business processes. Our clients consist of divisions of Fortune 100 and Fortune 500 corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipal, state and federal government agencies, and educational institutions. We serve clients in most major US metropolitan markets.
We provide services to our clients that address the full life cycle of a business solution, from needs analysis, through planning, solution development, deployment, and testing, to on-going maintenance and support. We act a single-source provider of business technology solutions to our clients, an increasingly mandated requirement in today’s marketplace.
Critical Accounting Policies
We prepare our financial statements in accordance with U.S. generally accepted accounting principles. As such, management is required to make certain estimates, judgments and assumptions it believes are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. The Securities and Exchange Commission has defined critical accounting policies as policies that involve critical accounting estimates that require (a) management to make assumptions that are highly uncertain at the time the estimate is made and (b) different estimates that could have been reasonably used for the current period, or changes in the estimates that are reasonably
likely to occur from period to period, which would have a material impact on the presentation of our financial condition, changes in financial condition or in result of operations. Based on this definition, our most critical policies include: revenue recognition, allowance for doubtful accounts, inventory valuation reserve, impairment of long-lived assets, the assessment of recoverability of goodwill and intangible assets, and valuation of deferred tax assets.
Revenue Recognition
We recognize revenue in accordance with Staff Accounting Bulletin No. 104. We recognize revenue from the sales of hardware when the rights and risks of ownership have passed to the customer, upon shipment or receipt by the customer, depending on the terms of the sales contract with the customer. Revenue from the sales of software not requiring significant modification or customization is recognized upon delivery or installation. Revenue from services is recognized upon performance and acceptance after consideration of all of the terms and conditions of the customer contract. Service contracts generally do not extend over one year, and are billed when persuasive evidence of an arrangement exists, the sales price is fixed and determinable, and collection of the resulting receivable is reasonable assured. Revenue arrangements
generally do not include specific customer acceptance criteria. For arrangements with multiple deliverables, delivered items are accounted for separately, provided that the delivered item has value to the customer on a stand alone basis and there is objective and reliable evidence of the fair value of the undelivered items. Revenue billed on retainer is recognized as services are performed and amounts not recognized are recorded as deferred revenue.
12

We periodically receive discretionary cost reimbursements from suppliers. These reimbursements are accounted for as reductions to the cost of sales products.
Goodwill and Intangibles
The Company tests goodwill for impairment at the reporting unit level on an annual basis or more frequently if the Company believes indicators of impairment exist. The performance of the test involves a two-step process. The first step of the impairment test involves calculating the fair values of the applicable reporting units using the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the Company performs the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit’s goodwill with
the carrying value of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recorded in net income (loss).
Circumstances that could trigger an impairment test include but are not limited to: significant adverse change in the business climate or legal factors; an adverse action or assessment by a regulator; unanticipated competition; loss of key personnel; the likelihood that a reporting unit or significant portion of a reporting unit will be sold or otherwise disposed of; results of testing for recoverability of a significant asset group within a reporting unit; and recognition of a goodwill impairment loss in the financial statement of a subsidiary that is a component of a reporting unit.
Intangible Assets
We recorded intangible assets with related to the acquisitions of DataVox Technologies, Inc., Network Catalyst, Inc., Vector Global ESP, Inc. and Info Systems, Inc.
Intangibles consist of the following:
Gross
Amount

Accumulated
Amortization(in thousands)Customer relationships

$
6,588


$
768Know-how


710



59Total

$
7,298


$
827The customer relationships and know-how are being amortized over periods of 3 to 4 years.
Amortization expense amounted to $0.8 million for the year ended March 31, 2005. Estimated amortization expense for the next four years is as follows:
Year ending March 31,

(in thousands)2006

$
2,2612007


2,2612008


1,5192009


430Accounts Receivable
Accounts receivable are reported at their outstanding unpaid principal balances reduced by an allowance for doubtful accounts, based on certain percentages of aged receivables. We estimate doubtful accounts based on historical bad debts, factors related to specific customers’ ability to pay and current economic trends. We write off accounts receivable against the allowance when a balance is determined to be uncollectible.
13

Inventories
Inventories, comprised principally of computer hardware and software, are stated at the lower of cost or market using the first-in, first-out method.
Property and Equipment
Property and equipment is stated at cost and is depreciated using the straight-line method. Furniture, fixtures and other equipment and software development costs have useful lives ranging from 3-7 years. Leasehold improvements are amortized over the shorter of the lease term or economic life of the related improvement. Expenditures which extend the useful lives of the existing assets are capitalized. Maintenance and repairs are charged to operations as incurred.
We incurred approximately $1.7 million, $1.6 million and $1.6 million of depreciation and amortization expense for the years March 31, 2005, 2004 and 2003, respectively.
Contractual Obligations
The following table set forth as of March 31, 2005 the Company's known contractual obligations.
Payment Due by PeriodContractual Obligations

Total

Less than
1 year

1-2
years

3-5
years

More than
5 years(In thousands of dollars)Promissory Notes

$
1,033


$
366


$
667Capital Lease Obligations


466



191



275Operating Lease Obligations


7,921



1,719



2,665


$
1,571


$
1,966Total

$
9,420


$
2,276


$
3,607


$
1,571


$
1,966Results of Operations
The following table sets forth for the periods presented information derived form our audited consolidation statement of operations expressed as a percentage of net revenue:
Year Ended March 31,2005

2004

2003Net revenue:Products


72.3
%


74.6
%


62.2
%Services


27.7
%


25.4
%


37.8
%Total net revenue


100.0
%


100.0
%


100.0
%Cost of products


87.8
%


96.9
%


93.2
%Cost of services


64.8
%


91.1
%


63.2
%Gross profitProducts


12.2
%


3.1
%


6.8
%Services


35.2
%


8.9
%


36.8
%Total net gross profit


18.6
%


4.6
%


18.1
%Selling, general and administrative(a)


21.5
%


19.2
%


20.7
%Operating (loss) income


(2.9)
%


(14.6)
%


(2.6)
%Interest expense(b)


4.6
%


0.9
%


0.5
%Net (loss) income


(7.6)
%


(15.5)
%


(2.2)
%
(a)

Includes $1.1 million of expenses in the year ended March 31, 2005, for payments made to two officers of the Company in connection with the Pequot Investment(b)

Includes $4.1 million of non cash interest related to convertible debt.14

Years Ended March 31, 2005 and 2004
Net Revenue
Net revenue for the year ended March 31, 2005, was $101.2 million, as compared with net revenue of $52.3 million for the comparable 2004 year. The Company has achieved growth of 88% for products and 111% for services over the prior year. Revenue split for services amounted to 28% for the year ended March 31, 2005, compared to 25% in the prior year. The increase in revenue primarily was due to the inclusion of the results of our acquisitions during the year as well as an increase in customer demand for our products and services.
Gross Profit
Gross profit amounted to $18.8 million for the year ended March 31, 2005, as compared with a gross profit of $2.4 million for the prior year. The Company achieved blended gross margins of 19% for the year ended March 31, 2005 with margins for services at 35% and margins for product margins at 12%. In the prior year, blended gross margins amounted to 5% with services margins at 9% and product margins at 3%. Improved gross margins resulted primarily from the impact of our acquisitions.
Selling, General and Administrative
Selling, general and administrative expenses increased to $21.8 million for the year ended March 31, 2005 from $10 million in the comparable period. Included in the general and administrative expenses for the 2005 year is a $1.1 million charge for special compensation arrangements incurred in connection with the Pequot investment. Increased expenses are predominately related to the additional costs incurred from the integration of our acquisitions.
EBITDA
Earnings before interest, taxes, depreciation and amortization (“EBITDA”) amounted to a negative $0.4 million for the year ended March 31, 2005, as compared to a negative $6 million in the comparable year ended 2004. The EBITDA improvements resulted from both increased net revenue and improved gross margins discussed above, partially offset by increased selling, general and administrative expenses. The following table sets forth a reconciliation of EBITDA to the net loss for the years presented.
Years Ended March 31,2005

2004(In thousands of dollars)Net (loss) Income

$
(7,681
)

$
(8,109
)Depreciation and amortization


2,558



1,636Interest expense(a)


4,686



494Other income






(6
)Income taxes


13EBITDA

$
(424
)

$
(5,985
)
(a)

Year ended March 31, 2005 includes $4,118 of non-cash interest expense related to the convertible notesThe Company believes that its non-GAAP measure of EBITDA provides investors with a useful supplemental measure of its operating performance by excluding the impact of interest, taxes, depreciation, and amortization. Management uses EBITDA to assist in evaluating operating performance. These non-GAAP results should be evaluated in light of the Company’s financial results prepared in accordance with GAAP. EBITDA is not a recognized measure for financial statement presentation under GAAP. Non-GAAP earnings measures do not have any standardized definition and are therefore unlikely to be comparable to similar measures presented by other
15

reporting companies. This non-GAAP measure is provided to assist readers in evaluating the Company’s operating performance. Readers are encouraged to consider this non-GAAP measure in conjunction with the Company’s GAAP results.
Interest Expense
Interest expense was $4.7 million in the year ended March 31, 2005, and $0.5 million for the comparable period in 2004. The primary increase is due to non-cash interest expense of $4.1 million related to the convertible subordinated notes issued by us in December 2004 and March 2005. On June 23, 2005 the convertible notes were converted into Series A-4 Preferred Stock.
Net Income (Loss)
The Company had a net loss of $7.7 million for the year ended March 31, 2005 as compared to a net loss of $8.1 million in the comparable 2004 year. The reduction in net loss resulted from an increase in net revenues and an improvement in both product and service gross profit margins. These improvements were offset, in part, by an increase in selling, general and administrative expenses, a non-cash interest expense of $4.1 million related to convertible notes issued by the Company in December 2004 and March 2005, and a $1.1 million expense relating to special compensation arrangements incurred in connection with the closing of the initial Pequot investment in May 2004.
Liquidity and Capital Resources
We measure our liquidity in a number of ways, including the following:
Year Ended March 31,2005

2004(Dollars in thousands)Cash and cash equivalents

$
4,010


$
370Working capital

$
(18,792
)

$
(1,277
)Current ratio


0.71:1



0.91:1Secured notes payable

$
13,614


$
5,919Cash and cash equivalents generally consist of cash and money market funds. We consider all highly liquid investments purchased with maturities of three months or less to be cash equivalents. Such investments are stated at cost, which approximates fair value, and are considered cash equivalents for purposes of reporting cash flows.
During the year ended March 31, 2005, we used cash of approximately $11.5 million in operating activities. This primarily resulted from the decreases in accounts payable of $8.3 million, a decrease in deferred revenue of $1.4 million, and increase in prepaid expenses and current assets of $1.0 and an increase in accounts receivable from customers of $0.9 million, depreciation and amortization charges of $2.6 million, amortization of debt discount of $3.8 million, and the net loss of $7.7 million.
Net cash used in investing activities amounted to approximately $31.4 million. The significant uses were for the acquisition of businesses of $28.8 million, an increase in restricted cash of $1.0 million and for the acquisition of property and equipment in the amount of $1.6 million. In addition, net cash provided by financing activities was $46.5 million primarily related to the net proceeds from the issuance of shares of Series A Preferred Stock in the amount of $23.8 million, proceeds from the issuance of subordinated promissory notes $16.0 million and net borrowings under our secured notes payable and inventory financing $7.2 million.
As a result of the foregoing, our cash increased approximately $3.6 million.
On June 8, 2005, we entered into a secured revolving credit facility (the “CIT Facility”) with CIT Group/Business Credit, Inc. (“CIT”) and a new Amended and Restated Loan and Security Agreement (the “New Textron Facility”) with Textron Financial Corporation (“Textron”), providing a combined maximum availability of up to $40 million. The CIT Facility and the New Textron Facility will be used to fund working capital and floor-planning needs, and were also used to
16

refinance the existing Textron floor planning facility under the former Textron facility (the “Old Textron Facility”).
The CIT Facility is a three year revolving credit facility for up to $25 million, subject to a borrowing base based on eligible accounts receivable, eligible in-transit inventory (up to $0.5 million) and eligible finished goods inventory (up to $0.5 million). The CIT Facility requires, among other things, that we maintain certain financial covenants including that we maintain Consolidated Senior Leverage of not greater than 4.00 to 1.00 for the trailing four quarters and that we maintain a Consolidated Fixed Charge Coverage Ratio of not less than 1.00 to 1.00 for the trailing four quarters, restricts our ability to incur certain additional indebtedness, and contains various customary provisions, including affirmative and negative covenants, representations and warranties and events of default. Amounts borrowed
under the CIT facility will bear interest at either the prime rate or at LIBOR plus 3%, in each case at our option.
The New Textron Facility allows us to finance inventory purchases up to $15 million from approved vendors on a 45-day interest-free basis in most cases. This replaces the $10 million Old Textron Facility. Interest accrues after expiration of the applicable interest free period at the rate equal to a specified prime rate plus 4%. The financial and other covenants in the New Textron Facility are substantially the same as those in the CIT Facility.
Our total outstanding debt under the revolving receivable financing portion of the Old Textron Facility was $13.6 million at March 31, 2005 and $5.9 million at March 31, 2004. The amount outstanding under the inventory portion of the Old Textron Facility agreement was $2.9 million at March 31, 2005 and $3.5 million at March 31, 2004.
Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. We place our cash with high credit quality institutions. At times, such amounts may be in excess of the FDIC insurance limits.
Credit is extended to customers based on an evaluation of their financial condition, and collateral is generally not required. The evaluation of financial condition is performed to reduce the risk of loss.
Item 7A.Quantitative and Qualitative Disclosures about Market Risk.
Our risk investments only consisted of cash deposited in various money market funds. We do not use interest rate derivative instruments to manage our exposure to interest rate changes. Due to the limited investment risks involving money market funds, we do not anticipate any material loss in connection with such investments.
Item 8.Financial Statements and Supplementary Data.
Set forth below is a list of our audited consolidated financial statements included in this Annual Report on Form 10-K and their location.
Item

Page*Report of Goldstein Golub Kessler LLP

F-1MTM Technologies, Inc. and subsidiaries consolidated balance sheet at March 31, 2005 and 2004

F-2MTM Technologies, Inc. and subsidiaries consolidated statements of operations for the years ended March 31, 2005, 2004 and 2003

F-3MTM Technologies, Inc. and subsidiaries consolidated statements of shareholders’ equity for the years ended March 31, 2005, 2004 and 2003

F-4MTM Technologies, Inc. and subsidiaries consolidated statements of cash flows for the years ended March 31, 2005, 2004 and 2003

F-5MTM Technologies, Inc. and subsidiaries notes to consolidated financial statements

F-6Report of Squar, Milner, Reehl & Williamson, LLP

F-26Network Catalyst, Inc. balance sheets at June 30, 2004 and December 31, 2003

F-2717

Item

Page*Network Catalyst, Inc. statements of operations and accumulated deficit for the six month period ended June 30, 2004 and the year ended December 31, 2003


F-28Network Catalyst, Inc. statements of cash flows for the six month period ended June 30, 2004 and the year ended December 31, 2003


F-29Network Catalyst, Inc. notes to financial statements


F-30Report of UHY Advisors NY, Inc.


F-36Vector Global Services, Inc. and subsidiaries consolidated balance sheet at September 30, 2004


F-37Vector Global Services, Inc. and subsidiaries consolidated statements of operations for the nine months ended September 30, 2004


F-38Vector Global Services, Inc. and subsidiaries consolidated statements of changes in shareholders’ equity for the nine months ended September 30, 2004


F-39Vector Global Services, Inc. and subsidiaries consolidated statements of cash flows or the nine months ended September 30, 2004


F-40Vector Global Services, Inc. and subsidiaries notes to consolidated financial statements of September 30, 2004


F-41Report of Ernst & Young LLP


F-49Vector Global Services, Inc. and subsidiaries consolidated balance sheet at December 31, 2003 and 2002


F-50Vector Global Services, Inc. and subsidiaries consolidated statements of operations for the years ended December 31, 2003 and 2002


F-51Vector Global Services, Inc. and subsidiaries consolidated statements of changes in shareholders’ equity for the years ended December 31, 2003 and 2002


F-52Vector Global Services, Inc. and subsidiaries consolidated statements of cash flows or the years ended December 31, 2003 and 2002


F-53Vector Global Services, Inc. and subsidiaries notes to consolidated financial statements


F-54Report of Gunnip & Company, LLP


F-64Info Systems, Inc. balance sheet at December 31, 2004 and 2003


F-65Info Systems, Inc. statement of operations for the years ended December 31, 2004 and 2003


F-66Info Systems, Inc. statement of changes in stockholders’ equity for the years ended December 31, 2004 and 2003


F-67Info Systems, Inc. statement of cash flows for the years ended December 31, 2004 and 2003


F-68Info Systems, Inc. notes to financial statements


F-69* Page F-1 follows Part III to this Annual Report on Form 10-K.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
Item 9A.Controls and Procedures.
An evaluation was performed, as of March 31, 2005, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on such evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of March 31, 2005. There has been no change in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
18

PART III
Item 10.Directors and Executive Officers of the Registrant.
Directors and Executive Officers
Set forth below is a brief description of the background of each of our current directors and executive officers, based on information provided to us by them.
Name

Age

Principal Positions and
Offices with our Company

Director
SinceGerald A. Poch


58


Chairman of the Board of Directors


2004Francis J. Alfano


44


Chief Executive Officer and Director


2004Steven H. Rothman


56


Executive Vice President and Director; Chairman of the Board of Directors and CFO until May 21, 2004


1986Clifford H. Friedman


49


Director


2004Arnold J. Wasserman


67


Director


1998Richard R. Heitzman


33


Director


2004William Lerner


70


Director


1995Alvin E. Nashman


78


Director


1998Steven Stringer


50


President and Chief Operating Officer


N/AAlan Schwartz


62


Senior Vice President and Chief Financial Officer


N/AJohn F. Kohler


41


Senior Vice President and General Counsel


N/AGerald A. Pochhas served as Managing Director of Pequot Capital Management, Inc., the investment manager/advisor for Pequot Private Equity Fund III, L.P. and Pequot Offshore Private Equity Partners III L.P., since January 2000. He is also a Managing General Partner of both Pequot Fund and Pequot Partners. From August 1998 through January 2000, he was a principal of Pequot Capital Management, Inc. and co-leader of Pequot Fund’s and Pequot Partners’ venture capital team. From August 1996 to June 1998 he was the Chairman, President and Chief Executive Officer of GE Capital Information Technology Solutions, Inc., a technology solutions provider. Prior to that, he was a founder, and served as Co-Chairman and Co-President, of AmeriData Technologies, Inc., a value-added reseller and
systems integrator of hardware and software systems. Mr. Poch is also a director of Analex Corporation, Andrew Corporation, and NETGEAR, Inc., each a publicly-traded company. In addition, Mr. Poch is a director of a number of private companies.
Francis J. Alfanohas served as our Chief Executive Officer since May 2004. Heserved as Chief Executive Officer, President and a director of Interliant, Inc., an Internet infrastructure business focused on collaboration, security, and managed hosting solutions from August 2002 to June 2003. On August 5, 2002, Interliant filed for protection under title 11 of the U.S. Bankruptcy Code. Mr. Alfano led the restructuring of Interliant’s businesses resulting in the ultimate sale of its operations. From May 2001 through July 2002, he served as Interliant’s Chief Financial Officer. From December 1998 to May 2001, he was Interliant’s Senior Vice President of Corporate Development, with responsibility for strategic business relationships
and execution of all merger and acquisitions. Prior to that time Mr. Alfano served as Vice President of Business Development at G.E. Capital Information Technology Solutions, Inc., (the successor to AmeriData Technologies, Inc.) and was with Ernst & Young.
Steven H. Rothmanhas served as an Executive Vice President since May 2004. He served as our Chairman of the Board from September 2002 to May 2004. From May 1986 to August 2002, he served as our President. Mr. Rothman served as our Chief Executive Officer from September 1996 to August 2002 and as Co-Chief Executive Officer from May 1986 to August 1996.
Clifford H. Friedman,served as a Senior Managing Director of Constellation since September 1997. From January 1996 through August 1997, Mr. Friedman served as a Senior Vice President of Universal Studios where he was responsible for the creation and development of the Studio's New Media Group. From February 1995 through January 1996, Mr. Friedman served as Vice President—Strategic Development at NBC and from 1990 through January 1995, he was a Senior
19

Managing Director in the Media and Technology Group at Bear Stearns. Mr. Friedman serves as a director of Net Insight AB and Savvis Communications. In addition, Mr. Friedman is a director of a number of private companies.
Arnold J. Wassermanhas served as chairman of our audit committee since March 1999 and our lead independent director since June 2002. Mr. Wasserman has been a principal of Panda Financial Associates, Inc., a leasing/consulting firm, for the past 35 years. He is a director of Stratasys, Inc., a Nasdaq National Market listed company which manufactures rapid prototyping systems and materials, and serves as chairman of its audit committee.
Richard R. Heitzmannhas served as a Senior Vice President at Pequot Capital Management, Inc., where he focuses on software and services investments, since January 2004. From June 2003 to January 2004, Mr. Heitzmann was Vice President of Corporate Development with First Advantage Corp., a public company involved in the risk mitigation industry. From November 2001 to June 2003, Mr. Heitzmann was the Senior Vice President of Corporate Development and a member of the board of directors of US Search.Com, Inc. From August 1999 to November 2001, Mr. Heitzmann served as a Vice President of Pequot Capital Management, Inc. Mr. Heitzmann served as an executive with Nationsbanc Montgomery Securities from July 1998 to September 1998 and with Booz-Allen and Hamilton in its Financial
Services and Healthcare Group from September 1997 to December 1997. Mr. Heitzmann was a financial analyst and associate at Houlihan Lokey Howard and Zukin from July 1994 to September 1997.
William Lernerhas served as chairman of our corporate governance and nominating committee since November 2003. Mr. Lerner has been engaged in the private practice of corporate and securities law in New York since 1961 and in Pennsylvania since 1990. Mr. Lerner is a director of Rent-way, Inc., New York Stock Exchange listed company engaged in the rental-purchase industry; and Cortland Trust, Inc., a money market mutual fund distributed primarily through securities brokerage firms and commercial banks.
Alvin E. Nashmanhas been an independent consultant in the field of computer service for the past ten years. Dr. Nashman is a director of James Monroe Bancorp Inc.
Steven Stringerhas served as our President since June 2005 and as our Chief Operating Officer since October 1, 2004. From June through September 2004 he was employed by Pequot as a consultant and was made available by Pequot to us to assist with the selection, evaluation and integration of acquisitions. From January 2002 through May 2004 Mr. Stringer pursued private investment opportunities. Prior to that time he served in a number of senior executive roles with Rhythms NetConnections Inc. (“Rhythms”), including as chief executive officer and president from July through December 2001, chief executive officer, president and chief operating officer from April through July 2001, and president and chief operating officer from April 1999 through March 2001. Rhythms was
a national provider of digital subscriber line services and operated one of the largest DSL networks in the United States, serving 60 major markets with 67,000 digital subscriber lines in service.
Alan Schwartzis a certified public accountant who has served as a Senior Vice President, as well as our Chief Financial Officer, since May 2004. Mr. Schwartz served as Vice President—Finance for Interliant, Inc. from 1999 to 2003, where he managed financial and operational reporting for various domestic and international segments of the business. From August 1996 until joining Interliant, Mr. Schwartz was employed by GE Capital IT Solutions, last serving as Vice President—Financial Planning and Analysis. For four years prior to his serving at GE Capital IT Solutions, Mr. Schwartz was employed by AmeriData Technologies, Inc., last serving in the position of Vice President—Finance.
John F. Kohlerhas served as a Senior Vice President, as well as our General Counsel and Corporate Secretary, since May 2004. From May 2000 to January 2003, he served as Vice President—Mergers and Acquisitions for Interliant, Inc., a technology solutions provider, primarily responsible for Interliant’s acquisition and restructuring activities. From May 1995 to April 2000, he was a corporate lawyer with Weil, Gotshal & Manges LLP, a law firm in New York, and from September 1993 to April 1995, he was a corporate lawyer with Jenkens & Gilchrist, P.C., a law
20

firm in Dallas. Mr. Kohler served as an officer in the United States Army from May 1986 to September 1990.
Board Committees
Our board of directors currently has four standing committees, consisting of an audit committee, a compensation committee,a corporate governance committee and an independent directors committee.
Our audit committee currently is composed of William Lerner, Alvin E. Nashman and Arnold J. Wasserman, with Mr. Wasserman serving as its chairman. We believe that each of these committee members are “independent,” within the meaning of such term under applicable law and the Marketplace Rules of The Nasdaq Stock Market, Inc. Our board of directors has determined that Mr. Wasserman is an “audit committee financial expert,” as such term is defined by the SEC. The audit committee is primarily concerned with the accuracy and effectiveness of the audits of our financial statements by our internal audit staff and by our independent auditors. Its duties include:
•
selecting and retaining the independent auditors, as well as ascertaining the auditors’ independence;•
reviewing the scope of the audits to be conducted, as well as the results of their audits;•
approving non-audit services provided to our company by the independent auditors;•
reviewing the organization and scope of our internal system of audit, financial and disclosure controls;•
appraising our financial reporting activities, including our Annual Report on Form 10-K, and the accounting standards and principles followed; and•
conducting other reviews relating to compliance by employees with our internal policies and applicable laws.Our compensation committee currently is composed of Richard Heitzmann, William Lerner and Alvin Nashman, with Mr. Heitzmann serving as its chairman. The duties of our compensation committee include recommending to the full board of directors remuneration to be paid our executive officers, determining the number and conditions to exercise of options and other equity incentives granted pursuant to our various stock option plans and recommending the establishment of and monitoring a compensation and incentive program for all of our executive officers.
Our corporate governance committee currently is composed of Richard Heitzmann, William Lerner, Arnold J. Wasserman and Clifford Friedman, with Mr. Lerner serving as its chairman. The duties of our corporate governance committee include overseeing that our board’s policies, as well as ensuring that we are in compliance with all applicable federal and state securities laws and the Nasdaq rules, and determining our board of directors’ slate of director-nominees for each shareholder election of directors.
Our independent directors committee was formed by our Board in September 2004. It consists only of directors who are neither members of the management nor associated with Pequot or Constellation (or other similar investors) and is to consider, review and provide guidance and oversight regarding transactions or other situations in which other board members, who are either members of management or employees of Pequot or Constellation (or other similar investors), have interests that may be in addition to, or different from, the interests of the shareholders in general. This committee currently is composed of William Lerner, Alvin E. Nashman and Arnold J. Wasserman, with Mr. Wasserman serving as its chairman.
Meetings of Our Board of Directors and its Committees
Our board of directors held 15 formal meetings during our fiscal year ended March 31, 2005. Our audit committee held 7 formal meetings, our compensation committee held 4 formal meetings, our corporate governance committee held 1 formal meetings, and our independent directors
21

committee held 3 formal meetings, during our 2005 fiscal year. Each member of our board of directors attended, in person or telephonically, at least 75% of the total number of meetings of our board and each committee of the board on which the director serves.
Director Fees
Each director who is not an employee of our company receives an annual fee of $16,000 as compensation for serving on our board of directors, plus an additional $1,500 for each board meeting attended in person and $750 for each board meeting attended by telephonic conference call. Each member of the board’s audit, compensation and corporate governance committees receives $2,500 per year, and each chairman of the committees receives $3,500 (except the chairman of the audit committee who receives $5,000), as compensation for serving on such committees, as well as an additional $1,000 for each committee meeting attended in person and $500 for each committee meeting attended by telephonic conference call, in each case if the committee meeting is held on a day other than a day on which the board itself is meeting.
Audit Committee Charter
Our board of directors adopted a charter for its audit committee in 2001. We amended the audit committee charter in June 2003 in order to comply with rules mandated by the Securities and Exchange Commission. A copy of the revised charter was made Appendix A to the proxy statement we issued in connection with the annual meeting of our shareholders held on November 7, 2003.
Section 16(a) Beneficial Ownership Reporting Compliance
Based solely upon a review of Forms 3, 4 and 5 and amendments to these forms furnished to us, together with representations received by us from applicable parties that no Form 5 was required to be filed by such parties, all parties subject to the reporting requirements of Section 16(a) of the Exchange Act filed all such required reports during and with respect to our 2005 fiscal year.
Code of Ethics
Our board of directors has established a code of ethics that applies to our principal executive, financial and accounting officer(s). A copy of our code of ethics was filed as exhibit 14.1 to our Annual Report on Form 10-K for fiscal year 2004.
Item 11.Executive Compensation
Summary Compensation
The following table sets forth, with respect to the our fiscal years ended March 31, 2005, 2004 and 2003, all compensation earned by each person who served as our chief executive officer during our 2005 fiscal year and such other persons who were serving as executive officers at the end of our 2005 fiscal year and whose total annual salary and bonus earned during our 2005 fiscal year exceeded $100,000.
22

Annual Compensation

Long-Term
Compensation
AwardsName and Principal Position(s)

Fiscal
Year

Salary

Bonus

Other Annual
Compensation(1)

Securities
Underlying
OptionsFrancis J. Alfano,      
Chief Executive Officer


2005


$
215,800


$
50,000


—


400,000Howard A. Pavony,


2005


$
265,000



—


—


—Executive Vice President(2)


2004



265,000



—


—


—2003



265,000


$
8,200


—


—Steven H. Rothman,


2005


$
265,000



—


—


—Executive Vice President(3)


2004



265,000



—


—


—2003



265,000


$
8,200


—


—Alan Schwartz,      
Senior Vice President and Chief Financial Officer since May 2004


2005


$
169,400


$
25,000


—


150,000John F. Kohler,      
Senior Vice President and General Counsel since May 2004


2005


$
156,900


$
25,000


—


75,000
(1)

Represents perquisites and other personal benefits, securities or property which aggregated to less than $50,000 or 10% of the total annual salary and bonus paid during the fiscal year to the named executive officer.(2)

President and Chief Executive Officer until May 21, 2004. Chief Operating Officer until October 1, 2004 and President until December 21, 2004.(3)

Chairman of the Board and Chief Financial Officer until May 21, 2004.Option Grants In Last Fiscal Year
The following table sets forth, with respect to our fiscal year ended March 31, 2005, all grants of stock options to each named executive officer listed in the Summary Compensation Table contained in this Item 11.
Name

Number of
Securities
Underlying
Option

Percent of
Total Options
Granted to
Employee in
Fiscal Year

Exercise
Price

Expiration
Date

Grant Date
Value(1)Francis J. Alfano


400,000



18.2%


$
2.15


May 21, 2014

$
616,000Alan Schwartz


150,000



6.8%


$
2.15


May 21, 2014

$
231,000John F. Kohler


75,000



3.4%


$
2.15


May 21, 2014

$
116,000
(1)

Valuation done using the Black Scholes Option Pricing Model assuming a 10 year life expectancy, volatility of 113%, a risk free interest rate of 4.72% and no turnover.Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values
None of the named executive officers listed in the Summary Compensation Table contained in this Item 11 exercised any of their options during the year ended March 31, 2005.
The following table sets forth:
•
the total number of unexercised options held, as of March 31, 2005, by each of the named executive officers listed in the Summary Compensation Table contained in this Item 11, separately identified between those exercisable and those not exercisable, and•
the aggregate value of in-the-money, unexercised options held, as of March 31, 2005, by each of the named executive officers, separately identified between those exercisable and those not exercisable.23

Number of
Unexercised Options
as of March 31, 2005

Value of Unexercised
In-the-Money Options
as of March 31, 2005(1)Name

Exercisable

Unexercisable

Exercisable

UnexercisableFrancis J. Alfano


66,667



333,333


$
154,000


$
770,000Howard A. Pavony


115,800



0



300,317



0Steven H. Rothman


115,800



0



300,317



0Alan Schwartz


25,000



125,000



57,750



288,750John F. Kohler


12,750



67,500



28,875



144,375
(1)

The value of unexercised in-the-money options is calculated by subtracting the aggregate exercise price of the options from the aggregate market price of the shares underlying the options as of March 31, 2005 of $4.46 per share.Stock Plans
We have adopted the following stock plans:
•
a 1993 Stock Option Plan, which provides for the grant of options to purchase an aggregate of 250,000 shares of our common stock, of which, as of March 31, 2005, 76,166 shares have been issued upon exercise of options and 126,334 shares are subject to outstanding options;•
a 1996 Stock Option Plan, which provides for the grant of options to purchase an aggregate of 350,000 shares of our common stock, of which, as of March 31, 2005, 92,200 shares have been issued upon exercise of options and 166,600 shares are subject to outstanding options;•
a 1998 Stock Option Plan, which provides for the grant of options to purchase an aggregate of 250,000 shares of our common stock, of which, as of March 31, 2005, 28,500 shares have been issued upon exercise of options and 139,900 shares are subject to outstanding options;•
a 2000 Long Term Performance Plan, which provides for the award of an aggregate of 350,000 shares of our common stock, of which, as of March 31, 2005, 10,000 shares have been issued upon the exercise of options and 332,100 shares have been awarded or subject to outstanding awards;•
a 2002 Long Term Performance Plan, which provides for the award of an aggregate of 250,000 shares of our common stock, of which, as of March 31, 2005, 92,500 shares have been awarded or subject to outstanding awards; and•
a 2004 Equity Incentive Plan, which provides for the award of an aggregate of 3,000,000 shares of our common stock, of which, as of March 31, 2005, 2,162,750 shares have been awarded or subject to outstanding awards.The 1993 Stock Option Plan has expired. Accordingly, we can no longer grant options under such plan.
Employees (including officers), directors and others who provide services to us are eligible to participate in our stock plans. The plans are administered by our board of directors or the compensation committee of the board. Options granted under the plans may be incentive stock options (as defined in Section 422 of the Internal Revenue Code of 1986, as amended), or non-qualified stock options. Non-qualified stock options may be granted in tandem with stock appreciation rights. The exercise price of options may not be less than 100% of the fair market value of the common stock as of the date of grant, except that this limitation does not apply to options granted under the 1998 Stock Option Plan and the exercise price of ISOs granted to an employee who owns more than ten percent of the outstanding common stock may not be
less than 110% of the fair market value as of the date of grant. Options may not be exercised more than ten years after the date of grant, or five years in the case of ISOs granted to an employee who owns more than 10% of the outstanding shares of our common stock. An option may be exercised by tendering payment of the purchase price to us or, at the discretion of the administrator of the plans, by delivery of shares of our common stock having a fair market value equal to the exercise
24

price. The number of shares that may be acquired upon exercise of an option and the exercise price of an option are subject to adjustment in the event of a merger, recapitalization, stock split or stock dividend.
The 2000 Long Term Performance Plan and 2002 Long Term Performance Plan permits the grant of any form of award, including stock options, stock appreciation rights, and stock or cash awards. Awards under the 2000 Long Term Performance Plan may be in stock or denominated in units of stock, which may be subject to restrictions on transfer and include forfeiture provisions.
Our shareholders approved our 2004 Equity Incentive Plan in May 2004. We have reserved a total of 3 million shares of our common stock for issuance under the 2004 plan. The types of awards that may be granted under the 2004 plan include one or more of the following types, either alone or in any combination thereof:
•
options, including incentive stock options and non-qualified options;•
stock appreciation rights;•
restricted stock;•
performance grants;•
stock bonuses; and•
any other type of award deemed by the administrator of the 2004 plan to be consistent with the purposes of the 2004 plan (including, but not limited to, awards of or options or similar rights granted with respect to unbundled stock units or components thereof, and awards to be made to participants who are foreign nationals or are employed or performing services outside the United States).Employment Agreements
We entered into an employment agreement, dated May 21, 2004, with Francis J. Alfano (as amended, the “Alfano Employment Agreement”) to employ Mr. Alfano as our Chief Executive Officer. The Alfano Employment Agreement has an initial term of three (3) years (the “Initial Term”). On the third and each subsequent anniversary of the commencement of such agreement, the term of the agreement shall automatically be extended for an additional period of twelve (12) months; provided, however, that either party may elect not to extend the agreement by giving written notice to the other party at least twelve (12) months prior to any such anniversary date. Mr. Alfano is paid a base salary of $350,000 per annum and is entitled to receive additional compensation, at such times and in such amounts, as shall
be determined in the sole discretion of the Board of Directors. In the event of a termination of Mr. Alfano's employment during the term of the agreement by us other than for “cause” or by Mr. Alfano for “good reason” or as a result of his death or permanent and total disability we shall provide him, among other things, a continuance of his then current base salary for a period equal to the greater of (i) one (1) year from the date of termination or (ii) the period ending on the last day of the Initial Term (the “Severance Period”). Additionally, in the event of termination for other than “cause” or for “good reason,” any unvested stock options or restricted stock units shall become fully vested and immediately exercisable and shall remain exercisable for the remainder of their term.
We also entered into employment agreements, dated May 21, 2004, with Steven H. Rothman (the “Rothman Employment Agreement”) and Howard A. Pavony (as amended, the “Pavony Employment Agreement” and together with the Rothman Employment Agreement, the “Founder Employment Agreements”) to employ Mr. Rothman and Mr. Pavony as Executive Vice Presidents. The Founder Employment Agreements are on substantially the same terms as the Alfano Employment Agreement, including with respect to the acceleration of stock option and restricted stock units. Each of Mr. Rothman and Mr. Pavony are paid a base salary of $265,000 per annum.
Additionally, we entered into a severance agreement, dated May 21, 2004, with Alan Schwartz (as amended the “Schwartz Severance Agreement”) and John Kohler (as amended the “Kohler Severance Agreement” and together with the Schwartz Severance Agreement, the “Severance Agreements”) to employ Mr. Schwartz as our Chief Financial Officer and Mr. Kohler as our
25

General Counsel. Each Severance Agreement has a term of four (4) years. In the event of a termination of Mr. Schwartz's or Mr. Kohler's employment during the term of his agreement by the Company other than for “cause” or by such executive for “good reason” or as a result of his death or permanent and total disability we shall provide such executive, among other things, a continuance of his then current base salary for a period equal to one (1) year. Mr. Schwartz is paid a base salary of $250,000 per annum and Mr. Kohler is paid a base salary of $200,000. Additionally, in the event of termination of the executive for other than “cause” or for “good reason,” any unvested stock options or restricted stock units shall become fully vested and immediately exercisable and shall remain exercisable
for the remained of their term.
Securities Authorized for Issuance Under Equity Incentive Plans
We have provided in the “Equity Compensation Plan Information” section of Item 5 of this Annual Report on Form 10-K certain information with respect to securities authorized for issuance under our equity incentive plans.
Compensation Committee Interlocks and Insider Participation
No member of our compensation committee is or was an officer employee of our company, nor had any relationship requiring disclosure under Item 13 of this Annual Report on Form 10-K. In addition, to our knowledge, none of our executive officers:
•
served as a member of a compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served on our compensation committee;•
served as a director of another entity, one of whose executive officers served on our compensation committee; nor•
served as a member of a compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served as a director of our company.Item 12.Security Ownership of Certain Beneficial Owners and Management.
Our Current Beneficial Owners
Our Series A Convertible Preferred Stock and common stock are the only classes of our voting securities presently outstanding. The Series A Preferred Stock votes on an “as converted” basis, such that each share of Series A Preferred Stock is entitled to that number of votes as equals the number of shares of common stock that the holder of such share of Series A Preferred Stock would receive upon conversion of the share of Series A Preferred Stock, but such number of votes shall not exceed such number of shares of common stock which would be received based on a conversion price of $1.45 per preferred share (in the case of Series A-1, A-2 and A-3 shares) or the market price of the common stock on the date of issuance of the preferred shares (in the case of Series A-4 and A-5
shares).
The following
  table sets forth as of June 23, 2005 the beneficial ownership of the following
  persons:
•
each person known by us to beneficially own 5% or more of our Series A Preferred Stock and/or our common stock, based on filings with the SEC and certain other information;•
each of our “named executive officers” and directors; and•
all of our executive officers and directors as a group.Beneficial ownership is determined in accordance with the rules of the SEC and includes voting and investment power. In addition, under SEC rules, a person is deemed to be the beneficial owner of securities which may be acquired by such person upon the exercise of options and warrants or the conversion of convertible securities within 60 days from the date on which
26

beneficial ownership is to be determined. Our “named executive officers,” in accordance with SEC rules, are those executive officers who are required to be listed Summary Compensation Table provided in Item 11 of this Annual Report on Form 10-K. Except as otherwise indicated in the notes to the Beneficial Ownership Table:
•
we believe that all shares are beneficially owned, and investment and voting power is held by, the persons named as owners; and the address for each beneficial owner listed in the table, except where otherwise noted, is MTM Technologies, Inc., 850 Canal Street, Stamford, Connecticut 06902.Series A Preferred Stock

Common StockName of Shareholder

Amount and Nature
of Beneficial
Ownership

Percentage of
Outstanding
Shares

Amount and Nature
of Beneficial
Ownership

Percentage of
Outstanding
SharesPequot Capital
Management, Inc.(1)


    15,356,499
(2)


    71.2%



    17,641,116
(3)


    70.5%Gerald A. Poch(4)


    15,356,499
(5)


    71.2%



    17,641,116
(6)


    70.5%Constellation Group(7)


    6,206,796
(8)


    28.8%



    7,105,351
(9)


    49.0%Bear Stearns Asset Management Inc.(10)


    6,206,796
(11)


    28.8%



    7,105,351
(12)


    49.0%Constellation Ventures Management II, LLC(13)


    6,162,022
(14)


    28.6%



    7,060,577
(15)


    48.9%Clifford Friedman(16)


    6,206,796
(17)


    28.8%



    7,105,351
(18)


    49.0%Steven H. Rothman


0



0.0%



900,561
(19)


12.0%Howard A. Pavony


0



0.0%



895,656
(20)


11.9%Norbert Sluzewski


0



0.0%



361,483



4.9%Michael Ritchken


0



0.0%



361,483



4.9%Arnold Wasserman


0



0.0%



119,750
(21)


1.6%William Lerner


0



0.0%



92,250
(22)


1.3%Alvin E. Nashman


0



0.0%



87,250
(23)


1.2%Francis J. Alfano


0



0.0%



150,000
(24)


2.0%John F. Kohler


0



0.0%



28,125
(25)


0.4%Richard R. Heitzmann(26)


0
(27)


0.0%



0
(28)


0.0%Alan Schwartz


0



0.0%



56,250
(29)


0.8%Mark Stellini


0



0.0%



524,814



7.1%All directors and executive officers as a group (fourteen persons)


    21,563,295
(30)


    100.0%



    26,939,050
(31)


    82.1%
(1)

According to a Schedule 13D/A filed with the SEC on March 25, 2005, Pequot Capital Management, Inc. is the investment advisor/manager for both the Pequot Fund and Pequot Partners and exercises sole investment discretion over the Pequot Fund and Pequot Partners. The address for Pequot Capital Management, Inc., as well as the Pequot Fund and Pequot Partners is 500 Nyala Farm Road, Westport, Connecticut 06880.(2)

    Represents (a) 2,853,555
      shares of Series A-1 Preferred Stock owned of record by the Pequot
      Fund, (b) 402,259 shares of Series A-1 Preferred Stock owned of
      record by Pequot Partners, (c) 1,752,898 shares of Series A-2
      Preferred Stock owned of record by the Pequot Fund, (d) 247,102 shares
      of Series A-2 Preferred Stock owned of record by Pequot Partners, (e) 1,685,479
      shares of Series A-3 Preferred Stock owned of record by Pequot Fund,
      (f) 237,598 shares of Series A-3 Preferred Stock owned of record
      by Pequot Partners, (g) 2,987,269 shares of Series A-4 Preferred
      Stock owned of record by Pequot Fund, (h) 421,108 shares of Series A-4
      Preferred Stock owned of record by Pequot Partners, (i) 1,692,308 shares
      of Series A-4 Preferred Stock which Pequot has a right to purchase
      from us at any time prior to September 10, 2005, and (j) 3,076,923
      shares of Series A-5 Preferred Stock which Pequot has a right to purchase
      from us at any time prior to December 10, 2005. Does not include any shares
      of Series A Preferred Stock that we may issue in lieu of cash(footnotes continued on next page)
27

(footnotes continued from previous page)
dividends on the Series A Preferred Stock for the period between May 21, 2006 and May 20, 2008. Accrual of dividends on the Series A Preferred Stock will not commence until May 21,
    2006.(3)

    Represents (a) the maximum
      15,356,499 shares of our common stock issuable upon conversion of all of
      the Series A Preferred Stock currently owned of record and that may be issued
      to the Pequot Fund and Pequot Partners, as discussed in note (2) to
      this Beneficial Ownership Table, which shares are convertible within the
      60 days following the date of the Beneficial Ownership Table, (b) 1,705,706
      shares of our common stock issuable upon exercise of warrants held of record
      by the Pequot Fund, which shares are exercisable within the 60 days following
      the date of this Beneficial Ownership Table, (c) 240,449 shares of
      our common stock issuable upon exercise of warrants held of record by Pequot
      Partners, which shares are exercisable within the 60 days following the
      date of this Beneficial Ownership Table and (d) 338,462 shares of our
      common stock issuable upon exercise of warrants that Pequot will acquire
      in connection with its purchase of 1,692,308 shares of Series A-4 Preferred
      Stock, which common stock will be immediately exercisable upon acquisition
      of such warrants. The numbers of shares of our common stock issuable upon
      conversion of the Series A Preferred Stock and exercise of the warrants
      which the Pequot Fund and Pequot Partners own of record or have the right
      to acquire from us are subject to anti-dilution adjustment. Does not include
      any shares of Series A Preferred Stock that we may issue in lieu of
      cash dividends on the Series A Preferred Stock for the period between
      May 21, 2006 and May 20, 2008. Accrual of dividends on the Series A
      Preferred Stock will not commence until May 21, 2006.(4)

The address for Mr. Poch is c/o Pequot Capital Management, Inc., 500 Nyala Farm Road, Westport, Connecticut 06880.(5)

Includes the shares of Series A Preferred Stock beneficially owned by Pequot Capital Management, Inc. (see note (2) to this Beneficial Ownership Table), of which Mr. Poch is a Managing Director. Mr. Poch disclaims beneficial ownership to the Series A Preferred Stock beneficially owned by Pequot Capital Management, Inc., except to the extent of his pecuniary interest therein.(6)

Includes the shares of our common stock beneficially owned by Pequot Capital Management, Inc. (see note (3) to this Beneficial Ownership Table), of which Mr. Poch is a Managing Director. Mr. Poch disclaims beneficial ownership to our common stock beneficially owned by Pequot Capital Management, Inc., except to the extent of his pecuniary interest therein.(7)

The Constellation Group consists of Constellation Venture, Constellation Offshore, BSC and CVC. The address for each of these entities is 383 Madison Avenue, New York, New York 10179.(8)

Represents (a) 960,068 shares
    of Series A-3 Preferred Stock owned of record by Constellation Venture,
    (b) 510,903 shares of Series A-3 Preferred Stock owned of record
    by Constellation Offshore, (c) 428,131 shares of Series A-3 Preferred
    Stock owned of record by BSC, (d) 23,975 shares of Series A-3 Preferred
    Stock owned of record by CVC, (e) 832,892 shares of Series A-4
    Preferred Stock owned of record by Constellation Venture, (f) 443,226
    shares of Series A-4 Preferred Stock owned of record by Constellation
    Offshore, (g) 371,417 shares of(footnotes continued on next page)
28
(footnotes continued from previous page)
Series A-4 Preferred Stock
    owned of record by BSC, (h) 20,799 shares of Series A-4 Preferred
    Stock owned of record by CVC, (i) 1,076,923 shares of Series A-4
    Preferred Stock which the Constellation Group has a right to purchase from
    us at any
    time prior to September 10, 2005, and (j) 1,538,462 shares of Series A-5
    Preferred Stock which the Constellation Group has a right to purchase from
    us at any time prior to December 10, 2005. Does not include any shares of
    Series A Preferred Stock that we may issue in lieu of cash dividends
    on the Series A Preferred Stock for the period between May 21,
    2006 and May 20, 2008. Accrual of dividends on the Series A Preferred
    Stock will not commence until May 21, 2006.(9)

Represents (a) the maximum 6,206,796
    shares of our common stock issuable upon conversion of all of the Series A
    Preferred Stock currently owned of record and that may be issued to the Constellation
    Group, as discussed in note (8) to this Beneficial Ownership Table, which
    shares are convertible within the 60 days following the date of the Beneficial
    Ownership Table, (b) 353,306 shares of our common stock issuable upon
    exercise of warrants held of record by Constellation Venture, which shares
    are exercisable within the 60 days following the date of this Beneficial
    Ownership Table, (c) 163,490 shares of our common stock issuable upon
    exercise of warrants held of record by Constellation Offshore, which shares
    are exercisable within the 60 days following the date of this Beneficial
    Ownership Table, (d) 157,552 shares of our common
stock issuable upon exercise of warrants held of record by BSC, which shares
    are exercisable within the 60 days following the date of this Beneficial
    Ownership Table, (e) 8,823 shares of our common stock issuable upon
    exercise of warrants held of record by CVC, which shares are exercisable
    within the 60 days following the date of this Beneficial Ownership Table,
    and (f) 215,384 shares of our common stock issuable upon exercise of
    warrants that the Constellation Group shall acquire in connection with its
    purchase of 1,076,923 shares of Series A-4 Preferred Stock, which common
    stock will be immediately exercisable upon acquisition of such warrants.
    The numbers of shares of our common stock issuable upon conversion of the
    Series A Preferred Stock and exercise of the warrants which the Constellation
    Group owns of record or has the right to acquire from us are subject to anti-dilution

adjustment. Does not include any shares of Series A Preferred Stock that
we may issue in lieu of cash dividends on the Series A Preferred Stock for
the period between May 21, 2006 and May 20, 2008. Accrual of dividends on
the Series A Preferred Stock will not commence until May 21, 2006.(10)

According to a Schedule 13D filed with the SEC on December 20, 2004, Bear Stearns Asset Management Inc. is the Managing Member of Constellation Ventures Management II, LLC, Constellation Ventures Management II, LLC is the sole general partner of Constellation Venture, the sole general partner of Constellation Offshore and one of two general partners of BSC. Pursuant to an investment management agreement, Bear Stearns Asset Management Inc. has voting power with respect to the securities owned by CVC and makes investment decisions on behalf of CVC. The address for Bear Stearns Asset Management Inc. is 383 Madison Avenue, New York, New York 10179.(11)

Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore, BSC and CVC (see note (8) to this Beneficial Ownership Table).(footnotes continued on next page)
29
(footnotes continued from previous page)
Bear Stearns Asset Management Inc. disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.(12)

Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore, BSC and CVC (see note (9) to this Beneficial Ownership Table). Bear Stearns Asset Management Inc. disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.(13)

According to a Schedule 13D filed with the SEC on December 20, 2004, Constellation Ventures Management II, LLC is the sole general partner of Constellation Venture, the sole general partner of Constellation Offshore and one of two general partners of BSC. The address for Bear Stearns Asset Management Inc is 383 Madison Avenue, New York, New York 10179.(14)

Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore and BSC (see note (8) to this Beneficial Ownership Table). Constellation Ventures Management II, LLC disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.(15)

Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore and BSC (see note (9) to this Beneficial Ownership Table). Constellation Ventures Management II, LLC disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.(16)

The address for Mr. Friedman is c/o Bear Stearns Asset Management Inc., 383 Madison Avenue, New York, New York 10179.(17)

Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore, BSC and CVC (see note (8) to this Beneficial Ownership Table). Clifford Friedman is a Senior Managing Director of Bear Stearns Asset Management Inc. Clifford Friedman is also a member of CVC. Clifford Friedman disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.(18)

Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore, BSC and CVC (see note (9) to this Beneficial Ownership Table). Clifford Friedman is a Senior Managing Director of Bear Stearns Asset Management Inc. Clifford Friedman is also a member of CVC. Clifford Friedman disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.(19)

Includes 115,200 shares of our common stock issuable upon exercise of options granted to Mr. Rothman, which shares are exercisable within the 60 days following the date of this Beneficial Ownership Table. Does not include 8,000 shares of our common stock issuable upon exercise of options, which shares are not exercisable within the 60 days following the date of this Beneficial Ownership table nor does it include 2,000 restricted share units which do not vest within the 60 days following the date of this Beneficial Ownership table, or 1,125 shares of our common stock held by Mr. Rothman’s spouse.(20)

Includes 115,200 shares of our common stock issuable upon exercise of options granted to Mr. Pavony, which are exercisable within the 60 days following the date of this Beneficial Ownership Table.(21)

Includes 118,000 shares of our common stock issuable upon exercise of options granted to Mr. Wasserman, which are exercisable within the 60 days following the date of this Beneficial Ownership Table.(footnotes continued on next page)
30
(footnotes continued from previous page)
(22)

Includes 90,500 shares of our common stock issuable upon exercise of options granted to Mr. Lerner, which are exercisable within the 60 days following the date of this Beneficial Ownership Table.(23)

Includes 85,500 shares of our common stock issuable upon exercise of options granted to Dr. Nashman, which are exercisable within the 60 days following the date of this Beneficial Ownership Table.(24)

Represents 150,000 shares of our common stock issuable upon exercise of options granted to Mr. Alfano, which are exercisable within the 60 days following the date of this Beneficial Ownership Table. Does not include 314,000 shares of our common stock issuable upon exercise of options, which are not exercisable within the 60 days following the date of this Beneficial Ownership Table nor does it include 8,000 restricted stock units which do not vest within the 60 days following the date of this Beneficial Ownership table.(25)

Represents 28,125 shares of our common stock issuable upon exercise of options granted to Mr. Kohler, which shares are exercisable within the 60 days following the date of this Beneficial Ownership Table. Does not include 58,875 shares of our common stock issuable upon exercise of options, which shares are not exercisable within the 60 days following the date of this Beneficial Ownership Table nor does it include the 1,500 restricted stock units which do not vest within the 60 days following the date of this Beneficial Ownership Table.(26)

The address for Mr. Heitzmann is c/o Pequot Capital Management, Inc., 500 Nyala Farm Road, Westport, Connecticut 06880.(27)

Does not include the shares of Series A Preferred Stock beneficially owned by Pequot Capital Management, Inc. (see note (2) to this Beneficial Ownership Table), of which Mr. Heitzmann is a Senior Vice President. Messrs. Heitzmann does not have voting power nor investment power with respect to the Series A Preferred Stock beneficially owned by Pequot Capital Management, Inc.(28)

Does not include the shares of our common stock beneficially owned by Pequot Capital Management, Inc. (see note (3) to this Beneficial Ownership Table), of which Mr. Heitzmann is a Senior Vice President. Messrs. Heitzmann does not have voting power nor investment power with respect to our common stock beneficially owned by Pequot Capital Management, Inc.(29)

Represents 56,250 shares of our common stock issuable upon exercise of options granted to Mr. Schwartz, which are exercisable within the 60 days following the date of this Beneficial Ownership Table. Does not include 117,750 shares of our common stock issuable upon exercise of options, which are not exercisable within the 60 days following the date of this Beneficial Ownership Table nor does it include 3,000 restricted stock units which do not vest within 60 days following the date of this Beneficial Ownership table.(30)

Includes those Series A Preferred Stock beneficially owned by our current executives officers and directors, as set forth in notes to this Beneficial Ownership Table.(31)

Includes those common shares beneficially owned by our current executives officers and directors, as set forth in notes to this Beneficial Ownership Table.Restated Shareholders’ Agreement
We entered into a Shareholders’ Agreement with the Pequot Fund, Pequot Partners, Howard A. Pavony and Steven H. Rothman on May 21, 2004, as a condition to the consummation of our sale to the Pequot Fund and Pequot Partners of an aggregate 3,255,814 shares of Series A-1 Preferred Stock.
On December 21, 2004 we entered into an Amended and Restated Shareholders' Agreement (the “Restated Shareholders' Agreement”) with Pequot, Constellation, Howard A. Pavony and Steven H. Rothman. The Restated Shareholders’ Agreement reflected Mr. Pavony’s resignation
31
from the Board of Directors which became effective on March 31, 2005. The parties agreed to vote, or cause to be voted, all securities of the company owned by such party or over which such party has voting control so that the number of directors will consist of: (i) the company’s chief executive officer (“CEO”); (ii) two directors designated by Pequot Capital Management, Inc., or its assignee; (iii) one director designated by Constellation or its assignee; (iv) Mr. Rothman; (v) three “independent” directors, within the meaning of “independent” under the current rules of Nasdaq, selected by the company’s nominating and corporate governance committee; and (vi) two additional independent directors to be selected by the CEO and reasonably acceptable to the company's nominating
and corporate governance committee. Under certain circumstances where Pequot holds less than 25% of the securities Pequot purchased pursuant to the Purchase Agreement, the right to designate two directors in (ii) above will be reduced to one director and the above voting provisions will be adjusted in the manner described in the Restated Shareholders' Agreement.
The obligation of the parties under the Restated Shareholders' Agreement will expire upon the earliest to occur of (i) the completion of any voluntary or involuntary liquidation or dissolution of the Company, (ii) the sale of all or substantially all of the company’s assets or of a majority of the outstanding equity of the Company to any person that is not a party to the Restated Shareholders’ Agreement, or (iii) December 10, 2009. The obligation of the Investors to vote in favor of the appointment of Mr. Rothman as a Director will expire on May 21, 2007, provided that he has not terminated his employment, other than for “good reason,” nor has been terminated for “cause.” Messrs. Rothman and Pavony’s obligation to vote for (i) two directors designated
by Pequot Capital Management, Inc., and (ii) one director designated by Constellation or its assignee, shall terminate if (a) Pequot or their assignees own less than 10% of the Outstanding Series A Preferred Stock (or shares of our common stock issuable upon conversion thereof) issued to Pequot, (b) Constellation or its assignees own less than 10% of the Series A-3 Preferred Stock (or shares of our common stock issuable upon conversion thereof) issued to Constellation, or (c) any other shareholders that are introduced to the company by Pequot own less than 10% of the shares acquired by such shareholders from the company in a transaction not including a public offering or (ii) if Messrs. Pavony and Rothman individually own less than less than 10% of the number of shares of common stock owned by such person on December 10, 2004.
The Restated Shareholders' Agreement also contains provisions (i) restricting the transfer of any securities by shareholders party to the Restated Shareholders' Agreement in certain circumstances and (ii) granting the Investors certain rights of first refusal and tag-along rights with respect to any dispositions by Messrs. Pavony and Rothman of their shares of Common Stock.
Item 13.Certain Relationships and Related Party Transactions.
Not applicable.
Item 14.Principal Accountant Fees and Services.
Principal Accounting Fees and Services
The following table sets forth the fees billed by our independent accountants for each of our last two fiscal years for the categories of services indicated.
2005

2004Audit fees(1)

$
149,000


$
76,500Audit-related fees(2)


6,500



12,245Tax fees(3)


6,750



15,000All other fees(4)


44,990



35,193(1)

Consists of fees billed for the audit of our annual financial statements, review of financial statements included in our Quarterly Reports on Form 10-Q and services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements.(footnotes continued on next page)
32
(footnotes continued from previous page)
(2)

Consists of assurance and related services that are reasonably related to the performance of the audit and reviews of our financial statements and are not included in “audit fees” in this table. The services provided by our accountants within this category consisted of advice relating to SEC matters and employee benefit matters.(3)

Consists of professional services rendered by a company aligned with our principal accountant for tax compliance, tax advice and tax planning.(4)

The services provided by our accountants within this category consisted of advice and other services relating to our transaction with the Pequot entities and other matters.Such fees have been preapproved by our Audit Committee.Audit Committee Pre-Approval Policy
In addition to retaining Goldstein Golub Kessler LLP to audit our consolidated financial statements for the years ended March 31, 2005 and 2004, we retained Goldstein Golub Kessler to provide other auditing and advisory services to us in our 2005 and 2004 fiscal years. We understand the need for Goldstein Golub Kessler to maintain objectivity and independence in its audit of our financial statements. To minimize relationships that could appear to impair the objectivity of Goldstein Golub Kessler, our audit committee has restricted the non-audit services that Goldstein Golub Kessler and its aligned company may provide to us primarily to tax services and merger and acquisition due diligence and audit services, and has determined that we would obtain even these non-audit services from Goldstein Golub Kessler and/or its
aligned company only when the services offered by Goldstein Golub Kessler and its aligned company are more effective or economical than services available from other service providers.
The audit committee also has adopted policies and procedures for pre-approving all non-audit work performed by Goldstein Golub Kessler and any other accounting firms we may retain. Specifically, the audit committee has pre-approved the use of Goldstein Golub Kessler and its aligned company for detailed, specific types of services within the following categories of non-audit services: merger and acquisition due diligence and audit services; tax services; internal control reviews; and reviews and procedures that we request Goldstein Golub Kessler to undertake to provide assurances of accuracy on matters not required by laws or regulations. In each case, the audit committee has also set a specific annual limit on the amount of such services which we would obtain from Goldstein Golub Kessler, and has required management to
report the specific engagements to the committee on a quarterly basis and to obtain specific pre-approval from the audit committee for all engagements.
33
Item 15.Exhibits, Financial Statements Schedules.
Exhibits
Set forth below is a list of the exhibits to this Annual Report on Form 10-K.
Exhibit Number


Description3
.1

—
MTM Technologies, Inc. Restated Certificate of Incorporation.*3
.2

—
Amended and Restated By-Laws, as amended.*4
.1

—
Form of warrant certificate issued to Sunrise Securities Corp.*4
.2

—
Form of warrant certificate issued to investors in 2000 private placement*4
.3

—
Form of Series A-3 Warrant Certificate*4
.4

—
Form of the A-4 Notes and A-5 Notes*4
.5

—
Form of the A-4 Warrants*10
.1

—
Financing Agreement among the CIT Group/Business Credit, Inc., the Lenders that are parties thereto, MTM Technologies, Inc., and its subsidiaries that are parties thereto, dated as of June 8, 2005.*10
.2

—
Loan and Security Agreement among Textron Financial Corporation, MTM Technologies, Inc. MTM Technologies (California) Inc., MTM Technologies (Texas) Inc., MTM Technologies (US), Inc., and Info Systems, Inc., dated as of June 8, 2005*10
.3

—
Purchase Agreement, dated January 29, 2004, among Micros-to-Mainframes, Inc., Pequot Private Equity Fund III, L.P. and Pequot Offshore Private Equity Partners III, L.P.*10
.4

—
Purchase Agreement, dated December 7, 2004 by and among MTM Technologies, Inc., Pequot Private Equity Fund III, LLP, Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC.*10
.5

—
Amended and Restated Shareholders' Agreement dated December 21, 2004 by and among, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, LLP, Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC.*10
.6

—
Amended and Restated Registration Rights Agreement dated December 10, 2004 by and among, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, LLP, Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC.*10
.7

—
Asset Purchase Agreement, dated September 17, 2004 by and among Network Catalyst, Inc., William Corbin, Rocci J. Della Maggiore and MTM Technologies, Inc.*10
.8

—
Asset Purchase Agreement, dated December 1, 2004, by and among Vector ESP, Inc., Vector ESP Management, Inc. and Vector Global Services, Inc. and MTM Technologies, Inc.*10
.9

—
Stock Purchase Agreement, dated January 27, 2005, by and among Info Systems, Inc., Mark Stellini, Emidio F. Stellini, Jr., Jay Foggy, Richard Roux, Jennifer McKenzie and MTM Technologies, Inc.*10
.10

—
MTM Technologies, Inc. 2004 Equity Incentive Plan.*10
.11

—
Micros-to-Mainframes, Inc. 2002 Long-Term Incentive Plan.*10
.12

—
Micros-to-Mainframes, Inc. 2000 Long-Term Incentive Plan.*10
.13

—
Micros-to-Mainframes, Inc. 1998 Stock Option Plan.*10
.14

—
Micros-to-Mainframes, Inc. 1996 Stock Option Plan.*10
.15

—
Micros-to-Mainframes, Inc. Revised 1993 Employee Stock Option Plan.*10
.16

—
Employment Agreement, dated May 21, 2004, between MTM Technologies, Inc. and Francis J. Alfano.*34
10
.17

—
Amendment No.1 to Employment Agreement between MTM Technologies, Inc. and Francis J. Alfano*10
.18

—
Employment Agreement, dated October 1, 2004 by and between MTM Technologies, Inc. and Steven Stringer*10
.19

—
Severance Letter, dated May 21, 2004, between MTM Technologies, Inc. and Alan Schwartz*10
.20

—
Amendment to Severance Letter between MTM Technologies, Inc. and Alan Schwartz*10
.21

—
Form of Employee Stock Option Agreement*10
.22

—
Stock Option Award Agreement, dated November 2, 2004, between MTM Technologies, Inc. and Steven Stringer*10
.23

—
Restricted Stock Unit Award Agreement, dated November 2, 2004, between MTM Technologies, Inc. and Steven Stringer*10
.24

—
Lease Agreement, dated as of June 16, 2004, between Eight Fifty Canal, LLC and MTM Technologies, Inc.*14
.1

—
Code of ethics.*21
.1

—
Subsidiaries of MTM Technologies, Inc.23
.1

—
Consent from Goldstein Golub Kessler LLP.23
.2

—
Consent of Ernst & Young LLP23
.3

—
Consent of UHY LLP23
.4

—
Consent of Squar, Milner, Reehl & Williamson LLP23
.5

—
Consent of Gunnip & Co.31
.1

—
Certification pursuant to Exchange Act Rule 13a-14(a) of Francis J. Alfano.31
.2

—
Certification pursuant to Exchange Act Rule 13a-14(a) of Alan Schwartz.32
.1

—
Certification pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 of Francis J. Alfano.32
.2

—
Certification pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 of Alan Schwartz.* Incorporated by Reference. See Exhibit Index.
Financial Statements and Schedules
We have provided in Item 8 to this Annual Report on Form 10-K a complete list of the financial statements being filed with this Form 10-K. There are no financial statement schedules applicable to this Form 10-K.
35
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and ShareholdersMTM TECHNOLOGIES, INC.
We have audited the accompanying consolidated balance sheets of MTM Technologies, Inc. and Subsidiaries as of March 31, 2005 and 2004, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended March 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MTM Technologies, Inc. and Subsidiaries as of March 31, 2005 and 2004 and the results of their operation and their cash flows for each of the three years in the period ended March 31, 2005 in conformity with United State generally accepted accounting principles.
GOLDSTEINGOLUBKESSLERLLP
New York, New York
June 3, 2005, except for the fifth, sixth and seventh paragraphs of Note 2, as to which the date is June 8, 2005 and the eleventh paragraph of Note 10 as to which the date is June 23, 2005.
F-1
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS
March 31,2005

2004(In thousands)ASSETSCurrent assets:Cash and cash equivalents

$
4,010


$
370Restricted cash


1,000Accounts receivable—trade, net of allowance of $741 and $233, respectively


34,180



11,279Inventories


3,408



859Prepaid expenses and other current assets


2,360



526Total current assets


44,958



13,034Property and Equipment:


16,234



9,746Less accumulated depreciation and amortization


11,016



7,0385,218



2,708Goodwill


36,235



3,229Intangibles, net of amortization


6,471Other assets


332



504Total assets

$
93,214


$
19,475LIABILITIES AND SHAREHOLDERS' EQUITYCurrent liabilities:Secured notes payable

$
13,614


$
5,919Inventory financing agreements


2,930



3,456Current portion of promissory notes


366Accounts payable and accrued expenses


22,477



3,252Convertible subordinated promissory notes


13,321Warrants and future rights liability


6,335Deferred revenue


4,522



1,584Current portion of capital lease obligations


185



100Total current liabilities


63,750



14,311Non-current portion of promissory notes


667Non-current portion of capital lease obligation


281Total liabilities


64,698



14,311Shareholders' equity:Serial A preferred stock, par value $.001 per share; 14,000 shares authorized; 9,102 shares issued and outstanding at March 31, 2005


16,997Common stock—$.001 par value; authorized 80,000 and 10,000 shares respectively, issued and 7,376 and 4,723 shares outstanding, respectively


8



5Additional paid-in capital


29,397



15,364Accumulated deficit


(17,886
)


(10,205
)Total shareholders' equity


28,516



5,164Total liabilities and shareholders' equity

$
93,214


$
19,475See Notes to Consolidated Financial Statements
F-2
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended March 31,2005

2004

2003(In thousands, except for share amounts)Net revenue:Products

$
73,161


$
38,976


$
34,471Services


28,033



13,288



20,985101,194



52,264



55,456Costs and expenses:Cost of products sold


64,246



37,757



32,139Cost of services provided


18,160



12,103



13,272Selling, general and administrative expenses


21,770



10,025



11,484104,176



59,885



56,895Operating (loss):


(2,982
)


(7,621
)


(1,439
)Other income


—



6



98Interest expense, net of interest income


(4,686
)


(494
)


(286
)(7,668
)


(8,109
)


(1,627
)Provision (Benefit) for income taxes


13



—



(416
)Net (loss)

$
(7,681
)

$
(8,109
)

$
(1,211
)Net (loss) per common share, basic and diluted:

$
(1.34
)

$
(1.72
)

$
(0.26
)Weighted-average number of common shares outstanding:Basic and diluted


5,714



4,723



4,734See Notes to Consolidated Financial Statements
F-3
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Preferred Stock

Common StockNumber of
Shares

Amount

Number of
Shares

Amount

Additional
Paid-in
Capital

Accumulated
Deficit

Total(In thousands)Balance at March 31, 2002










4,958


$
5


$
15,685


$
(885
)

$
14,805Repurchase of common stock










(235
)






(352
)






(352
)Net loss






















(1,211
)


(1,211
)Balance at March 31, 2003










4,723



5



15,333



(2,096
)


13,242Issuance of stock options


















31







31Net loss






















(8,109
)


(8,109
)Balance at March 31, 2004










4,723



5



15,364



(10,205
)


5,164Issuance of preferred stock


9,102


$
16,997











6,776







23,773Exercise of stock options










59







87







87Issuance of common stock in connection with acquisitions










2,567



3



7,115







7,118Stock-based compensation


















10







10Issuance of common stock for consulting services










27







45







45Net loss






















(7,681
)


(7,681
)Balance at March 31, 2005


9,102


$
16,997



7,376


$
8


$
29,397


$
(17,886
)

$
28,516See Notes to Consolidated Financial Statements
F-4
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CASH FLOWS(In thousands)
Year Ended March 31,2005

2004

2003Cash flows from operating activities:Net loss

$
(7,681
)

$
(8,109
)

$
(1,211
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation


1,731



1,636



1,604Amortization of intangibles


827Amortization of debt discount


3,882Stock based compensation expense


11Gain in fair value of warrants


(462
)Deferred income taxes










(433
)Stock options issued for services






32Changes in operating assets and liabilities net of effects of acquisitions:Decrease in accounts receivable


923



2,181



44(Increase) decrease in inventory


(431
)


482



403(Increase) decrease in prepaid expenses and other current assets


(1,038
)


368



539Decrease in refundable income taxes










862Decrease (increase) in other assets


498



(311
)


(13
)(Decrease) increase in accounts payable and accrued expenses


(8,316
)


1,138



225(Decrease) increase in deferred revenue


(1,422
)


1,584Net cash (used in) provided by operating activities


(11,478
)


(999
)


2,020Cash flows used in investing activities:Acquisition of property and equipment


(1,624
)


(649
)


(1,239
)Acquisition of businesses, net of cash acquired


(28,795
)Increase in restricted cash


(1,000
)Net cash (used in) investing activities


(31,419
)


(649
)


(1,239
)Cash flows from financing activities:Borrowing (repayment) of secured notes payable


7,695



1,153



(470
)(Repayment) borrowing on inventory financing


(526
)


1,123



(696
)Purchases and retirement of common stock










(353
)Proceeds from issuance of preferred stock, net


23,818Proceeds from issuance of subordinated promissory notes


16,000Proceeds from stock options exercised


87Payments on promissory note


(450
)Payments on capital lease obligations


(87
)


(376
)


(362
)Net cash provided by (used in) financing activities


46,537



1,900



(1,881
)Net increase (decrease) in cash and cash equivalents


3,640



252



(1,100
)Cash and cash equivalents at beginning of period


370



118



1,218Cash and cash equivalents at end of period

$
4,010


$
370


$
118Supplemental disclosures of cash flow information:Cash paid during the year for:Interest

$
568


$
451


$
291Income taxes

$
0


$
0


$
30Supplemental disclosure of investing and financing activities:Fair value of stock issued for acquisitions at the date of acquisition

$
7,118


$
0


$
0See Notes to Consolidated Financial Statements
F-5
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands, except for per share amounts)
1. Summary of Significant Accounting Policies
Principles of Consolidation and Nature of Operations
The accompanying consolidated financial statements include the accounts of MTM Technologies, Inc. (formerly Micros-to-Mainframes, Inc.) and its wholly owned subsidiaries, Data.Com RESULTS, Inc. (“Data.Com”), MTM Advanced Technology, Inc. (“MTM”), PTI Corporation (formerly known as Pivot Technologies) (“Pivot”), MTM Technologies (California), Inc., MTM Technologies (Texas), Inc., MTM Technologies (US), Inc. and Info Systems, Inc. hereinafter collectively referred to as the “Company.” All significant intercompany accounts and transactions have been eliminated.
“Pequot Fund” refers to Pequot Private Equity Fund III, L.P., “Pequot Partners” refers to Pequot Offshore Private Equity Partners III, L.P., and collectively with Pequot Fund, “Pequot,” “Constellation Venture” refers to Constellation Venture Capital II, L.P., “Constellation Offshore” refers to Constellation Venture Capital Offshore II, L.P., “BSC” refers to The BSC Employee Fund VI, L.P., “CVC” refers to CVC Partners II, LLC, and collectively with Constellation Venture, Constellation Offshore and BSC, “Constellation,” and together with Pequot, the “Investors.”
The Company is a leading national computer and communications technology management company providing information technology (“IT”) networking, communications, software applications and data center services, including secure access, voice over internet protocol (“VOIP”), storage, security and messaging solutions. The Company serves as a single source provider of advanced technology solutions to support its clients' mission-critical business processes. The Company's clients consist of divisions of Fortune 100 and Fortune 500 corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipal, state and federal government agencies, and educational institutions. The Company serves clients in most major US metropolitan.
The Company purchases software, computers and related products directly from suppliers as either an authorized dealer or a value-added reseller. The Company has entered into authorization agreements with major suppliers, which can be terminated by the supplier, with or without cause, upon short notice, or immediately upon the occurrence of certain events. The sales of products from the Company's four largest suppliers accounted for 27%, 14%, 13% and 12% of all product sales for the year ended March 31, 2005. The sales from the Company's three largest suppliers accounted for 40%, 23% and 9% of all product sales for the year ended March 31, 2004. The sales of product from the Company's three largest suppliers accounted for 42%, 26% and 8% of all product sales for the year ended March 31, 2003. The
Company believes it has excellent relationships with its suppliers; however, there can be no assurance that the aforementioned agreements will be renewed. If these agreements are not renewed, the Company may have difficulty in obtaining inventory at a sufficiently low cost to allow for resale at a competitive market price.
Liquidity
The Company sustained net losses during the years ended March 31, 2005, 2004 and 2003 and at March 31, 2005 had a net working capital deficit of $18,792. To improve its working capital position the Company undertook cost reduction initiatives, discontinued certain sales of low margin products, and negotiated new credit facilities as discussed in Note 2. In addition, to fund its growth through acquisition strategy the Company sold notes and preferred stock as discussed in Notes 9 and 10. The Company anticipates that the preferred stock, debt and credit facilities will provide the Company with the capital necessary to meet its obligations as they come due.
F-6
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents generally consist of cash and money market funds. We consider all highly liquid investments purchased with maturities of three months or less to be cash equivalents. Such investments are stated at cost, which approximates fair value, and are considered cash equivalents for purposes of reporting cash flows.
Restricted Cash
The Company has restricted $1,000,000 of cash in a blocked account for the benefit of a lender under the Old Textron Facility discussed in Note 2.
Accounts Receivable
Accounts receivable are reported at their outstanding unpaid principal balances reduced by an allowance for doubtful accounts, based on certain percentages of aged receivables. The Company estimates doubtful accounts based on historical bad debts, factors related to specific customers' ability to pay and current economic trends. The Company writes off accounts receivable against the allowance when a balance is determined to be uncollectible.
Inventories
Inventories, comprised principally of computer hardware and software, are stated at the lower of cost or market using the first-in, first-out method.
Property and Equipment
Property and equipment is stated at cost and is depreciated using the straight-line method. Furniture, fixtures and other equipment and software development costs have useful lives ranging from 3-7 years. Leasehold improvements are amortized over the shorter of the lease term or economic life of the related improvement. Expenditures which extend the useful lives of the existing assets are capitalized. Maintenance and repairs are charged to operations as incurred.
The Company incurred approximately $1,731, $1,636 and $1,604 of depreciation and amortization expense for the years March 31, 2005, 2004 and 2003, respectively.
The following is a summary of property and equipment held by the Company:
F-7
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
March 31,2005

2004Furniture, fixtures and office equipment

$
5,353


$
2,667Capitalized lease equipment


1,564



1,183Software and software development costs


8,074



5,722Leasehold Improvements


911



174Vehicles


332



—16,234



9,746Less accumulated depreciation and amortization


11,016



7,038Property and equipment, net

$
5,218


$
2,708Software Development Costs
The cost of software developed for internal use incurred during the preliminary project stage is expensed as incurred. Direct costs incurred during the application development stage are capitalized. Costs incurred during the post implementation/operation stage are expensed as incurred. Capitalized software development costs are amortized on a straight-line basis over their estimated useful lives.
Impairment of Living—Lived Assets
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An asset is considered to be impaired when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition exceeds its carrying amount. The amount of impairment loss, if any, is measured as the difference between the net book value of the asset and its estimated fair value. At March 31, 2005, no such impairment existed.
Income Taxes
Deferred income taxes are provided, using the asset and liability method, for temporary differences between financial and tax reporting purposes which arise principally from the deduction related to the allowances for doubtful accounts, certain capitalized software costs, the basis of inventory and differences arising from book versus tax depreciation methods.
Revenue Recognition
The Company recognizes revenue in accordance with Staff Accounting Bulletin No. 104. The Company recognizes revenue from the sales of hardware when the rights and risks of ownership have passed to the customer, upon shipment or receipt by the customer, depending on the terms of the sales contract with the customer. Revenue from the sales of software not requiring significant modification or customization is recognized upon delivery or installation. Revenue from services is recognized upon performance and acceptance after consideration of all of the terms and conditions of the customer contract. Service contracts generally do not extend over one year, and are billed when persuasive evidence of an arrangement exists, the sales price is fixed and determinable, and collection of the resulting receivable is reasonably assured.
Revenue arrangements generally do not include specific customer acceptance criteria. For arrangements with multiple deliverables, delivered items are accounted for separately, provided that the delivered item has value to the customer on a stand alone basis and there is objective and reliable evidence of the fair value of the undelivered items. Revenue billed on retainer is recognized as services are performed and amounts not recognized are recorded as deferred revenue.
F-8
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
The Company periodically receives discretionary cost reimbursements from suppliers. These reimbursements are accounted for as reductions to the cost of sales products.
Shipping and handling costs are included in the cost of sales.
Fair Value of Financial Instruments
The estimated fair value of amounts reported in the consolidated financial statements has been determined by using available market information and appropriate valuation methodologies. All current assets are carried at their cost and current liabilities are recorded at their contract amount, which approximates fair value because of their short term nature. The fair value of the convertible subordinated promissory notes approximate their principal amount due to their short term nature.
Per Share Data
Basic net (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted net (loss) per share is calculated using the weighted-average number of common shares plus dilutive potential common shares outstanding during the period. Dilutive securities amounting to 23,012, 983, and 887 in the year ended March 31, 2005, 2004 and 2003, respectively, have not been included in the weighted-average shares used for the calculation of earnings per share because the effect of such securities would be anti-dilutive.
Stock-Based Compensation
The Company has elected, in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” to apply the current accounting rules under APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for employee stock options and, accordingly, has presented the disclosure-only information as required by SFAS No. 123. If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date, as prescribed by SFAS No. 123, net (loss) and net (loss) per common share for the years ended March 31, 2005, 2004 and 2003 would approximate the pro forma
amounts indicated in the tables below.
Year Ended March 31,2005

2004

2003Net (loss)—as reported

$
(7,681
)

$
(8,109
)

$
(1,211
)Stock-based compensation using the fair-value method


(1,564
)


(176
)


(162
)Net (loss)—pro forma


(9,245
)


(8,285
)


(1,373
)Basic and diluted net (loss) per common share—as reported


(1.34
)


(1.72
)


(0.26
)Basic and diluted net (loss) per common share—pro forma


(1.62
)


(1.75
)


(0.29
)Pro forma information regarding net (loss) and earnings per share is required by SFAS No. 123, and has been determined as if the Company accounted for its employee stock options under the fair value method of the statement. The fair value of these options was estimated at the date of grant using a Black-Sholes option pricing model with the following with following weighted-average assumptions for the years ended March 31, 2005, 2004, and 2003: risk-free interest rate of 4.1%, 3% –4% , and 2.8%, respectively: no dividend yield; a volatility factor of the expected market price of the Company's common stock of 1.13, 1.00 and 1.24, respectively; and an expected life of 4.0, 4.0 and 4.0 years, respectively.
The Black-Sholes option valuation model was developed for use in estimating the fair value of publicly traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected
F-9
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of publicly traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the Black-Sholes option valuation model does not necessarily provide a reliable single measure of the fair value of its employee stock options.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. We place our cash with high credit quality institutions. At times, such amounts may be in excess of the FDIC insurance limits.
The Company does not have any customer at March 31, 2005 which accounts for more than 10% of our total accounts receivable.
At March 31, 2004 one customer accounted for approximately 16% of the Company's accounts receivable.
Credit is extended to customers based on an evaluation of their financial condition, and collateral is generally not required. The evaluation of financial condition is performed to reduce the risk of loss.
Goodwill
The Company tests goodwill for impairment at the reporting unit level on an annual basis or more frequently if the Company believes indicators of impairment exist. The performance of the test involves a two-step process. The first step of the impairment test involves comparing the fair values of the applicable reporting units using the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, the Company performs the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit's goodwill with the
carrying value of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recorded in net income (loss).
Circumstances that could trigger an impairment test include but are not limited to: significant adverse change in the business climate or legal factors; an adverse action or assessment by a regulator; unanticipated competition; loss of key personnel; the likelihood that a reporting unit or significant portion of a reporting unit will be sold or otherwise disposed of; results of testing for recoverability of a significant asset group within a reporting unit; and recognition of a goodwill impairment loss in the financial statement of a subsidiary that is a component of a reporting unit.
Intangibles Assets
The company recorded intangible assets which related to the acquisitions of the assets of DataVox Technologies, Inc., Network Catalyst, Inc., Vector ESP, Inc. and the capital stock of Info Systems, Inc.
Intangibles consist of the following:
F-10
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
Gross
Amount

Accumulated
AmortizationCustomer relationships

$
6,588


$
768Know-how


710



59Total

$
7,298


$
827The customer relationships and know-how are being amortized over periods of 3 to 4 years.
Amortization expense amounted to $0.8 million for the year ended March 31, 2005. Estimated amortization expense for the next four years is as follows:
Year ending March 31,2006

$
2,2612007


2,2612008


1,5192009


430Recently Issued Accounting Standards
In December 2004, the FASB issued SFAS No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”), which requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in an entity's statement of income. The accounting provisions of SFAR 123R are effective for annual reporting periods beginning after June 15, 2005. The Company is required to adopt the provisions of SFAS 123R in the quarter ending June 30, 2006. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Although the Company has not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current
pro forma disclosures under SFAS 123, the Company is evaluating the requirements under SFAS 123R and expects the adoption to have a material impact on the consolidated statements of operations and net income (loss) per share.
Management does not believe any other recently issued, but not yet effective, accounting standards if currently adopted would have a material effect on the accompanying consolidated financial statements.
2. Credit Facilities
On May 21, 2004, the Company and its subsidiaries entered into an Amended and Restated Financing Facility (the “Old Textron Facility”) with Textron Financial Corporation (“Textron”). The Old Textron Facility provided for a credit facility of up to $15 million, secured by all of the Company's assets, except for permitted encumbrances, and was to expire on May 21, 2005. Effective as of December 27, 2004, the Schedule to the Old Textron Facility was amended to change certain of the financial covenants contained therein.
On February 1, 2005, the Company received a temporary increase from Textron in the maximum amount of the Old Textron Facility to $20 million.
Two forms of loans were made under the Old Textron Facility: floor plan financings and revolving receivable financings. The floor plan financings generally allowed the Company to finance inventory purchases from approved vendors on a 30-day interest-free basis. Interest accrued on floor plan financings after such 30-day period at the rate equal to six basis points over a specified prime rate. The revolving receivable financings allowed the Company to borrow against current account receivables that meet certain specified standards. Interest accrued on revolving receivable financings immediately upon funding at a specified prime rate. The Old Textron Facility contained
F-11
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
other affirmative and negative covenants, including those relating to the Company's tangible capital funds and other financial conditions. The Company was required to pay additional fees if it exceeded the maximum permitted aggregate loan amount then in effect or if the Company was found to be in default under the Old Textron Facility.
The Company's total outstanding debt under the Old Textron Facility's revolving receivable financing facility was $13,614 as at March 31, 2005 and $5,919 as at March 31, 2004. The amount outstanding under the Old Textron Facility's inventory financing was $2,930 as at March 31, 2005 and $3,456 as at March 31, 2004.
On June 8, 2005, the Company entered into a secured revolving credit facility (the “CIT Facility”) with CIT Group/Business Credit Inc. (“CIT”) and a new Amended and Restated Loan and Security Agreement (the “New Textron Facility”) with Textron, providing a combined maximum availability of up to $40 million. The CIT Facility and the New Textron Facility will be used to fund working capital and floor-planning needs, and were also used to refinance the Old Textron Facility.
The CIT Facility is a three year revolving credit facility for up to $25 million, subject to a borrowing base based on eligible accounts receivable, eligible in-transit inventory (up to $0.5 million) and eligible finished goods inventory (up to $0.5 million). The CIT Facility requires, among other things, that the Company maintain certain financial covenants including that the Company maintain Consolidated Senior Leverage of not greater than 4.00 to 1.00 for the trailing four quarters and that the Company maintain a Consolidated Fixed Charge Coverage Ratio of not less than 1.00 to 1.00 for the trailing four quarters, restricts the Company's ability to incur certain additional indebtedness, and contains various customary provisions, including affirmative and negative covenants, representations and warranties and events
of default. Amounts borrowed under the CIT facility will bear interest at either the prime rate or at LIBOR plus 3%, in each case at the Company's option.
The New Textron Facility allows the Company to finance inventory purchases up to $15 million from approved vendors on a 45-day interest-free basis in most cases. Interest accrues after expiration of the applicable interest free period at the rate equal to a specified prime rate plus 4%. The financial and other covenants in the New Textron Facility are substantially the same as those in the CIT Facility.
At March 31, 2005, the Company was in violation of certain covenants contained in the Old Textron Facility. The Company received a letter of forbearance from Textron related to these violations. In connection with the New Textron Facility, the covenants contained in the Old Textron Facility were eliminated and replaced with new covenants. The Company anticipates that it will be in compliance with the new covenants at the respective measurement dates.
The components of debt as of March 31 are as follows:
2005

2004Secured notes payable

$
13,614


$
5,9197% Convertible subordinated promissory notes


13,321Inventory financing agreements


2,930



3,456Promissory notes


1,033Capital lease obligation


466



100Total

$
31,364


$
9,475The Company's future debt maturities at March 31, 2005 are summarized below:
F-12
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
Year ended2006

$
30,4222007


8552008


87Total minimum debt payments

$
31,364Less current maturities


(30,416
)Total Long-term Debt

$
9483. Shareholders' Equity
Preferred Stock
As of March 31, 2005, the Company had authorized 20 million shares of preferred stock, 14 million of which are designated Series A Preferred Stock, par value $.001 per share and 6 million of which are “blank check” preferred stock, par value $.001 per share. As of March 31, 2005 there were 9.1 million shares of Series A Preferred Stock issued. See Note 10 for a discussion of the issuance of Series A Preferred Stock. As of March 31, 2004, the Company had authorized 2 million shares of “blank check” preferred stock, par value $.001 per share. As of March 31, 2004 there were no preferred shares issued.
Stock Options
The 1993 Employee Stock Option Plan (the “1993 Plan”) was adopted by the Company in May 1993; the 1996 Stock Option Plan (the “1996 Plan”) was approved by the shareholders of the Company on August 20, 1996; and the 1998 Stock Option Plan (the “1998 Plan”) was approved by the shareholders of the Company on October 16, 1998. The 2000 Employee Stock Option Plan (the “2000 Plan”) was adopted by the Company in September 2000. The 2002 Long-Term Performance Plan (the “2002 Plan”) was approved by the shareholders of the Company on November 8, 2002. The 2004 Equity Incentive Plan (the “2004 Plan”) was approved by the shareholders of the Company on May 21, 2004 and an amendment to the 2004 Plan was approved by the shareholders of the Company on
November 19, 2004.
The plans provide for granting of options, including incentive stock options, nonqualified stock options and stock appreciation rights to qualified employees, outside directors, independent contractors, consultants and other individuals, to purchase up to an aggregate of 250, 350, 250, 350, 250 and 3,000 shares of the Company's common stock under the 1993 Plan, the 1996 Plan, the 1998 Plan, the 2000 Plan, the 2002 Plan and the 2004 Plan, respectively. The exercise price of options generally may not be less than 100% of the fair market value of the Company's common stock at the date of grant. Options may not be exercised more than 10 years after the date of grant. Options granted under the plans become exercisable in accordance with different vesting schedules determined at the time of grant.
A summary of the status of the Company's options as of March 31, 2005, 2004 and 2003, and changes during the years then ended, is presented below:
F-13
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
2005

2004

2003Number
of Shares

Weighted-
Average
Exercise
Price

Number
of Shares

Weighted-
Average
Exercise
Price

Number
of Shares

Weighted-
Average
Exercise
PriceOutstanding at beginning of year


983


$
2.19



887


$
2.21



910


$
2.34Canceled/Expired


(116
)


3.22



(27
)


1.19



(98
)


2.32Granted


2,202



2.90



123



1.19



75



0.75Exercised


(59
)


1.48



—



—



—



—Outstanding at end of year


3,010


$
2.93



983


$
2.19



887


$
2.21The weighted-average contractual life of the total options outstanding at March 31, 2005 is 8.1 years.
The weighted-average fair value of options granted during the years ended March 31, 2005, 2004, and 2003 is $2.58, $1.19 and $0.75, respectively.
There were 1,046, 983 and 784 options exercisable at March 31, 2005, 2004 and 2003, respectively. The weighted-average exercise price of the total options exercisable at March 31, 2005 is $2.19. Granted and Outstanding at end of year totals for 2005 include 58 restricted stock units which do not have an exercise price. The value of the restricted stock units is approximately $180 and $10 was charged to operations for the year ended March 31, 2005.
Earnings per Share
The following table presents the computation of basic and diluted (loss) per share:
Year Ended March 31,2005

2004

2003Numerator:Net (loss)

$
(7,681
)

$
(8,109
)

$
(1,211
)Denominator:Denominator for basic earnings per share—weighted-average shares


5,714



4,723



4,734Denominator for diluted earnings per share


5,714



4,723



4,734Net (loss) per share—basic

$
(1.34
)

$
(1.72
)

$
(0.26
)Net (loss) per share—diluted

$
(1.34
)

$
(1.72
)

$
(0.26
)4. Accounts Payable and Accrued Expenses
Accounts Payable and accrued expenses consist of the following:
March 31,2005

2004Trade accounts payable

$
15,455


$
2,636Compensation related costs


4,783Accrued other


2,239



616$
22,477


$
3,252F-14
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
5. Income Taxes
The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
The provision (benefit) for income taxes consists of the following:
Year Ended March 31,2005

2004

2003Federal:Current

$
—


$
—


$
17Deferred


—



—



(300
)—



—



(283
)State:Current


13



—



—Deferred


—



—



(133
)$
13


$
—


$
(416
)The reconciliations of income tax provision (benefit) computed at the federal statutory tax rates to actual income tax provision (benefit) are as follows:
Year Ended March 31,2005

2004

2003Tax expense at statutory rates applied to pretax earnings

$
(2,607
)

$
(2,757
)

$
(553
)State income taxes, net of federal benefit


(391
)


(405
)


(83
)Changes in valuation allowance


3,075



3,150



332Other permanent items


25



41



(25
)Adjustment to prior provisions


(89
)


(29
)


—Research and development credit


—



—



(87
)$
13


$
0


$
(416
)The tax effects of temporary differences that give rise to the net short-term deferred income tax asset at March 31, 2005 and 2004 are presented below:
March 31,2005

2004Reserve for bad debts

$
302


$
91Inventory


87



7Valuation allowance


(389
)


(98
)Total short-term deferred income tax asset

$
0


$
0F-15
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
The tax effects of temporary differences that give rise to the net long-term deferred income tax asset (liability) are presented below:
March 31,2005

2004Property and Equipment, net

$
(477
)

$
(725
)Goodwill


(234
)Other


77



12Net operating loss


6,612



3,907Research and development credit


190



190Valuation allowance


(6,168
)


(3,384
)Net long-term deferred income liability

$
0


$
0The Company has net operating loss carryforwards of (a) $16,579 to offset federal taxable income, and (b) $19,507 of available state carryforwards to offset taxable income through the year 2025. Realization of the benefit of the carryforward losses depends on earning sufficient taxable income before expiration of loss carryforwards. The utilization of the net operating loss carry forwards may also be limited as a result of ownership changes. At March 31, 2005 and 2004, the Company has established a valuation allowance that offsets the deferred tax assets.
6. Commitments and Contingencies
The Company leases 27 locations for its administrative and operational functions under operating leases expiring at various dates through 2016. Certain leases are subject to escalation based on the Company's share of increases in operating expenses for the locations. In addition, the Company leases equipment used in operations.
Approximate future minimum annual lease payments under noncancelable operating leases are as follows:
Year ending March 31,2006

$
1,7192007


1,4932008


1,1722009


8672010


704Thereafter


1,966$
7,921Rental expense for operating leases including amounts from cancelable leases approximated $1,077, $742 and $703 for the years ended March 31, 2005, 2004 and 2003, respectively.
Employment Agreements
The Company has entered into employment agreements, which require the following payments:
Year ending March 31,2006

$
3,5372007


2,6452008


122$
6,304F-16
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
In addition, certain other agreements provide for bonus compensation based on certain performance goals, as defined.
Litigation
The Company is involved in various claims and legal actions arising in the ordinary course of business. Management is of the opinion that the ultimate outcome of these matters would not have a material adverse impact on the financial position of the Company or the results of its operations.
7. Employee Savings Plan
The Company has an employee savings plan which qualifies under Section 401(k) of the Internal Revenue Code. Under this plan, all employees who are at least 20.5 years of age are eligible to defer up to 60% of their pretax compensation, but not more than the limit prescribed by the Internal Revenue Service. Company matches are discretionary. The Company contributed approximately $26, $29 and $30 to the plan for the years ended March 31, 2005, 2004 and 2003, respectively.
8. Allowance for Doubtful Accounts
Information relating to the allowance for doubtful accounts is as follows:
Beginning of
Year

Costs and
Expenses

Other
Additions

Deductions

At End of
YearYear ended March 31,2003

$
335


$
538


$
—


$
—


$
8732004


873



—



—



640(a
)


2332005


233



—



615(b
)


107(a
)


741
(a)

Write-off of uncollectible accounts receivable and/or revision to estimates computed.(b)

Allowance for doubtful accounts assumed through acquisitions.9. Acquisitions
In executing its growth-through-acquisition strategy during the 2005 fiscal year, the Company has acquired the businesses and operating assets of three companies and all of the outstanding stock of a fourth company.
On July 2, 2004, the Company acquired the assets and business operations of DataVox Technologies, Inc. (“DataVox”), a Cisco AVVID (Architecture for Voice, Video and Integrated Data) authorized partner, offering advanced technology solutions, including IP telephony, security, storage, networking and wireless technology solutions, as well as network facilities engineering and data center technology consulting services. The results of operations are included in the Company's financial results as of July 2, 2004. The purchase price of DataVox was recorded as $2,089 and was allocated to specific assets acquired and liabilities assumed. The purchase price was paid in the form of cash in amount of $650, promissory notes in the amount of $250, 753 shares (at $1.58 per share, or $1,189 total), plus transaction costs
of $51 (including 12 shares).
The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition. The Company performed a valuation of certain intangible assets and allocated a portion of the purchase price to Customer Relationships.
F-17
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
Current assets

$
1,023Property, plant and equipment


187Intangible assets


265Other non-current assets


57Total assets acquired


1,532Current liabilities


(822
)Long-term debt


(205
)Net assets acquired

$
505Goodwill related to the acquisition of DataVox amounted to $1,635 and is expected to be deductible for tax purposes. For the year ended March 31, 2005, $82 is expected to be deductible for tax purposes.
On September 17 2004, the Company acquired the assets and business operations of Network Catalyst Inc. (“Network Catalyst”). Network Catalyst provides advanced technology solutions in the VOIP (Voice Over Internet Protocol), infrastructure and security fields to clients located throughout the Southern California region. Network Catalyst was acquired to improve the geographical presence and deepen the technical capabilities of the Company. The results of operations are included in the Company's financials results beginning September 18, 2004. The purchase price of the Network Catalyst acquisition was recorded as $4,800 and was allocated to the specific assets acquired and liabilities assumed. The purchase price was paid in the form of cash in the amount of $4,000, 500 shares (at $1.60 per share, or $800
total) of the Company's common stock, plus transaction costs of $239. As part of the purchase price, the Company agreed to pay to the former shareholders of Network Catalyst additional cash amounts as well as transfer to the former shareholders of Network Catalyst additional shares of common stock on the achievement of certain financial targets. More particularly, in the event that as of the end of any fiscal quarter, the earnings before interest, taxes, depreciation and amortization (“EBITDA”) attributable to the acquired business during the period beginning October 1, 2004 and ending on September 30, 2005 (the “Network Catalyst Earnout Period”) equals or exceeds $2,000 then the Company is required to (x) pay to the former shareholders of Network Catalyst $960 in cash, and (y) issue to the former shareholders of Network Catalyst that number
of shares of common stock determined by dividing $240 by the greater of (A) the average trading price of the common stock for the 20 business days ending immediately preceding the end of the Network Catalyst Earnout Period and (B) $2.15.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The Company obtained a third party valuation estimate of certain intangible assets and allocated a portion of the purchase price to Customer Relationships. Therefore, the allocation of the purchase price is subject to refinement.
Current assets

$
7,806Property, plant and equipment


253Intangible assets


1,779Other non-current assets


61Total assets acquired


9,899Current liabilities


(9,395
)Long-term debt


(48
)Net assets acquired

$
456Goodwill related to the acquisition of Network Catalyst amounted to $4,583 and is expected to be deductible for tax purposes. For the year ended March 31, 2005, $153 is expected to be
F-18
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
deductible for tax purposes. In addition, amounts allocated to Customer Relationships is $1,779, with an expected life of 3 years.
On December 10, 2004, the Company acquired the assets and business operations of Vector ESP, Inc. and Vector ESP Management, Inc. (collectively, “Vector”). Vector provides advanced technology solutions in application delivery and deployment, network infrastructure, messaging and collaboration, remote office connectivity and workforce mobility products and services. Vector was acquired to improve the geographical presence and deepen the technical capabilities of the Company. The results of operations are included in the Company's financial results beginning December 1, 2004. The purchase price of the Vector acquisition was recorded as $19,765 and was allocated to the specific assets acquired and liabilities assumed. The purchase price was paid in the form of cash in the amount of $16,833, promissory
notes in the amount of $667, and 434 shares (at $5.22 per share or $2,265 total) of the Company's common stock, plus transaction costs of $712. As part of the Vector purchase price, the Company agreed to issue to Vector Global Services, Inc. (the “Vector Shareholder”) additional shares of common stock on the achievement of certain financial targets. More particularly, if the EBITDA attributable to the acquired business during the period beginning on January 1, 2005 and ending on the date one year thereafter (the “Vector Earnout Period”) equals or exceeds $2,975, then, as additional consideration the Company shall issue to the Vector Shareholder the number of shares of common stock determined by (x) dividing $3,000 by the greater of (A) the weighted average trading price of the Company's common stock for the 10 business days immediately preceding
the end of the Vector Earnout Period and (B) $2.75 and (y) multiplying such amount by a fraction, the numerator of which shall equal the EBITDA of the acquired business for the year ending on the last day of the Vector Earnout Period and the denominator of which shall equal $3,500 (the “Vector Earnout Consideration”); provided, however, that in no event shall the value of the Vector Earnout Consideration exceed $3,000.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The Company obtained a third party valuation of certain intangible assets and allocated a portion of the purchase price to Customer Relationships and Know-How.
Current assets

$
8,404Property, plant and equipment


799Intangible assets


3,880Other non-current assets


70Total assets acquired


13,153Current liabilities


(11,188
)Long-term debt


(8
)Net assets acquired

$
1,957Goodwill related to the acquisition of Vector amounted to $18,520 and is expected to be deductible for tax purposes. For the year ended March 31, 2005, $412 is expected to be deductible for tax purposes. In addition, amounts allocated to Customer Relationships and Know-How is $3,880 with an average expected life of 3.5 years.
On March 11, 2005, the Company acquired all of the stock of Info Systems, Inc. (“Info Systems). Info Systems conducts an information technology business and certain management and consulting businesses consisting of providing connectivity (network infrastructure), server architecture (applications, directory and computing infrastructure), convergence (legacy and VOIP, security (assessment, policy design) and storage (SAN, data migration) solutions, as well as telecommunications and structured cabling services, outsourced information technology (IT), staff
F-19
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
augmentation and remote network monitoring, management and support services throuth its Network Operations Center. InfoSystems was acquired to improve the geographical presence and deepen the technical capabilities of the Company. The results of operations are included in the company's financial results beginning March 1, 2005. The aggregate purchase price for the stock of Info Systems amounted to $11,121 and consisted of $8,300 in cash, an aggregate of 868 shares (at $3.25 per share or $2,821 total) of the Company's common stock, plus transaction costs of $225. The Earnout Consideration is as follows: if the EBITDA attributable to the Business during the six months following March 11, 2005 (the “Earnout Period”) equals or exceeds $600, then we shall, at our option, either (i) pay $500 in cash to the shareholders of Info
Systems, or (ii) issue to the shareholders of Info Systems, the number of shares of the Company's common stock determined by dividing $500 by the greater of (A) the average NASDAQ closing price of the common stock for the 10 business days ending immediately prior to the end of the Earnout Period and (B) $2.75 (the amounts payable to the shareholders of Info Systems pursuant to this paragraph, the “Initial Earnout Consideration”). For each $1.00 of the EBITDA attributable to the acquired business during the Earnout Period in excess of $600, the Company shall, at its option, either (i) pay to the shareholders of Info Systems cash in an amount equal to 30% of such excess, or, (ii) issue to the shareholders of Info Systems the number of shares of common stock determined by dividing 30% of such excess by the greater of (x) the average NASDAQ closing
price of common stock for the 10 business days ending immediately prior to the end of the Earnout Period and (y) $2.75, (the amounts payable to the shareholders of Info Systems pursuant to Section 3.2(b) of the stock purchase agreement), the “Additional Earnout Consideration” and together with the Initial Earnout Consideration, the “Earnout Consideration”); provided, however, that in no event shall the value of the Additional Earnout Consideration exceed $200.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The Company obtained a third party valuation of certain intangible assets and allocated a portion of the purchase price to Customer Relationships.
Current assets

$
10,902Property, plant and equipment


973Intangible assets


1,374Other non-current assets


20Total assets acquired


13,269Current liabilities


(9,650
)Long-term debt


(542
)Net assets acquired

$
3,077Goodwill related to the stock purchase of Info Systems amounted to $8,269 and is expected to be deductible for tax purposes. For the year ended March 31, 2005, $46 is expected to be deductible for tax purposes. In addition, amounts allocated to Customer Relationships is $1,374, with an expected life of 4 years.
The Company believes that there is an opportunity to consolidate similar businesses throughout the United States. The Company will focus its acquisition strategy on businesses providing secure access, voice over internet protocol (VOIP), storage, networking and messaging solutions. The acquisition targets will include companies providing IT services and products, as well as certain managed solutions. The Company intends to seek acquisitions to enhance our current service offerings and extend its geographic presence. The Company seeks to identify businesses which will add technical expertise and service offerings, customers, sales capabilities and/or geographic coverage while generating a positive rate of return on investment. Furthermore, the Company intends to capitalize on the business practices of acquired companies
that the Company believes will best maintain or strengthen its competitive advantage and ensure ongoing delivery of
F-20
MTM TECHNOLOGIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)(In thousands, except for per share amounts)
high quality IT solutions to its customers. The acquisition candidates the Company may investigate can be large, and their acquisition by the Company could have a significant and lasting impact on our business.
Unaudited Pro Forma Summary
The following pro forma consolidated amounts give effect to the Company's Network Catalyst, Vector and Info Systems acquisitions accounted for by the purchase method of accounting as if they had occurred at the beginning of the period by consolidating the results of operations of the acquired net assets for the year ended March 31, 2005.
The pro forma consolidated statements of operations are not necessarily indicative of the operating results that would have been achieved had the transaction been in effect as of the beginning of the periods presented and should not be construed as being representative of future operating results.
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except for share amounts)
For the Year Ended
March 31,2005

2004Net Revenues:Products

$
141,637


$
138,874Services


64,615



52,237206,252



191,111Costs and expenses:Cost of products sold


125,777



123,666Cost of services provided


39,553



37,740Selling, general and administrative expenses


42,967



38,431208,297



199,837Other Income


53



7Provision for income taxes


(151
)


(49
)Interest expense(1)


(7,952
)


(8,036
)Net (loss)

$
(10,095
)

$
(16,804
)Net (loss) per common share:Basic and diluted

$
(1.42
)

$
(2.58
)Weighted average number of common shares outstanding:Basic and diluted(2)


7,085



6,525(1) Interest expense includes 3,102 and 7,220 of non-cash interest related to convertible debt, for the years ended March 31, 2005 and 2004, respectively.
(2) The weighted average shares used to compute proforma basic and diluted net (loss) per share for the year ended March 31, 2004 includes 1,801 shares of common stock issued as if the shares were issued on April 1, 2003.
10. Debt, Capital Lease Obligations and Series A Preferred Stock and Notes
On January 29, 2004 the Company entered into an agreement (the “Pequot Purchase Agreement”) with Pequot to sell to Pequot an aggregate of up to $25 million of Series A Convertible Preferred Stock, together with warrants to purchase additional shares of common stock.
F-21
The Series A Preferred Stock accrues dividends at 6% per annum payable semi-annual, commencing on May 21, 2006. Therefore, the Company will accrue dividends payable each applicable semi-annual period commencing May 21, 2006. Both the accretion of and dividends on the Series A Preferred Stock will reduce net income attributable to our common shareholders.
On May 21, 2004, Pequot purchased $7 million of Series A-1 Convertible Preferred Stock which is convertible into 3,256 shares of the Company's common stock at the conversion price of $2.15 per share, and 500 common stock warrants which are exercisable at a price of $2.46 per share. Pequot also received rights to purchase, solely at its option, Series A-2 Convertible Preferred Stock and Series A-3 Convertible Preferred Stock aggregating up to $18 million, plus warrants to purchase additional shares of common stock. Costs incurred in connection with the consummation of the initial Pequot transaction amounted to approximately $1 million which was recorded as a reduction of the proceeds. Payments aggregating $1.1 million were made to two officers of the Company and an additional $400 funded a rabbi trust from
which payments aggregating $200 will be paid to these officers on each of May 21, 2005 and 2006. These payments are included in selling, general and administrative expenses. On September 16, 2004, Pequot purchased $5.5 million of Series A-2 Convertible Preferred Stock which is convertible into 2,000 shares of the Company's common stock at the conversion price of $2.75 per share, and 400 common stock warrants which are exercisable at a price of $3.44 per share. Pequot retained its right to purchase, solely at its option, Series A-3 Convertible Preferred Stock aggregating up to $12.5 million, plus warrants to purchase additional shares of common stock. Costs incurred in connection with the consummation of the second Pequot transaction amounted to approximately $25. The Company used the proceeds from these sales to fund the cash portions of the purchase prices for the acquisitions
of DataVox Technologies, Inc. and Network Catalyst, respectively, referred to in Note 9.
On December 7, 2004, Pequot assigned to Constellation all of Pequot's rights and obligations under the Pequot Purchase Agreement to purchase a portion of the shares of the Series A-3 Convertible Preferred Stock and common stock warrants covered by that agreement. On that date the Company also entered into a purchase agreement (the “Pequot/Constellation Purchase Agreement”) with Pequot and Constellation for up to $40 million (or in certain limited circumstances, up to $47.5 million) of additional financing in the form of 7% convertible secured notes in three tranches. Immediately thereafter, Pequot purchased from the Company $6,250 of the Series A-3 Convertible Preferred Stock and 385 common stock warrants and Constellation purchased $6,250 of the Series A-3 Convertible Preferred Stock and 385 common
stock warrants. The A-3 Convertible Preferred Stock is convertible into 3,846 shares of common stock at a conversion price of $3.25 per share and the associated common stock warrants are exercisable for 769 shares of common stock at an exercise price of $4.06 per share.
In connection with the initial Pequot investment, the Company allocated the net proceeds from the sale of the (a) Series A-1 Convertible Preferred Stock, (b) warrants to purchase 500 shares of the Company's common stock and (c) rights to purchase the Series A-2 Convertible Preferred Stock, Series A-3 Convertible Preferred Stock and related warrants based on their relative fair values as at the date of the sale of the Series A-1 Convertible Preferred Stock and 500 warrants. The Company allocated and recorded $2.9 million to the Series A-1 Convertible Preferred Stock and assigned and credited to additional paid-in capital (x) $600 for the 500 warrants sold with the Series A-1 Preferred Stock and (y) $3.2 million for the rights to purchase the Series A-2 Convertible
Preferred Stock, Series A-3 Convertible Preferred Stock and related warrants based on an independent appraisal. Additionally, the Company paid a finder's fee consisting of $70 in cash and 27 shares of the Company's common stock, valued at $45, which was charged against additional paid-in capital.
In connection with the Pequot purchase of the Series A-2 Convertible Preferred Stock and related warrants the Company allocated and recorded $5.1 million to the Series A-2 Convertible Preferred Stock and assigned and credited to additional paid in capital $0.4 million for the fair value of the warrants. The value attributed to the warrants was determined by independent valuation utilizing the Black Scholes Model.
F-22
In connection with the Pequot and Constellation purchase of the Series A-3 Convertible Preferred Stock and related warrants the Company allocated and recorded $9.0 million to Series A-3 Convertible Preferred Stock and assigned and credited to additional paid in capital $3.5 million for the fair value of the warrants. The value attributed to the warrants was determined by independent valuation utilizing the Black Scholes Model.
On December 10, 2004, to fund the cash portion of the purchase price for the assets of Vector the Company sold to Pequot and Constellation pursuant to the Pequot/Constellation Purchase Agreement, $10,000 aggregate principal amount of notes (the “Series A-4 First Tranche Notes”) and issued to Pequot and Constellation warrants to purchase 615 shares of the Company's common stock at an exercise price of $4.06 per share (the “Series A-4 First Tranche Warrants”).
On March 10, 2005, to fund the cash portion of the purchase of Info Systems the Company sold to Pequot and Constellation pursuant to the Pequot/Constellation Purchase Agreement, $6,000 aggregate principal amount of notes (the “Series A-4 Second Tranche Notes”) and issued to Pequot and Constellation warrants to purchase 369 shares of the Company's common stock at an exercise price of $4.06 per share (the “Series A-4 Second Tranche Warrants”). The Series A-4 First Tranche Notes and the Series A-4 Second Tranche Notes are collectively referred to as “Series A-4 Notes.”
The Series A-4 Notes bear interest at an annual rate of 7%, payable quarterly. The interest accrued on each such payment date will be added to the principal of the Series A-4 Notes. The Series A-4 Notes are convertible into 7,692 shares of Series A-4 Convertible Preferred Stock which is in turn convertible into 7,692 shares of the Company's common stock at a conversion price of $3.25.
The outstanding principal and accrued interest will be automatically converted into Series A-4 Convertible Preferred Stock on the date of shareholders' approval. If the Series A-4 Notes have not already been converted into Series A-4 Convertible Preferred Stock, they will be due and payable on demand, which may be given by 662⁄3% of the holders of the notes at any time following the later of the date that is (x) 150 days following the date of issuance or (y) if the Securities and Exchange Commission (the “SEC”) reviews the Company's filings seeking shareholder approval, 180 days following the date of issuance. The Series A-4 Notes were converted into
shares of Series A-4 Preferred Stock upon approval by the Company's shareholders on June 23, 2005.
The Company assigned a value of $6,797 to the beneficial conversion feature of the Series A-4 notes, the warrants, and the options based on the relative fair values (using the Black Scholes Model) at the date of issuance and recorded this value as a discount to the Series A-4 Notes. This discount is being accreted to interest expense over the expected term of the Series A-4 Notes. During the period ended March 31, 2005 the discount accreted to interest expense amounted to approximately $3.8 million. At March 31, 2005, the remaining discounted to be accreted amounted to approximately $2.9 million.
Pequot and Constellation (or in certain circumstances, a third party) also have the right to purchase up to an additional $9,000 in aggregate principal amount of Series A-4 Notes, which amounts may be adjusted in accordance with the terms of the Pequot/Constellation Purchase Agreement. This additional right is exercisable until September 10, 2005. Pequot and Constellation also have the right to purchase up to $15,000 (or in certain limited circumstances, up to $22,500) in aggregate principal amount of notes (the “Series A-5 Notes”), which following shareholder approval will be converted into 4,615 shares (or in certain limited circumstances, 6,923 shares) of Series A-5 Convertible Preferred Stock, which is in turn convertible into 4,615 shares (or in certain limited circumstances, 6,923 shares) of the Company's
common stock at a conversion price of $3.25. This additional right is exercisable until December 10, 2005.
In accordance with Emerging Issues Task Force Issue 00-19 (“EITF 00-19”), ”Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled in, a Company's Own Stock,“ the Company has initially accounted for the fair value of $6.8 million for the warrants and the option as a liability since the Company is required to register the underlying common stock. The
F-23
fair value of the warrants was calculated utilizing the Black Scholes Model. From the date of issuance through the end of the fiscal year, there was a change in the market value of the Company's common stock, and therefore, the Company recorded a $462 decrease in the carrying value of the liability which is included as a reduction in selling, general and administrative expenses. Any additional change in the future market value of the underlying securities may cause the value of the liability to change. Any change in the carrying value of the liability will be made through the Company's current statement of operations.
11. Segment Information
In prior years the Company reported three separate segments. As a result of the acquisitions completed during the fiscal year and the changes in the structure of the Company's internal organization, the Company has concluded that it currently operates in a single operating segment. The Company currently operates only within the United States. Substantially, all of the Company's revenue generating operations have similar economic characteristics, including the nature of the products and services sold, the type and class of clients for products and services, the methods used to deliver products and services and regulatory environments.
F-24
12. Quarterly Results of Operations
The following is a summary of the quarterly results of operations for the years ended March 31, 2005, 2004, and 2003.
June 30

September 30

December 31

March 31(In thousands, except per share data)2005Net revenue

$
15,233


$
18,721


$
29,692


$
37,548Cost of products sold


11,417



12,405



18,696



21,728Cost of services provided


2,355



3,634



4,972



7,199Net income (loss)


(2,505
)


(836
)


(775
)


(3,565
)Net income (loss) per common share:Basic

$
(0.53
)

$
(0.16
)

$
(0.13
)

$
(0.53
)Diluted

$
(0.53
)

$
(0.16
)

$
(0.13
)

$
(0.53
)2004Net revenue

$
13,638


$
15,526


$
14,744


$
8,356Cost of products sold


8,039



11,021



10,005



8,692Cost of services provided


3,051



2,450



3,460



3,142Net income (loss)


37



(668
)


(1,446
)


(6,032
)Net income (loss) per common share:Basic

$
0.01


$
(0.14
)

$
(0.31
)

$
(1.28
)Diluted

$
0.01


$
(0.14
)

$
(0.31
)

$
(1.28
)2003Net revenue

$
15,430


$
14,634


$
14,188


$
11,204Cost of products sold


9,459



8,363



8,558



5,758Cost of services provided


3,579



3,457



3,175



3,061Net income (loss)


(438
)


41



(189
)


(625
)Net income (loss) per common share:Basic

$
(0.09
)

$
0.01


$
(0.04
)

$
(0.14
)Diluted

$
(0.09
)

$
0.01


$
(0.04
)

$
(0.14
)Earnings (loss) per common share calculations for each of the quarters were based on the weighted-average number of shares outstanding and the sum of the quarters may not necessarily be equal to the full year earnings per common share amount.
F-25
[LETTERHEAD OF SQUAR MILNER]
INDEPENDENT AUDITORS’ REPORT
To the StockholdersNETWORKCATALYST, INC.
We have audited the accompanying balance sheets of Network Catalyst, Inc. (the “Company”) as of June 30, 2004 and December 31, 2003, and the related statements of operations and accumulated deficit, and cash flows for the six month period ended June 30, 2004 and the year ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Network Catalyst, Inc. as of June 30, 2004 and December 31, 2003, and the results of its operations and cash flows for the six month period ended June 30, 2004 and the year ended December 31, 2003 in conformity with accounting principles generally accepted in the United States.
As discussed in Note 10, the Company sold substantially all of its assets to a publicly traded company on September 17, 2004.
/s/ Squar, Milner, Reehl & Williamson, LLP
July 30, 2004, except for the last paragraph of this report
   and Note 10 as to which the date is September 17, 2004
Newport Beach, California
F-26
NETWORK CATALYST, INC.BALANCE SHEETSJune 30, 2004 and December 31, 2003
June 30,
2004

December 31,
2003ASSETSCurrent assetsCash

$
—


$
327,924Accounts receivable, net


7,681,630



3,573,876Inventory, net


871,528



676,853Prepaid expenses


143,349



134,474Deferred costs


188,033



—8,884,540



4,713,127Advances to related parties


1,294,969



1,049,455Property and equipment, net


265,488



287,692Other assets


38,578



24,828$
10,483,575


$
6,075,102LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)Current liabilitiesBank overdraft

$
225,925


$
—Accounts payable


7,473,646



5,852,602Accrued expenses


587,013



226,817Advances from related party


200,000



—Deferred revenues


689,822



—9,176,406



6,079,419Commitments and contingenciesStockholders’ equity (deficit)Capital stock, 10,000,000 shares authorized, no par value, 9,043,438 shares issued and outstanding


23,150



23,150Additional paid-in capital


1,386,000



196,000Accumulated deficit


(101,981
)


(223,467
)1,307,169



(4,317
)$
10,483,575


$
6,075,102F-27
NETWORK CATALYST, INC.STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICITFor the Six Month Period Ended June 30, 2004 and
the Year Ended December 31, 2003
Six Months
Ended June 30,
2004

Year Ended
December 31,
2003Net Sales

$
13,746,973


$
31,891,897Cost of Sales


11,568,116



27,270,446Gross Profit


2,178,857



4,621,451Operating Expenses


1,827,876



4,382,383Income from Operations


350,981



239,068Interest Expense


139,495



310,936Net Income (loss)


211,486



(71,868
)Distributions to Stockholders


(90,000
)


(131,208
)Accumulated Deficit—Beginning of Period


(223,467
)


(20,391
)Accumulated Deficit—End of Period

$
(101,981
)

$
(223,467
)F-28
NETWORK CATALYST, INC.STATEMENT OF CASH FLOWSFor the Six Month Period Ended June 30, 2004 and
the Year Ended December 31, 2003
Six Months
Ended June 30,
2004

Year Ended
December 31,
2003Cash flows from operating activitiesNet income (loss)

$
211,486


$
(71,868
)Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:Depreciation and amortization


44,624



106,182Changes in operating assets and liabilities:Accounts receivable


(4,107,754
)


1,532,193Inventories


(194,675
)


424,891Prepaid expenses


(8,875
)


(37,015
)Deferred costs


(188,033
)


—Other assets


(13,750
)


28Bank overdraft


225,925



(161,118
)Accounts payable


1,621,044



1,116,268Accrued expenses


360,196



(123,056
)Deferred revenues


689,822



—Net cash (used in) provided by operating activities


(1,359,990
)


2,786,505Cash flows from investing activitiesPurchases of property and equipment


(22,420
)


(71,779
)Advances from related party


200,000



—Advances to related parties


(245,514
)


(367,810
)Net cash used in investing activities


(67,934
)


(439,589
)Cash flows from financing activitiesNet (repayments) borrowings on line-of-credit


—



(2,083,784
)Contributions from stockholders


1,190,000



196,000Distributions to stockholders


(90,000
)


(131,208
)Net cash provided by (used in) financing activities


1,100,000



(2,018,992
)Net (decrease) increase in cash


(327,924
)


327,924Cash—beginning of period


327,924



—Cash—end of period

$
—


$
327,924Supplemental disclosure of cash flow informationCash paid during the year for interest

$
139,495


$
310,936F-29
NETWORK CATALYST, INC.NOTES TO FINANCIAL STATEMENTS
1. Organization
Network Catalyst, Inc. (the “Company” ) was incorporated on March 11, 1991, and engages in computer network design, consulting, and implementation throughout the United States.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates made by management, among others, are the realization of inventories, the realization of long-lived assets, and the allowance for doubtful accounts. Actual results could differ from those estimates.
Concentrations of Credit Risk
The Company currently maintains substantially all of its day-to-day operating cash with one major financial institution. At times, cash balances may be in excess of amounts insured by the Federal Deposit Insurance Corporation.
The Company’s accounts receivable result primarily from sales to customers in California, Arizona and Massachusetts. The Company extends credit to customers based upon evaluation of each customer’s financial condition and credit history. The Company generally does not require collateral from customers.
At June 30, 2004 and December 31, 2003, one customer and three customers accounted for approximately 52% and 73% of gross accounts receivable, respectively. No other single customer accounted for more than 10% of gross accounts receivable at either balance sheet date. For the six months ended June 30, 2004 and the year ended December 31, 2003, two customers and one customer accounted for approximately 41% and 40% of net sales, respectively. No other single customer accounted for more than 10% of net sales for either reporting period. For the six month period ended June 30, 2004 and the year ended December 31, 2003, one vendor and another different vendor accounted for approximately 52% and 15% of total purchases, respectively. No other single vendor accounted for more than 10% of total purchases for
either reporting period.
Allowance for Doubtful Accounts
The Company performs periodic reviews of collectibility and provides an allowance for doubtful accounts receivable as management deems necessary. Management considers historical and industry trends in establishing such allowance. Management considers the allowance for doubtful accounts at June 30, 2004 and December 31, 2003 of approximately $2,000 to be adequate to provide for losses, which could be sustained in the realization of these accounts. Although the Company expects to collect net amounts due, actual collections may differ from these estimated amounts.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market, and consist primarily of computer networking equipment. Market is determined by comparison with recent sales or net realizable value. Such net realizable value is based on management’s forecasts for sales of the Company’s products in the ensuing years. The industry the Company operates in is characterized by technological change. Should the demand for the Company’s products prove to be significantly
F-30
NETWORK CATALYST, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
less than anticipated, the ultimate realizable value of the Company’s inventory could be substantially less than the amount in the accompanying balance sheet. The Company periodically reviews the age and turnover of its inventory to determine whether any inventory has become obsolete or has declined in value and records a charge to cost of revenues for known and estimated inventory obsolescence. At June 30, 2004, the allowance for obsolete inventory was approximately $100,000. There was no such obsolescence allowance at December 31, 2003.
Property and Equipment
Property and equipment are stated at cost. Major renewals and improvements are capitalized, while replacements, maintenance and repairs, which do not significantly improve the useful life of the asset, are expensed when incurred. Depreciation is provided over the estimated useful lives of the assets, which range from five to seven years, using accelerated methods. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the improvements or the lease term.
Revenue Recognition
The Company has four primary sources of revenue: (1) Sales of network hardware and third party developed software; (2) Network consulting revenue; (3) Third party maintenance contracts; and (4) Managed service maintenance contracts. The Company records revenue from sales of network hardware and third party developed software at the time the products are shipped. Network consulting revenue is recognized upon performance of the related consulting services. Revenue from third party maintenance contracts, in which the Company acts as an agent, is recognized at the time such contracts are sold. Managed service maintenance contract revenue is recognized on a straight-line basis over the related maintenance contract period, generally one year in duration. Incremental direct costs associated with acquisition
of the managed service maintenance contracts are also deferred and amortized over the contract period in accordance with Statement of Financial Accounting Standards No. 91 (“SFAS 91”) and FASB Technical Bulletin 90-1 (“FTB 90-1”). Deferred revenues and costs were approximately $690,000 and $188,000 at June 30, 2004, respectively. The Company did not engage in managed service maintenance contract activity prior to January 1, 2004.
Income Taxes
The Company has elected to be taxed as an “S” corporation for federal and state income tax purposes. Accordingly, the Company has not provided for federal income taxes, as the income tax liability is the responsibility of the individual shareholders. The Company is subject to California state income taxes at the rate of 1.5% of taxable income and, accordingly, a provision for such taxes has been included in the accompanying financial statements.
Long Lived Assets
The Company periodically evaluates the carrying value of its long-lived assets under the provisions of Statement of Financial Accounting Standards No. 144 ( “SFAS No. 144” ), “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires impairment losses to be recorded on long-lived assets used in operations, including amortizable intangible assets when indicators of impairment are present. Indicators of impairment include an economic downturn or a change in the assessment of future operations. In the event a condition is identified that may indicate an impairment issue, an assessment is performed using a variety of methodologies, including analysis of undiscounted future cash flows, estimates of
sales proceeds and independent appraisals. If such assets are impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the estimated fair market value
F-31
NETWORK CATALYST, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
of the assets. Assets to be disposed of are reported at the lower of the carrying value or estimated fair market value, less cost to sell. Based on management’s analysis, no such impairment charges existed or were deemed necessary during the six month period ended June 30, 2004 or the year ended December 31, 2003. There can be no assurance, however, that market conditions will not change or demand for the Company’s products or services will continue which could result in impairment of long-lived assets in the future.
Stock Options
The Company has one stock option plan and accounts for such plan under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. No stock-based compensation expense is reflected in the accompanying financial statements since all options were granted prior to 2002, vested immediately, and had an exercise price equal to or greater than the estimated fair market value of the underlying common stock on the date of grant. Accordingly, the disclosures required under SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure, an Amendment of FASB Statement No. 123”, are not applicable.
Significant Recent Accounting Pronouncements
SFAS No. 146, “Accounting for Costs Associated with Exit and Disposal Activities,” was issued in June 2002 and is effective for exit and disposal activities initiated after December 31, 2002. Management currently believes that such pronouncement will not have a material impact on the Company’s future financial statements.
In November 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, while the disclosure requirements became applicable in 2002. Management believes FIN No. 45 currently has no effect on the Company’s financial statements.
In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB 51.” The primary objectives of FIN No. 46 are to provide guidance on the identification of entities for which control is achieved through means other than voting rights (“variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity for which either: (1) the equity investors (if any) do not have a controlling financial interest; or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial
support from other parties. In addition, FIN No. 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. As amended in December 2003, the effective dates of FIN No. 46 for public entities that are small business issuers, as defined (“SBIs”), are as follows: (a) For interests in special-purpose entities: periods ended after December 15, 2003; and (b) For all other VIEs: periods ending after December 31, 2004. The December 2003 amendment of FIN No. 46 also includes transition provisions that govern how an SBI, which previously adopted the pronouncement (as it was originally issued), must account for consolidated VIEs. The Company is evaluating the effects of FIN No. 46 on its financial statements and currently believes the adoption of FIN No. 46
will not have a material impact.
In April 2003, the FASB issued SFAS No. 149, “Amendments of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting
F-32
NETWORK CATALYST, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. This pronouncement is effective for contracts entered into or modified after June 30, 2003 (with certain exceptions), and for hedging relationships designated after June 30, 2003. Management currently believes the adoption of SFAS No. 149 will not have a material impact on the Company’s financial statements.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and is effective (except for certain mandatorily redeemable non-controlling interests) for financial instruments entered into or modified after May 31, 2003. Management currently believes the adoption of SFAS No. 150 will not have a material impact on the Company’s financial statements.
3. Property and Equipment
Property and equipment consist of the following at June 30, 2004 and December 31, 2003:
June 30,
2004

December 31,
2003Furniture and fixtures

$
203,115


$
203,115Office and computer equipment


548,908



526,488Computer software


197,822



197,822Leasehold improvements


77,552



77,5521,027,397



1,004,977Accumulated depreciation and amortization


(761,909
)


(717,285
)$
265,488


$
287,6924. Line-of-Credit
During 2001, the Company entered into a credit facility agreement with Deutsche Financial Services (“DFS”) that was personally guaranteed by the stockholders. Under such agreement, as amended, a $3,000,000 accounts receivable facility (“AR Facility”) and an $8,000,000 inventory floor plan credit facility (“Inventory Facility”) were established. Under the AR Facility, the Company could borrow up to 80% of eligible accounts receivable, as defined. Under the Inventory Facility, the Company could borrow to purchase inventory from approved vendors or for other approved purposes. The principal amount outstanding under the AR Facility and the Inventory Facility, in the aggregate, may not exceed $8,000,000. Interest accrued at the prime rate, with a 6% floor, plus 1.25%. This credit facility
was secured by substantially all of the assets of the Company. Additionally, the Company could assign accounts receivable to DFS to borrow additional amounts. Such borrowings were under the same terms as the credit facility agreement above, with the exception that amounts borrowed were not part of the aforementioned $8,000,000 maximum.
Such line-of-credit was terminated and paid in full during April 2003.
5. Factoring Agreement
During April 2003, the Company entered into a financing agreement with a lender to transfer ownership of accounts receivable in exchange for cash (“factoring agreement”). Such agreement has been accounted for under SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a Replacement of FASB Statement No. 125,” as a factoring arrangement whereby the customer account receivable is considered transferred to the lender and removed from the Company’s books in exchange for cash, less a factoring fee of 0.4%
F-33
NETWORK CATALYST, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
to 0.5%. At June 30, 2004 and December 31, 2003, the amount of accounts receivable factored was approximately $777,000 and $3,261,000, respectively. Such balances also bear a finance charge under the factoring agreement of not less than 7.0% annually. Factoring fees have been recorded as interest expense in the accompanying financial statements.
The Company’s stockholders have personally guaranteed the lender against certain losses outside the ordinary course of business under this agreement.
Such agreement was terminated in July 2004.
6. Related Party Transactions
The Company periodically advances funds and receives repayments from its stockholders or their affiliate company, Network Catalyst Software, LLC. These advances are non-interest bearing, due on demand and are to be repaid as cash becomes available. At June 30, 2004 and December 31, 2003, such advances totaled $1,294,969 and $1,049,455, respectively. During the six months ended June 30, 2004 and the year ended December 31, 2003, the Company made additional advances of approximately $245,514 and $367,810, respectively. During the six month period ended June 30, 2004, one stockholder advanced $200,000 to the Company, which comprises advances from related party in the accompanying balance sheets. There were no repayments of advances by stockholders for either reporting period in the accompanying financial
statements.
During the six months ended June 30, 2004 and the year ended December 31, 2003, a stockholder contributed $1,190,000 and $196,000, respectively, to the Company as additional paid-in capital.
7. Commitments and Contingencies
The Company leases office space at several locations and various pieces of equipment under noncancelable operating leases which expire at various times through 2005.
At June 30, 2004, future minimum payments under these noncancelable operating leases are as follows for the years ending June 30:
2005

$
99,0002006


48,000$
147,000Rent expense for the six months ended June 30, 2004 and the year ended December 31, 2003 approximated $163,000 and $332,000, respectively.
8. Stock Option Plan
As discussed in Note 2, the Company has a nonqualified stock option plan (the “Plan”), which provides for the granting of options to employees, consultants, and nonemployee directors. A maximum of 1,000,000 shares of common stock may be issued under the Plan. The option price, number of shares and grant date are determined at the discretion of the Company’s board of directors. Grantees vest in the options at the option grant date. Options granted under the Plan are exercisable for a period not to exceed ten years from the option grant date. During the year ended December 31, 2003, there were 10,000 options granted under the Plan. There were no options granted during the six month period ended June 30, 2004. A total of 380,000 and 390,000 stock options were outstanding at June 30, 2004 and
December 31, 2003, respectively.
F-34
NETWORK CATALYST, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
Stock option activity and information is summarized as follows:
Number of
Shares

Weighted-
Average
Exercise PriceOptions outstanding and exercisable at December 31, 2002


420,000


$
0.42Granted


10,000


$
0.42Exercised


—



—Forfeited or expired


(40,000
)

$
0.42Options outstanding and exercisable at December 31, 2003


390,000


$
0.42Granted


—



—Exercised


—



—Forfeited or expired


(10,000
)

$
0.42Options outstanding and exercisable at June 30, 2004


380,000


$
0.42The weighted average remaining life of the options at June 30, 2004 was approximately 5 years. The pro-forma disclosure requirements under Statement of Financial Accounting Standards No. 123 (“SFAS 123”),Accounting for Stock Based Compensation, are not significant.
9. Employee Benefit Plan
The Company has a profit sharing plan for the purpose of establishing a salary deferral program under Section 401(k) of the Internal Revenue Code. During the six months ended June 30, 2004 and the year ended December 31, 2003, the Company made no matching or discretionary contributions to this plan.
10. Event Subsequent to the July 30, 2004 Date of the Independent Auditors’ Report (Unaudited)
On September 17, 2004 pursuant to an asset purchase agreement, the Company sold substantially all its assets to a publicly traded company known as MTM Technologies, Inc. (“MTM”), in exchange for cash, the assumption of certain Company liabilities, and the issuance of MTM restricted common stock.
F-35
INDEPENDENT AUDITOR’S REPORT
Board of Directors and ShareholdersVECTORGLOBALSERVICES, INC.
We have audited the accompanying consolidated balance sheet of Vector Global Services, Inc. (a Delaware corporation), and subsidiaries (the “Company”) as of September 30, 2004, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for the nine months then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2004 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vector Global Services, Inc., and subsidiaries as of September 30, 2004, and the results of their operations and their cash flows for the nine months then ended, in conformity with accounting principles generally accepted in the United States of America.
UHY LLP
New York, New York
November 5, 2004
F-36
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSeptember 30, 2004
September 30, 2004ASSETSCurrent assets:Cash and cash equivalents

$
5,199,010Accounts receivable, net of allowance for doubtful accounts for $197,887


8,477,732Inventory, net


538,333Prepaid expenses and other current assets


353,905Total current assets


14,568,980Property and equipment, net


841,930Goodwill


4,088,464Other assets


69,693Total assets


19,569,067LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent liabilitiesAccounts payable


4,995,078Accrued liabilities


1,329,369Deferred revenue


2,969,791Current portion of capital lease obligation


1,232Current portion of notes payable


22,485Total current liabilities


9,317,955Shareholders’ equityConvertible preferred stock, $0.01 par value; 30,000,000 shares authorized, 28,295,342 shares issued and outstanding at September 30, 2004


282,954Common stock, $0.01 par value; 40,000,000 shares authorized, 1,706,017 shares issued and outstanding at September 30, 2004


17,060Additional paid-in capital


59,957,208Common stock warrants


2,123,139Deferred stock compensation


(8,060
)Retained deficit


(52,121,189
)Total shareholders’ equity


10,251,112Total liabilities and shareholders’ equity

$
19,569,067See Notes to Financial Statements
F-37
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF OPERATIONSNine Months Ended September 30, 2004
September 30, 2004RevenueEquipment and software

$
27,944,481Services


11,716,959Commissions


526,458Total revenues


40,187,898ExpensesCost of equipment and software


23,785,271Cost of services


6,436,747Selling expenses


5,178,272General and administrative expenses


3,953,609Depreciation and amortization expense


531,935Total expenses


39,885,834Income from operations


302,064Interest income, net


24,205Other income, net


51,733Net income before taxes


378,002Income tax benefit


26,202Net income


404,204See Notes to Financial Statements
F-38
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITYNine Months Ended September 30, 2004
Preferred Stock

Common StockShares

Amount

Shares

Amount

Additional
Paid-in Capital

Common Stock
Warrants

Deferred
Compensation

Accumulated
Deficit

TotalBalance, December 31, 2003


28,295,342


$
282,954



1,706,017


$
17,060


$
59,957,208


$
2,123,139


$
(17,250
)

$
(52,525,393
)

$
9,837,718Amortization of deferred
stock compensation


























9,190







9,190Net Income






























404,204



404,204Balance, September 30, 2004


28,295,342


$
282,954



1,706,017


$
17,060


$
59,957,208



2,123,139


$
(8,060
)

$
(52,121,189
)

$
10,251,112F-39
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CASH FLOWSNine Months Ended September 30, 2004
September 30, 2004Cash flows from operating activitiesNet income

$
404,204Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


531,935Deferred stock compensation


9,190Changes in:Accounts receivable


(381,857
)Inventory


(409,450
)Other current assets


(1,120
)Other noncurrent assets


(21,844
)Accounts payable


232,149Other accrued liabilities


157,827Net cash provided by operating activities


521,034Cash flows from investing activitiesPurchase of property and equipment


(281,407
)Net cash used in investing activities


(281,407
)Cash flows from financing activitiesProceeds from issuing notes payable


66,896Repayment on notes payable


(44,411
)Repayment of capital lease obligation


(8,136
)Net cash provided by financing activities


14,349Net increase in cash


253,976Cash and cash equivalents, beginning of year


4,945,034Cash and cash equivalents, end of period

$
5,199,010See Notes to Financial Statements
F-40
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSSeptember 30, 2004
Note 1—Organization and Summary of Significant Accounting Policies
Organization
Vector Global Services, Inc., and subsidiaries (collectively, the “Company”) is a leading server-based computing integrator in the United States. The Company provides information system integration services and sells the related hardware and software products through its operating subsidiary, Vector ESP, Inc. The Company is in the initial stages of developing application and infrastructure management services. These services will encompass the management or hosting of both the applications and infrastructure on behalf of small and medium-sized enterprises. The Company was incorporated under the laws of the state of Delaware on March 3, 2000, and is headquartered in Houston, Texas.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Revenue Recognition
Revenue from the resale of computer hardware and software is recorded upon shipment or upon installation when required under contract terms. The related shipping and handling costs for delivery of hardware and software are included in cost of equipment and software on the accompanying consolidated statement of operations.
The Company also generates revenue from consulting services, implementation services, training, and postcontract support. Revenue from consulting and implementation services is recognized as the services are provided. Revenue from customer training and education is recognized at the date the services are performed. Revenue from postcontract support, consisting principally of help desk support, is recognized ratably over the period the support is provided.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consist principally of cash on deposit with a bank and money market accounts that are stated at cost, which approximates fair value.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, and accounts receivable. Sales to the Company’s customers are generally made on an open account. The Company performs initial and periodic credit evaluations of its significant customers and generally does not require collateral. Losses related to receivables have not been significant.
The Company maintains cash deposits in bank accounts that, at times, may exceed federally insured limits. The Company has not experienced losses in such accounts and does not currently believe it is exposed to any significant credit risk related to its cash and cash equivalents.
F-41
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)September 30, 2004
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, which include accounts receivable and accounts payable, approximate their fair values at September 30, 2004.
Inventory
Inventory, consisting of computer hardware and software held for resale, is recorded at the lower of cost or market. Cost is determined using the specific identification and first in, first-out methods.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the lease term.
Office furniture and equipment

5–10 yearsComputer equipment

3–5 yearsSoftware

3 yearsVehicles

5 yearsLeasehold improvements

1–5 yearsIncome Taxes
The Company accounts for its income taxes in accordance with the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees. Under APB Opinion No. 25, compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company’s stock and the exercise price. Deferred compensation is amortized and expensed in accordance with the graded vesting approach provided for in Financial Accounting Standards Board (“FASB”) Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. The Company accounts
for stock issued to nonemployees in accordance with the provisions of SFAS No. 123,Accounting for Stock-Based Compensation, and Emerging Issues Task Force Issue No. 96-18,Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, Goods or Services. The Company uses the Black-Scholes option pricing model to value options granted to nonemployees. The related expense is recorded over the period in which the related services are received.
The following table illustrates the effect on net income if the fair value recognition provisions of SFAS No. 123 had been applied to all outstanding and unvested awards:
Net income, as reported

$
404,204Deduct: Total stock-based employee compensation expense


47,608Pro forma net income

$
356,596F-42
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)September 30, 2004
Goodwill
Goodwill represents the excess of the aggregate purchase price paid by the Company in acquisitions accounted for as purchases over the fair value of the net tangible assets acquired. Prior to 2002, goodwill was amortized on a straight-line basis over 3 years. Effective January 1, 2002, the Company adopted SFAS No. 142, which requires companies to assess goodwill asset amounts for impairment each year, and more frequently if circumstances suggest an impairment may have occurred.
No impairment of goodwill has been recorded during the nine months ended September 30, 2004.
Reportable Segments
SFAS No. 131,Disclosures About Segments of an Enterprise and Related Information, establishes standards for disclosures about operating segments, products and services, geographical areas and major customers. The Company is organized and operates as one reportable segment, providing server-based computing services. The Company operates in one geographic area, the United States.
Note 2—Property and Equipment
The Company’s property and equipment was comprised of the following as of September 30, 2004:
Office furniture and equipment

$
491,399Computer equipment


2,079,285Software


1,112,041Vehicles


26,880Leasehold improvements


146,8383,856,443Less: accumulated depreciation


(3,014,513
)Property and equipment, net

$
841,930Note 3—Income Taxes
The Company files a consolidated federal income tax return, which includes the operations of the acquired companies for periods subsequent to their acquisitions.
The income tax benefit consists of a current state benefit of $26,202 for the period ended September 30, 2004.
The following table reconciles the differences between the statutory federal income tax rate (34%) and the effective tax rate for the years ended September 30, 2004:
September 30, 2004Tax Expense
(Benefit)

% of Pretax
IncomeTax benefit at U.S. statutory rate

$
128,521



34%Increase (decrease) in taxes resulting from:


—



—Nondeductible permanent differences


42,516



11%State taxes, net of federal taxes


—



—Valuation allowance


(197,239
)


(32%
)Income tax provision (benefit) effective rate

$
(26,202
)


(7%
)F-43
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)September 30, 2004
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The net deferred tax assets and liabilities at September 30, 2004, are comprised of the following:
September 30, 2004Deferred tax assets:Net operating loss carryforwards

$
5,071,968Intangible assets


3,728,033Accrued expenses


85,688Allowance for doubtful accounts


78,027Fixed assets


13,670Total deferred tax assets

$
8,977,386Deferred tax liabilities:Other


2,167Total net deferred tax assets


8,975,219Less: valuation allowance


(8,975,219
)Net deferred tax asset

$
—The Company has net operating loss carryforwards of $11,973,495 for federal income tax purposes at September 30, 2004, which, if not utilized, will expire in 2020 through 2024.
The Company has recorded a valuation allowance for the full amount of deferred tax assets in light of its operating loss since its inception and the uncertainty regarding the realization of the net deferred tax assets.
Note 4—Credit Facilities
Notes Payable
The Company has a note payable with a financial institution totaling $22,485 at September 30, 2004. The note bears interest at competitive market rates, requires monthly payments and matures in 2005. Interest expense totaled $812 for the period ended September 30, 2004.
Accounts Receivable Credit Arrangement
In February 2002, the Company entered into a purchase and sale agreement (the “Agreement”) with a bank which permits the Company to sell and/or assign trade receivables to the bank for financing purposes. Generally, the bank will advance 80% of the face amount of the receivable, and fund the remaining portion, net of financing fees, when the customer remits payment. As of September 30, 2004, the Company had no balance outstanding under the Agreement. If at any time there is an amount outstanding under the Agreement, such obligation would be secured by the assets of the Company. In addition, the Company would be required to repurchase any receivable which extends beyond 90 days from the date of sale or if any dispute arises with respect to the underlying receivable.
Note 5—Leases
The Company leases office space and computer equipment under noncancelable capital and operating leases with various expiration dates through 2016. The Company leases certain facilities at market rates from certain shareholders who are also employees of the Company. Certain of the operating leases for office space provide for escalating annual rent. Rent expense under operating
F-44
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)September 30, 2004
leases for the period ended September 30, 2004, was $600,598, which includes amounts to related parties of $151,332.
Future minimum lease payments under noncancelable capital and operating leases, together with the present value of the net minimum lease payments, as of September 30, 2004, are as follows:
Operating LeasesCapital
Leases

Related
Party

Third
Party

TotalYear Ending2005

$
1,503


$
112,780


$
528,122


$
640,9022006


—



97,100



568,617



665,7172007


—



—



489,927



489,9272008


—



—



187,624



187,6242009


—



—



144,648



144,648Thereafter


—



—



1,024,590



1,024,590Total


1,503


$
209,880


$
2,943,528


$
3,153,408Less: amount representing interest


(271
)Present value of net minimum lease


1,232Less: current maturities


(1,232
)Long-term portion

$
—Assets capitalized under capital leases totaled $76,164 at September 30, 2004. Accumulated amortization for assets capitalized under capital leases totaled $73,671. Amortization of leased assets is included in depreciation and amortization expense.
Note 6—Shareholders’ Equity
Preferred Stock
The Company currently has authorized for issuance an aggregate of 30,000,000 shares of $0.01 par value preferred stock. At September 30, 2004, the following table represents shares of each series of preferred stock, authorized and issued and outstanding:
Shares
Authorized

Shares
Issued and
OutstandingSeries A-1


6,380,001



6,380,001Series A-2


11,065,454



11,065,454Series B


5,066,667



5,066,667Series B-2


1,298,901



1,298,091Series B-3


2,887,369



2,887,369Series B-4


264,427



264,427Series C


1,333,333



1,333,333Unallocated shares


1,704,658



—30,000,000



28,295,342The holders of preferred stock have various rights and preferences as follows:
Voting—Each share of preferred stock has voting rights equal to an equivalent number of shares of common stock, into which it is convertible, and votes together as one class with the common stock subject to a Series A-1 and A-2 preferred stock class vote for certain actions. The Series A-1 and A-2 preferred stock voting as a single class, and excluding all other classes, has the right to elect four of seven members of the board of directors.
F-45
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)September 30, 2004
Dividends—Holders of Series A-1, A-2, B, B-2, B-3, and B-4 convertible preferred stock are entitled to receive noncumulative dividends in preference to holders of common stock and Series C preferred stock when and if declared by the board of directors based on the number of shares of common stock held on an as-if-converted basis. Holders of Series C convertible preferred stock are entitled to receive noncumulative dividends in preference to holders of common stock (but subordinate to holders of Series A-1, A-2, B, B-2, and B-3 preferred stock) when and if declared by the board of directors based on the number of shares of common stock held on an as-if-converted basis. No dividends on convertible preferred stock or common stock have been declared
by the board for the period ended September 30, 2004.
Liquidation—Upon any liquidation, dissolution or winding up of the Company, the holders of Series A-2 preferred stock pari passu with the holders of Series B-4 preferred stock, before any other class of stock, are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. Similarly, upon any liquidation, dissolution, or winding up of the Company, the holders of Series A-1, B, B-2, and B-3 preferred stock, before the holders of Series C preferred stock (but subordinate to Series A-2 and B-4 preferred stock), are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. Similarly, upon any liquidation, dissolution,
or winding up of the Company, the holders of Series C preferred stock, before the holders of common stock (but subordinate to Series A-1, A-2, B, B-2, B-3, and B-4 preferred stock), are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. At the option of the preferred shareholders, a liquidating event can include the following: any merger, consolidation, business combination, reorganization, or recapitalization of the Company in which the shareholders of the Company immediately prior to such transaction own less than 50% of the Company’s voting power immediately following the transaction.



| | Conversion—Each share of preferred stock is convertible, at the option of the holder, into the number of shares of common stock as determined by the then effective conversion ratio (1:1 as of September 30, 2004). Each share of preferred stock automatically converts into the number of shares of common stock into which such shares are convertible at the then-effective conversion ratio upon the closing of a public offering of common stock at a per share price of at least $8.25 per share with gross proceeds of at least $30,000,000.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Warrants to Purchase Common Stock

As of September 30, 2004, the Company has outstanding warrants to purchase 1,659,818 shares of common stock for $0.01 per share at any time up to the date of the closing of a public offering of common stock at a per share price of at least $8.25 per share with gross proceeds of at least $30,000,000. The warrants were recorded at their fair market value at the time of issuance.

The Company has reserved shares of common stock for issuance as follows at September 30, 2004:

| | Conversion of preferred stock                                  |  | $ | 28,295,342 | 
| | -------------------------------------------------------------- |  | - | ---------- | 
| | Outstanding common stock warrants                              |  |   | 1,659,818  | 
| | Outstanding common stock options                               |  |   | 1,667,632  | 
| | Shares available for grant under the 2000 stock incentive plan |  |   | 4,382,643  | 
| |                                                                |  |   |            | 
| |                                                                |  | $ | 36,005,435 | 
| |                                                                |  |   |            | 

F-46



---

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)September 30, 2004
Note 7—Stock Compensation Plans
2000 Stock Incentive Plan
Under the Company’s 2000 stock incentive plan (the “Plan”), the Company is authorized to issue up to 7,089,625 shares of common stock to directors, employees and consultants. The Plan provides for the issuance of stock purchase rights, restricted stock awards, incentive stock options, and nonstatutory stock options. Options granted generally expire 10 years after the grant date and vest ratably over a five-year period.
On August 28, 2000, the board of directors approved the issuance of 1,555,750 shares of restricted common stock to certain members of management, of which no shares were forfeited during 2004. The shares have a purchase price of $0.01 per share, are restricted from transfer and are subject to repurchase at $0.01 per share upon termination of employment. These restrictions lapse 20% per year on the anniversary date of the grant until fully vested. These shares of restricted common stock become fully vested upon the occurrence of a change of control (as defined in the Plan) or a qualified initial public offering (as defined in the agreement, as amended, pursuant to which the grants were issued). The Company recorded $1,151,255 of deferred compensation on September 30, 2000, for the difference between the purchase price of
the Company’s restricted stock under the Plan and the fair value of the underlying common stock at the time of the grant. Such amount has been presented as a reduction of shareholders’ equity and is being amortized over the vesting period. The Company has recognized no compensation (income) expense related to the amortization of the deferred compensation for these stock grants for the period ended September 30, 2004.
In November 2000, the Company sold 54,545 shares of Series B-2 convertible preferred stock to an employee in exchange for a note. The note provides for the annual forgiveness of 20% of the outstanding principal and related interest, provided the participant is currently employed. The note is secured by the Series B-2 convertible preferred stock. This transaction has been accounted for as a stock grant, and the related $149,999 of deferred compensation is being amortized ratably over the five-year term of the note. The Company has recognized $9,190 of compensation expense, (which is included in general and administrative expense) related to the amortization of the deferred compensation for this stock grant for the period ended September 30, 2004.
A summary of the activity under the Plan is as follows for the years ended September 30, 2004:
September 30, 2004Shares

AverageOutstanding at beginning of year


2,077,277



1.53Granted


—



—Canceled


(409,645
)


2.35Outstanding at end of period


1,667,632



1.33Options exercisable at end of period


562,301F-47

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)September 30, 2004
The following table summarizes information concerning currently outstanding and exercisable options as of September 30, 2004:
OptionsOutstanding

ExercisableExercise Price

Number
outstanding

Weighted
Average
Remaining
Contractual

Number
Exercisable
and Vested$0.10


890,463



8.73



178,093$1.50


20,500



5.72



16,400$2.75


531,240



6.37



258,144$2.85


225,429



6.79



109,6641,667,632







562,301The fair value of each option grant is estimated on the date of grant using the minimum value option pricing model with the following weighted average assumptions: no dividend yield for all periods, risk-free interest rate of 3.26% in 2003 and 4.74% in 2002, and an expected useful life of seven years.
Note 8—Employee Benefit Plan
Effective February 1, 2001, the Company formed a new 401(k) plan (the “401k Plan”) which is available to all full-time Company employees who have completed at least six months of service. Participants are permitted, in accordance with the provisions of Section 401(k) of the Internal Revenue Code, to contribute up to 19% of their earnings into the 401k Plan. The Company matches 50% of employees’ contributions not to exceed 6% of employees’ eligible compensation. The Company incurred $137,402 of expenses related to all defined contribution plans for the period ended September 30, 2004.
Note 9—Significant Event
On September 29, 2004, the Company entered into a Letter of Intent with a potential acquirer to sell all of the assets in operations of the Company for an amount in excess of the carrying amount of the Company’s assets.
F-48

REPORT OF INDEPENDENT AUDITORS
Board of Directors and ShareholdersVECTORGLOBALSERVICES, INC.
We have audited the accompanying consolidated balance sheets of Vector Global Services, Inc. (a Delaware corporation), and subsidiaries (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Vector Global Services, Inc., and subsidiaries at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
ERNST& YOUNGLLP
February 20, 2004
F-49

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS
December 31,2003

2002ASSETSCurrent assets:Cash and cash equivalents

$
4,945,034


$
4,027,612Accounts receivable, net of allowance for doubtful accounts of $288,860 and $273,358, respectively


8,095,875



8,032,358Inventory, net


128,883



467,887Federal income tax receivable


—



39,432Prepaid expenses and other current assets


352,785



293,464Total current assets


13,522,577



12,860,753Property and equipment, net


1,092,458



1,554,056Goodwill


4,088,464



4,178,133Other assets


47,849



54,250Total assets

$
18,751,348


$
18,647,192LIABILITIES AND SHAREHOLDERS' EQUITYCurrent liabilities:Accounts payable

$
4,762,929


$
3,281,554Accrued liabilities


1,522,518



1,560,366Deferred revenue


2,618,815



1,953,055Current portion of capital lease obligation


9,368



25,638Current portion of notes payable


—



3,450Total current liabilities


8,913,630



6,824,063Long-term liabilities:Capital lease obligations, less current portion


—



7,453Total liabilities


8,913,630



6,831,516Shareholders’ equity:Convertible preferred stock, $0.01 par value; 30,000,000 shares authorized, 28,295,342 shares issued and outstanding at December 31, 2003 and 2002


282,954



282,954Common stock, $0.01 par value; 40,000,000 shares authorized, 1,706,017 and 1,899,017 shares issued and outstanding at December 31, 2003 and 2002


17,060



18,990Additional paid-in capital


59,957,208



60,100,430Common stock warrants


2,123,139



2,123,139Deferred stock compensation


(17,250
)


(56,751
)Retained deficit


(52,525,393
)


(50,653,086
)Total shareholders’ equity


9,837,718



11,815,676Total liabilities and shareholders’ equity

$
18,751,348


$
18,647,192See accompanying notes.
F-50

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,2003

2002Revenue:Equipment and software

$
31,771,252


$
32,423,378Services


13,560,530



16,815,428Commissions


769,535



455,077Total revenues


46,101,317



49,693,883Expenses:Cost of equipment and software


26,772,515



27,553,000Cost of services


7,798,987



8,551,778Selling expenses


6,393,523



5,970,556General and administrative expenses


6,222,359



8,321,949Depreciation and amortization expense


916,441



895,541Noncash stock compensation


(103,321
)


(8,591
)Total expenses


48,000,504



51,284,233Loss from operations


(1,899,187
)


(1,590,350
)Interest income, net


24,795



26,060Other income, net


2,085



81,601Net loss before taxes


(1,872,307
)


(1,482,689
)Income tax provision


—



(15,813
)Net loss from continuing operations


(1,872,307
)


(1,498,502
)Loss from operations of discontinued business component
(net of income taxes of $-0-)


—



(1,103,972
)Net loss before cumulative effect of change in accounting principle


(1,872,307
)


(2,602,474
)Cumulative effect of change in accounting principle
(net of taxes of $-0-)


—



(27,671,227
)Net loss

$
(1,872,307
)

$
(30,273,701
)See accompanying notes.
F-51

VECTOR GLOBAL SERVICES, INC., AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Preferred Stock

Common StockShares

Amount

Shares

Amount

Additional
Paid-In
Capital

Common
Stock
Warrants

Preferred
Stock
Pending
Issuance

Deferred
Stock
Compensation

Subscriptions
Receivable

Retained
Deficit

TotalBalance, December 31, 2001 (unaudited)


27,562,232


$
275,623



2,222,417


$
22,224


$
58,257,714


$
2,123,139


$
2,089,363


$
(287,476
)

$
—


$
(20,379,385
)

$
42,101,202Issuance of Series B-3 and B-4 preferred stock on January 31, 2002


733,110



7,331



—



—



2,082,032



—



(2,089,363
)


—



—



—



—Forfeiture of common stock grants


—



—



(323,400
)


(3,234
)


(239,316
)


—



—



239,316



—



—



(3,234
)Amortization of deferred compensation


—



—



—



—



—



—



—



(8,591
)


—



—



(8,591
)Net loss


—



—



—



—



—



—



—



—



—



(30,273,701
)


(30,273,701
)Balance, December 31, 2002


28,295,342



282,954



1,899,017



18,990



60,100,430



2,123,139



—



(56,751
)


—



(50,653,086
)


11,815,676Forfeiture of common stock grants


—



—



(193,000
)


(1,930
)


(143,222
)


—



—



142,822



—



—



(2,330
)Amortization of deferred compensation


—



—



—



—



—



—



—



(103,321
)


—



—



(103,321
)Net loss


—



—



—



—



—



—



—



—



—



(1,872,307
)


(1,872,307
)Balance, December 31, 2003


28,295,342


$
282,954



1,706,017


$
17,060


$
59,957,208


$
2,123,139


$
—


$
(17,250
)

$
—


$
(52,525,393
)

$
9,837,718See accompanying notes.
F-52

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,2003

2002Operating activitiesNet loss

$
(1,872,307
)

$
(30,273,701
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


916,441



895,541Cumulative effect of accounting change


—



27,671,227Stock compensation


(103,321
)


(8,591
)Deferred income tax provision


—



293,112Changes in operating assets and liabilities, excluding effect of acquisitions:Accounts receivable


(65,847
)


(629,610
)Inventory


339,004



226,360Other current assets


(19,889
)


1,416,095Other noncurrent assets


6,401



(44,623
)Accounts payable


1,481,375



(519,816
)Other accrued liabilities


717,581



(513,127
)Net cash provided by (used in) operating activities


1,399,438



(1,487,133
)Investing activitiesPurchase of property and equipment


(454,843
)


(520,844
)Net cash used in investing activities


(454,843
)


(520,844
)Financing activitiesRepayment on notes payable


(3,450
)


(19,538
)Repayment of capital lease obligation


(23,723
)


(21,080
)Net cash used in financing activities


(27,173
)


(40,618
)Net increase (decrease) in cash


917,422



(2,048,595
)Cash and cash equivalents, beginning of year


4,027,612



6,076,207Cash and cash equivalents, end of year

$
4,945,034


$
4,027,612Supplemental disclosure of non-cash activities:Forgiveness of receivables to officers for forfeited stock grants

$
2,330


$
3,234Reduction of preacquisition contingencies

$
89,669


$
—See accompanying notes.
F-53

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2003
1. Organization and Summary of Significant Accounting Policies
Organization
Vector Global Services, Inc. and subsidiaries (collectively, the “Company”) is a leading information technology integrator in the United States focused on the secure deployment of network and application infrastructure. The Company provides information system integration services and sells the related hardware and software products through its operating subsidiary, Vector ESP, Inc. The Company was incorporated under the laws of the state of Delaware on March 3, 2000, and is headquartered in Houston, Texas.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consist principally of cash on deposit with a bank and money market accounts that are stated at cost, which approximates fair value.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, and accounts receivable. Sales to the Company’s customers, which are primarily located in the United States, are generally made on an open account. The Company performs initial and periodic credit evaluations of its significant customers and generally does not require collateral. Losses related to receivables have not been significant.
The Company maintains cash deposits in bank accounts that, at times, may exceed federally insured limits. The Company has not experienced losses in such accounts and does not currently believe it is exposed to any significant credit risk related to its cash and cash equivalents.
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, which include accounts receivable and accounts payable, approximate their fair values at December 31, 2003 and 2002.
Inventory
Inventory, consisting of computer hardware and software held for resale, is recorded at the lower of cost or market. Cost is determined using the specific identification and first-in, first-out methods.
F-54

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the lease term.
Office furniture and equipment

5–7 yearsComputer equipment

3–5 yearsSoftware

3 yearsVehicles

5 yearsLeasehold improvements

1–5 yearsIncome Taxes
The Company accounts for its income taxes in accordance with the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Revenue Recognition
Revenue from the resale of computer hardware and software is recorded upon shipment or upon installation when required under contract terms. The related shipping and handling costs for delivery of hardware and software are included in cost of equipment and software on the accompanying consolidated statements of operations.
The Company also generates revenue from consulting services, implementation services, training, and postcontract support. Revenue from consulting and implementation services is recognized as the services are provided. Revenue from customer training and education is recognized at the date the services are performed. Revenue from postcontract support, i.e., telephone support, is recognized ratably over the period the support is provided.
Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees. Under APB Opinion No. 25, compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company’s stock and the exercise price. Deferred compensation is amortized and expensed in accordance with the graded vesting approach provided for in Financial Accounting Standards Board (“FASB”) Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. The Company accounts
for stock issued to nonemployees in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123,Accounting for Stock-Based Compensation, and Emerging Issues Task Force Issue No. 96-18,Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, Goods or Services. The Company uses the Black-Scholes option pricing model to value options granted to nonemployees. The related expense is recorded over the period in which the related services are received.
F-55

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
The following table illustrates the effect on net loss if the fair value recognition provisions of SFAS No. 123 had been applied to all outstanding and unvested awards in each period:
Year Ended December 31,2003

2002Net loss, as reported

$
(1,872,307
)

$
(30,273,701
)Deduct: total stock-based employee compensation expense determined under fair value based method for all awards


227,236



(276,487
)Pro forma net loss

$
(1,645,071
)

$
(30,550,188
)Impairment of Long-Lived Assets
Long-lived assets and certain identifiable intangible assets to be held and used are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the assets, the assets are written down to their estimated fair values.
Goodwill
Goodwill represents the excess of the aggregate purchase price paid by the Company in acquisitions accounted for as purchases over the fair value of the net tangible assets acquired. Prior to 2002, goodwill was amortized on a straight-line basis over three years. As further discussed in Note 3, effective January 1, 2002, goodwill is no longer subject to scheduled amortization, but is subjected to an annual impairment test. There was no impairment of goodwill in 2003.
Reportable Segments
SFAS No. 131,Disclosures About Segments of an Enterprise and Related Information, establishes standards for disclosures about operating segments, products and services, geographical areas and major customers. The Company is organized and operates as one reportable segment, providing server-based computing services. The Company operates in one geographic area, the United States.
Recent Accounting Pronouncements
In November 2002, the FASB issued Interpretation (“FIN”) No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 elaborates on the existing disclosure requirements for most guarantees, including residual value guarantees issued in conjunction with operating lease agreements. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value of the obligation it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements were effective for financial statements of annual periods ending after December 15, 2002. The adoption of FIN No. 45 did not have a material impact on the results of the Company’s operations and financial position.
In June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated With Exit or Disposal Activities, which addresses accounting for restructuring, discontinued operation, plant
F-56

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
closing, or other exit or disposal activity. SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of SFAS No. 146 did not have an impact on the Company’s financial position and results of operations.
In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation—Transition and Disclosure. This statement amends SFAS No. 123,Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has elected to continue to follow the intrinsic
value method of accounting as prescribed by APB Opinion No. 25,Accounting for Stock Issued to Employees, to account for employee stock options. The additional disclosures required under SFAS No. 148 are effective for fiscal years ending after December 15, 2002, and have been provided in Note 1.
In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables. This consensus requires that revenue arrangements with multiple deliverables be divided into separate units of accounting if the delivered items have value to the customer on a standalone basis, there is objective and reliable evidence of fair value of the undelivered items and, if the arrangement includes a general right of return, performance of the undelivered item is considered probable and substantially in the Company’s control. The final consensus is applicable to agreements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21
did not have a material impact on the Company’s financial statements.
2. Property and Equipment
The Company’s property and equipment was comprised of the following as of December 31:
2003

2002Office furniture and equipment

$
467,388


$
456,470Computer equipment


1,972,980



1,790,751Software


997,635



738,889Vehicles


27,130



23,636Leasehold improvements


109,903



106,4233,575,036



3,116,169Less: accumulated depreciation


(2,482,578
)


(1,562,113
)Property and equipment, net

$
1,092,458


$
1,554,0563. Goodwill
Effective January 1, 2002, the Company adopted SFAS No. 142, which requires companies to assess goodwill asset amounts for impairment each year, and more frequently if circumstances suggest an impairment may have occurred. In addition to discontinuing the regular charge, or amortization, of goodwill against income, the new standard also introduces more rigorous criteria for determining how much goodwill should be reflected as an asset in a company’s balance sheet.
To perform the transitional impairment testing required by SFAS No. 142 under its new, more rigorous impairment criteria, the Company broke its operations into “reporting units,” as prescribed by the new standard, and tested each of these reporting units for impairment by comparing the unit’s fair value to its carrying value. The fair value of each reporting unit was
F-57

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
estimated using a discounted cash flow model combined with market valuation approaches. Significant estimates and assumptions were used in assessing the fair value of reporting units. These estimates and assumptions involved future cash flows, growth rates, discount rates, weighted-average cost of capital, and estimates of market valuations for each of the reporting units.
As provided by SFAS No. 142, the transitional impairment loss identified by applying the standard’s new, more rigorous valuation methodology upon initial adoption of the standard was reflected as a cumulative effect of a change in accounting principle in the Company’s statement of operations. The resulting non-cash charge was $27,671,227.
The changes in the carrying amount of goodwill for the year ended December 31, 2003 and 2002 are as follows:
2003

2002Goodwill balance as of January 1

$
4,178,133


$
31,780,514
(a)Adjustments to preliminary purchase price allocation


(89,669
)


80,811Impairment adjustment


—



(27,671,227
)Goodwill related to discontinuation of operations


—



(11,965
)Goodwill balance as of

$
4,088,464


$
4,178,133
(a)

A portion of this goodwill balance is included in assets related to discontinued operations in the Company’s consolidated balance sheet.4. Income Taxes
The Company will file a consolidated federal income tax return which includes the operations of the acquired companies for periods subsequent to their acquisitions.
The income tax provision consists of the following for the years ended December 31, 2003 and 2002:
2003

2002Current:Federal

$
—


$
13,753State


—



2,060Deferred:Federal


—



—State


—



—$
—


$
15,813The following table reconciles the differences between the statutory federal income tax rate (34%) and the effective tax rate for the years ended December 31:
2003

2002Tax Expense
(Benefit)

Percent of
Pretax Loss

Tax Expense
(Benefit)

Percent of
Pretax LossTax benefit at U.S. statutory rate

$
(636,584
)


(34
)%

$
(504,114
)


(34
)%Increase (decrease) in taxes resulting from:Nondeductible permanent differences


(10,681
)


(1
)


28,933



2State taxes, net of federal taxes


—



—



2,140



—Valuation allowance


647,265



35



488,854



33Income tax provision effective rate

$
—



—
%

$
15,813



1
%F-58

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The net deferred tax assets and liabilities at December 21, 2003 and 2002, are comprised of the following:
2003

2002Deferred tax assets:Net operating loss carryforwards

$
4,983,205


$
3,740,273Intangible assets


4,016,225



4,429,057Accrued expenses


120,931



210,910Deferred revenue


—



34,058Allowance for doubtful accounts


113,897



107,785Total deferred tax assets


9,234,258



8,522,083Deferred tax liabilities:Fixed assets


59,633



11,595Other


2,167



330Total deferred tax liabilities


61,800



11,925Less: valuation allowance


9,172,458



8,510,158Net deferred tax asset

$
—


$
—The Company had federal and state net operating loss carryovers for income tax purposes of $11,712,424 and $12,177,375 at December 31, 2003, respectively, which, if not utilized, the federal net operating loss carryovers will expire in 2020 through 2023.
The Company has recorded a valuation allowance for the full amount of deferred tax assets in light of its operating loss since its inception and the uncertainty regarding the realization of the net deferred tax assets.
5. Credit Facilities
Accounts Receivable Credit Arrangement
In February 2002, the Company entered into a purchase and sale agreement (the “Agreement”) with a bank which permits the Company to sell and/or assign trade receivables to the bank for financing purposes. Generally, the bank will advance 80% of the face amount of the receivable up to $10.0 million, and fund the remaining portion, net of financing fees, when the customer remits payment. As of December 31, 2003 and 2002, the Company had $-0- outstanding under the Agreement. If at any time there is an amount outstanding under the Agreement, such obligation would be secured by the assets of the Company. In addition, the Company would be required to repurchase any receivable which extends beyond 90 days from the date of sale or if any dispute arises with respect to the underlying receivable. Interest and financing
fees totaled $1,224 in 2003 and $1,829 in 2002.
6. Leases
The Company leases office space and computer equipment under noncancelable capital and operating leases with various expiration dates through 2016. The Company leases certain facilities at market rates from the former owners of acquired companies, who are shareholders of and continue to be employed by the Company. Certain of the operating leases for office space provide for escalating yearly rent. Rent expense under operating leases for the years ended December 31,
F-59

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
2003 and 2002, was $1,074,272 and $1,068,345, respectively, which includes amounts to related parties of $219,530 and $237,088, respectively.
Future minimum lease payments under noncancelable capital and operating leases, together with the present value of the net minimum lease payments, as of December 31, 2003, are as follows:
Operating LeasesCapital
Leases

Related
Party

Third
Party

TotalYear ending:2004

$
9,774


$
109,519


$
319,564


$
429,0832005


—



114,112



292,002



406,1142006


—



67,970



292,136



360,1062007


—



—



194,603



194,6032008


—



—



144,648



144,648Thereafter


—



—



1,133,076



1,133,076Total


9,774


$
291,601


$
2,376,029


$
2,667,630Less: amount representing interest


(406
)Present value of net minimum lease payments


9,368Less: current maturities


(9,368
)Long-term portion

$
—Assets capitalized under capital leases totaled $78,577 at December 31, 2003 and 2002. Accumulated amortization for assets capitalized under capital leases totaled $66,357 and $43,205 at December 31, 2003 and 2002, respectively. Amortization of leased assets is included in depreciation and amortization expense.
7. Shareholders’ Equity
Preferred Stock
The Company currently has authorized for issuance an aggregate of 30,000,000 shares of $0.01 par value preferred stock. At December 31, 2003, the following numbers of shares of each series of preferred stock were authorized and were issued and outstanding:
Shares
Authorized

Shares Issued
and
OutstandingSeries A-1


6,380,001



6,380,001Series A-2


11,065,454



11,065,454Series B


5,066,667



5,066,667Series B-2


1,298,091



1,298,091Series B-3


2,887,369



2,887,369Series B-4


264,427



264,427Series C


1,333,333



1,333,333Unallocated shares


1,704,658



—30,000,000



28,295,342The holders of preferred stock have various rights and preferences as follows:
F-60

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
a.Voting—Each share of preferred stock has voting rights equal to an equivalent number of shares of common stock, into which it is convertible, and votes together as one class with the common stock subject to a Series A-1 and A-2 preferred stock class vote for certain actions. The Series A-1 and A-2 preferred stock voting as a single class, and excluding all other classes, has the right to elect four of seven members of the board of directors.b.Dividends—Holders of Series A-1, A-2, B, B-2, B-3, and B-4 convertible preferred stock are entitled to receive noncumulative dividends in preference to holders of common stock and Series C preferred stock when and if declared by the board of directors based on the number of shares of common stock held on an as-if-converted basis. Holders of Series C convertible preferred stock are entitled to receive noncumulative dividends in preference to holders of common stock (but subordinate to holders of Series A-1, A-2, B, B-2, B-3, and B-4 preferred stock) when and if declared by the board of directors based on the number of shares of common stock held on an as-if converted basis. No dividends
on convertible preferred stock or common stock have been declared by the board for the years ended December 31, 2003 and 2002.c.Liquidation—Upon any liquidation, dissolution, or winding up of the Company, the holders of Series A-2 preferred stock pari passu with the holders of Series B-4 preferred stock, before any other class of stock, are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. Similarly, upon any liquidation, dissolution, or winding up of the Company, the holders of Series A-1, B, B-2, and B-3 preferred stock, before the holders of Series C preferred stock (but subordinate to Series A-2 and B-4 preferred stock), are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but
unpaid dividends. Similarly, upon any liquidation, dissolution, or winding up of the Company, the holders of Series C preferred stock, before the holders of common stock (but subordinate to Series A-1, A-2, B, B-2, B-3, and B-4 preferred stock), are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. At the option of the preferred shareholders, a liquidating event can include the following: any merger, consolidation, business combination, reorganization, or recapitalization of the Company in which the shareholders of the Company immediately prior to such transaction own less than 50% of the Company’s voting power immediately following the transaction.d.Conversion—Each share of preferred stock is convertible, at the option of the holder, into the number of shares of common stock as determined by the then-effective conversion ratio (1:1 as of December 31, 2003). Each share of preferred stock automatically converts into the number of shares of common stock into which such shares are convertible at the then-effective conversion ratio upon the closing of a public offering of common stock at a per share price of at least $8.25 per share with gross proceeds of at least $30,000,000.Warrants to Purchase Common Stock
As of December 31, 2003, the Company has outstanding warrants to purchase 1,659,818 shares of common stock for $0.01 per share at any time up to the date of the closing of a public offering of common stock at a per share price of at least $8.25 per share with gross proceeds of at least $30,000,000. The warrants were recorded at their fair market value at the time of issuance.
F-61

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
Shares Reserved for Future Issuance
The Company has reserved shares of common stock for issuance as follows at December 31, 2003:
Conversion of preferred stock


28,295,342Outstanding common stock warrants


1,659,818Outstanding common stock options


2,077,277Shares available for grant under the 2000 stock incentive plan


3,972,99836,005,4358. Stock Compensation Plans
2000 Stock Incentive Plan
Under the Company’s 2000 stock incentive plan (the “Plan”), the Company is authorized to issue up to 7,089,625 shares of common stock to directors, employees and consultants. The Plan 8. Stock Compensation Plans provides for the issuance of stock purchase rights, restricted stock awards, incentive stock options, and nonstatutory stock options. Options granted generally expire ten years after the grant date and vest ratably over a five-year period.
On August 28, 2000, the board of directors approved the issuance of 1,555,750 shares of restricted common stock to certain members of management. The shares have a purchase price of $0.01 per share, are restricted from transfer and are subject to repurchase at $0.01 per share upon termination of employment. These restrictions lapse 20% per year on the anniversary date of the grant until fully vested. These shares of restricted common stock become fully vested upon the occurrence of a change of control (as defined in the Plan) or a qualified initial public offering (as defined in the agreement, as amended, pursuant to which the grants were issued). The Company recorded $1,151,255 of deferred compensation on December 31, 2000, for the difference between the purchase price of the Company’s restricted stock under
the Plan and the fair value of the underlying common stock at the time of the grant. Such amount has been presented as a reduction of shareholders’ equity and is being amortized over the vesting period. During 2003 and 2002, respectively, 193,000 and 323,400 shares of the restricted stock grants were forfeited. The Company has recognized $125,152 and $44,591 of compensation income related to the amortization of the deferred compensation for these stock grants for the years ended December 31, 2003 and 2002, respectively, as a result of the difference in the vesting period of the options compared to the amount of compensation expense previously recognized using the graded vesting approach of FASB Interpretation No. 28 (see Note 1).
In November 2000, the Company sold 54,545 shares of Series B-2 convertible preferred stock to an employee in exchange for a note. The note provides for the annual forgiveness of 20% of the outstanding principal and related interest, provided that employment is continuing. The note is secured by the Series B-2 convertible preferred stock. This transaction has been accounted for as a stock grant, and the related $149,999 of deferred compensation is being amortized ratably over the five-year term of the note. The Company has recognized $21,831 and $36,000 of compensation expense related to the amortization of the deferred compensation for this stock grant for the years ended December 31, 2003 and 2002, respectively.
F-62

VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)December 31, 2003
A summary of the activity under the Plan is as follows for the years ended December 31, 2003 and 2002:
2003

2002Number of
Shares

Weighted-
Average
Exercise
Price

Number of
Shares

Weighted-
Average
Exercise
PriceOutstanding at beginning of year:


2,437,662


$
2.75



3,484,117


$
2.76Granted


1,132,793



0.10



300,000



2.85Canceled


(1,493,178
)


2.44



(1,346,455
)


2.79Outstanding at end of year


2,077,277



1.53



2,437,662



2.75Options exercisable at end of year


437,148







523,414The following table summarizes information concerning currently outstanding and exercisable options as of December 31, 2003:
Options Outstanding

Options
ExercisableExercise Price

Number
Outstanding

Weighted-
Average
Remaining
Contractual
Life

Number
Exercisable
and Vested$0.10


954,547



9.48



—1.50


34,000



6.47



20,4002.75


651,560



7.12



200,0242.85


437,170



7.55



216,7242,077,277







437,148The weighted-average fair value of the options granted at grant date was $0.02 and $0.80 per share for 2003 and 2002, respectively. The exercise price for all of the options granted in 2003 and 2002 was equal to the estimated fair value of the underlying common stock. The fair value of each option grant is estimated on the date of grant using the minimum value option pricing model with the following weighted-average assumptions: no dividend yield for all periods, risk-free interest rate of 3.36% in 2003 and 4.74% in 2002, and an expected useful life of seven years.
9. Employee Benefit Plan
The Company has a 401(k) plan (the “401k Plan”) which is available to all full-time Company employees who have completed at least six months of service. Participants are permitted, in accordance with the provisions of Section 401(k) of the Internal Revenue Code, to contribute up to 60% of their earnings into the 401k Plan. The Company matches 50% of employees’ contributions not to exceed 6% of employees’ eligible compensation. The contribution plans for the years ended December 31, 2003 and 2002, respectively.
10. Discontinued Operations
On May 30, 2002, due to poor operating performance, the Company decided to discontinue operations in Philadelphia. The assets and liabilities primarily As of December 31, 2002, the Company had liquidated all assets and liabilities for the Philadelphia operations. Due to the nature of the assets and their recent acquisition, the liquidation value on disposal approximated their carrying value. The revenues and pre-tax loss for the discontinued operations were as follows for the year ended December 31, 2002:
2002Revenue

$
1,420,072Pre-tax loss

$
(1,103,972
)Included in the 2002 pretax loss from operations was approximately $11,965 of goodwill that has been written off.
F-63

INDEPENDENT AUDITORS' REPORT
To the Board of DirectorsINFOSYSTEMS, INC.
We have audited the accompanying balance sheet of Info Systems, Inc. as of December 31, 2004 and 2003, and the related statements of operations, changes in stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Info Systems, Inc. as of December 31, 2004 and 2003, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
GUNNIP& COMPANYLLP
Wilmington, Delaware
March 17, 2005
F-64

INFO SYSTEMS, INC.BALANCE SHEETDecember 31, 2004 and 2003
2004

2003ASSETSCurrent assetsCash

$
586,869


$
1,076Accounts receivableTrade, net of allowance for doubtful accounts of $325,004 and $379,307 in 2004 and 2003, respectively


8,761,574



8,637,907Inventories


427,258



745,888Prepaid expenses and other current assets


244,986



94,751Deferred income taxes


166,462



306,869Income taxes receivable


0



7,059Total current assets


10,187,149



9,793,550Amounts due from shareholders


102,593



95,565Property and equipment, net


361,845



391,427Goodwill


286,246



286,246Other assets


12,165



16,083$
10,949,998


$
10,582,871LIABILITIESCurrent liabilitiesLine of credit

$
0


$
56,584Accounts payable—trade


6,154,166



6,355,272Accrued expenses


1,845,734



1,635,275Customer deposits


10,750



14,525Deferred revenue


493,157



594,264Current portion of notes payable


220,371



202,858Income taxes payable


174,378



0Total current liabilities


8,898,556



8,858,778Long-term liabilitiesNotes payable, less current portion


460,510



630,290Total liabilities


9,359,066



9,489,068STOCKHOLDERS' EQUITYCommon stock, no par value


5,105



5,105Preferred stock, $1,000 par value


600,000



600,000Paid-in capital


85,907



85,907Retained earnings


1,811,920



1,314,791Treasury stock, at cost


(912,000
)


(912,000
)Total stockholders' equity


1,590,932



1,093,803$
10,949,998


$
10,582,871See accompanying notes to financial statements.
F-65

INFO SYSTEMS, INC.STATEMENT OF OPERATIONSFor the Years Ended December 31, 2004 and 2003
2004

2003RevenuesService, net

$
19,636,055


$
16,809,559Product, net


38,723,906



40,546,270Total


58,359,961



57,355,829Cost of sales


46,474,060



46,737,412Gross profit from sales


11,885,901



10,618,417Operating expensesCompensation and related benefits


6,755,982



6,608,715General and administrative


2,417,488



2,280,401Sales and marketing


1,613,914



1,485,703Depreciation and amortization


185,853



295,855Total operating expenses


10,973,237



10,670,674Income (loss) from operations


912,664



(52,257
)Interest expense


(56,922
)


(37,120
)Income (loss) before income taxes


855,742



(89,377
)Provision for income taxes


358,613



49,134Net income (loss)

$
497,129


$
(138,511
)See accompanying notes to financial statements.
F-66

INFO SYSTEMS, INC.STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITYFor the Years Ended December 31, 2004 and 2003
Common Stock
No Par Value
100 Shares Authorized
100 Shares Issued,
75 Shares Outstanding

Preferred Stock
$1,000 Par Value
1,500 Shares Authorized

Treasury StockShares

Amount

Shares

Amount

Shares

Amount

Additional
Paid-In
Capital

Retained
Earnings

Stockholders’
EquityBalance, December 31, 2002


75.000


$
5,105



600


$
600,000



25.000


$
(912,000
)

$
85,907


$
1,453,302


$
1,232,314Net Loss






























(138,511
)


(138,511
)Balance, December 31, 2003


75.000



5,105



600



600,000



25.000



(912,000
)


85,907



1,314,791



1,093,803Net Income






























497,129



497,129Balance, December 31, 2004


75.000


$
5,105



600


$
600,000



25.000


$
(912,000
)

$
85,907


$
1,811,920


$
1,590,932See accompanying notes to financial statements.
F-67

INFO SYSTEMS, INC.STATEMENT OF CASH FLOWSFor the Years Ended December 31, 2004 and 2003
2004

2003Operating activitiesNet income (loss)

$
497,129


$
(138,511
)Noncash items included in net income (loss)Depreciation and amortization


185,853



295,855Provision for losses on accounts receivable


(54,303
)


7,541Deferred income taxes


140,407



(6,010
)Net change in accounts receivable


(69,364
)


(2,144,346
)Net change in inventories


318,630



135,389Net change in other current assets, net


(150,204
)


317,830Net change in other assets


3,918



2,273Net change in accounts payable


(201,106
)


2,471,833Net change in deferred revenue


(101,107
)


(239,443
)Net change in accrued expenses


381,062



(92,011
)Loss from sale of equipment


3,244



6,428Net cash flow from operating activities


954,159



616,828Investing activitiesPurchases of property and equipment


(47,060
)


(97,561
)Net cash flow used by investing activities


(47,060
)


(97,561
)Financing activitiesNet repayments under line of credit agreement


(56,584
)


(874,772
)Principal payments on capital leases obligations


0



(28,153
)Principal payments on notes payable


(264,722
)


(197,818
)Net cash flow used by financing activities


(321,306
)


(1,100,743
)Net change in cash


585,793



(581,476
)Cash, beginning of year


1,076



582,552Cash, end of year

$
586,869


$
1,076Cash paid forInterest

$
56,922


$
75,129Income taxes

$
35,800


$
3,000Schedule of noncash investing and financing activitiesPurchase of property and equipment financed by notes payable

$
112,455


$
39,467Repayment of debt through trade-in of property and equipment

$
0


$
17,530See accompanying notes to financial statements.
F-68

INFO SYSTEMS, INC.NOTES TO FINANCIAL STATEMENTS
Note 1. Summary of Company activities and significant accounting policies
Company Activities
Info Systems, Inc. (“the Company”) is an information technology management and consulting company. The business is to assess, design, integrate and manage technologies and resources that relate directly to the way voice, data, and video are distributed, stored, managed, and secured. Offerings include consulting, infrastructure solutions, managed services, staffing augmentation and telecommunications, as well as related equipment sales. The Company has offices located in Delaware, Pennsylvania and Maryland.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method. Inventories principally consist of computer hardware and software for resale, and computer parts and supplies. Inventories are stated net of an allowance for obsolete inventory of $40,512 and $53,529 in 2004 and 2003, respectively.
Property and Equipment
Property and equipment is recorded at cost. Depreciation, which includes amortization of assets under capital leases, is provided using a straight-line method over the estimated useful lives of the respective assets which are generally three to seven years.
Renewals and improvements are capitalized. Normal maintenance and repairs are charged to income as incurred.
Concentrations of Credit Risk and Major Customer
Credit Risk
Financial instruments which potentially subject the Company to significant concentrations of credit risk are principally cash and accounts receivable.
Cash deposits are maintained in a highly rated financial institution within the Company’s operating area. Management continually monitors the financial strength of the institution to minimize its risk. The maximum loss that would have resulted from that risk totaled $991,750 at December 31, 2004 and $0 at December 31, 2003, representing the excess of the deposit liabilities reported by the institution over the amounts that would have been covered by federal insurance.
Accounts receivable represent unsecured credit sales. Economic conditions in this industry have a direct effect on the Company’s operations. The collectibility of these accounts is periodically reviewed by management, and an allowance for doubtful accounts is maintained.
Major Customer
Financial instruments that potentially subject the Company to credit risk consist principally of accounts receivable. The Company performs ongoing credit evaluations of its customers and
F-69

INFO SYSTEMS, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
generally does not require collateral. Revenues to one customer represented 22% of total revenues during 2004 and one customer represented 22% of total revenues during 2003. Accounts receivable from the customer represented 6% of the accounts receivable balance at December 31, 2004 and accounts receivable from the customer represented 15% of the accounts receivable balance at December 31, 2003.
Revenue Recognition
Revenue from sales of computer equipment and related software products is recognized upon shipment. Revenue from service contracts is recognized over the term of the respective contracts. Revenue from design and installation projects, which are usually of short-term duration, is recognized upon completion of the installation. Revenue from staff augmentation and consulting projects is recognized during the period the project is performed. Included in deferred revenue are amounts billed and received on staff augmentation, telecommunications and consulting projects which will be earned in subsequent periods. Deferred revenue also represents the unamortized portion of service contract revenue also recognized ratably over the term of the contract.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense was $62,464 and $23,657 during the years ended December 31, 2004 and 2003, respectively.
Impairment of Goodwill
In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. In accordance with FAS No. 142,Goodwill and Other Intangible Assets, goodwill cannot be amortized, however, it must be tested annually for impairment. This impairment test is calculated at the operating unit level. The goodwill impairment test has two steps. The first identifies potential impairments by comparing the fair value of an operating unit with its book value, including goodwill. If the fair value of the operating unit exceeds the carrying amount, goodwill is not impaired and
the second step is not necessary. If the carrying value exceeds the fair value, the second step calculates the possible impairment loss by comparing the implied fair value of goodwill with the carrying amount. If the implied goodwill is less than the carrying amount, a write-down is recorded.
Based on the impairment tests performed, the value of goodwill recorded was deemed not impaired at December 31, 2004 and 2003.
Note 2. Amounts Due from Shareholders
Amounts due from shareholders represent unsecured, non-interest bearing advances, and are due on demand. Outstanding advances totaled $102,593 at December 31, 2004 ($95,565 in 2003).
F-70

INFO SYSTEMS, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
Note 3. Property and Equipment
Property and equipment consist of the following:
2004

2003Office equipment

$
700,400


$
2,114,220Software


465,103



475,543Vehicles


373,073



378,055Leasehold improvements


306,406



330,508Machinery and equipment


11,200



11,2001,856,182



3,309,526Less accumulated depreciation and amortization


1,494,337



2,918,099$
361,845


$
391,427Note 4. Short-term Borrowings
The Company has a credit facility with its bank that is effective through September 2005 and is renewable annually. This credit facility, as amended, has a maximum borrowing availability of $12,000,000. At December 31, 2004 and 2003, there were $0 and $56,584 outstanding on this facility. The available borrowings on this facility were reduced by a $6,000,000 irrevocable letter of credit related to the Company’s inventory credit facility. This agreement bears interest at the bank’s prime rate of 5.25% and 4.00% at December 31, 2004 and 2003, respectively. The credit facility is for working capital purposes and borrowings at any point in time are limited based on eligible assets of the Company. Borrowings under the credit facility are secured by substantially all of the assets of the Company. The credit
facility is personally guaranteed by the majority stockholder of the Company.
The Company also has a $6,000,000 floor plan credit facility with another bank available for eligible inventory purchases (“inventory facility”) which extends the Company’s trade payment terms with certain vendors. At December 31, 2004 and 2003, accounts payable includes $1,827,544 and $2,045,863 related to these inventory purchases. The inventory facility is guaranteed by the letter of credit referenced above.
Note 5. Notes Payable
Notes payable are summarized as follows:
2004

2003Note payable to shareholder (amended in March 2001), interest at 7% per annum, monthly principal and interest payments of $11,000 through March 2009. The note is secured by 25 shares of the Company’s common stock. Interest expense for the year ended December 31, 2004 was $37,505 ($43,875 in 2003).

$
484,053


$
578,548Note payable to bank, interest at prime plus .5% (5.75%), monthly principal and interest payments of $8,300 through February 2006. The note is secured by substantially all of the assets of the Company and is guaranteed by the majority stockholder.


71,893



165,648Note payable to bank, interest at prime (5.25%) per annum; monthly principal and interest payments of $1,936 through July 2006. The note is secured by an automobile.


35,504



44,500Notes payable to banks, with interest ranging from 4.9% to 8.09%, maturing from March 2005 to August 2008. The notes are generally secured by automobiles and certain of the notes are guaranteed by the majority stockholder.


89,431



44,452680,881



833,148Less current portion


220,371



202,858$
460,510


$
630,290F-71

INFO SYSTEMS, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
Principal repayments on long-term debt are summarized as follows:
2005

$
220,3712006


147,0532007


142,9642008


137,8582009


32,635$
680,881Note 6. Income taxes
The components of the Company’s net deferred income tax asset are as follows:
2004

2003Allowance for doubtful accounts

$
130,002


$
151,723Inventory reserves and uniform capitalization costs


21,381



30,256Goodwill


(25,211
)


(16,807
)Net operating loss


0



18,624Depreciation expense


(13,905
)


47,998Other


54,195



75,075Total deferred income taxes

$
166,462


$
306,869The provision (benefit) for income taxes is as follows:
2004

2003Current:Federal

$
190,768


$
35,096State


27,438



20,048218,206



55,144Deferred:Federal


115,694



(12,243
)State


24,713



6,233140,407



(6,010
)Total

$
358,613


$
49,134The provision for income taxes differs from the statutory U.S. Federal rate due to state income taxes and certain nondeductible items. A valuation allowance has not been established as management believes it is more likely than not the deferred tax asset will be realized.
Note 7. Commitments
The Company leases office and warehouse space from a partnership which is 83% owned by current and past shareholders of the Company which, based on its terms, is classified for financial statement purposes as an operating lease. The lease expires in April 2012, requires minimum annual rent payments and is subject to adjustment at the end of each lease year based on the consumer price index for the prior twelve-month period. Rent expense under this lease, including base rental adjustments, was $186,516 in 2004 and $172,879 in 2003.
The Company had leased equipment under capital lease obligations expiring through November 2003. The equipment is recorded at the present value of minimum lease payments and amortized over its estimated productive life.
F-72

INFO SYSTEMS, INC.NOTES TO FINANCIAL STATEMENTS—(Continued)
Property and equipment includes the following amounts for capitalized leases:
2004

2003Equipment cost

$
0


$
437,766Less: accumulated amortization


0



393,315$
0


$
44,451The Company also leases office space, equipment, and vehicles under various noncancelable operating leases expiring through December 2012. Rent expense under these leases was $379,351 and $538,969 for the years ended December 31, 2004 and 2003, respectively.
Future minimum rental payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 2004 are as follows:
Operating
Leases2005

$
260,4402006


239,1432007


196,0022008


165,0002009


165,000Thereafter


357,500Total minimum lease payments

$
1,383,085Note 8. Employee Benefit Plan
The Company sponsors a defined contribution 401(k) plan (Plan) which covers substantially all employees. Employees become eligible upon attaining age 21 and completing six months of service. Employees may elect to contribute up to 15% of their annual compensation up to the maximum allowable under the Internal Revenue Code. The Company pays all administrative costs of the Plan and matches employee contributions up to fifty percent of the first six percent of employee contributions. The Company’s contributions to the Plan were $275,815 and $292,211 for the years ended December 31, 2004 and 2003, respectively.
Note 9. Equity
The Company has authorized the issuance of 1,500 shares of $1,000 par, 6% cumulative preferred stock, of which 600 shares are outstanding. Cumulative dividends in arrears at December 31, 2004 and 2003 were approximately $216,000 and $182,000, respectively. On March 8, 2005, the Board of Directors declared the dividends for payment.
Note 10. Subsequent Event
Subsequent to year end, a total of 7.71 shares of common stock were issued to certain employees of the Company as part of their compensation. The stock was issued out of Treasury stock. The total cost of compensation that will be recognized in 2005 for this transaction is $206,018, using the fair value method.
In 2004, the shareholders of the Company entered into an agreement to sell their stock in the Company to MTM Technologies, Inc. for $8,300,000 in cash plus shares in the acquiring entity valued at $3,200,000. Payment for the stock is subject to the terms of the Stock Purchase Agreement between the Company and MTM Technologies, Inc. The sale was completed on March 11, 2005.
F-73

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: June 29, 2005

MTM TECHNOLOGIES, INC.By:

/S/ FRANCISJ. ALFANOFrancis J. Alfano,
Chief Executive OfficerPursuant to the requirements of the Securities Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/S/ GERALD A.
    POCHGerald A. Poch

Chairman of the Board of Directors

June 29, 2005/S/ FRANCIS J. ALFANOFrancis J. Alfano

Chief Executive Officer (Principal Executive
Officer) and Director

June 29, 2005/S/ ALAN SCHWARTZAlan Schwartz

Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

June 29, 2005/S/ STEVEN H. ROTHMANSteven H. Rothman

Executive Vice President and Director

June 29, 2005/S/ RICHARD R. HEITZMANNRichard R. Heitzmann

Director

June 29, 2005/S/ CLIFFORD H. FRIEDMANClifford H. Friedman

Director

June 29, 2005/S/ WILLIAM LERNERWilliam Lerner

Director

June 29, 2005/S/ ALVIN E. NASHMANAlvin E. Nashman

Director

June 29, 2005/S/ ARNOLD J. WASSERMANArnold J. Wasserman

Director

June 29, 2005F-74

MTM TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-KFiscal Year Ended March 31, 2005EXHIBIT INDEX
Exhibit
Number

Description3
.1
—
MTM Technologies, Inc. Restated Certificate of Incorporation. [Incorporated by reference to Exhibit 4.1 to the registrant's Current Report on Form 8-K (Date of Report: December 7, 2004) filed with the Securities and Exchange Commission on December 13, 2004.]3
.2
—
Amended and Restated By-Laws, as amended. [Incorporated by reference to exhibit 3.1 to the registrant's Current Report on Form 8-K (Date of Report: August 5, 2004), filed with the Securities and Exchange Commission on August 13, 2004.]4
.1
—
Form of warrant certificate issued to Sunrise Securities Corp. [Incorporated by reference to exhibit 4.1 to the registrant’s Registration Statement on Form S-3, filed with the Securities and Exchange Commission on November 13, 2000.]4
.2
—
Form of warrant certificate issued to investors in 2000 private placement [Incorporated by reference to exhibit 4.2 to the registrant’s Registration Statement on Form S-3, filed with the Securities and Exchange Commission on November 13, 2000.]4
.3
—
Form of Series A-3 Warrant Certificate [Incorporated by reference to Exhibit 10.7 of the registrant's Current Report on Form 8-K (Date of Report: December 7, 2004), filed with the Securities and Exchange Commission on December 13, 2004.]4
.4
—
Form of the A-4 Notes and A-5 Notes [Incorporated by reference to exhibit 10.2 to the registrant's Current Report on Form 8-K (Date of Report: December 7, 2004), filed with the Securities and Exchange Commission on December 13, 2004.]4
.5
—
Form of the A-4 Warrants [Incorporated by reference to Exhibit 10.3 to the registrant’s Current Report on Form 8-K (Date of Report: December 7, 2005), filed with the Securities and Exchange Commission on December 13, 2004].10
.1
—
Financing Agreement among the CIT Group/Business Credit, Inc., the Lenders that are parties thereto, MTM Technologies, Inc., and its subsidiaries that are parties thereto, dated as of June 8, 2005. [Incorporated by reference to exhibit 10.1 to the registrant’s Current Report on Form 8-K (Date of Report: June 8, 2005), filed with the Securities and Exchange Commission on June 14, 2005.]10
.2
—
Loan and Security Agreement among Textron Financial Corporation, MTM Technologies, Inc. MTM Technologies (California) Inc., MTM Technologies (Texas) Inc., MTM Technologies (US), Inc., and Info Systems, Inc., dated as of June 8, 2005. [Incorporated by reference to exhibit 10.2 to the registrant’s Current Report on Form 8-K (Date of Report: June 8, 2005), filed with the Securities and Exchange Commission on June 14, 2005.]10
.3
—
Purchase Agreement, dated January 29, 2004, among Micros-to- Mainframes, Inc., Pequot Private Equity Fund III, L.P. and Pequot Offshore Private Equity Partners III, L.P. [Incorporated by reference to Appendix A to the proxy statement contained as part of the registrant's definitive Schedule 14A, filed with the Securities and Exchange Commission on April 15, 2004.]10
.4
—
Purchase Agreement, dated December 7, 2004 by and among MTM Technologies, Inc., Pequot Private Equity Fund III, LLP, Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to exhibit 10.1 to the registrant's Current Report on Form 8-K (Date of Report: December 7, 2004), filed with the Securities and Exchange Commission on December 13, 2004.]

10
.5
—
Amended and Restated Shareholders' Agreement dated December 21, 2004 by and among, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, LLP, Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to exhibit 10.1 to the registrant's Current Report on Form 8-K (Date of Report: December 21, 2004), filed with the Securities and Exchange Commission on December 23, 2004.]10
.6
—
Amended and Restated Registration Rights Agreement dated December 10, 2004 by and among, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, LLP, Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to exhibit 10.4 to the registrant's Current Report on Form 8-K (Date of Report: December 7, 2004), filed with the Securities and Exchange Commission on December 13, 2004.]10
.7
—
Asset Purchase Agreement, dated September 17, 2004 by and among Network Catalyst, Inc., William Corbin, Rocci J. Della Maggiore and MTM Technologies, Inc. [Incorporated by reference to exhibit 10.1 to the registrant's Current Report on Form 8-K (Date of Report: September 16, 2004), filed with the Securities and Exchange Commission on September 22, 2004.]10
.8
—
Asset Purchase Agreement, dated December 1, 2004, by and among Vector ESP, Inc., Vector ESP Management, Inc. and Vector Global Services, Inc. and MTM Technologies, Inc. [Incorporated by reference to exhibit 2.1 to the registrant's Current Report on Form 8-K (Date of Report: December 7, 2004), filed with the Securities and Exchange Commission on December 13, 2004.]10
.9
—
Stock Purchase Agreement, dated January 27, 2005, by and among Info Systems, Inc., Mark Stellini, Emidio F. Stellini, Jr., Jay Foggy, Richard Roux, Jennifer McKenzie and MTM Technologies, Inc. [Incorporated by reference to Exhibit 2.1 to the registrant’s Current Report on Form 8-K (Date of Report: January 26, 2005) filed with the Securities and Exchange Commission on February 1, 2005].10
.10
—
MTM Technologies, Inc. 2004 Equity Incentive Plan. [Incorporated by reference to Appendix L to the proxy statement contained as part of the Company's definitive Schedule 14A, filed with the Securities and Exchange Commission on April 15, 2004.]10
.11
—
Micros-to-Mainframes, Inc. 2002 Long-Term Incentive Plan. [Incorporated by reference to Exhibit 10.2 to the registrant’s Registration Statement on Form S-8, filed with the Securities and Exchange Commission on March 4, 2005.]10
.12
—
Micros-to-Mainframes, Inc. 2000 Long-Term Incentive Plan. [Incorporated by reference to exhibit 99.B1 to the Company's definitive Schedule 14A, filed with the Securities and Exchange Commission on September 25, 2000.]10
.13
—
Micros-to-Mainframes, Inc. 1998 Stock Option Plan. [Incorporated by reference to exhibit 4.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, filed with the Securities and Exchange Commission on November 2, 1998.]10
.14
—
Micros-to-Mainframes, Inc. 1996 Stock Option Plan. [Incorporated by reference to exhibit 4.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, filed with the Securities and Exchange Commission on November 2, 1998.]10
.15
—
Micros-to-Mainframes, Inc. Revised 1993 Employee Stock Option Plan. [Incorporated by reference to exhibit 10.2 to Amendment Number 2 to the registrant’s Registration Statement on Form S-2, filed with the Securities and Exchange Commission on July 14, 1993.]

10
.16
—
Employment Agreement, dated May 21, 2004, between MTM Technologies, Inc. and Francis J. Alfano. [Incorporated by reference to exhibit 10.5 to the registrant's Current Report on Form 8-K (Date of Report: May 21, 2004), filed with the Securities and Exchange Commission on June 7, 2004.]10
.17
—
Amendment No.1 to Employment Agreement between MTM Technologies, Inc. and Francis J. Alfano [Incorporated by reference to exhibit 10.1 to the registrant's Current Report on Form 8-K (Date of Report: Jan 3, 2005), filed with the Securities and Exchange Commission on Jan 6, 2005.]10
.18
—
Employment Agreement, dated October 1, 2004 by and between MTM Technologies, Inc. and Steven Stringer. [Incorporated by reference to exhibit 10.2 to the registrant's Current Report on Form 8-K (Date of Report: October 1, 2004), filed with the Securities and Exchange Commission on October 7, 2004.]10
.19
—
Severance Letter, dated May 21, 2004, between MTM Technologies, Inc. and Alan Schwartz [Incorporated by reference to exhibit 10.2 to the registrant's Current Report on Form 8-K (Date of Report: Jan 3, 2005), filed with the Securities and Exchange Commission on Jan 6, 2005.]10
.20
—
Amendment to Severance Letter between MTM Technologies, Inc. and Alan Schwartz [Incorporated by reference to exhibit 10.3 to the registrant's Current Report on Form 8-K (Date of Report: Jan 3, 2005), filed with the Securities and Exchange Commission on Jan 6, 2005.]10
.21
—
Form of Employee Stock Option Agreement. [Incorporated by reference to exhibit 10.4 to the registrant's Quarterly Report on Form 10-Q for the Quarter ended September 30, 2004, filed with the Securities and Exchange Commission on November 15, 2004.]10
.22
—
Stock Option Award Agreement, dated November 2, 2004, between MTM Technologies, Inc. and Steven Stringer [Incorporated by reference to exhibit 10.4 to the registrant's Current Report on Form 8-K (Date of Report: Jan 3, 2005), filed with the Securities and Exchange Commission on Jan 6, 2005.]10
.23
—
Restricted Stock Unit Award Agreement, dated November 2, 2004, between MTM Technologies, Inc. and Steven Stringer [Incorporated by reference to exhibit 10.5 to the registrant's Current Report on Form 8-K (Date of Report: Jan 3, 2005), filed with the Securities and Exchange Commission on Jan 6, 2005.]10
.24
—
Lease Agreement, dated as of June 16, 2004, between Eight Fifty Canal, LLC and MTM Technologies, Inc. [Incorporated by reference to exhibit 10.11 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2004, filed with the Securities and Exchange Commission on June 29, 2004.]14
.1
—
Code of ethics. [Incorporated by reference to exhibit 14.1 to the registrant's Annual Report on Form 10-K for the year ended March 31, 2004, filed with the Securities and Exchange Commission on June 29, 2004.]21
.1
—
Subsidiaries of MTM Technologies, Inc.23
.1
—
Consent from Goldstein Golub Kessler LLP.23
.2
—
Consent of Ernst & Young LLP23
.3
—
Consent of UHY LLP23
.4
—
Consent of Squar, Milner, Reehl & Williamson LLP23
.5
—
Consent of Gunnip & Co.31
.1
—
Certification pursuant to Exchange Act Rule 13a-14(a) of Francis J. Alfano.31
.2
—
Certification pursuant to Exchange Act Rule 13a-14(a) of Alan Schwartz.32
.1
—
Certification pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 of Francis J. Alfano.32
.2
—
Certification pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 of Alan Schwartz.