**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-KSB/A**




**ý**
            
            **Annual
                report pursuant to section 13 or 15(d) of the Securities Exchange Act
                of 1934.****For
                the fiscal year ending December 31, 2005****Or****o**
            
            **Transition
                report pursuant to Section 13 or 15(d) of the Securities Exchange Act
                of 1934.****For
                the transition period from ______ to ______
                .****Commission
                file number 
001-32623**




**CONVERSION
      SERVICES INTERNATIONAL, INC.**


(Exact
      name of registrant as specified in its charter)




**Delaware**
            
            **20-0101495**(State
                or other jurisdiction
              of
                incorporation or organization)
            
            (IRS
                Employer
              Identification
                number)**100
                Eagle Rock Avenue, East Hanover, NJ**
            
            **07936**(Address
                of Principal Executive Offices)
            
            (Zip
                Code)




**973-560-9400**


(Registrant’s
      Telephone Number, Including Area Code)




Securities
      registered pursuant to Section 12(b) of the Act:




**Title
                of Each Class**
            
            **Name
                of Each Exchange**
              **On
                Which Registered**Common
                Stock, $.001 par value
            
            American
                Stock Exchange





Securities
      registered pursuant to Section 12(g) of the Act: None




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Exchange
      Act.    Yes  མ    No x .





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the preceding 12 months (or for such shorter period that the registrant was
      required to file such reports) and (2) has been subject to such filing
      requirements for the past 90 days. YES  o NO ý




Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosure will 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-KSB or any
      amendment to this Form 10-KSB. ý




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).    Yes o No x







State
      issuer’s revenues for its most recent fiscal year: $27.6 million




The
      aggregate market value of the voting stock held by non-affiliates of the
      registrant was approximately $15,240,210 as of March 31, 2006 (based on the
      closing price for such stock as of March 31, 2006).





Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock:




**Class**
            
            **Outstanding
                at March 31, 2006**Common
                Stock, $.001 par value
            
            49,997,834








**** INDEX





PART
                I
            
            1Item
                1.
            Business
            1Item
                2.
            Description
                of Property
            35Item
                3.
            Legal
                Proceedings
            36Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            36PART
                II
            
            37Item
                5.
            Market
                for Common Equity and Related Stockholder Matters
            37Item
                6.
            Management’s
                Discussion and Analysis or Plan of Operation
            38Item
                7.
            Financial
                Statements
            61Item
                8.
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure
            62Item
                8A.
            Controls
                and Procedures
            62Item
                8B.
            Other
                Information
            66PART
                III
            
            67Item
                9.
            Directors,
                Executive Officers, Promoters and Control Persons; Compliance With
                Section
                16(a) of the Exchange Act
            67Item
                10.
            Executive
                Compensation
            72Item
                11.
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            78Item
                12.
            Certain
                Relationships and Related Transactions
            79Item
                13.
            Exhibits
            80Item
                14.
            Principal
                Accountant Fees and Services
            87Signatures
            131









Explanatory
        Note
  This Amendment No. 1 to this Annual Report of Form 10-KSB for the year ended
        December 31, 2005 was filed in order to restate the consolidated financial
        statements as of and for the year ended December 31, 2005 to revise the
        accounting treatment for the recorded gain on financial instruments. An
        incorrect stock price was previously used in the valuation of the liability
        for
        the Laurus common stock warrants and the compound embedded derivative liability
        at December 31, 2005.
  Parts 1 and 2 have been amended herein to reflect this change. This amendment
        does not otherwise update information in the original filing to reflect facts
        or
        events occurring subsequent to the date of the original filing.  All
        information contained in this Amendment No. 1 and the original filing is
        subject
        to updating and supplementing as provided in periodic reports subsequent
        to the
        original filing date of this Form 10-KSB with the Securities and Exchange
        Commission.





**PART
      I**




**ITEM
      1.  BUSINESS**




References
      in this Form 10-KSB to the “Company,” “CSI,” “we,” “our,” and “us” refer to
      Conversion Services International, Inc. and our consolidated subsidiaries.
      We
      are a technology firm providing professional services to the Global 2000 as
      well
      as mid-market clientele. Our core competency areas include strategic consulting,
      data warehousing, business intelligence and data management consulting. Our
      clients are primarily in the financial services, pharmaceutical, healthcare
      and
      telecommunications industries, although we do have clients in other industries.
      Our clients are primarily located in the northeastern United States. We enable
      organizations to leverage their corporate information assets by providing
      strategy, process, methodology, data warehousing, business intelligence,
      enterprise reporting and analytic solutions. Our organization delivers value
      to
      our clients, utilizing a combination of business acumen, technical proficiency,
      experience and a proven set of “best practices” methodologies to deliver cost
      effective services through time and material engagements (or on occasion fixed
      price engagements). CSI empowers clients to gain insight and intelligence from
      corporate data through our combination of business acumen, technical proficiency
      and proven methodology. We are committed to being a leader in data warehousing
      and business intelligence consulting, allowing us to be a valuable asset and
      trusted advisor to our customers.





We
      believe that our primary strengths that distinguish us from our competitors
      are
      our:





·
            role
                as a full life-cycle solution
                provider;


·
            ability
                to provide strategic guidance and ensure that business requirements
                are
                properly supported by technology;


·
            ability
                to provide solutions that integrate people, improve process and integrate
                technologies;


·
            extensive
                service offerings as it relates to data warehousing, business
                intelligence, strategy and data
                quality;


·
            our
                perspective regarding the accuracy of data and our data purification
                process;


·
            best
                practices methodology, process and
                procedures;


·
            experience
                in architecting, recommending and implementing large and complex
                data
                warehousing and business intelligence solutions;


·
            understanding
                of data management solutions; and


·
            ability
                to consolidate inefficient environments into robust, scalable, reliable
                and manageable enterprise
                solutions.





Our
      goal
      is to be the premier provider of data warehousing, business intelligence and
      related strategic consulting services for organizations seeking to leverage
      their corporate information. In support of this goal we intend to:





·
            enhance
                our brand and mindshare;


·
            continue
                growth both organically and via
                acquisition;


·
            increase
                our geographic coverage;


·
            expand
                our client relationships;


·
            introduce
                new and creative service offerings;
                and


·
            leverage
                our strategic alliances.





1


We
      are
      committed to being a leader in data warehousing and business intelligence
      consulting. As a data warehousing and business intelligence specialist, we
      approach business intelligence from a strategic perspective, providing
      integrated data warehousing and business intelligence strategy and technology
      implementation services to clients that are attempting to leverage their
      enterprise information. Our matrix of services includes strategy consulting,
      data warehousing and business intelligence architecture and implementation
      solutions, data quality solutions and data management solutions. We have
      developed a methodology which provides a framework for each stage of a client
      engagement, from helping the client conceive its strategy, to architecting,
      engineering and extending its information. We believe that our integrated
      methodology allows us to deliver reliable, robust, scalable, secure and
      extensible business intelligence solutions in rapid timeframes based on accurate
      information.





We
      are a
      Delaware corporation formerly named LCS Group, Inc. In January 2004, a
      privately-held company named Conversion Services International, Inc. (“Old CSI”)
      merged with and into our wholly owned subsidiary, LCS Acquisition Corp. In
      connection with such transaction: (i) a 16-year old information technology
      business (formed in 1990) became our operating business, (ii) the former
      stockholders of Old CSI assumed control of our Board of Directors and were
      issued approximately 75.9% of the outstanding shares of our common stock at
      that
      time (due to subsequent events, that percentage of ownership has decreased),
      and
      (iii) we changed our name to “Conversion Services International, Inc.” The
      acquisition was accounted for as a reverse acquisition .
      Please
      see Note 1 Accounting Policies of the Notes to Consolidated Financial Statements
      for further discussion on this transaction.





On
      September 21, 2005, our common stock began trading on the American Stock
      Exchange under the symbol “CVN”.





Our
      offices are located at 100 Eagle Rock Avenue, East Hanover, New Jersey 07936,
      and our telephone number is (973) 560-9400.





**Our
      Services**





As
      a full
      service strategic consulting, business intelligence, data warehousing and data
      management firm, we offer services in the following solution
      categories:





**Strategic
      Consulting:** Involves
      planning and assessing both process and technology, performing gap analysis,
      making recommendations regarding technology and business process improvements
      to
      help our clients realize their business goals and maximize their investments
      in
      people and technology.




2
 
  Business
          and Process Consulting
  ·
                  Information,
                        Process and Infrastructure (IPI) Diagrams (Claritypath) -
                        A blueprinting
                        process and service that facilitates and accelerates the
                        strategic
                        planning process.
 ·
                  Change
                        Management Consulting - Assist clients with implementing
                        project
                        management governance and best practices for large scale
                        change
                        initiatives, including consolidations, conversions, integration
                        of new
                        business processes and systems
                        applications.
 ·
                  Integration
                      Management, Mergers and Acquisitions - Work with clients to
                      implement best
                      practices for mergers and acquisitions. Support all aspects
                      of the
                      integration process from initial assessment through implementation
                      support.
 ·
                    Acquisition
                          Readiness - Work with clients to better prepare them for
                          large scale
                          acquisitions in the financial services domain. This includes
                          building best
                          practices, mapping and gapping and implementing a strategic
                          roadmap to
                          integrate multiple companies.
 ·
                    Process
                        Improvement (Lean, Six Sigma) - Provide a full array of products
                        and
                        services in support of Lean and Six Sigma, including training,
                        process
                        improvement, project management and implementation
                        support.
 ·
                    Regulatory Compliance (The Health Insurance
                      Portability
                      and Accountability Act of 1996, Basel II, Sarbanes-Oxley) -
                      Work with
                      clients to analyze, design and implement operational control,
                      procedures
                      and business intelligence that will align the organization
                      to meet new
                      regulatory requirements.
 ·
                    Project
                        Management (PMO) - Setting up an internal office at a client
                        location,
                        staffed with senior/certified project managers that act in
                        accordance with
                        the policies and procedures identified in CSI Best Practices
                        for Project
                        Management.
 ·
                    Request
                        For Proposal Creation and Responses - Gather user and technical
                        requirements and develop Requests For Proposals (RFP) on
                        behalf of our
                        clients. Respond to client RFPs with detailed project plans,
                        solutions and
                        cost.


Technology
      Consulting





·
            Data
                Warehousing and Business Intelligence Strategic Planning - Helping
                clients
                develop a strategic roadmap to align with a data warehouse or business
                intelligence implementation. These engagements are focused on six
                strategic domains that have been identified and documented by CSI:
                Business Case, Program Formulation, Organizational Design, Program
                Methodologies, Architecture and Operations and Servicing.


·
            Business
                Technology Alignment - A strategic offering that consists of a series
                of
                interviews including both the business and technology constituents
                to
                collect information regarding user satisfaction, user requirements
                and
                expectations, as well as the technology groups understanding of needs
                and
                current and future deliverables. The result is a set of recommendations
                that will better align the user and technology groups and deliver
                more
                perceived value.


·
            Business
                Intelligence Strategy - Helping clients develop a roadmap to leverage
                a
                business intelligence platform throughout the enterprise aligning
                the
                client with best practices.


·
            BI/DW
                Software Selection - Evaluation, analysis and recommendation of
                appropriate software tools for deploying BI/DW solutions. Gather
                business
                and technical requirements and measure those requirements against
                the
                capabilities of available tools in the current marketplace. Software
                evaluated and recommended include reporting, ad-hoc query, analytics,
                extract, transform and load processes (ETL), data profiling, database
                and
                data modeling.





3


**Business
      Intelligence:** A
      category of applications and technologies for gathering, storing, analyzing
      and
      providing access to data to help enterprise users make better and quicker
      business decisions.





·
            Business
                Intelligence, Architecture and Implementation - Develop architecture
                plans
                and install all tools required to implement a business intelligence
                solution, including enterprise reporting, ad-hoc reporting, analytical
                views and data mining. Solutions are typically developed using tools
                such
                as Cognos, Business Objects, MicroStrategy, SAS and Crystal
                Reports.


·
            Business
                Intelligence Competency Center - Set up an internal office at a client
                location, staffed with a mix of senior business intelligence developers
                and business intelligence architects that will implement best practices,
                policies, procedures, standards and provide training and mentoring
                to
                further increase the use of the data warehouse and facilitate the
                business
                owners embracing of the business intelligence
                solution.


·
            Analytics
                and Dashboards - Identify and document dashboard requirements. These
                requirements are typically driven by Key Performance Indicators (KPIs)
                identified by upper management. Architect a supporting database structure
                to support the identified hierarchies, drill-downs and slice and
                dice
                requirements, implement a dashboard tool, provide training and
                education.


·
            Business
                Performance Management - Leveraging a new or existing business
                intelligence implementation to monitor and manage both business process
                and IT events through key performance
                indicators.


·
            Data
                Mining - Implementing data mining tools that extract implicit, previously
                unknown, and potentially useful information from data. These tools
                typically use statistical and visualization techniques to discover
                and
                present knowledge in a form which is easily comprehensible to humans.
                Business intelligence tools will answer questions based on information
                that has already been captured (history). Data mining tools will
                discover
                information and project information based on historic
                information.


·
            Proof
                of Concepts and Prototypes - Gather requirements, design and implement
                a
                small scale business intelligence implementation called a Proof of
                Concept. The Proof of Concept will validate the technology and/or
                business
                case, as well as “sell” the concept of business intelligence to
                management.


·
            Outsourcing
                - Development of new reports offsite/offshore and redeployment of
                reports
                in new technologies in support of technology
                consolidation.


·
            Training
                and Education - Provide formal classroom training for Business Objects
                software products. Provide training in data warehousing and business
                intelligence methodologies and best practices, as well as technology
                tool
                training, including business intelligence tools such as Cognos and
                MicroStrategy.





4


**Data
      Warehousing:** A
      consolidated view of high quality enterprise information, making it simpler
      and
      more efficient to analyze and report on that information.





·
            Data
                Warehousing and Data Mart Design, Development and Implementation
                - Design,
                development and implementation of custom data warehouse solutions.
                These
                solutions are based on our methodology and best
                practices.


·
            Proof
                of Concepts and Prototypes - Gather requirements, design and implement
                a
                small scale data warehouse that is called a Proof of Concept. The
                Proof of
                Concept will validate the technology and/or business case, as well
                as
                “sell” the concept of data warehousing to
                management.


·
            Extract,
                Transformation and Loading (ETL) - Design, development and implementation
                of data integration solutions with particular expertise and best
                practices
                for integrating ETL tools with other data warehouse
                tools.


·
            Enterprise
                Information Integration (EII) - Enterprise Information Integration
                tools
                are used to integrate information by providing a logical view of
                data
                without moving any data. This is particularly useful when bridging
                a
                business intelligence tool to multiple data marts or data
                warehouses.


·
            Outsourcing
                - Implementing and supporting a client data warehouse solution at
                a CSI
                location.





**Data
      Management:** Innovative
      solutions for managing data (information) throughout an enterprise.





·
            Enterprise
                Information Architecture - Leveraging our Information, Process and
                Infrastructure (IPI) Diagrams to create a “snapshot” of the current
                information flow and desired information flow throughout the enterprise.


·
            Metadata
                Management - Based on our Data Warehouse Framework, we will build
                a
                metadata repository that is integrated with all tools used in a data
                warehouse implementation and will be leveraged by the business
                intelligence environment.


·
            Data
                Quality Center of Excellence - Set up an internal office at a client
                location, staffed with a mix of senior data quality developers and
                data
                quality architects that will implement best practices, policies,
                procedures, standards and provide training and mentoring to further
                increase the level of data quality throughout the enterprise and
                increase
                the awareness and importance of data quality as it pertains to decision
                making.


·
            Data
                Quality/Cleansing/Profiling - Leveraging profiling as an automated
                data
                analysis process that significantly accelerates the data analysis
                process.
                Leveraging our best practices to identify data quality concerns and
                provide rules to cleanse and purify the
                information.






5


·
            Data
                Migrations and Conversions - Design, development and implementation
                of
                custom data migrations. These solutions are based on our methodology
                and
                best practices.


·
            Quality
                Assurance Testing (Verification, Validation, Certification) - We
                have
                developed a quality assurance process referred to as Verification,
                Validation, Certification (VVC) of information. This is a repeatable
                process that will insure that all data has been validated to be accurate,
                consistent and trustworthy.


·
            Application
                Development - Custom application development or integration to support
                data management or data warehouse initiatives. This may include
                modification of existing enterprise applications to capture additional
                information required in the warehouse or may be a standalone application
                developed to facilitate improved integration of existing
                information.


·
            Infrastructure
                Management and Support - An infrastructure must be in place to support
                any
                data warehouse or data management initiative. This may include servers,
                cables, disaster recovery or any process and procedure needed to
                support
                these types of initiatives.





The
      following illustrates the percentage of revenues provided by each category
      of
      services as a percentage of overall revenues:




Category
                  of Services
              
              Percentage
                  of Revenues for the year ended December 31,2005
              
              
              2004Strategic
                  Consulting
              
              
              40.6
              %
              
              35.9
              %Business
                  Intelligence
              
              
              22.4
              %
              
              22.7
              %Data
                  Warehousing
              
              
              22.8
              %
              
              16.7
              %Data
                  Management
              
              
              13.2
              %
              
              23.4
              %Software
                  & Support
              
              
              0.0
              %
              
              1.0
              %Other
              
              
              1.0
              %
              
              0.3
              %




**Recent
      Acquisitions and Divestiture**





We
      will
      also continue to pursue strategic acquisitions that strengthen our ability
      to
      compete and extend our ability to provide clients with a core comprehensive
      services offering.





In
      March
      2004, we acquired DeLeeuw Associates, Inc. (“DeLeeuw Associates”), a management
      consulting firm in the information technology sector with core competency in
      delivering Change Management Consulting, including both Six Sigma and Lean
      domain expertise to enhance service delivery, with proven process methodologies
      resulting in time to market improvements within the financial services and
      banking industries. In connection with the DeLeeuw Associates acquisition,
      we: (i)
      paid
      Mr. Robert C. DeLeeuw, as the sole stockholder of DeLeeuw Associates, $1.9
      million; and (ii) issued 5,333,334 shares
      of
      our common stock to Mr. DeLeeuw. Please see Note 1 of our Notes To Consolidated
      Financial Statements for further discussion on this transaction.





6


Integration
      of DeLeeuw’s Change Management Consulting practices with CSI’s Data Warehousing
      and Business Intelligence core competency “The Center for Data Warehousing” was
      completed in 2004. The Change Management, Six Sigma and Lean methodology have
      been introduced to our clients along with our innovative Information, Process
      and Infrastructure (IPI) Diagrams, which provide detailed blueprints of our
      client’s information, business processes and infrastructure on a single highly
      detailed diagram. These diagrams can be utilized for risk management,
      compliance, validation, planning and budgeting requirements. The IPI diagram
      offering, launched in the first quarter of 2004, continues to receive favorable
      reaction from our clients. In addition, we expanded our Data Warehouse
      Assessment, Business Technology Alignment (BTA) and Quality Management Offering
      (QMO) related offerings in 2005, which will be the focus of our marketing and
      communications programs for 2006. A QMO offering is a combination of
      methodologies, best practices and automated techniques leveraged to
      establish and enforce standards and procedures as it relates to elevating
      the quality of executive information in an efficient and effective
      manner. We believe that these offerings will drive greater understanding and
      demand for both data warehousing and business intelligence implementations
      by
      delivering best practices methodologies, tools and techniques to reduce risk,
      time to market and total cost of ownership of these engagements. One component
      of our business strategy is to continue to enhance and expand our offerings
      which include best practices, process improvement, methodologies, advisory
      services and implementation expertise.





In
      May
      2004, CSI acquired 49% of all issued and outstanding shares of common stock
      of
      Leading Edge Communications Corporation (LEC). The acquisition was completed
      through a Stock Purchase Agreement between CSI and the sole stockholder of
      LEC.
      In connection with the acquisition, CSI (i) repaid a bank loan on behalf of
      the
      seller in the amount of $35,000; (ii) repaid an LEC bank loan in the amount
      of
      $38,000; and (iii) satisfied an LEC obligation for $10,000 of prior compensation
      to an employee. LEC provides enterprise software and services solutions for
      technology infrastructure management. Previously, in November 2003, CSI executed
      an Independent Contractor Agreement with LEC, whereby CSI agreed to be a
      subcontractor for LEC, and to provide consultants as required to LEC. In return
      for these services, CSI receives a fee from LEC based on the hourly rates
      established for consultants subcontracted to LEC.





In
      June
      2004, we acquired substantially all of the assets and assumed substantially
      all
      of the liabilities of Evoke Software Corporation (“Evoke”), which designed,
      developed, marketed and supported software programs for data analysis, data
      profiling and database migration applications and provides related support
      and
      consulting services. In
      connection with the Evoke acquisition, we: (i) issued 4,836,264 shares
      of
      our common stock to Evoke, 476,667 of which were deposited into an escrow
      account for a period of one year and were reduced based upon claims for
      indemnification that were made pursuant to the asset purchase agreement; (ii)
      issued 5% of the outstanding shares of our acquisition subsidiary to Evoke;
      (iii) issued 261,273 shares of our common stock to certain executives of Evoke
      as a severance payment and to certain employees as retention shares; (iv) paid
      approximately $0.5 million in deferred compensation to certain employees of
      Evoke; and (v) assumed substantially all of Evoke’s liabilities. Evoke changed
      its name to WHRT I Corp. Before
      the merger, certain investors of Evoke invested $0.55 million in Evoke, which
      investment was converted into approximately 366,667 shares of our common stock
      upon effectuation of the merger. On February 2, 2006, we bought back WHRT I
      Corp.’s remaining holdings of our common stock, 3,892,355 shares, for
      $1,848,868.60, and such shares were placed back into the Company’s treasury. An
      additional 253,027 shares of our common stock relating to the escrowed shares
      (see above) were placed into treasury as well. Please
      see Note 23 of our Notes to Consolidated Financial Statements for further
      discussion on this transaction.





7


In
      July
      2005, the Company completed the sale of substantially all of the assets of
      its
      subsidiary Evoke Software Corporation and received an aggregate consideration
      of
      $645,000 cash, the assumption by Similarity Systems (“Similarity”) and
      Similarity Vector Technologies, Ltd. (“SVT”) of certain liabilities, shares of
      Similarity which were issuable by Similarity subject to the Company’s
      satisfactory completion of certain post-closing obligations, and an earnout
      in
      an amount equal to 13% of certain Similarity revenues. The maximum earnout
      consideration to which the Company was entitled under this agreement was
      $1,400,000 and was to be received over a three year period. CSI changed the
      name
      of its “Evoke Software Corporation” subsidiary to “CSI Sub Corp II (DE)” in
      August 2005.  On
      February 13, 2006, the Company received $2,050,000 from Informatica, SVT and
      Similarity Systems related to Informatica’s acquisition of SVT and Similarity as
      final payment on all future consideration related to our agreement with SVT
      and
      Similarity.





In
      July
      2005, we acquired McKnight Associates, Inc. ("McKnight Associates"). Since
      inception, McKnight Associates has focused on successfully designing, developing
      and implementing data warehousing and business intelligence solutions for its
      clients in numerous industries. In consideration of this merger agreement,
      the
      Company paid the following consideration to Mr. William McKnight, the sole
      stockholder of McKnight Associates: (i) $500,000 in cash, (ii) the commitment
      to
      pay an additional $250,000 in cash by June 2006 (the Company paid Mr. McKnight
      $125,000 in March 2006), (iii) the issuance of 909,091 shares of the Company’s
      common stock, and (iv) the assumption of substantially all of the liabilities
      of
      McKnight Associates. Mr. McKnight joined the Company as Senior Vice President
      -
      Data Warehousing and is
      a
      well-known industry leader, frequently
      speaks at national trade shows and contributes
      to major data management trade publications.





In
      July
      2005, we acquired Integrated Strategies, Inc. ("ISI"). With offices in New
      York
      City, ISI is a professional services firm with a solutions-oriented approach
      to
      complex business and technical challenges. Similar to our wholly owned
      subsidiary, DeLeeuw Associates, which is best known for its large-scale merger
      integration management and business process change programs for the financial
      services markets, ISI also counts many industry leaders in this sector among
      its
      customers. Because of this shared focus, the operations of ISI were folded
      into
      DeLeeuw Associates. In consideration of this merger agreement, the Company
      paid
      the following consideration to Adam Hock and Larry Hock, individual majority
      stockholders of ISI: (i) $2,050,000 in cash (reduced by certain amounts), (ii)
      the issuance of a promissory note in the amount of $177,937 (which was later
      reduced to $76,054), (iii) the issuance by the Company of a subordinated
      promissory note in the amount of $165,000, and (iv) the assumption of
      substantially all the liabilities of ISI. The agreement also provides for the
      commitment, subject to certain revenue and profit thresholds (as described
      in
      the agreement), to pay additional cash and issue shares of the Company common
      stock.





8


We
      believe that as new opportunities are created, Global 2000 companies will
      continue the trend of expanding the utilization of external consulting expertise
      to support corporate initiatives focused on maximizing Return On Investment
      (ROI), leveraging existing technology infrastructure through optimizations
      and
      best practices and will continue to leverage and derive value from corporate
      information assets such as data warehousing, business intelligence and
      analytics. We believe that we are positioned to expand our client base by
      delivering business value resulting from our 16 years of domain expertise,
      proven best practices, methodologies, processes and automation within data
      warehousing architecture and implementation. Our ability to apply Six Sigma
      and
      Lean core competency to client processes and implementation strategies further
      strengthens our competitive standing. CSI is well positioned to support the
      increasing industry emphasis on data quality and the use of automation to reduce
      the costs associated with data warehouse and business intelligence projects,
      data migrations and conversions, as well as packaged application implementations
      such as Enterprise Resource Planning (ERP), Customer Relationship Management
      (CRM) and Supply Chain Management (SCM) by leveraging the automation and
      validation gained by the use of data profiling technology.





**Recent
      External Financings**





*Taurus*





In
      May
      2004, pursuant to the complete conversion of a $2.0 million unsecured
      convertible line of credit note issued in October 2003 at $1.80 per share,
      certain investors represented by Taurus Advisory Group, LLC (“Taurus”) received
      1,111,111 shares of our common stock, plus interest paid in cash. Because we
      failed to perform a private investment in public equity transaction by September
      1, 2004, the conversion price on the October 2003 note was adjusted to a fixed
      conversion price of $1.575 per share, and 158,730 additional shares of common
      stock were issued to Taurus. No additional proceeds were received by us. In
      addition, Taurus received a warrant to purchase 277,778 shares of our common
      stock, which has an exercise price of $1.575 per share. This warrant expires
      in
      June 2009. Further in May 2004, we raised an additional $2.0 million pursuant
      to
      a new five-year unsecured promissory note with Taurus. In June 2004, we replaced
      the May 2004 note by issuing a five-year $2.0 million unsecured convertible line
      of credit note with Taurus. **** The
      note
      accrues interest at an annual rate of 7%, and the conversion price of the shares
      of common stock issuable under the note is equal to $1.575 per
      share.





In
      July
      2005, the Company obtained two $250,000 short term loans from certain investors
      represented by Taurus. Both notes bear interest at 8% per annum. The first
      note
      is dated July 6, 2005 and initially matured on September 6, 2005. The maturity
      date for this note has been extended to May 6, 2006. The second note is dated
      July 22, 2005 and originally matured on September 22, 2005. The maturity date
      for this note has been extended to April 22, 2006. These
      short term note holders have agreed to extend their maturity date on a
      month-to-month basis until the Company raises sufficient funds to repay the
      notes.





9


In
      December 2005, the Company obtained a $1,000,000 short term loan from certain
      investors represented by Taurus. This note bears interest at 8% per annum.
      The
      note is dated December 19, 2005 and initially matured on January 31, 2006.
      The
      maturity date for this note has been extended to June 1, 2006. In conjunction
      with this note, these investors received a warrant to purchase 277,777 shares
      of
      our common stock with an exercise price of $0.675 per share in December 2005,
      a
      warrant to purchase 277,777 shares of our common stock with an exercise price
      of
      $0.75 per share in February 2006 and a warrant to purchase 554,000 shares of
      our
      common stock with an exercise price of $1.30 per share in March 2006. These
      warrants expire in December 2008, January 2009 and February 2009, respectively.
      As of December 31, 2005, the Company had borrowed $500,000 under this note.
      The
      remaining $500,000 was borrowed by the Company in January 2006, and the entire
      $1,000,000 remains outstanding. These
      short term note holders have agreed to extend their maturity date on a
      month-to-month basis until the Company raises sufficient funds to repay the
      notes.





On
      February 2, 2006, the Company entered into a Securities Purchase Agreement
      with
      Taurus, pursuant to which the Company issued 19,000 shares of the Company’s
      newly created Series A Convertible Preferred Stock, $.001 par value (the “Series
      A Preferred”). Each share of Series A Preferred has a stated value of $100.00.
      The Company utilized the proceeds ($1,900,000) to repurchase shares of its
      common stock from WHRT I Corp. (see above “Recent Acquisitions and
      Divestiture”). The Series A Preferred has a cumulative annual dividend equal to
      five percent (5%), which is payable semi-annually  in cash or common stock,
      at the election of the Company, and is convertible into shares of the Company’s
      common stock at any time at a price equal to $0.50 per share (subject to adjustments
      related to stock splits, reclassifications, combinations, dividends, change
      of
      control or the issuance of pari passu securities). In addition, the
      Series A Preferred has no voting rights, but has liquidation preferences and
      certain other privileges. All shares of Series A Preferred not previously
      converted shall be redeemed by the Company, in cash or common stock, at the
      election of Taurus, on February 1, 2011. Pursuant to the Securities Purchase
      Agreement, Taurus was also granted a warrant to purchase 1,900,000 shares of
      the
      Company’s common stock exercisable at a price of $0.60 per share (subject to
adjustments
      related to stock splits, reclassifications, combinations, dividends, change
      of
      control or the issuance of pari passu securities), exercisable for a
      period of five years.





See
      chart
      on page 58 in Liquidity and Capital Resources.





*Laurus*





In
      August
      2004, we replaced our $3 .0
      million line of credit with North Fork Bank with a revolving line of credit
      with
      Laurus Master Fund, Ltd. (“Laurus”), whereby we had access to borrow up to $6.0
      million based upon eligible accounts receivable. A portion of Laurus’s revolving
      line of credit was used to pay off all outstanding borrowings from North Fork
      Bank. This revolving line, effectuated through a $2.0 million convertible
      minimum borrowing note and a $4.0 million revolving note, provided for advances
      at an advance rate of 90% against eligible accounts receivable, with an annual
      interest rate of prime rate (as reported in the Wall Street Journal) plus 1%,
      and matured in three years. We had no obligation to meet financial covenants
      under the $2.0 million convertible minimum borrowing note or the $4.0 million
      revolving note. This line of credit is secured by substantially all the
      corporate assets. Both the $2.0 million convertible minimum borrowing note
      and
      the $4.0 million revolving note provided for conversion at the option of the
      holder of the amounts outstanding into our common stock at a fixed conversion
      price of $2.10 per share.





10


Additionally,
      in exchange for a $5,000,000 secured convertible term note bearing interest
      at
      prime rate (as reported in the Wall Street Journal) plus 1%, Laurus had
      established a $5.0 million account to be used only for acquisition targets
      identified by us that were approved by Laurus in Laurus’ sole discretion. We had
      no obligation to meet financial covenants under the $5.0 million secured
      convertible term note. This note was convertible into our common stock at a
      fixed conversion price of $2.10 per share. This note was to mature in three
      years. We issued Laurus a common stock purchase warrant that provided Laurus
      with the right to purchase 800,000 shares of our common stock. The exercise
      price for the first 400,000 shares acquired under the warrant is $4.35 per
      share, the exercise price for the next 200,000 shares acquired under the warrant
      is $4.65 per share, and the exercise price for the final 200,000 shares acquired
      under the warrant is $5.25 per share. The common stock purchase warrant expires
      on August 15, 2011. We paid $0.75 million in brokerage and transaction closing
      related costs. These costs were deducted from the $5.0 million restricted cash
      balance being provided to us by Laurus.





In
      May
      2005, Laurus elected to convert $1,000,000 of debt underlying the minimum
      borrowing note into the Company’s common stock. As a result of this conversion,
      the Company obtained $1,000,000 of additional borrowing capacity under its
      revolving line of credit and in return, issued 476,191  shares
      of
      Company common stock to Laurus.





In
      July
      2005, the Company entered into amendments of the notes dated August 16, 2004
      between the Company and Laurus. Pursuant to the amendment, the Company released
      $4,327,295 (the “Funds”) to Laurus, which was being held in the Restricted
      Account (which was available to the Company for acquisitions) and issued an
      amended and restated convertible note in the principal amount of $749,000.
      In
      satisfaction of the balance of the accrued interest and any liquidated damages
      to which it was entitled pursuant the Registration Rights Agreement entered
      into
      in August 2004, the Company issued an option to purchase 333,334 shares of
      the
      Company’s common stock at a purchase price of $0.015 per share. Laurus fully
      exercised this option to purchase Company stock on August 1, 2005. Laurus also
      agreed to extend the required filing date and effective date of the Registration
      Statement. For accounting purposes, the Company recorded this transaction as
      an
      early extinguishment of debt and recorded the remaining discount and liability
      on gain or loss on the early extinguishment of debt.




The
      Company also issued an amended and restated convertible secured revolving note
      in the principal amount of $4.5 million in favor of Laurus which amended the
      $4
      million Revolving Note executed in August 2004. In connection with this note,
      the Company and Laurus entered into an Overadvance Letter Agreement, pursuant
      to
      which Laurus made a loan to the Company in excess of the amount available using
      the Company accounts receivable as collateral in the principal amount of $2.7
      million. The Company utilized the $2.7 million which was advanced to it by
      Laurus to acquire McKnight Associates, Inc., Integrated Strategies, Inc. and
      ISI
      Consulting, LLC. Except as noted above, all terms of the August 2004 agreements
      continued to remain in effect.





On
      November 30, 2005, the Company (i) amended and restated the convertible
      term note in the principal amount of $749,000 by reducing the conversion rate
      of
      such note from $2.10 to $1.00, (ii) amended and restated the secured
      revolving convertible note by increasing the principal amount available from
      $4,500,000 to $5,500,000 and reducing the conversion rate from $2.10 to $1.00,
      and (iii) amended and restated the secured convertible minimum borrowing
      note in the principal amount of $2,000,000 by reducing the fixed conversion
      price from $2.10 to $0.65.





11


On
      February 1, 2006, the Company restructured its financing with Laurus again
      by
      entering into financing agreements with Laurus, pursuant to which it, among
      other things, (a) issued a secured non-convertible term note in the principal
      amount of $1,000,000 to Laurus (the “Term Note”), (b) issued a secured
      non-convertible revolving note in the principal amount of $10,000,000 to Laurus
      (the “Revolving Note”, collectively with the Term Note, the “Notes”), and (c)
      issued an option to purchase up to 3,080,000 shares of the Company's common
      stock to Laurus (the “Option”) at an exercise price of $.001 per share. The
      proceeds from the issuance of the Notes were used to refinance the Company’s
      outstanding obligations under the existing facility with Laurus (originally
      entered into in August 2004 and subsequently amended in July 2005) at a 5%
      premium. The Notes bear an annual interest rate of prime (as reported in the
      Wall Street Journal, which was 7.25% as of January 31, 2006) plus 1.0%, with
      a
      floor of 5.0%. Payments of interest will be made in equal monthly amounts until
      maturity of the Notes on December 31, 2007, at which time the 5% premium will
      also be due. In addition, payments of principal on the Term Note will be made
      in
      equal monthly amounts until maturity of the Notes on December 31,
      2007.




In
      connection with the Notes, the Company and Laurus entered into an Overadvance
      Letter Agreement, pursuant to which Laurus exercised its discretion granted
      to
      it pursuant to the Security Agreement entered into in August 2004 to make a
      loan
      to the Company in excess of the “Formula Amount” (as defined therein). The
      Company also entered into a Stock Pledge Agreement and Security Agreement
      securing its obligations to Laurus, both prior to and including the Notes,
      as
      well as a Registration Rights Agreement pursuant to which the Company agreed
      to
      file a registration statement to register the shares of the Company’s common
      stock underlying the Option, as well as the shares of the Company’s common stock
      and the shares of the Company’s common stock underlying the warrants held by
      Laurus, within 90 days. As of the date of this filing, Laurus owns approximately
      809,525 shares of the Company’s common stock, an option to purchase up to
      3,080,000 shares of the Company's common stock at an exercise price of $.001
      per
      share and warrants to purchase 400,000 shares of the Company’s common stock at
      $4.35 per share, 200,000 shares of the Company’s common stock at $4.65 per share
      and 200,000 shares of the Company’s common stock at $5.25 per share. Please see
      Risk Factors for more information related to certain events of default related
      to the Laurus transaction.





See
      chart
      on page 58 in Liquidity and Capital Resources.





*Laidlaw/Sands*





In
      September 2004, we issued to Sands Brothers Venture Capital LLC, Sands Brothers
      Venture Capital III LLC and Sands Brothers Venture Capital IV LLC (collectively,
      “Sands”) three subordinated secured convertible promissory notes equaling $1.0
      million (the “Notes”), each with an annual interest rate of 8% expiring
      September 22, 2005. The Notes were secured by substantially all corporate
      assets, subordinate to Laurus. The Notes are convertible into shares of our
      common stock at the election of Sands at any time following the consummation
      of
      a convertible debt or equity financing with gross proceeds of $5.0 million
      or
      greater (a “Qualified Financing”). The conversion price of the shares of our
      common stock issuable upon conversion of the Notes shall be equal to a price
      per
      share of common stock equal to forty percent (40%) of the price of the
      securities issued pursuant to a Qualified Financing. Since no Qualified
      Financing had been consummated by September 8, 2005, Sands is entitled to elect
      to convert the Notes at a fixed conversion price of $2.10 per share. In the
      event that we issue stock or derivatives convertible into our stock for a price
      less than the aforementioned fixed conversion price, then the fixed conversion
      price is reset using a weighted average dilution calculation. We also issued
      Sands three common stock purchase warrants (the “Warrants”) providing Sands with
      the right to purchase 400,000 shares of our common stock. The exercise price
      of
      the shares of our common stock issuable upon exercise of the Warrants shall
      be
      equal to $2.10 or in the event of a Qualified Financing, a price per share
      of
      common stock equal to forty percent (40%) of the price of the securities issued
      pursuant to such Qualified Financing. The latest that the Warrants may expire
      is
      September 8, 2008.





12


On
      September 22, 2005, upon maturity of the September 2004 notes, the Company
      issued to Sands three amended subordinated secured convertible promissory notes
      equaling $1.08 million, each with an annual interest rate of 12% expiring on
      January 1, 2007. The Company also issued Sands three common stock purchase
      warrants (the “Additional Warrants”) providing Sands with the right to purchase
      400,000 shares of the Company’s common stock. The exercise price of the shares
      of the Company’s common stock issuable upon exercise of the Additional Warrants
      shall be equal to a price per share of common stock equal to one hundred twenty
      percent (120%) of the price of the securities issued pursuant to a Qualified
      Financing. If no Qualified Financing has been consummated by December 15, 2006,
      then Sands may elect to exercise the Additional Warrants at a fixed conversion
      price of $2.10 per share. The latest that the Warrants may expire is December
      15, 2009.





*Other*





On
      November 8, 2004, we entered into a Stock Purchase Agreement (the “Agreement”)
      with a private investor, CMKX-treme, Inc.  Pursuant to the Agreement,
      CMKX-treme, Inc. agreed to purchase 833,333 shares of common stock for a
      purchase price of $1.75 million.  Under the terms of the Agreement,
      CMKX-treme, Inc. initially purchased 238,095 shares of common stock for $0.5
      million, and it was required to purchase the remaining 595,238 shares of Common
      Stock for $1.25 million by December 31, 2004. As of March 17, 2005, CMKX-treme,
      Inc. remitted final payment for the remaining 595,238 shares.





**Clients**





For
      16
      years, we have helped our clients develop strategies and implement technology
      solutions to help them leverage corporate information.





Our
      clients are primarily in the financial services, pharmaceutical, healthcare
      and
      telecommunications industries and are primarily located in the northeastern
      United States. During the year ended December 31, 2005, two of our clients,
      Leading Edge Communications Corporation, a related party, (13.4%) and Bank
      of
      America (27.2%), accounted collectively for approximately 40.6% of total
      revenues. During the year ended December 31, 2004, two of our clients, Leading
      Edge Communications Corporation, a related party, (16.1%) and Bank of America
      (16.7%), accounted collectively for approximately 32.8% of total revenues.
      As we
      continue to pursue and consummate acquisitions, our dependence on these
      customers should be less significant. We do not have long-term contracts with
      any of these customers. The loss of any of our largest customers could have
      a
      material adverse effect on our business. We have not had any collections
      problems with any of these customers to date.





13


**Marketing**





We
      currently market our services through our internal marketing group, our external
      public relations firm, and our sales force comprised of 14 employees. We also
      receive new business opportunities through referrals from current clients,
      strategic partners, independent industry analysts and industry associations.
      We
      are engaging in the following specific sales related programs and activities
      to
      expand our brand awareness and generate sales leads:





·
            *Advertising
                and Sponsorships*:
                Through advertising and sponsorship programs within the leading industry
                publications, we obtain new business leads and further increase our
                brand
                awareness. Throughout the year, we sponsor publications and newsletters
                published by DM Review, The Business Intelligence Network, The Data
                Warehousing Institute and iSix Sigma. Most of these sponsorships
                include
                web banner advertising and registration vehicles to promote CSI white
                papers and best practices research.





·
            *Web
                Site Promotion*:
                Our website (www.csiwhq.com)
                provides a comprehensive view of our service offerings and promotes
                our
                subject matter expertise via white papers, articles and industry
                presentations. We are currently promoting our website through internet
                search engine advertising, direct marketing and through reciprocity
                from
                partner sites.





·
            *Trade
                Show and Conference Participation*:
                Our participation in trade shows and conferences has further solidified
                our position in our industry. There are a number of trade shows and
                conferences within our target industry that provide significant exposure
                to prospective customers, business and trade media and industry analysts,
                as well as collaborative networking with technology partners. As
                with most
                trade show events, the higher the level of sponsorship, the greater
                exposure and benefits received, such as the location of our booth,
                banner
                and advertising space, and position on the conference agenda. We
                participated at the Shared Insights/DCI Data Warehousing and Business
                Intelligence Conference with a sponsorship, exhibit and keynote
                presentations (in San Diego in April 2005, Orlando in September 2005
                and
                in Chicago in February 2006). We are a partner member of The Data
                Warehouse Institute (TDWI) and we sponsor and provide speakers for
                several
                of the conferences TDWI holds each year (in Baltimore in May 2005,
                in
                Orlando in October 2005 and upcoming in Chicago in May
                2006).





14


·
            *Web
                Seminars:*Participation in web seminars provides exposure to new sales prospects
                and
                affords us the opportunity to demonstrate our subject matter expertise.
                We
                sponsor approximately three web seminars annually, in addition to
                participating as guest presenters at partner and vendor sponsored
                web
                seminars.





·
            *Thought
                Leadership:*We
                continually demonstrate our thought leadership by writing and promoting
                our white papers via our web site, the TDWI web site and through
                direct
                mail. Monthly articles by our consultants are published in DM Review,
                on
                The Business Intelligence Network Pharmaceutical Channel and the
                iSix
                Sigma financial services channel. We intend to continue and expand
                all our
                publishing activities, including blogs, by-line articles and expert
                web
                channels where our experts respond to end-user questions (searchCRM
                and
                searchDataManagement.com).





·
            *Sponsorships
                of Vendor Marketing Activities*: 
                We expect that joint marketing activities with leading software vendors
                should also stimulate new business prospect generation.  This
                participation also enhances the market perception of CSI as experts
                in
                individual product areas by co-sponsoring and participating in vendor
                marketing activities. We are invited to write white papers and articles
                for vendors such as Microsoft, Teradata and Dataflux. We sponsor
                and
                present at the Annual User Conferences for Business Objects and Teradata,
                as well as new product launch seminars with Business Objects and
                Cognos.





·
            *Vendor
                Relations*:
                We are continually identifying key vendor relationships. With the
                ability
                to leverage our 16 year history, we intend to continue to forge and
                maintain relationships with technical, service and industry vendors.
                We
                have solidified and continue to develop strategic relationships with
                technology vendors in the data warehousing and business intelligence
                arena. These relationships designate our status as a systems integration
                and/or reseller which authorizes us to provide consulting services
                and to
                resell select vendor software. We employ certified consultants in
                our
                vendor partner technology platforms. We maintain vendor independence
                by
                consistently evaluating the respective vendors’ technologies in our lab
                located at our headquarters in East Hanover, New Jersey.   We
                regularly attend vendor partnership events, including partner summits
                and
                user group meetings, in support of our partnership programs. We currently
                maintain relationships with the
                following:





**Database
      Vendors:**


**IBM**-
            We
                are an Indirect Passport Advantage Reseller Partner which enables
                us to
                resell IBM software products. We also employ consulting staff trained
                and
                certified in IBM technology.


**Oracle**-
            We
                are part of the Oracle Partner Program (OPP) as a Certified Solution
                Provider (CSP). We also employ certified Oracle professionals and
                our
                partnership allows us to utilize Oracle support channels for technical
                advisement.




15


**Microsoft**-
            We
                are a Microsoft Certified Solution Provider. We maintain the required
                number of Microsoft certified professionals to hold this
                designation.


**Sybase**-
            We
                have a Systems Integration Agreement and employ professionals trained
                in
                the vendor’s technology.





**Business
      Intelligence Vendors:**


**Busines
              Objects -**
            We
                are a Systems Integration and Reseller Partner. We employ and maintain
                a
                staff of professionals that are certified in the vendor’s technology. In
                addition, we are a Certified Onsite Education Partner, which allows
                us to
                directly market and provide a certified training partner, which enables
                us
                to provide onsite training classes in the respective vendor
                technology.


**Cognos
              -**
            We
                are a Systems Integration and Reseller Partner. We employ and maintain
                a
                staff of professionals that are certified in the vendor’s
                technology.


**MicroStrategy**-
            We
                are a Systems Integration and Reseller Partner. We employ and maintain
                a
                staff of professionals that are certified in the vendor’s
                technology.


**Spotfire**-
            We
                are a Systems Integration and Reseller Partner. We employ and maintain
                a
                staff of professionals that are certified in the vendor’s
                technology.





**Data
      Warehousing Vendors:**


**Informatica**-
            We
                are a Systems Integration and Reseller Partner. We employ and maintain
                a
                staff of professionals that are certified in the vendor’s
                technology.


**Ascential
              Software**-
            We
                are a Systems Integration and Reseller Partner. We employ and maintain
                a
                staff of professionals that are certified in the vendor’s
                technology.


**Computer
              Associates**
            We
                are an affiliate partner. We employ and maintain a staff of professionals
                that are certified in the vendor’s technology.





·
            *Expanded
                Direct Sales Activities*:
                We are continually updating and increasing our direct contact programs
                for
                lead generation, cross selling and up-selling. We conduct direct
                sales
                activities, such as e-mail and direct mail campaigns, telemarketing,
                networking and attending partnership functions to generate leads
                for
                direct sales opportunities. In addition, we have developed a number
                of
                best practices service offerings which encompass selection, deployment,
                implementation, maintenance and knowledge transfer. In some cases,
                these
                service offerings include methodologies and best practices for integrating
                several vendor technology platforms resulting in cross selling and
                up
                selling opportunities when applicable.





16


**Protection
      Against Disclosure of Client Information**





As
      our
      core business relates to the storage and use of client information, which is
      often confidential, we have implemented policies to prevent client information
      from being disclosed to unauthorized parties or used inappropriately. Our
      employee handbook, of which every employee receives and acknowledges, mandates
      that it is strictly prohibited for employees to disclose client information
      to
      third parties. Our handbook further mandates that disciplinary action be taken
      against those who violate such policy, including possible termination. Our
      outside consultants sign non-disclosure agreements prohibiting disclosure of
      client information to third parties, among other things, and we perform
      background checks on employees and outside consultants.





**Intellectual
      Property**





The
      trademarks “TECH SMART BUSINESS WISE”, “QUALITY MANAGEMENT OFFICE”, “QMO” and
      DQXPRESS have been registered with the United States Patent and Trademark Office
      (“USPTO”). Our trademark registration application for the mark DQROI is
      presently pending before the USPTO. We use non-disclosure agreements with our
      employees, independent contractors and clients to protect information which
      we
      believe are proprietary or constitute trade secrets.





**Competition**





To
      our
      knowledge, there are no publicly-traded competitors that focus solely on data
      warehousing and business intelligence consulting and strategy. However, we
      have
      several competitors in the general marketplace, including data warehouse and
      business intelligence practices within large international, national and
      regional consulting and implementation firms, as well as smaller boutique
      technology firms. Many
      of
      our competitors are large companies that have substantially greater market
      presence, longer operating histories, more significant client bases, and
      financial, technical, facilities, marketing, capital and other resources than
      we
      have. We
      believe that we compete with these firms on the basis of the quality of our
      services, industry reputation and price. **** We
      believe our competitors include firms such as:





·
            Accenture


·
            Cap
                Gemini Ernst & Young


·
            IBM
                Global Services


·
            Keane


·
            Bearing
                Point


·
            Answerthink





17
 **Employees**





As
      of
      December 31, 2005, we had 37 outside consultants, 118 consultants on the payroll
      and 44 non-consultant employees. Outside consultants are not our employees,
      and
      as such, do not receive benefits or have taxes withheld.   These
      consultants are members or employees of separate corporations, they are
      responsible for providing us with a current certificate of insurance and they
      are responsible for filing and payment of their own taxes.  We maintain
      relationships with these consultants and their status is updated in a
      proprietary data base application that we have built. Consultants on the payroll
      are our employees, billable to clients, and they have taxes withheld similar
      to
      other employees.





None
      of
      our employees are represented by a labor union or subject to a collective
      bargaining agreement. We have never experienced a work stoppage and we believe
      that our relations with employees are good.




**Available
      Information**





We
      file
      annual, quarterly and current reports, proxy statements and other information
      with the Securities and Exchange Commission (the “Commission”). You may read and
      copy any document we file with the Commission at the Commission's public
      reference rooms at 450 Fifth Street, N.W., Washington, D.C. 20549, 233 Broadway,
      New York, New York 10279, and Citicorp Center, 500 West Madison Street, Suite
      1400, Chicago, Illinois 60661-2511. Please call the Commission at 1-800-SEC-0330
      for further information on the public reference rooms. Our Commission filings
      are also available to the public from the Commission's Website at
      "http://www.sec.gov." We make available free of charge our annual, quarterly
      and
      current reports, proxy statements and other information upon request. To request
      such materials, please send a written request to Mitchell Peipert, our Chief
      Financial Officer, at our address as set forth above or at (973)
      560-9400.





We
      maintain a Website at www.csiwhq.com (this is not a hyperlink, you must visit
      this website through an internet browser). Our Website and the information
      contained therein or connected thereto are not incorporated into this Annual
      Report on Form 10-KSB.








***SPECIAL
      NOTE ON FORWARD LOOKING STATEMENTS***




*In
      addition to historical information, this Annual Report on Form 10-KSB contains
      forward looking statements within the meaning of the Private Securities
      Litigation Reform Act of 1995.  The forward-looking statements are subject
      to certain risks and uncertainties that could cause actual results to differ
      materially from those reflected in such forward-looking statements. 
Factors that might cause such a difference include, but are not limited to,
      those discussed in the sections entitled “Business”, “Risk Factors”, and
“Management’s Discussion and Analysis or Plan of Operation.”  Readers are
      cautioned not to place undue reliance on these forward-looking statements,
      which
      reflect management’s opinions only as of the date thereof.  We undertake no
      obligation to revise or publicly release the results of any revision of these
      forward-looking statements.  Readers should carefully review the risk
      factors described in this Annual Report and in other documents that we file
      from
      time to time with the Securities and Exchange Commission.*





18


*In
      some cases, you can identify forward-looking statements by terminology such
      as
“may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,”
“estimates,” “predicts,” “potential,” “proposed,” “intended,” or “continue” or
      the negative of these terms or other comparable terminology. You should read
      statements that contain these words carefully, because they discuss our
      expectations about our future operating results or our future financial
      condition or state other “forward-looking” information. There may be events in
      the future that we are not able to accurately predict or control. You should
      be
      aware that the occurrence of any of the events described in these risk factors
      and elsewhere in this Annual Report could substantially harm our business,
      results of operations and financial condition, and that upon the occurrence
      of
      any of these events, the trading price of our securities could decline. Although
      we believe that the expectations reflected in the forward-looking statements
      are
      reasonable, we cannot guarantee future results, growth rates, levels of
      activity, performance or achievements.*





*Except
      as required by applicable law, including the securities laws of the United
      States, we do not intend to update any of the forward-looking statements to
      conform these statements to actual results. The following discussion should
      be
      read in conjunction with our financial statements and the related notes that
      appear elsewhere in this report.*





*We
      cannot give any guarantee that these plans, intentions or expectations will
      be
      achieved. All forward-looking statements involve risks and uncertainties, and
      actual results may differ materially from those discussed in the forward-looking
      statements as a result of various factors, including those factors described
      in
      the “Risk Factors” section of this Annual Report. Listed below and discussed
      elsewhere in this Annual Report are some important risks, uncertainties and
      contingencies that could cause our actual results, performances or achievements
      to be materially different from the forward-looking statements included in
      this
      Annual Report. These risks, uncertainties and contingencies include, but are
      not
      limited to, the following:*







·
            *our
                ability to finance our operations on acceptable terms, either through
                the
                raising of capital, the incurrence of convertible or other indebtedness
                or
                through strategic financing
                partnerships;*




·
              *our ability to maintain the continued listing
                standards of the American Stock
                Exchange;*
 ·
              *our
                  ability to retain members of our management team and our
                  employees;*




·
            *our
                ability to retain existing clients or attract new
                clients;*


·
            *our
                ability to adapt to the rapid technological change constantly occurring
                in
                the areas in which we provide
                services*


·
            *our
                ability to offer pricing for services which is acceptable to clients;*


·
            *the
                competition that may arise in the future;
                and*


·
            *identifying
                suitable acquisition candidates and integrating new
                acquisitions.*





*The
      foregoing does not represent an exhaustive list of risks. Please see “Risk
      Factors” below for additional risks which could adversely impact our business
      and financial performance. Moreover, new risks emerge from time to time and
      it
      is not possible for our management to predict all risks, nor can we assess
      the
      impact of all risks on our business or the extent to which any risk, or
      combination of risks, may cause actual results to differ from those contained
      in
      any forward-looking statements. All forward-looking statements included in
      this
      Report are based on information available to us on the date of this Report.
      Except to the extent required by applicable laws or rules, we undertake no
      obligation to publicly update or revise any forward-looking statement, whether
      as a result of new information, future events or otherwise. All subsequent
      written and oral forward-looking statements attributable to us or persons acting
      on our behalf are expressly qualified in their entirety by the cautionary
      statements contained throughout this Report.*





19




**RISK
      FACTORS**




The
      following factors should be considered carefully in evaluating the Company
      and
      its business:




**Risks
      Relating to Our Business**





**Because
      we depend on a small number of key clients, non-recurring revenue and contracts
      terminable on short notice, our business could be adversely affected if we
      fail
      to retain these clients and/or obtain new clients at a level sufficient to
      support our operations and/or broaden our client base.**





During
      the year ended December 31, 2005, two of the Company’s clients, Leading Edge
      Communications Corporation (LEC), a related party, and Bank of America,
      accounted for approximately 13.4% and 27.2%, respectively, of total revenues.
      During the year ended December 31, 2004, two of our clients, LEC and Bank of
      America, accounted for approximately 16.1% and 16.7% of total revenues. Further,
      the majority of our current assets consist of accounts receivable, and as of
      December 31, 2005, one customer, LEC, accounted for 14% of our accounts
      receivable balance. With the recent acquisition of new businesses and our
      objective of acquiring more over the next year, we believe that our reliance
      on
      these clients will continue to decline in the future. **** The
      loss
      of any of our largest clients could have a material adverse effect on our
      business. In addition, our contracts provide that our services are terminable
      upon short notice, typically not more than 30 days. Non-renewal or termination
      of contracts with these or other clients without adequate replacements could
      have a material and adverse effect upon our business. In addition, a large
      portion of our revenues are derived from information technology consulting
      services that are generally non-recurring in nature. There can be no assurance
      that we will:





·
            obtain
                additional contracts for projects similar in scope to those previously
                obtained from our clients;





·
            be
                able to retain existing clients or attract new
                clients;





·
            provide
                services in a manner acceptable to
                clients;





·
            offer
                pricing for services which is acceptable to clients;
                or





·
            broaden
                our client base so that we will not remain largely dependent upon
                a
                limited number of clients****that
                will continue to account for a substantial portion of our
                revenues.





20


**Our
      internal controls and procedures have been materially deficient, and we are
      in
      the process of correcting internal control deficiencies.**





In
      the
      first quarter of 2005, resulting from comments related to the Company’s
      Registration Statement on Form SB-2/A, the Company and its independent
      registered public accounting firm recognized that our internal controls had
      material weaknesses. In April 2005, we restated our results of operations for
      the Company's quarterly results for the quarters ended March 31, 2004, June
      30,
      2004 and September 30, 2004 related primarily to our purchase accounting for
      two
      acquisitions completed in 2004. In November 2005, resulting from discussions
      with the Staff of the SEC, we restated our results of operations for the
      Company's quarterly results for the quarters ended June 30, 2004, September
      30,
      2004 and March 31, 2005, and for the year ended December 31, 2004 primarily
      as a
      result of revised accounting treatment related to the our issuance of financial
      instruments in 2004 and to properly record the loss resulting from the fair
      value adjustment of the financial instruments. Finally, with this filing,
      resulting from discussions with the Staff of the SEC, we restated the
      manner in which we recorded and accounted for the beneficial conversion feature
      associated with convertible notes issued in 2004 in our
      results of operations for the Company's quarterly results for the quarters
      ended
      September 30, 2004, March 31, 2005, June 30, 2005 and September 30, 2005, and
      for the year ended December 31, 2004. As
      a
      result of this latest restatement, we were unable to file this Form 10-KSB
      in a
      timely fashion. Further restatements could cause us to miss our filing deadlines
      in the future, which could bring us out of compliance
      with the continued listing standards of the American Stock Exchange and/or
      cause
      us to default on certain of our financing arrangements, which would have a
      material adverse effect on our business.





If
      we
      cannot rectify these material weaknesses through remedial measures and
      improvements to our systems and procedures, management may encounter
      difficulties in timely assessing business performance and identifying incipient
      strategic and oversight issues. Management is currently focused on remedying
      internal control deficiencies, and this focus will require management from
      time
      to time to devote its attention away from other planning, oversight and
      performance functions.





We
      cannot
      provide assurances as to the timing of the completion of these efforts. We
      cannot be certain that the measures we take will ensure that we implement and
      maintain adequate internal controls in the future. Any failure to implement
      required new or improved controls, or difficulties encountered in their
      implementation, could harm our operating results or cause us to fail to meet
      our
      reporting obligations.





**The
      Company may have liability in connection with its recent securities
      offerings.**





We
      have
      completed various financings through the issuance of our common stock, as well
      as the issuance of notes and warrants convertible into our common stock, while
      a
      Registration Statement on Form SB-2 was on file with the SEC but had not yet
      been declared effective (those transactions were with certain investors of
      Taurus Advisory Group, LLC, Laurus Master Fund, Ltd. and three entities
      affiliated with Sands Brothers International Limited). We also issued our common
      stock in connection with the acquisition of substantially all the assets of
      Evoke Software Corporation during this time (we subsequently sold such assets
      in
      July 2005). Even though all stockholders, noteholders and warrantholders have
      been advised of their rights to rescind those financing transactions and they
      each have waived their rights to rescind those transactions, there is a remote
      possibility that each of those transactions could be reversed and the
      consideration received by us may have to be repaid. In such an event, our
      business could be adversely affected and we may have an obligation to fund
      such
      rescissions.




21





**Certain
      client-related complications may materially adversely affect our
      business.**





We
      may be
      subject to additional risks relating to our clients that could materially
      adversely affect our business, such as delays in clients paying their
      outstanding invoices, lengthy client review processes for awarding contracts,
      delay, termination, reduction or modification of contracts in the event of
      changes in client policies or as a result of budgetary constraints, and/or
      increased or unexpected costs resulting in losses under fixed-fee contracts,
      which factors could also adversely affect our business.





**We
      have a history of losses and we could incur losses in the
      future.**





During
      the fiscal years ended December 31, 2005 and December 31, 2004, we sustained
      operating losses and cannot be sure that we will operate profitably in the
      future. During the fiscal year ended December 31, 2005, we reported a net loss
      in the approximate amount of ($5.1 million). The Company recorded a ($6.1
      million) loss from operating activities for the fiscal year ended December
      31,
      2005. During the fiscal year ended December 31, 2004, we sustained a net loss
      in
      the approximate amount of ($35.3 million). The Company recorded a ($17.0
      million) loss from operating activities for the fiscal year ended December
      31,
      2004, of which $12.2 million of the loss resulted from impairment of goodwill
      and intangibles for the year ended December 31, 2004. If we do not become
      profitable, we could have difficulty obtaining funds to continue our operations.
      We have incurred net losses since our merger with LCS Group, Inc. We may
      continue to generate losses from the ongoing business prior to returning the
      Company to profitability.





**We
      have a significant amount of debt, which, in the event of a default, could
      have
      material adverse consequences upon us.**





Our
      total
      debt as of March 31, 2006 is approximately $15.0 million. The degree to which
      we
      are leveraged could have important consequences to us, including the
      following:





·
            A
                portion of our cash flow must be used to pay interest on our indebtedness,
                and therefore is not available for use in our
                business;





·
            Our
                indebtedness increases our vulnerability to changes in general economic
                and industry conditions;





·
            Our
                ability to obtain additional financing for working capital, capital
                expenditures, general corporate purposes or other purposes could
                be
                impaired;





22




·
            Our
                failure to comply with restrictions contained in the terms of our
                borrowings could lead to a default which could cause all or a significant
                portion of our debt to become immediately payable;
                and





·
            If
                we default, the loans will become due and we may not have the funds
                to
                repay the loans, and we could discontinue our business and investors
                could
                lose all their money.





In
      addition, certain terms of such loans require the prior consent of Laurus Master
      Fund, Ltd. on many corporate actions including, but not limited to, mergers
      and
      acquisitions—which is part of our ongoing business strategy **.**





**If
      an event of default occurs under our notes with Laurus, it could seriously
      harm
      our operations.**




On
      February 1, 2006, we issued two separate secured non-convertible term notes
      to
      Laurus in the amounts of up to $10 million and $1 million respectively. The
      note
      and related agreements contain several events of default which include:




·
            failure
                to pay interest, principal payments or other fees when
                due;


·
            failure
                to pay taxes when due unless such taxes are being contested in good
                faith;


·
            breach
                by us of any material covenant or term or condition of the notes
                or any
                agreements made in connection
                therewith;


·
            default
                on any indebtedness to which we or our subsidiaries are a
                party;


·
            breach
                by us of any material representation or warranty made in the notes
                or in
                any agreements made in connection
                therewith;


·
            attachment
                is made or levy upon collateral securing the Laurus debt which is
                valued
                at more than $150,000 and is not timely
                mitigated.


·
            any
                lien created under the notes and agreements is not valid and perfected
                having a first priority interest;


·
            assignment
                for the benefit of our creditors, or a receiver or trustee is appointed
                for us;


·
            bankruptcy
                or insolvency proceeding instituted by or against us and not dismissed
                within 30 days;


·
            the
                inability to pay debts as they become due or cease business
                operations;


·
            sale,
                assignment, transfer or conveyance of any assets except as
                permitted;


·
            a
                person or group becomes beneficial owner of 35% on fully diluted
                basis of
                the outstanding voting equity interest or the present directors cease
                to
                be the majority on the Board of
                Directors;


·
            indictment
                or threatened criminal indictment, or commencement of threatened
                commencement of any criminal or civil proceeding against the Company
                or
                any executive officer; and


·
            common
                stock suspension for five consecutive days or five days during any
                10
                consecutive days from a principal market, provided that we are unable
                to
                cure such suspension within 30 days or list our common stock on another
                principal market within 60 days.




23




If
      we
      default on the notes and the holder demands all payments due and payable, the
      cash required to pay such amounts would most likely come out of working capital,
      which may not be sufficient to repay the amounts due. The default payment shall
      be 115% of the outstanding principal amount of the note, plus accrued but unpaid
      interest, all other fees then remaining unpaid, and all other amounts payable
      thereunder. In addition, since we rely on our working capital for our day to
      day
      operations, such a default on the note could materially adversely affect our
      business, operating results or financial condition to such extent that we are
      forced to restructure, file for bankruptcy, sell assets or cease operations.
      Further, our obligations under the notes are secured by substantially all of
      our
      assets. Failure to fulfill our obligations under the notes and related
      agreements could lead to loss of these assets, which would be detrimental to
      our
      operations.




**Our
      operating results are difficult to forecast.**





We
      may
      increase our general and administrative expenses in the event that we increase
      our business and/or acquire other businesses, while our operating expenses
      for
      sales and marketing and costs of services for technical personnel to provide
      and
      support our services also increases. Additionally, although most of our clients
      are large, creditworthy entities, at any given point in time, we may have
      significant accounts receivable balances with clients that expose us to credit
      risks if such clients either delay or elect not to pay or are unable to pay
      such
      obligations. If we have an unexpected shortfall in revenues in relation to
      our
      expenses, or significant bad debt experience, our business could be materially
      and adversely affected.





**Our
      profitability, if any, will suffer if we are not able to** **retain
      existing clients or attract new clients. A continuation of current pricing
      pressures could result in permanent changes in pricing policies and delivery
      capabilities.**





Our
      gross
      profit margin is largely a function of the rates we are able to charge for
      our
      information technology services. Accordingly, if we are not able to maintain
      the
      pricing for our services or an appropriate utilization of our professionals
      without corresponding cost reductions, our margins will suffer. The rates we
      are
      able to charge for our services are affected by a number of factors,
      including:





·
            our
                clients’ perceptions of our ability to add value through our
                services;





·
            pricing
                policies of our competitors;





·
            our
                ability to accurately estimate, attain and sustain engagement revenues,
                margins and cash flows over increasingly longer contract
                periods;





·
            the
                use of globally sourced, lower-cost service delivery capabilities
                by our
                competitors and our clients; and





·
            general
                economic and political conditions.





Our
      gross
      margins are also a function of our ability to control our costs and improve
      our
      efficiency. If the continuation of current pricing pressures persists it could
      result in permanent changes in pricing policies and delivery capabilities and
      we
      must continuously improve our management of costs.





24


**Unexpected
      costs or delays could make our contracts unprofitable.**





In
      the
      future, we may have many types of contracts, including time-and-materials
      contracts, fixed-price contracts and contracts with features of both of these
      contract types. Any increased or unexpected costs or unanticipated delays in
      connection with the performance of these engagements, including delays caused
      by
      factors outside our control, could make these contracts less profitable or
      unprofitable, which would have an adverse effect on all of our margins and
      potential net income.





**Our
      business could be adversely affected if we fail to adapt to emerging and
      evolving markets.**





The
      markets for our services are changing rapidly and evolving and, therefore,
      the
      ultimate level of demand for our services is subject to substantial uncertainty.
      Most of our historic revenue was generated from providing information technology
      services only. During the last several years, we have focused our efforts on
      providing data warehousing services in particular since we believe that there
      is
      going to be an increased need in this area. Any significant decline in demand
      for programming, applications development, information technology or data
      warehousing consulting services could materially and adversely affect our
      business and prospects.





Our
      ability to achieve growth targets is dependent in part on maintaining existing
      clients and continually attracting and retaining new clients to replace those
      who have not renewed their contracts. Our ability to achieve market acceptance,
      including for data warehousing, will require substantial efforts and
      expenditures on our part to create awareness of our services.





**If
      we should experience rapid growth, such growth could strain our managerial
      and
      operational resources, which could adversely affect our
      business.**





Any
      rapid
      growth that we may experience would most likely place a significant strain
      on
      our managerial and operational resources. If we continue to acquire other
      companies, we will be required to manage multiple relationships with various
      clients, strategic partners and other third parties. Further growth (organic
      or
      by acquisition) or an increase in the number of strategic relationships may
      increase this strain on existing managerial and operational resources,
      inhibiting our ability to achieve the rapid execution necessary to implement
      our
      growth strategy without incurring additional corporate expenses.





**Lack
      of detailed written contracts could impair our ability to collect fees, protect
      our intellectual property and protect ourselves from liability to
      others.**





We
      try to
      protect ourselves by entering into detailed written contracts with our clients
      covering the terms and contingencies of the client engagement. In some cases,
      however, consistent with what we believe to be industry practice, work is
      performed for clients on the basis of a limited statement of work or verbal
      agreements before a detailed written contact can be finalized. To the extent
      that we fail to have detailed written contracts in place, our ability to collect
      fees, protect our intellectual property and protect ourselves from liability
      from others may be impaired.





25


**Failure
      to achieve and maintain effective internal controls in accordance with Section
      404 of the Sarbanes-Oxley Act could have a material adverse effect on our
      business and operating results. In addition, current and potential stockholders
      could lose confidence in our financial reporting, which could have a material
      adverse effect on our stock price.**





Effective
      internal controls are necessary for us to provide reliable financial reports
      and
      effectively prevent fraud. If we cannot provide reliable financial reports
      or
      prevent fraud, our operating results could be harmed.





Commencing
      in July 2007, we will be required to document and test our internal control
      procedures in order to satisfy the requirements of Section 404 of the
      Sarbanes-Oxley Act, which requires annual management assessments of the
      effectiveness of our internal controls over financial reporting and a report
      by
      our independent registered public accounting firm addressing these assessments.
      During the course of our testing, we may identify deficiencies which we may
      not
      be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley
      Act for compliance with the requirements of Section 404. In addition, if we
      fail
      to maintain the adequacy of our internal controls, as such standards are
      modified, supplemented or amended from time to time, we may not be able to
      ensure that we can conclude on an ongoing basis that we have effective internal
      controls over financial reporting in accordance with Section 404 of the
      Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal
      control environment could also cause investors to lose confidence in our
      reported financial information, which could have a material adverse effect
      on
      our stock price.





**Compliance
      with changing regulation of corporate governance and public disclosure may
      result in additional expenses.**





Changing
      laws, regulations and standards relating to corporate governance and public
      disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and
      exchange rules (although not, as of the date of this Annual Report, applicable
      to us), are creating uncertainty for companies such as ours. These new or
      changed laws, regulations and standards are subject to varying interpretations
      in many cases due to their lack of specificity, and as a result, their
      application in practice may evolve over time as new guidance is provided by
      regulatory and governing bodies, which could result in continuing uncertainty
      regarding compliance matters and higher costs necessitated by ongoing revisions
      to disclosure and governance practices. We are committed to maintaining high
      standards of corporate governance and public disclosure. As a result, our
      efforts to comply with evolving laws, regulations and standards have resulted
      in, and are likely to continue to result in, increased general and
      administrative expenses and a diversion of management time and attention from
      revenue-generating activities to compliance activities. In particular, our
      efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the
      related regulations regarding our required assessment of our internal controls
      over financial reporting and our independent registered public accounting firm's
      audit of that assessment will require the commitment of significant financial
      and managerial resources. Further, our board members, chief executive officer
      and chief financial officer could face an increased risk of personal liability
      in connection with the performance of their duties. As a result, we may have
      difficulty attracting and retaining qualified board members and executive
      officers, which could harm our business. If our efforts to comply with new
      or
      changed laws, regulations and standards differ from the activities intended
      by
      regulatory or governing bodies due to ambiguities related to practice, our
      reputation may be harmed.





26


**We
      face intense competition and our failure to meet this competition could
      adversely affect our business.**





Competition
      for our information technology consulting services, including data warehousing,
      is significant and we expect that this competition will continue to intensify
      due to the low barriers to entry. We may not have the financial resources,
      technical expertise, sales and marketing or support capabilities to adequately
      meet this competition. We compete against numerous large companies, including,
      among others, multi-national and other major consulting firms. These firms
      have
      substantially greater market presence, longer operating histories, more
      significant client bases and greater financial, technical, facilities,
      marketing, capital and other resources than we have. If we are unable to compete
      against such competitors, our business will be adversely affected.





Our
      competitors may respond more quickly than us to new or emerging technologies
      and
      changes in client requirements. Our competitors may also devote greater
      resources than we can to the development, promotion and sales of our services.
      If one or more of our competitors develops and implements methodologies that
      result in superior productivity and price reductions without adversely affecting
      their profit margins, our business could suffer. Competitors may
      also:





·
            engage
                in more extensive research and
                development;





·
            undertake
                more extensive marketing campaigns;





·
            adopt
                more aggressive pricing policies;
                and





·
            make
                more attractive offers to our existing and potential employees and
                strategic partners.





In
      addition, current and potential competitors have established or may establish
      cooperative relationships among themselves or with third parties that could
      be
      detrimental to our business.





New
      competitors, including large computer hardware, software, professional services
      and other technology companies, may enter our markets and rapidly acquire
      significant market share. As a result of increased competition and vertical
      and
      horizontal integration in the industry, we could encounter significant pricing
      pressures. These pricing pressures could result in substantially lower average
      selling prices for our services. We may not be able to offset the effects of
      any
      price reductions with an increase in the number of clients, higher revenue
      from
      consulting services, cost reductions or otherwise. In addition, professional
      services businesses are likely to encounter consolidation in the near future,
      which could result in decreased pricing and other competition.





27


**If
      we fail to adapt to the rapid technological change constantly occurring in
      the
      areas in which we provide services, including data warehousing, our business
      could be adversely affected.**





The
      market for information technology consulting services and data warehousing
      is
      rapidly evolving. Significant technological changes could render our existing
      services obsolete. We must adapt to this rapidly changing market by continually
      improving the responsiveness, functionality and features of our services to
      meet
      clients’ needs. If we are unable to respond to technological advances and
      conform to emerging industry standards in a cost-effective and timely manner,
      our business could be materially and adversely affected.





**We
      depend on our management. If we fail to retain key personnel, our business
      could
      be adversely affected.**





There
      is
      intense competition for qualified personnel in the areas in which we operate.
      The loss of existing personnel or the failure to recruit additional qualified
      managerial, technical and sales personnel, as well as expenses in connection
      with hiring and retaining personnel, particularly in the emerging area of data
      warehousing, could adversely affect our business. We also depend upon the
      performance of our executive officers and key employees in particular, Messrs.
      Scott Newman, Glenn Peipert and Robert C. DeLeeuw. Although we have entered
      into
      employment agreements with Messrs. Newman, Peipert and DeLeeuw, the loss of
      any
      of these individuals could have a material adverse effect upon us. In addition,
      we have not obtained “key man” life insurance on the lives of Messrs. Newman,
      Peipert or DeLeeuw.





We
      will
      need to attract, train and retain more employees for management, engineering,
      programming, sales and marketing, and client service and support positions.
      As
      noted above, competition for qualified employees, particularly engineers,
      programmers and consultants, continues to be intense. Consequently, we may
      not
      be able to attract, train and retain the personnel we need to continue to offer
      solutions and services to current and future clients in a cost effective manner,
      if at all.





**If
      we fail to raise capital that we may need to support and increase our
      operations, our business could be adversely affected.**





Our
      future capital uses and requirements will depend on several factors,
      including:





·
            the
                extent to which our solutions and services gain market
                acceptance;





·
            the
                level of revenues from current and future solutions and
                services;





·
            the
                expansion of operations;





·
            the
                costs and timing of product and service developments and sales and
                marketing activities;





·
            the
                costs related to acquisitions of technology or businesses;
                and





·
            competitive
                developments.





28




We
      may
      require additional capital in order to continue to support and increase our
      sales and marketing efforts, continue to expand and enhance the solutions and
      services we are able to offer to current and future clients and fund potential
      acquisitions. This capital may not be available on terms acceptable to us,
      if at
      all. In addition, we may be required to spend greater-than-anticipated funds
      if
      unforeseen difficulties arise in the course of these or other aspects of our
      business. As a consequence, we will be required to raise additional capital
      through public or private equity or debt financings, collaborative
      relationships, bank facilities or other arrangements. We cannot assure you
      that
      such additional capital will be available on terms acceptable to us, if at
      all.
      Further, if we raise capital though an equity or debt financing at reduced
      exercise or conversion price, it could trigger certain anti-dilution provisions
      with other investors. Any additional equity financing is expected to be dilutive
      to our stockholders, and debt financing, if available, may involve restrictive
      covenants and increased interest costs. Our inability to obtain sufficient
      financing may require us to delay, scale back or eliminate some or all of our
      expansion programs or to limit the marketing of our services. This could have
      a
      material and adverse effect on our business.





**We
      could have potential liability** **for
      intellectual property infringement, personal injury, property damage or breach
      of contract to our clients that could adversely affect our
      business.**





Our
      services involve development and implementation of computer systems and computer
      software that are critical to the operations of our clients’ businesses. If we
      fail or are unable to satisfy a client’s expectations in the performance of our
      services, our business reputation could be harmed or we could be subject to
      a
      claim for substantial damages, regardless of our responsibility for such failure
      or inability. In addition, in the course of performing services, our personnel
      often gain access to technologies and content which include confidential or
      proprietary client information.





Although
      we have implemented policies to prevent such client information from being
      disclosed to unauthorized parties or used inappropriately, any such unauthorized
      disclosure or use could result in a claim for substantial damages. Our business
      could be adversely affected if one or more large claims are asserted against
      us
      that are uninsured, exceed available insurance coverage or result in changes
      to
      our insurance policies, including premium increases or the imposition of large
      deductible or co-insurance requirements. Although we maintain general liability
      insurance coverage, including coverage for errors and omissions, there can
      be no
      assurance that such coverage will continue to be available on reasonable terms
      or will be available in sufficient amounts to cover one or more large
      claims.





**We
      do not intend to pay dividends on shares of our common stock in the foreseeable
      future.**





We
      have
      never paid cash dividends on our common stock other than distributions resulting
      from our past tax status as a Subchapter S corporation. Our current Board of
      Directors does not anticipate that we will pay cash dividends in the foreseeable
      future. Instead, we intend to retain future earnings for reinvestment in our
      business and/or to fund future acquisitions. In addition, the security agreement
      with Laurus Master Fund, Ltd. requires that we obtain their consent prior to
      paying any dividends on our common stock.





29


**Our
      management group owns or controls a significant number of the outstanding shares
      of our common stock and will continue to have significant ownership of our
      voting securities for the foreseeable future.**





Scott
      Newman and Glenn Peipert, our principal stockholders and our executive officers
      and two of our directors, beneficially own approximately 39.2% and 18.7%,
      respectively, of our outstanding common stock. Robert C. DeLeeuw, our Senior
      Vice President and President of our wholly owned subsidiary, DeLeeuw Associates,
      LLC, owns approximately 10.7% of our outstanding common stock. As a result,
      these persons will have the ability, acting as a group, to effectively control
      our affairs and business, including the election of directors and subject to
      certain limitations, approval or preclusion of fundamental corporate
      transactions. This concentration of ownership of our common stock
      may:





·
            delay
                or prevent a change in the control;





·
            impede
                a merger, consolidation, takeover or other transaction involving
                us;
                or





·
            discourage
                a potential acquirer from making a tender offer or otherwise attempting
                to
                obtain control of us.





**The
      authorization and issuance of “blank check” preferred stock could have an
      anti-takeover effect detrimental to the interests of our
      stockholders.**





Our
      certificate of incorporation allows the Board of Directors to issue 20,000,000
      shares of preferred stock with rights and preferences set by our board without
      further stockholder approval. The issuance of shares of this “blank check
      preferred” under particular circumstances could have an anti-takeover effect.
      For example, in the event of a hostile takeover attempt, it may be possible
      for
      management and the board to endeavor to impede the attempt by issuing shares
      of
      blank check preferred, thereby diluting or impairing the voting power of the
      other outstanding shares of common stock and increasing the potential costs
      to
      acquire control of us. Our Board of Directors has the right to issue blank
      check
      preferred without first offering them to holders of our common stock, as the
      holders of our common stock have no preemptive rights. To date, the Company
      has
      issued 19,000 shares of Series A Convertible Preferred Stock to Taurus Advisory
      Group, LLC.





**Our
      services or solutions may infringe upon the intellectual property rights of
      others.**





We
      cannot
      be sure that our services and solutions, or the solutions of others that we
      offer to our clients, do not infringe on the intellectual property rights of
      third parties, and we may have infringement claims asserted against us or
      against our clients. These claims may harm our reputation, cost us money and
      prevent us from offering some services or solutions. In some instances, the
      amount of these expenses may be greater than the revenues we receive from the
      client. Any claims or litigation in this area, whether we ultimately win or
      lose, could be time-consuming and costly, injure our reputation or require
      us to
      enter into royalty or licensing arrangements. We may not be able to enter into
      these royalty or licensing arrangements on acceptable terms. To the best of
      our
      knowledge, we have never infringed upon the intellectual property rights of
      another individual or entity.





30


**We
      could be subject to systems failures that could adversely affect our
      business.**





Our
      business depends on the efficient and uninterrupted operation of our computer
      and communications hardware systems and infrastructure. We currently maintain
      our computer systems in our facilities at our offices in New Jersey and
      elsewhere. We
      do not
      have complete redundancy in our systems and therefore any damage or destruction to our systems
      would significantly harm our business. Although
      we have taken precautions against systems failure, interruptions could result
      from natural disasters as well as power losses, telecommunications failures
      and
      similar events. Our
      systems are also subject to human error, security breaches, computer viruses,
      break-ins, “denial of service” attacks, sabotage, intentional acts of vandalism
      and tampering designed to disrupt our computer systems. We
      also
      lease telecommunications lines from local and regional carriers, whose service
      may be interrupted. Any damage or failure that interrupts or delays network
      operations could materially and adversely affect our business.





**Our
      business could be adversely affected if we fail to adequately address security
      issues.**





We
      have
      taken measures to protect the integrity of our technology infrastructure and
      the
      privacy of confidential information. Nonetheless, our technology **** infrastructure
      is potentially vulnerable to physical or electronic break-ins, viruses or
      similar problems. If a person or entity circumvents its security measures,
      they
      could jeopardize the security of confidential information stored on our systems,
      misappropriate proprietary information or cause interruptions in our operations.
      We may be required to make substantial additional investments and efforts to
      protect against or remedy security breaches. Security breaches that result
      in
      access to confidential information could damage our reputation and expose us
      to
      a risk of loss or liability.





**Risks
      Relating To Acquisitions**


**We
      face intense competition for acquisition candidates, and we may have limited
      cash available for such acquisitions.**





There
      is
      a high degree of competition among companies seeking to acquire interests in
      information technology service companies such as those we may target for
      acquisition. We are expected to continue to be an active participant in the
      business of seeking business relationships with, and acquisitions of interests
      in, such companies. A large number of established and well-financed entities,
      including venture capital firms, are active in acquiring interests in companies
      that we may find to be desirable acquisition candidates. Many of these
      investment-oriented entities have significantly greater financial resources,
      technical expertise and managerial capabilities than we do. Consequently, we
      may
      be at a competitive disadvantage in negotiating and executing possible
      investments in these entities as many competitors generally have easier access
      to capital, on which entrepreneur-founders of privately-held information
      technology service companies generally place greater emphasis than obtaining
      the
      management skills and networking services that we can provide. Even if we are
      able to compete with these venture capital entities, this competition may affect
      the terms and conditions of potential acquisitions and, as a result, we may
      pay
      more than expected for targeted acquisitions. If we cannot acquire interests
      in
      attractive companies on reasonable terms, our strategy to build our business
      through acquisitions may be inhibited.





31


**We
      will encounter difficulties in identifying suitable acquisition candidates
      and
      integrating new acquisitions.**





A
      key
      element of our expansion strategy is to grow through acquisitions. If we
      identify suitable candidates, we may not be able to make investments or
      acquisitions on commercially acceptable terms. Acquisitions may cause a
      disruption in our ongoing business, distract management, require other resources
      and make it difficult to maintain our standards, controls and procedures. We
      may
      not be able to retain key employees of the acquired companies or maintain good
      relations with their clients or suppliers. We may be required to incur
      additional debt and to issue equity securities, which may be dilutive to
      existing stockholders, to effect and/or fund acquisitions.





**We
      cannot assure you that any acquisitions we make will enhance our
      business.**





We
      cannot
      assure you that any completed acquisition will enhance our business. Since
      we
      anticipate that acquisitions could be made with both cash and our common stock,
      if we consummate one or more significant acquisitions, the potential impacts
      are:





·
            a
                substantial portion of our available cash could be used to consummate
                the
                acquisitions and/or we could incur or assume significant amounts
                of
                indebtedness;





·
            losses
                resulting from the on-going operations of these acquisitions could
                adversely affect our cash flow; and





·
            our
                stockholders could suffer significant dilution of their interest
                in our
                common stock.





Also,
      we
      are required to account for acquisitions under the purchase method, which would
      likely result in our recording significant amounts of goodwill. The inability
      of
      a subsidiary to sustain profitability may result in an impairment loss in the
      value of long-lived assets, principally goodwill and other tangible and
      intangible assets, which would adversely affect our financial statements.
      Additionally, we could choose to divest any acquisition that is not
      profitable.




32


**Risks
        Relating To Our Common Stock**
  **Our
        relationship with our majority stockholders presents potential conflicts
        of
        interest, which may result in decisions that favor them over our other
        stockholders.**


Our
      principal beneficial owners, Scott Newman, Glenn Peipert and Robert C. DeLeeuw,
      provide management and financial assistance to us. When their personal
      investment interests diverge from our interests, they and their affiliates
      may
      exercise their influence in their own best interests. Some decisions concerning
      our operations or finances may present conflicts of interest between us and
      these stockholders and their affiliated entities.





**The
      limited prior public market and trading market may cause possible volatility
      in
      our stock price** .





There
      has
      only been a limited public market for our securities and there can be no
      assurance that an active trading market in our securities will be maintained.
      In
      addition, the overall market for securities in recent years has experienced
      extreme price and volume fluctuations that have particularly affected the market
      prices of many smaller companies. The trading price of our common stock is
      expected to be subject to significant fluctuations including, but not limited
      to, the following:





·
            quarterly
                variations in operating results and achievement of key business
                metrics;





·
            changes
                in earnings estimates by securities analysts, if
                any;





·
            any
                differences between reported results and securities analysts’ published or
                unpublished expectations;





·
            announcements
                of new contracts or service offerings by us or our
                competitors;





·
            market
                reaction to any acquisitions, divestitures, joint ventures or strategic
                investments announced by us or our
                competitors;





·
            demand
                for our services and products;





·
            shares
                being sold pursuant to Rule 144 or upon exercise of warrants;
                and





·
            general
                economic or stock market conditions unrelated to our operating
                performance.





These
      fluctuations, as well as general economic and market conditions, may have a
      material or adverse effect on the market price of our common stock.





**We
      may be de-listed from the AMEX if we do not meet continued listing
      requirements.**





Our
      common stock commenced trading on the AMEX on September 21, 2005. The AMEX
      (Part
      10, Section 1003) requires stockholders’ equity (for continued listing) of at
      least $2.0 million if a listed company has sustained net losses in its five
      most
      recent fiscal years. As of December 31, 2005, our stockholders’ equity was
      approximately $1.6 million. However, Section 1003 includes an exception to
      such
      requirement. Specifically, AMEX will not normally consider suspending a listed
      company if the company (i) has a total market capitalization of at least $50
      million; or total assets and revenue of $50 million each in its last fiscal
      year, or in two of its last three fiscal years; and (ii) the Company has at
      least 1.1 million shares publicly held, a market value of publicly held shares
      of at least $15 million and 400 round lot stockholders. The Company currently
      meets such exception as well, however there can be no assurance that it will
      continue to do so, nor that AMEX will not consider the commencement of
      suspending or removing the Company’s listing on the AMEX.


As
        a
        result of failing to file this Form 10-KSB in a timely fashion, the Company
        failed to meet the continued listing requirements of the American Stock Exchange
        from its due date on April 17, 2006 until the date of this filing. In the
        future, if we fail to timely file our required reports, we could be subject
        to
        delisting.





33





If
      our
      common stock is de-listed by the AMEX, trading of our common stock would
      thereafter likely be conducted on the OTC Bulletin Board. In such case, the
      market liquidity for our common stock would likely be negatively affected,
      which
      may make it more difficult for holders of our common stock to sell their
      securities in the open market and we could face difficulty raising capital
      necessary for our continued operations.





**Additional
      authorized shares of our common stock and preferred stock available for issuance
      may adversely affect the market.**





We
      are
      authorized to issue 85 million shares of our common stock. As of March 31,
      2006,
      there were 49,997,834 shares
      of
      common stock issued and outstanding. However, the total number of shares of
      our
      common stock issued and outstanding does not include shares reserved in
      anticipation of the conversion of notes or the exercise of options or warrants.
      As of March 31,
      2006,
      we had 1,784,127 shares
      of
      common stock underlying convertible notes, and we have reserved shares of our
      common stock for issuance in connection with the potential conversion thereof.
      As of March 31,
      2006,
      we had outstanding stock options and warrants to purchase approximately 10,507,113 shares
      of
      our common stock, the exercise price of which range between $0.46 and $5.25
      per
      share, and we have reserved shares of our common stock for issuance in
      connection with the potential exercise thereof. Of the reserved shares, a total
      of 6,666,667 shares
      are currently reserved for issuance in connection with our 2003 Incentive Plan,
      of which options to purchase approximately 5, 619,781  shares
      have been issued under the plan as of March 31, 2006. A significant number
      of
      such options and warrants contain provisions for broker-assisted exercise.
      To
      the extent such options or warrants are exercised, the holders of our common
      stock will experience further dilution. In addition, in the event that any
      future financing should be in the form of, be convertible into or exchangeable
      for, equity securities, and upon the exercise of options and warrants, investors
      may experience additional dilution.





The
      exercise of the outstanding convertible securities will reduce the percentage
      of
      common stock held by our stockholders. Further, the terms on which we could
      obtain additional capital during the life of the convertible securities may
      be
      adversely affected, and it should be expected that the holders of the
      convertible securities would exercise them at a time when we would be able
      to
      obtain equity capital on terms more favorable than those provided for by such
      convertible securities. As a result, any issuance of additional shares of common
      stock may cause our current stockholders to suffer significant dilution which
      may adversely affect the market.





34




In
      addition to the above-referenced shares of common stock which may be issued
      without stockholder approval, we have 20
      million shares
      of
      authorized preferred stock, the terms of which may be fixed by our Board of
      Directors. To
      date,
      the Company has issued 19,000 shares of Series A Convertible Preferred Stock
      to
      Taurus Advisory Group LLC. While w e
      presently have no present plans to issue any more additional shares of preferred
      stock, our Board of Directors has the authority, without stockholder approval,
      to create and issue one or more series of such preferred stock and to determine
      the voting, dividend and other rights of holders of such preferred stock. The
      issuance of any of such series of preferred stock may have an adverse effect
      on
      the holders of common stock.





**Shares
      eligible for future sale may adversely affect the market.**





From
      time
      to time, certain of our stockholders may be eligible to sell all or some of
      their shares of common stock by means of ordinary brokerage transactions in
      the
      open market pursuant to Rule 144, promulgated under the Securities Act of 1933
      (Securities Act), subject to certain limitations. In general, pursuant to Rule
      144, a stockholder (or stockholders whose shares are aggregated) who has
      satisfied a one-year holding period may, under certain circumstances, sell
      within any three-month period a number of securities which does not exceed
      the
      greater of 1% of the then outstanding shares of common stock or the average
      weekly trading volume of the class during the four calendar weeks prior to
      such
      sale. Rule 144 also permits, under certain circumstances, the sale of
      securities, without any limitation, by our stockholders that are non-affiliates
      that have satisfied a two-year holding period. Any substantial sale of our
      common stock pursuant to Rule 144 or pursuant to any resale prospectus may
      have
      material adverse effect on the market price of our securities.





**Director
      and officer liability is limited.**





As
      permitted by Delaware law, our certificate of incorporation limits the liability
      of our directors for monetary damages for breach of a director's fiduciary
      duty
      except for liability in certain instances. As a result of our charter provision
      and Delaware law, stockholders may have limited rights to recover against
      directors for breach of fiduciary duty. In addition, our certificate of
      incorporation provides that we shall indemnify our directors and officers to
      the
      fullest extent permitted by law.




**ITEM
      2.**  **DESCRIPTION
      OF PROPERTY**




The
      Company's corporate headquarters are located at 100 Eagle Rock Avenue, East
      Hanover, New Jersey 07936, where it operates under an amended lease agreement
      expiring December 31, 2010. In addition to minimum rentals, the Company is
      liable for its proportionate share of real estate taxes and operating expenses,
      as defined. DeLeeuw Associates, LLC has an office at Suite 1460, Charlotte
      Plaza, 201 South College Street, Charlotte, North Carolina 28244. DeLeeuw leases
      this space which has a stated expiration date of December 31, 2010. The Company
      also leases office space at 11 Penn Plaza, New York, NY 10001. The current
      lease
      expiration date is March 31, 2007.





The
      Company is committed under several operating leases for automobiles that expire
      during 2007.




See
        Note
        20 to the Notes to Consolidated Financial Statements.





35




**ITEM
      3.**  **LEGAL
      PROCEEDINGS**




On
      August
      1, 2005, Sridhar Bhupatiraju and Scosys, Inc. commenced legal action against
      the
      Company in the Superior Court of New Jersey. The complaint alleges, among other
      things, the Company’s failure to make certain payments pursuant to an asset
      purchase agreement with Scosys, Inc. and the Company’s failure to make certain
      payments to Sridhar Bhupatiraju in accordance with his employment agreement
      with
      the Company. The plaintiffs are seeking unspecified compensatory damages,
      punitive damages, fees and other costs. On September 30, 2005, the Company
      filed
      its answer to complaint and third-party complaint against Scorpio Systems,
      alleging that Mr. Bhupatiraju embarked on a scheme to circumvent his contractual
      obligations under the asset purchase agreement, his non-compete agreement with
      the Company, and in violation of his duties of loyalty and fidelity to his
      employer (the Company) via Scorpio Systems, among other things Notwithstanding
      Mr. Bhupatiraju’s contractual obligations, the Company alleges that he sold the
      assets of Scosys while at the same time operating and/or owning a competing
      business, Scorpio Systems. Management believes the suit against the Company
      to
      be without merit and intends to vigorously defend the Company against this
      action and pursue its countersuit.







**ITEM
      4.**  **SUBMISSION
      OF MATTERS TO A VOTE TO SECURITY HOLDERS**




No
      matters were submitted to a vote of security holders during the fourth quarter
      of the fiscal year ended December 31, 2005.




36




**PART
      II**




**ITEM
      5.**  **MARKET
      FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**




*(a)*  ***Market
      Information*** .
      Our
      common stock traded on the OTC Bulletin Board, except as indicated below, and/or
      the Pink Sheets LLC under the symbol “LCSI” from July 16, 2003 through February
      2, 2004. From February 3, 2004 through September 20, 2005, our common stock
      traded on the OTC Bulletin Board under the symbol “CSII.” On September 21, 2005,
      our common stock began trading on the American Stock Exchange under the symbol
      “CVN.”





The
      following chart sets forth the high and low sales prices for each quarter
      from January 1, 2004 through September 20, 2005 and the closing
      high and low sales prices of the Company’s common stock as reported by the
      American Stock Exchange  for
      each
      quarter from September 20, 2005 through March 31, 2006. All numbers give effect
      to a 1 for 15 reverse stock split effected on September 20, 2005.




**High**
              
              **Low****2004
                  by Quarter**January
                  1 - March 31
              
              $
              3.75
              
              $
              1.80April
                  1 - June 30
              
              $
              3.975
              
              $
              1.65July
                  1 - September 30
              
              $
              4.65
              
              $
              2.70October
                  1 - December 31
              
              $
              3.75
              
              $
              2.40**2005
                  by Quarter**January
                  1 - March 31
              
              $
              3.825
              
              $
              2.175April
                  1 - June 30
              
              $
              4.20
              
              $
              1.67July
                  1 - September 30
              
              $
              2.33
              
              $
              1.28October
                  1 - December 31
              
              $
              2.01
              
              $
              0.40**2006
                  by Quarter**January
                  1 - March 31
              
              $
              1.49
              
              $
              0.41


Our
      Common stock is listed on the American Stock Exchange. On March 31, 2006, the
      closing price for shares of our common stock, as reported by the American Stock
      Exchange, was $1.03.





No
      prediction can be made as to the effect, if any, that future sales of shares
      of
      our common stock or the availability of our common stock for future sale will
      have on the market price of our common stock prevailing from time-to-time.
      The
      additional registration of our common stock and the sale of substantial amounts
      of our common stock in the public market could adversely affect the prevailing
      market price of our common stock.





37


*(b)*  ***Record
      Holders*** .
      As of
      March 31, 2006, there were 475 registered holders of our common stock, including
      shares held in street name. As of March 31, 2006, there were 49,997,834 shares
      of common stock issued and outstanding.





*(c)*  ***Dividends*** .
      We have
      not paid dividends on our common stock in the past and do not anticipate doing
      so in the foreseeable future. We currently intend to retain future earnings,
      if
      any, to fund the development and growth of our business. In addition, the
      security agreement with Laurus Master Fund, Ltd. requires that we obtain their
      consent prior to paying any dividends on our common stock.




*(d)*  ***Sales
      of Unregistered Securities***




During
      the period covered by this Annual Report, we did not issue any securities that
      were not registered under the Securities Act of 1933, as amended, except as
      previously included in a quarterly report on Form 10-QSB or a current report
      on
      Form 8-K.




**ITEM
      6.**  **MANAGEMENT’S
      DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.**





**Overview
      of our Business**





Management’s
      Discussion and Analysis contains statements that are forward-looking. These
      statements are based on current expectations and assumptions that are subject
      to
      risks and uncertainties. Actual results could differ materially because of
      factors discussed in “Risk Factors” and elsewhere in this report. The Company
      undertakes no duty to update any forward-looking statement to conform the
      statement to actual results or changes in the Company’s expectations.





Conversion
      Services International, Inc. provides professional services to the Global 2000,
      as well as mid-market clientele relating to strategic consulting, data
      warehousing, business intelligence and data management and, through strategic
      partners, the sale of software which is used to survey and quantify the quality
      of data. The Company’s services based clients are primarily in the financial
      services, pharmaceutical, healthcare and telecommunications industries, although
      it has clients in other industries as well. The Company’s clients are primarily
      located in the northeastern United States. The Company is committed to being
      a
      leader in data warehousing and business intelligence consulting, enabling it
      to
      be a valuable asset and trusted advisor to its customers. See Item 1 - Business
      for a full description of our services and offerings.





The
      Company began operations in 1990. Its services were originally focused on
      e-business solutions and data warehousing. In the late 1990s, the Company
      strategically repositioned itself to capitalize on its data warehousing
      expertise in the fast growing business intelligence/data warehousing space.
      The
      Company became a public company via its merger with a wholly owned subsidiary
      of
      LCS Group, Inc., effective January 30, 2004.





38


The
      Company’s core strategy includes capitalizing on the already established
      in-house business intelligence/data warehousing (“BI/DW”) technical expertise
      and its seasoned sales force. This is expected to result in organic growth
      through the addition of new customers. In addition, this foundation will be
      leveraged as the Company pursues targeted strategic acquisitions.




The
      Company derives a majority of its revenue from professional services
      engagements. Its revenue depends on the Company’s ability to generate new
      business, in addition to preserving present client engagements. The general
      domestic economic conditions in the industries the Company serves, the pace
      of
      technological change, and the business requirements and practices of its clients
      and potential clients directly affect this. When economic conditions decline,
      companies generally decrease their technology budgets and reduce the amount
      of
      spending on the type of information technology (IT) consulting the Company
      provides. The Company’s revenue is also impacted by the rate per hour it is able
      to charge for its services and by the size and chargeability, or utilization
      rate, of its professional workforce. If the Company is unable to maintain its
      billing rates or sustain appropriate utilization rates for its professionals,
      its overall profitability may decline. The Company continues to see improvements
      in economic conditions, which have recently led to increased spending on
      consulting services in certain vertical markets, particularly in financial
      services. The Company’s growing national presence and experienced, highly
      skilled workforce have enabled it to successfully differentiate its value and
      capabilities from those of its competitors, in effect, lessening the impact
      of
      current market pricing pressures.




The
        Company will continue to focus on a variety of growth initiatives in order
        to
        improve its market share and increase revenue. Moreover, as the Company
        endeavors to achieve top line growth, it will concentrate on improving margins
        and driving earnings to the bottom line. The Company will continue its best
        efforts to improve margins by limiting its use of outside consultants as
        employees provide higher levels of profitability. In addition, it will
        complement its service offerings with higher level management consulting
        opportunities, and continuously evaluating the size of its workforce in order
        to
        balance the Company’s skill base with the market demand for
        services.




In
      addition to the conditions described above for growing the Company’s current
      business, the Company will continue to grow through acquisitions.  One of
      the Company’s objectives is to make acquisitions of companies offering services
      complementary to the Company’s lines of business. This is expected to accelerate
      the Company’s business plan at lower costs than it would generate internally and
      also improve its competitive positioning and expand the Company’s offerings in a
      larger geographic area. The service industry is very fragmented, with a handful
      of large international firms having data warehousing and/or business
      intelligence divisions, and hundreds of regional boutiques throughout the United
      States.  These smaller firms do not have the financial wherewithal to scale
      their businesses or compete with the larger players.  To that end, the
      service industry has experienced consolidation during the past 24 months
      and the Company has been a participant in this consolidation. The Company has
      been active in acquiring companies during the last two years:




°  In
      March
      2004, the Company acquired DeLeeuw Associates, a management consulting firm
      in
      the information technology sector with core competency in delivering Change
      Management Consulting, including both Six Sigma and Lean domain expertise to
      enhance service delivery, with proven process methodologies resulting in time
      to
      market improvements within the financial services and banking industries.
      Historically, the DeLeeuw Associates business was involved in the operational
      integration of mergers and acquisitions, and would prescribe the systems
      integration work necessary. DeLeeuw Associates has now begun to sell the
      expanded suite of services offered by the Company, from operational integration
      to systems integration.





39


°  In
      May
      2004, the Company acquired 49% of all issued and outstanding shares of common
      stock of Leading Edge Communications Corporation (“LEC”). LEC provides
      enterprise software and services solutions for technology infrastructure
      management.




°   In
      June
      2004, the Company acquired substantially all of the assets and assumed
      substantially all of the liabilities of Evoke Software Corporation, which
      designed, developed, marketed and supported software programs for data analysis,
      data profiling and database migration applications and provides related support
      and consulting services. In July 2005, the Company divested substantially all
      of
      the assets of Evoke Software Corporation. The market for software has changed,
      and the Company determined that data profiling should no longer be a standalone
      product and needed to be part of a suite of tools. This is evidenced by the
      subsequent acquisition of the Evoke software product by Similarity Systems
      in
      July 2005 and then Informatica in January 2006.





°  In
      July
      2005, the Company acquired McKnight Associates, Inc. Since inception, McKnight
      Associates has focused on successfully designing, developing and implementing
      data warehousing and business intelligence solutions for its clients in numerous
      industries. Mr. William McKnight, the founder of McKnight Associates who joined
      the Company as Senior Vice President - Data Warehousing, is
      a
      well-known industry leader, frequently
      speaks at national trade shows and contributes
      to major data management trade publications.





°  In
      July
      2005, the Company acquired Integrated Strategies, Inc. (“ISI”). With offices in
      New York City, ISI is a professional services firm with a solutions-oriented
      approach to complex business and technical challenges. Similar to our wholly
      owned subsidiary, DeLeeuw Associates, which is best known for its large-scale
      merger integration management and business process change programs for the
      financial services markets, ISI also counts many industry leaders in this sector
      among its customers. Because of this shared focus, the operations of ISI were
      essentially folded into DeLeeuw Associates.





The
      Company’s most significant costs are personnel expenses, which consist of
      consultant fees, benefits and payroll-related expenses.





**Results
      of Operations**





The
      following table sets forth selected financial data for the periods
      indicated:




40


Selected
                  Statement of Operations Data for the YearsEnded
                  December 31,2005
              
              2004(as
                  Restated)Net
                  Revenue
              
              $
              27,269,909
              
              $
              23,893,106Gross
                  Profit
              
              
              7,097,506
              
              
              5,046,129Net
                  loss from continuing operations
              
              
              (4,014,302
              )
              
              (22,697,298
              )Loss
                  from discontinued operations
              
              
              (1,103,971
              )
              
              (12,650,908
              )Net
                  loss
              
              
              (5,118,273
              )
              
              (35,348,206
              )Basic
                  loss per shareFrom
                  continuing operations
              
              $
              (0.08
              )
              $
              (0.49
              )From
                  discontinued operations
              
              $
              (0.02
              )
              $
              (0.27
              )Net
                  loss per share
              
              $
              (0.10
              )
              $
              (0.76
              )Diluted
                  loss per share:From
                  continuing operations
              
              $
              (0.08
              )
              $
              (0.49
              )From
                  discontinued operations
              
              $
              (0.02
              )
              $
              (0.27
              )Net
                  loss per share
              
              $
              (0.10
              )
              $
              (0.76
              )
  Selected
                  Statement of Financial Position Data for the YearsEnded
                  December 31,2005
              
              2004(as
                  Restated)Working
                  capital
              
              $
              (7,587,860
              )
              $
              (13,923,181
              )Total
                  assets
              
              
              18,478,469
              
              
              28,868,029Long-term
                  debt
              
              
              3,042,914
              
              
              6,659,449Related
                party debt
              
              
              1,772,368
              
              
              307,981Total
                  stockholders' equity
              
              
              1,629,139
              
              
              1,294,522





**Years
      Ended December 31, 2005 and 2004**





Revenues
      for the Company are categorized by strategic consulting, business intelligence,
      data warehousing and data management. They are reflected in the chart below
      as a
      percentage of overall revenues:


Category
                  of Services
              
              Percentage
                  of Revenues for the year endedDecember
                  31,2005
              
              2004Strategic
                  Consulting
              
              
              40.6
              %
              
              35.9
              %Business
                  Intelligence
              
              
              22.4
              %
              
              22.7
              %Data
                  Warehousing
              
              
              22.8
              %
              
              16.7
              %Data
                  Management
              
              
              13.2
              %
              
              23.4
              %Software
                  & Support
              
              
              0.0
              %
              
              1.0
              %Other
              
              
              1.0
              %
              
              0.3
              %





Strategic
      consulting revenues were 40.6% of total revenues for the year ended December
      31,
      2005, increasing by 4.7% as compared to 35.9% of total revenues for the
      comparable prior year period. During March 2004, the Company acquired DeLeeuw
      Associates, whose revenue base is entirely in the strategic consulting category
      of services. In July 2005, the Company acquired Integrated Strategies, Inc.
      (ISI), whose revenue base is also entirely in the strategic consulting category
      of services. DeLeeuw and ISI account for all of the Company’s strategic
      consulting revenues. For the year ended December 31, 2005, DeLeeuw revenues
      were
      $9.3 million, as compared to $5.5 million year ended December 31, 2004,
      representing an increase of $3.8 million. The increase is mostly attributable
      to
      the increase in revenues at **** DeLeeuw’s
      largest client, which represented a $3.5 million increase in billings for the
      year ended December 31, 2005 and the addition of a new client that produced
      $0.7
      million in revenues for that period. ISI’s revenues were $1.9 million for the
      year ended December 31, 2005.





41


The
      DeLeeuw Associates acquisition in 2004 and the ISI acquisition in 2005 increased
      the Company’s revenue base and, as a result, the percentage of revenues
      contributed by each of the other services categories was impacted by the
      increased overall revenues in the strategic consulting category. The Company
      intends to continue to focus on increasing revenues in the strategic consulting,
      business intelligence and data warehousing lines of business during 2006 and
      is
      de-emphasizing the data management line of business since this category is
      less
      profitable to the Company than the other service categories.





Business
      intelligence service revenues were 22.4% of total revenues for the year ended
      December 31, 2005, decreasing by 0.3% as compared to 22.7% of total revenues
      for
      the comparable prior year period. On an absolute dollar basis, business
      intelligence revenues increased by $1.3 million for the year ended December
      31,
      2005 from $5.4 million for the year ended December 31, 2004 to $6.2 million
      for
      the year ended December 31, 2005. This increase is primarily attributable to
      an
      increase in average billing rates of 19.2% for the year ended December 31,
      2005
      versus the prior period, though it is partially offset by a 12.0% decrease
      in
      billable hours for this line of business. The increase in billing rates is
      attributable to the utilization of higher skilled consultants, while the
      decrease in billable hours is attributable to the reduction in the number of
      consultants utilized. The average number of consultants utilized for the year
      ended December 31, 2005 decreased by 10.9% as compared to the prior
      year.





Data
      warehousing revenues were 22.8% of total revenues for the year ended December
      31, 2005, increasing by 6.1% as compared to 16.7% of total revenues for the
      comparable prior year period. On an absolute dollar basis, data warehousing
      revenues increased by $1.4 million for the year ended December 31,
      2005, partially attributable to $0.5 million of revenues from McKnight
      Associates, from $4.9 million for the year ended December 31, 2004 to $6.3
      million for the year ended December 31, 2005. This increase for the year ended
      December 31, 2005 is primarily attributable to a 48.7% increase in total hours
      billed in this line of business for the period versus the same period in the
      prior year, though it is partially offset by a 13.2% decrease in billable rates
      for this line of business. The increase in billable hours is attributable to
      an
      increase in number of consultants utilized, which includes contributions of
      McKnight Associates, whose business is concentrated in data warehousing. The
      decrease in billable rates is primarily attributable to a reduction of
      higher-skilled consultants utilized by the Company. The average number of
      consultants utilized for the year ended December 31, 2005 increased by 57.1%
      as
      compared to the prior year.





Data
      management revenues were $3.6 million, or 13.2% of total revenues, for the
      year
      ended December 31, 2005, decreasing by $1.8 million, or 10.2% as compared to
      $5.4 million, or 23.4% of total revenues, for the comparable prior year period.
      This category of services is less profitable to the Company than the other
      service categories and, as a result, is being de-emphasized and the Company’s
      resources are being focused on the more profitable service categories.




42


**Years
      ended December 31, 2005 and 2004**





***Revenue***





The
      Company’s revenues are primarily comprised of billings to clients for consulting
      hours worked on client projects. Revenues for the year ended December 31, 2005
      were $27.6 million, an increase of $3.7 million, or 15.6%, as compared to
      revenues of $23.9 million for the year ended December 31, 2004.





*Services*





Services
      revenues for the year ended December 31, 2005 were $23.4 million, an increase
      of
      $3.6 million, or 18.4% of services revenues, as compared to services revenues
      of
      $19.8 million for the year ended December 31, 2004, respectively. DeLeeuw
      Associates contributed an additional $3.8 million of services revenue during
      the
      year ended December 31, 2005 as compared to the 10 month period subsequent
      to
      the acquisition of DeLeeuw Associates in the prior year. ISI contributed $1.9
      million during the current year. Partially offsetting this increase is a
      reduction in revenues from services of $2.1 million relating to a decrease
      in
      the number of consultants in the ongoing CSI business. **** Exclusive
      of DeLeeuw Associates, billable hours declined by 25.7% due to a **** 19.0%
      reduction in the number of consultants on billing for the year ended December
      31, 2005 compared to the same period for the prior year. This decline in the
      number of consultants on billing was attributable to the completion of certain
      client engagements, which resulted in unutilized consultant time for significant
      portions of the year ended December 31, 2005.





*Related
      party services*





Revenues
      from related parties for the year ended December 31, 2005 were $3.7 million,
      representing a decrease of $0.1 million, or 2.8% as compared to related party
      revenues of $3.8 million for the year ended December 31, 2004. The decrease
      for
      the year ended December 31, 2005 compared to the same period in the prior year,
      is primarily attributed to a 16.5% reduction in billable hours for the year
      ended December 31, 2005 versus the same period for the prior year. This is
      mostly offset by a 11.6% increase in billable rates. The decrease in billable
      hours is attributable to a reduction in the number of consultants required
      by
      our related party.





***Cost
      of revenue***




Cost
      of
      revenue primarily includes payroll and benefits costs for the Company’s
      consultants.   Cost of revenue was $20.5 million, or 74.3% of revenue,
      for the year ended December 31, 2005, compared to $18.8 **** million,
      or 78.9% of total revenue, for the year ended December 31, 2004, representing
      an
      increase of $1.7 million, or 8.9% as compared to the prior year. Cost
      of
      revenue for the year ended December 31, 2004 included a $1.4 million charge
      for
      stock based compensation. The cost of revenue would have been $17.4 million
      had
      this charge not occurred, or 73.0% of cost of revenue. The cost of revenue
      would
      have increased by 1.3% for the year ended December 31, 2005 compared to the
      year
      ended December 31, 2004.





43


*Services*





Cost
      of
      services was $17.3 million, or 74.0% of services revenue, for the year ended
      December 31, 2005, compared to $15.4 million, or 77.8% of services revenue,
      for
      the year ended December 31, 2004, representing an increase of $1.9 million,
      or
      12.7%. DeLeeuw Associates generated a $2.4 million increase in cost of services,
      directly associated with its increase in revenues in this category, for the
      year
      ended December 31, 2005 as compared to the 10 month period subsequent to the
      acquisition of DeLeeuw Associates in the prior year. ISI and McKnight
      contributed a cost of services of $1.5 million and $0.4 million in 2005.
      Partially  offsetting
      this increase was a reduction in cost of services of  $0.5
      million resulting from a  25.7%
      decrease in billable hours due to a  19.0%
      reduction in the number of consultants on billing and a  22.0%
      increase in the average pay rates for consultants. This shift reflects the
      higher skilled consultants employed in the categories of strategic consulting
      and data warehousing, whose revenues increase as a percentage of revenues as
      compared to the lower skilled consultants required in the shrinking category
      of
      data management.





*Related
      party services*





Cost
      of related
      party ** services
      was $3.2 million, or 86.2% of related party services revenue, for the year
      ended
      December 31, 2005, compared to $3.3 million, or 87.2% of related party services
      revenue, for the year ended December 31, 2004, respectively. The decreased
      cost
      as a percentage of related party services revenue is due to a 16.5% decrease
      in
      hours offset by an 18.2% increase in average pay rate. The decrease in billable
      hours is attributable to a reduction in the number of consultants utilized,
      while the increase in average pay reflects a reduction in the use of lower
      skilled consultants, resulting in an average higher pay rate.





***Gross
      Profit***




Gross
      profit was $7.1 million, or 25.7% of total revenue, for the year ended December
      31 ,
      2005,
      compared to $5.0 million, or 21.1% of total revenue, for the year ended December
      31 ,
      2004.  Gross profit for the year ended December 31, 2004 included a $1.4
      million charge for stock based compensation. The gross profit would have been
      27.0% had this charge not occurred, in which case gross profit would have
      decreased by 1.3% for the year ended December 31, 2005 compared to the year
      ended December 31, 2004.




As
      a
      percentage of total gross profit for the years ended December
      31 ,
      2005
      and 2004, respectively, services contributed 85.6%  and
      87.0%
      (89.8% if the charge for stock-based compensation had not occurred),
      respectively, related party services contributed 7.3% and 9.7% (7.6% if the
      charge for stock-based compensation had not occurred), respectively, and other,
      including software, support and maintenance contributed 7.1% and 3.3% (2.6%
      if
      the charge for stock-based compensation had not occurred), respectively,.





44


*Services*




Gross
      profit from services was
      $6.1
      million, or 26.0% of services revenue, for the year ended December 31, 2005,
      an
      increase of $1.7 million as compared to $4.4 million, or 22.2% services revenue,
      for the year ended December 31, 2004, respectively. Gross
      profit from services for the year ended December 31, 2004 included a $1.4
      million charge for stock based compensation. The gross profit from services
      would have been $5.8 million or 29.3% for the year ended December 31, 2004
      had
      this charge not occurred, or an increase instead of $0.3 million from the year
      ended December 31, 2005 compared to the year ended December 31, 2004.





DeLeeuw
      Associates contributed a 34.1% gross profit for the year ended December 31,
      2005
      as compared to a 33.0% gross profit for the year ended December 31, 2004.
      Exclusive of DeLeeuw Associates, the Company contributed a 21.5% gross profit
      for the year ended December 31, 2005 as compared to a 25.1% gross profit for
      the
      year ended December 31, 2004 (had the aforementioned charge for stock based
      compensation not occurred).





Exclusive
      of DeLeeuw Associates, billable hours declined by 25.7% due to a 19.0% reduction
      in the number of consultants on billing for the year ended December 31, 2005
      compared to the same period for the prior year. The decrease in billable hours,
      along with a 22% increase in average pay rate, accounted for the decrease in
      gross profit. The decrease in billable hours is attributable to a reduction
      in
      the number of consultants utilized, resulting from unutilized consultant time
      for significant portions of the year ended December 31, 2005. This cost had
      to
      be absorbed by the Company while the consultants were not utilized. The increase
      in average pay reflects a reduction in the use of lower skilled consultants,
      resulting in an average higher pay rate.





*Related
      party services*





Gross
      profit for related party services was $0.5 million,  or
      13.8%
      of related party services revenue, for the year ended December 31, 2005,
      compared to $0.5 million, or 12.8% of related party services revenue, for the
      year ended December 31, 2004, respectively.  Gross
      profit was flat due to  a
      11.6%
      increase in billable rates, which was impacted by an 18.2% increase in average
      pay rate, as well as a 16.5% reduction in billable hours. The decrease in
      billable hours is attributable to a reduction in the number of consultants
      utilized, while the increase in average pay reflects a reduction in the use
      of
      lower skilled consultants, resulting in an average higher pay rate.




***Selling
      and marketing***




Selling
      and marketing expenses include payroll, employee benefits and other
      headcount-related costs associated with sales and marketing personnel and
      advertising, promotions, tradeshows, seminars and other programs.  Selling
      and marketing expenses were $4.5 million, or 16.4% of revenue for the year
      ended
      December 31, 2005, compared to $3.2 million, or 13.4% of revenue for the year
      ended December 31, 2004, representing an increase of $1.3 million, or 5.5%
      of
      revenue, as compared to the prior year.  $0.7
      million of this increase relates to increased payroll expense, of which $0.4
      million relates to the reclassification of a senior executive of the Company
      from general and administrative expense to sales and marketing expense and
      $0.3
      million of the increase relates to increases in salaries and commissions.
      Additionally, $0.2 million of the increase relates to increased advertising,
      public relations and trade show expense during the year as the Company has
      continued to increase its visibility in the industry and the marketplace, $0.2
      million relates to the acquisition of ISI in 2005, and the remaining $0.2
      million primarily relates to increased professional fees, travel and
      subscriptions.




45


***General
      and administrative***




General
      and administrative costs include payroll, employee benefits and other
      headcount-related costs associated with the finance, legal, facilities, certain
      human resources and other administrative headcount, and legal and other
      professional and administrative fees.  General and administrative costs
      were $6.4 million, or 23.2% of revenue for the year ended December 31, 2005
      compared to $6.1 million, or 25.5% of revenue for the year ended December 31,
      2004, representing an increase of $0.3 million, or 1.4% of revenues, as compared
      to the prior year. General
      and administrative expense increased by $0.4 million as a result of the ISI
      and
      McKnight Associates acquisitions that occurred during 2005. Additionally, the
      Company recorded charges of $0.5 million in 2005 due to issuances of stock
      at
      below market prices, professional fees and insurance expense increased by $0.2
      million, and other expenses increased by $0.1 million. These increases were
      partially offset by a $0.2 million reduction in bad debt expense, a $0.3 million
      reduction in current year expense due to costs associated with the addition
      of
      certain employees of Software Forces and the LCS reverse merger in 2004, and
      $0.4 million reduction due to the reclassification of a senior executive of
      the
      Company.





***Goodwill
      and intangibles impairment***





Impairment
      of goodwill of $1.3 million for the year ended December 31, 2005 resulted from
      the Company’s annual impairment review of the goodwill for the ISI and McKnight
      Associates acquisitions which occurred in 2005. Statement of Financial
      Accounting Standards No. 142 (“SFAS No. 142”), *“Goodwill
      and Other Intangible Assets”* ,
      instructs the Company to test intangible assets for impairment annually, or
      more
      frequently if events or changes in circumstances indicate that the asset might
      be impaired. There were no specific events or changes in circumstances in either
      of the two acquired companies that would have required an interim impairment
      charge. The Company performed its annual impairment review as of December 31,
      2005 and determined that a goodwill impairment charge of $0.8 million was
      required relating to the goodwill associated with the ISI acquisition and $0.5
      million related to the goodwill associated with the McKnight Associates
      acquisition. The $12.2 million impairment charge for the year ended December
      31,
      2004 resulted from an $11.5 million impairment of the DeLeeuw Associates
      goodwill and a $0.7 million impairment of goodwill recorded for other Company
      assets.





46


***Depreciation
      and amortization***




Depreciation
      expense is recorded on the Company’s property and equipment which is generally
      depreciated over a period between three to seven years. Amortization of
      leasehold improvements is taken over the shorter of the estimated useful life
      of
      the asset or the remaining term of the lease. The Company amortizes deferred
      financing costs utilizing the effective interest method over the term of the
      related debt instrument. Acquired software is amortized on a straight-line
      basis
      over an estimated useful life of three years. Acquired contracts are amortized
      over a period of time that approximates the estimated life of the contracts,
      based upon the estimated annual cash flows obtained from those contracts,
      generally five to six years. Depreciation and amortization expenses were
      $0.9 million for the year ended December 31, 2005 compared to
      $0.5
      million for the year ended December 31, 2004, representing an increase of $0.4
      million as compared to the prior year. $0.2 million of this increase relates
      to
      amortization of intangibles associated with the McKnight Associates acquisition
      which occurred in 2005. The remaining $0.2 million increase relates to the
      amortization of the deferred financing costs being amortized for a full year
      in
      2005 as opposed to four months in 2004.





***Interest
      Expense***





The
      Company incurs interest expense on loans from financial institutions, from
      capital lease obligations related to the acquisition of equipment used in its
      business, and on outstanding convertible line of credit notes. Amortization
      of
      the discount on debt issued of $2.9 million and $0.9 million for the years
      ended
      December 31, 2005 and 2004, respectively, is also recorded as interest expense.
      In 2004, a $1.2 million charge for a beneficial conversion feature was also
      recorded as interest expense. Interest expense recorded was $4.2 million for
      the
      year ended December 31, 2005 compared to $5.0 million for the year ended
      December 31, 2004. This increase is primarily related to the Laurus, Sands
      and
      Taurus financing transactions described below in the Liquidity and Capital
      Resources section.





***Other
      income (expense)***





The
      Company recorded interest income of $69,000 and no other income for the year
      ended December 31, 2005, compared to interest income of $22,000 and other income
      of $7,300 for the year ended December 31, 2004. The
      Company recorded equity income in its investments in DeLeeuw International
      (Turkey) and Leading Edge Communications Corporation of approximately $5,000
      for
      the year ended December 31, 2005 and $6,000 for the year ended December 31,
      2004.





The
      Company adjusts the fair value of its financial instruments relating to its
      warrant and embedded derivative liabilities each quarter and records a gain
      or
      loss on the instruments. During the year ended December 31, 2005, the Company
      recorded a $7.8 million gain on the financial instruments and during the year
      ended December 31, 2004, the Company recorded a $0.6 million loss on the
      financial instruments. For
      accounting purposes, the Company recorded the renegotiation of the Laurus debt
      instruments in July 2005 and November 2005 as early extinguishments of debt
      and
      recorded the remaining discount and liability to gain or loss on the early
      extinguishments of debt. See
      Footnote 10 **** of
      the
      Notes to the Consolidated Financial Statements for further
      discussion.




47


***Income
      Taxes***




The
      Company evaluates the amount of deferred tax assets that are recorded against
      expected taxable income over its forecasting cycle which is currently two years.
      As a result of this evaluation, the Company has recorded a valuation allowance
      of $10.1 million
      and $8.0 million during the years ended December 31, 2005 and 2004,
      respectively. This allowance was recorded because, based on the weight of
      available information, it is more likely than not that some, or all, of the
      deferred tax asset may not be realized.





**Years
      Ended December 31, 2004 and 2003**





***Revenue***





Revenues
      for the Company are categorized by strategic consulting, business intelligence,
      data warehousing and data management. They are reflected in the chart below
      as a
      percentage of overall revenues:


Category
                  of Services
              
              Percentage
                  of Revenues for the year endedDecember
                  31,2004
              
              2003Strategic
                  Consulting
              
              
              35.9
              %
              
              17.3
              %Business
                  Intelligence
              
              
              22.7
              %
              
              22.2
              %Data
                  Warehousing
              
              
              16.7
              %
              
              14.8
              %Data
                  Management
              
              
              23.4
              %
              
              45.7
              %Software
              
              
              1.0
              %
              
              0.0
              %Other
              
              
              0.3
              %
              
              0.0
              %





Strategic
      consulting revenues increased from 17.3% to 35.9% of total revenues for the
      years ended December 31, 2003 and 2004, respectively. This is primarily
      attributable to the $5.4 million, or 62.8% of strategic consulting revenues,
      derived from DeLeeuw Associates which was acquired by the Company in March
      2004.
      After the acquisition of DeLeeuw Associates, the CSI core business flowed all
      strategic consulting work through DeLeeuw Associates. Excluding DeLeeuw
      Associates, strategic consulting revenues as a percent of total revenue for
      the
      year ended December 31, 2004 were 16.1%, a decrease of 1.2% from the 17.3%
      in
      the comparable prior year period. During 2004, the Company obtained new business
      and increased existing client business in this segment by 4.1% of total 2004
      revenues, however, due to the acquisition of a new software business segment
      in
      2004 which resulted in a larger revenue base attributable to a new business
      segment, the overall percentage of comparable year-to-year revenues (excluding
      the 2004 impact of the DeLeeuw Associates acquisition) declined.





Business
      intelligence services revenues were 22.7% of total revenues for the year ended
      December 31, 2004, increasing by 0.5% of revenues as compared to 22.2% for
      the
      comparable prior year period. While the percentage of total revenues
      attributable to this category increased in 2004 as compared to the prior year,
      the increase is primarily due to the acquisition of DeLeeuw Associates, which
      substantially increased revenues in the strategic consulting line of business.
      On an absolute dollar basis, revenues in this category of $5.4 million for
      the
      year ended December 31, 2004 increased by $2.2 million, or 68.8%, from $3.2
      million for the year ended December 31, 2003.





48


Data
      warehousing revenues represented 16.7% of total revenues for the year ended
      December 31, 2004, increasing by 1.9% of total revenues from 14.8% for the
      year
      ended December 31, 2003. While the percentage of total revenues attributable
      to
      this category remained constant in 2004 as compared to the prior year, this
      is
      primarily due to the acquisition of DeLeeuw Associates which substantially
      increased revenues in the strategic consulting line of business. On an absolute
      dollar basis, however, revenues in this category of $4.0 million for the year
      ended December 31, 2004 increased by $1.8 million, or 81.8%, from $2.2 million
      for the year ended December 31, 2003.





Data
      management revenues decreased as a percentage of total revenues by 22.4% of
      revenues, from 45.7% for the year ended December 31, 2003 to 23.4% for the
      year
      ended December 31, 2004. While the percentage of total revenues attributable
      to
      this category declined in 2004 as compared to the prior year, 15.4% of the
      decline is due to the acquisition of DeLeeuw Associates which substantially
      increased revenues in the strategic consulting line of business and 5.4% of
      the
      decline is due to a shift in the mix of the Company’s business from the data
      management line of business to the strategic consulting, business intelligence
      and data warehousing lines of business in 2004. In absolute dollars, 2004
      revenues in the data management line of business of $5.7 million, decreased
      by
      $0.9 million, or 13.6%, from $6.6 million for the year ended December 31, 2003.





The
      Company’s revenues are primarily comprised of billings to clients for consulting
      hours worked on client projects. Revenues for the year ended December 31, 2004
      were $23.9 million, an increase of $9.5 million, or 66.0%, over revenues of
      $14.4 million for the year ended December 31, 2003.





*Services*





Revenues
      from services for the year ended December 31, 2004 were $19.8 million, an
      increase of $5.8 million, or 41.4%, over revenues of $14.0 million for the
      year
      ended December 31, 2003. $5.5 million, or 27.3% of 2004 services revenues
      relates to revenues derived from DeLeeuw Associates which was acquired by the
      Company in March 2004. The
      remaining $0.4 million of increased 2004 revenue as compared to the prior year
      relates to an increase in the average billing rates coupled with a reduction
      in
      hours billed. The Company experienced a 15.9% increase in the average billing
      rate in 2004 as compared to the prior year, exclusive of the impact of the
      DeLeeuw Associates acquisition. This is
      a direct result of the increased revenues in the strategic consulting and
      business intelligence segments, both of which command higher billing rates
      than
      the other segments. Hours billed for time and material based work in 2004 were
      approximately 16.2% less than hours billed in 2003. This decline is partially
      due to resources that were utilized on a substantial fixed-price project that
      was undertaken by the Company during 2004. Additionally, the Company experienced
      some attrition in the consulting workforce coupled with increased nonbillable
      time due to gaps in the completion of ongoing assignments versus the start
      dates
      of new assignments.





49


*Related
      party services*





Revenues
      from related parties for the year ended December 31, 2004 were $3.8 million,
      an
      increase of $3.4 million over revenues of $0.4 million for the year ended
      December 31, 2003. T he
      increase in 2004 results from a full year of invoicing to LEC during 2004,
      versus six weeks in the prior year, under the independent contractor agreement
      executed by the Company and LEC in November 2003. Additionally, the average
      billing rate increased by 7.6% in 2004 as compared to 2003 which is primarily
      due to the hiring of six higher level consultants for a project obtained by
      this
      related party.





*Software*





Software
      revenues are derived from the sale of third-party software to our clients as
      part of a consulting engagement. Revenues from software for the year ended
      December 31, 2004 were $0.2 million as compared to zero in the prior year.





***Cost
      of revenue***




Cost
      of
      revenue primarily includes payroll and benefits costs for the Company’s
      consultants as well as the cost of software that is sold or licensed by the
      company.   Cost of revenue was $18.8 million, or 78.9% of revenue for
      the year ended December 31, 2004, compared to $10.3 million, or 71.5% of revenue
      for the year ended December 31, 2003.





*Services*





Cost
      of
      services was $15.4 million, or 77.8% of services revenue for the year ended
      December 31, 2004, compared to $10.0 million, or 71.2% of services revenue
      for
      the year ended December 31, 2003. Cost of revenue for DeLeeuw Associates, which
      was acquired by the Company on March 4, 2004, for the period March 4, 2004
      through December 31, 2004 was $3.7 million, or 18.6% of services revenues.
      Additionally, during 2004, the Company recorded a stock-based compensation
      charge of $1.4 million, or 7.0% of services revenues, to cost of services.
      Cost
      of services for the Company (excluding DeLeeuw Associates and the stock-based
      compensation charge) for the year ended December 31, 2004 were $10.3 million,
      an
      increase of $0.3 million, or 3.0%, as compared to $10.0 million for the year
      ended December 31, 2003. This increase is attributed to a 15.7% average increase
      in compensation cost, in 2004, for the Company’s consulting force as compared to
      the prior year. This increase is primarily attributable to hiring highly skilled
      consultants in the strategic consulting, data warehousing and business
      intelligence lines of business.





*Related
      party services*





Cost
      of related
      party ** services
      was $3.3 million, or 87.2% of related party services revenue for the year ended
      December 31, 2004, compared to $0.3 million, or 82.5% of related party services
      revenue for the year ended December 31, 2003. T he
      increase in 2004 results from a full year of costs related to the consultants
      which are providing services for this related party in 2004, versus six weeks
      of
      cost incurred in the prior year. Further, t he
      increase in 2004 reflects the cost of six higher level consultants hired for
      specialized work during the year and annual increases for the consulting
      force.





50


*Software*





Cost
      of
      software was $0.1 million, or 72.6% of software revenue for the year ended
      December 31, 2004, compared to zero for the year ended December 31, 2003.





***Gross
      Profit***




Gross
      profit was $5.0 million, or 21.1% of revenue for the year ended December 31,
      2004, compared to $4.1 million, or 28.5% of revenue for the year ended December
      31, 2003.




As
      a
      percentage of total gross profit for the years ended December 31, 2004 and
      2003,
      services contributed 87.0% and 98.4%, respectively, related party services
      contributed 9.7% and 1.6%, respectively, software contributed 3.3% and zero,
      respectively.




The
      gross
      profit percentage for the year ended December 31, 2004, was 33.2% and 17.5%
      for
      DeLeeuw Associates and
      ongoing operations of the Company, respectively. The Company’s gross profit
      percentage for the year ended December 31, 2003 was 28.5%. There is no
      comparable prior year amount for DeLeeuw Associates as they were acquired by
      the
      Company in 2004.





*Services*





Gross
      profit from services was
      $4.4
      million, for the year ended December 31, 2004, an increase of $0.4 million,
      or
      10.0%, as compared to $4.0 million for the year ended December 31, 2003. As
      a
      percent of services revenues, gross profit of 22.2% for the year ended December
      31, 2004 represented a decrease of 6.6% points as compared to 28.8% of services
      revenues for the year ended December 31, 2003. The Company recorded a $1.4
      million stock-based compensation charge during 2004 which reduced gross profit
      by 7.0% of services revenues. Excluding this charge, the 2004 gross profit
      percentage would have been 29.3%, an increase of 0.5% as compared to the prior
      year. This increase is the result of the
      gross
      profit attributable to DeLeeuw Associates, which had a gross profit percentage of 33.2% for the ten months
      ended December 31, 2004.





*Related
      party services*





Gross
      profit for related
      party ** services
      was $0.5 million, or 12.8% of related party services revenue for the year ended
      December 31, 2004, compared to $64,000, or 17.5% of related party services
      revenue for the year ended December 31, 2003. The 4.7% point decline in the
      related party services gross profit percentage relates to increased consultant
      costs in 2004 as compared to the prior year without corresponding increases
      in
      the billing rates charged to the client.





51


*Software*





Gross
      profit resulting
      from software was $0.1 million, or 27.4% of software revenue for the year ended
      December 31, 2004, compared to zero for the year ended December 31, 2003.


****


***Selling
      and marketing***




Selling
      and marketing expenses include payroll, employee benefits and other
      headcount-related costs associated with sales and marketing personnel and
      advertising, promotions, tradeshows, seminars and other programs.  Selling
      and marketing expenses were $3.2 million, or 13.4% of revenue for the year
      ended
      December 31, 2004, compared to $1.6 million, or 10.8% of revenue for the year
      ended December 31, 2003.  $0.4
      million of the increase in selling and marketing expenses during the year ended
      December 31, 2004 is attributed to the costs related to operating
      DeLeeuw Associates which
      was acquired during 2004.  $0.7 million of the increase resulted from
      increased payroll and related costs associated with the increased headcount
      in
      the Company’s existing sales force.  The remaining $0.5 million is
      reflected in the addition of six additional employees and a Director of
      Marketing and Corporate Communications both through new hires and retaining
      existing employees of the acquired companies as part of our strategy to gain
      new
      clients and increase revenue.




***General
      and administrative***




General
      and administrative costs include payroll, employee benefits and other
      headcount-related costs associated with the finance, legal, facilities, certain
      human resources and other administrative headcount, and legal and other
      professional and administrative fees.  General and administrative costs
      were $6.1 million, or 25.5% of revenue for the year ended December 31, 2004
      compared to $2.7 million, or 18.8% of revenue for the year ended December 31,
      2003. $1.2
      million of the increase in general and administrative expenses during the year
      ended December 31, 2004 is attributed to the costs of operating DeLeeuw Associates subsequent to the acquisition during 2004.  Additionally, $1.4 million is
      attributed to an increase in general and administrative payroll costs as the
      result **** of
      hiring
      a chief financial officer during the fourth quarter of 2003 and increasing
      the
      salaries of other Company officers to compensate them competitively with other
      public companies the size of the Company. $0.5 million represents an increase
      in
      development headcount by twelve employees during 2004, as compared to 2003,
      to
      support the increased size of the business and the increased compliance
      requirements inherent in becoming a public company. Professional fees related
      to
      legal and accounting increased by $0.3 million primarily due to work related
      to
      the Company’s public filing requirements.





***Goodwill
      impairment***





Impairment
      of goodwill of $12.2 million for the year ended December 31, 2004 resulted
      primarily from the Company’s annual impairment review for the DeLeeuw Associates
      acquisition which occurred in 2004. Statement of Financial Accounting Standards
      No. 142 (“SFAS No. 142”), *“Goodwill
      and Other Intangible Assets”* ,
      instructs the Company to test intangible assets for impairment annually, or
      more
      frequently if events or changes in circumstances indicate that the asset might
      be impaired. There were no specific events or changes in circumstances in the
      acquired company that would have required an interim impairment charge. The
      Company performed its annual impairment review as of December 31, 2004 and
      determined that an impairment charge of $12.2 million was required consisting
      of
      $11.5 million related to the goodwill previously recorded for DeLeeuw
      Associates, and $0.7 million related to goodwill recorded for other assets.
      There were no goodwill impairment charges recorded during the year ended
      December 31, 2003.





52


***Depreciation
      and amortization***




Depreciation
      expense is recorded on the Company’s property and equipment which is generally
      depreciated over a period between three to seven years. Amortization of
      leasehold improvements is taken over the shorter of the estimated useful life
      of
      the asset or the remaining term of the lease. The Company amortizes deferred
      financing costs utilizing the effective interest method over the term of the
      related debt instrument. Acquired software is amortized on a straight-line
      basis
      over an estimated useful life of three years. Acquired contracts are amortized
      over a period of time that approximates the estimated life of the contracts,
      based upon the estimated annual cash flows obtained from those contracts,
      generally five to six years.   Depreciation and amortization expenses
      were $0.5 million for the year ended December 31, 2004 compared to
      $0.2
      million for the year ended December 31, 2003. This increase in depreciation
      and
      amortization during the year ended December 31, 2004 is attributed to
      amortization of the acquired DeLeeuw Associates intangible assets and to
      depreciation on newly acquired assets.





***Interest
      Expense***





The
      Company incurs interest expense on loans from financial institutions, from
      capital lease obligations related to the acquisition of equipment used in its
      business, and on the outstanding convertible line of credit notes. Amortization
      of the discount on debt issued of $0.9 million is also recorded as interest
      expense. Interest expense recorded was $5.0 million for the year ended December
      31, 2004 compared to $0.1 million for the year ended December 31, 2003. This
      increase is primarily related to the Laurus and Sands financing transactions
      described below in the Liquidity and Capital Resources section.




***Other
      income (expense)***





The
      Company recorded interest income of $22,000 and other income of approximately
      $7,300 for the year ended December 31, 2004, compared to interest income of
      $5,000 for the year ended December 31, 2003. The
      Company recorded equity income in its investment in DeLeeuw International
      (Turkey) of approximately $5,000 for the year ended December 31,
      2004.




***Income
      Taxes***




The
      Company evaluates the amount of deferred tax assets that are recorded against
      expected taxable income over its forecasting cycle which is currently two years.
      As a result of this evaluation, the Company has recorded a valuation allowance
      of $9.0 million during the year ended December 31, 2004. This allowance was
      recorded because, based on the weight of available evidence, it is more likely
      than not that some, or all, of the deferred tax asset may not be
      realized.





53


No
      income
      tax expense or benefit was recorded in the prior year as the Company was an
“S”
Corporation through September 30, 2003. Pro forma income taxes for the prior
      year would have been an income tax benefit of $0.2 million using the effective
      tax rate of 40%.








**LIQUIDITY
      AND CAPITAL RESOURCES**




Cash
      totaled $0.2 million as of December 31, 2005 compared to $1.0 million as of
      December 31, 2004. The Company’s cash balance is primarily derived from customer
      remittances, bank borrowings and acquired cash and is used for general working
      capital needs.





The
      Company’s working capital deficit is ($7.6 million) as of December 31, 2005
      compared to ($13.9 million) **** as
      of
      December 31, 2004. The Company’s working capital position has improved during
      the current year primarily due to gains resulting from the fair value
      adjustments to the financial instruments during the current year. However,
      the
      losses generated by the Company have resulted in the need for $2.0 million
      of
      additional borrowings against the Company’s line of credit, a $1.0 million loan
      on a short term note payable, $1.3 million raised through the sale of Company
      common stock, and an additional $1.4 million of loans to the Company by the
      Chief Executive Officer and the Chief Operating Officer of the
      Company.


Cash used in operating activities during the year ended December 31, 2005
          was
          approximately $3.6 million, a decrease in cash used in operating activities
          of
          $0.8 million from the year ended December 31, 2004.  Cash used in operating
          activities primarily relates to cash used as a result of operating losses
          of
          approximately $4.0 million and a decline in accounts payable of approximately
          $0.6 million relating to the sale of Evoke Software Corporation, which
          is
          partially offset by payables acquired related to the acquisitions of McKnight
          Associates and Integrated Strategies.  Partially offsetting this cash
          decline is a approximately $1.0 million reduction in accounts receivable,
          also
          resulting from the sale of Evoke, partially offset by acquired receivables
          from
          the acquisitions of McKnight Associates and Integrated Strategies and the
          timing
          of collections from customers.
 Cash
        used
        by investing activities was $2.5 million during the year ended December 31,
        2005. This was due to payments of $2.2 million made primarily as acquisition
        payments for Integrated Strategies and $1.0 for McKnight Associates. This
        was
        offset by $0.6 million of cash received as part of the Evoke
        acquisition.




54
 
  Cash
          provided by financing activities was $5.3 million during the year ended
          December
          31, 2005. During 2005, $1.8 million was raised from stockholders, and $1.0
          million was raised from the issuance of a short-term note payable, additional
          line of credit borrowings of $1.9 million and $1.2 million was raised from
          the
          sale of Company common stock. $0.7 million of principal payments on long-term
          debt and on capital lease obligations, of which $0.4 million of
          payments were made on stockholder loans, were made by the Company during
          this
          time period.


There
      are currently no material commitments for capital expenditures.





The
      Company also expects to incur costs, in 2006, of approximately $0.3 million
      in
      order to improve its internal controls surrounding financial reporting and
      disclosure and in ensuring compliance with Sarbanes-Oxley
      requirements.





As
      of
      December 31, 2005 and 2004, the Company had accounts receivable due from LEC
      of
      approximately $0.6 million and $0.8 million, respectively. There are no known
      collections problems with respect to LEC.





For
      the
      years ended December 31, 2005 and 2004, we invoiced LEC $3.7 million and $3.8
      million, respectively, for the services of consultants subcontracted to LEC
      by
      us. The majority of its billing is derived from Fortune 100 clients.  The
      collection process is slow as these clients require separate approval on their
      own internal systems, which extends the payment cycle. We feel confident in
      the
      collectibility of these accounts receivable as the majority of the revenues
      from
      LEC derive from Fortune 100 clients.





In
      2004
      and 2005, the Company experienced negative cash flow and operating losses,
      therefore it effectuated the following transactions to support the
      Company:





Taurus





In
      May
      2004, pursuant to the complete conversion of a $2.0 million unsecured
      convertible line of credit note issued in October 2003 at $1.80 per
      share and a
      conversion price adjustment in September 2004 at $1.575 ,
      certain
      investors represented by Taurus Advisory Group, LLC (“Taurus”) received 1,269,841 shares
      of
      our common stock, plus interest paid in cash. The Taurus investors also received
      a warrant to purchase 277,778 shares of our common stock, which has an exercise
      price of $1.575 per share and expires in June 2009. Further in May 2004, we
      raised an additional $2.0 million pursuant to a new five-year unsecured
      promissory note with Taurus. In June 2004, we replaced the May 2004 note by
      issuing a five-year $2.0 million unsecured convertible line of credit note
      with
      Taurus. **** The
      note
      accrues interest at an annual rate of 7%, and the conversion price of the shares
      of common stock issuable under the note is equal to $1.575 per
      share.





In
      July
      2005, the Company obtained two $250,000 short term loans from certain investors
      represented by Taurus. Both notes bear interest at 8% per annum. The first
      note
      is dated July 6, 2005 and initially matured on September 5, 2005. The maturity
      date for this note has been extended to May 6, 2006. The second note is dated
      July 22, 2005 and originally matured on September 22, 2005. The maturity date
      for this note has been extended to April 22, 2006. These
      short term note holders have agreed to extend their maturity date on a
      month-to-month basis until the Company raises sufficient funds to repay the
      notes.





55


In
      December 2005, the Company obtained a $1 million short term loan from certain
      investors represented by Taurus. This note bears interest at 8% per annum.
      The
      note is dated December 19, 2005 and initially matured on January 31, 2006.
      The
      maturity date for this note has been extended to June 1, 2006. In conjunction
      with this note, these investors received a warrant to purchase 277,777 shares
      of
      our common stock with an exercise price of $0.675 per share in December 2005,
      a
      warrant to purchase 277,777 shares of our common stock with an exercise price
      of
      $0.75 per share in
      February 2006 and
      a
      warrant to purchase 554,000 shares of our common stock with an exercise price
      of
      $1.30 per share in March 2006. These warrants expire in December 2008, January
      2009 and February 2009, respectively. These
      short term note holders have agreed to extend their maturity date on a
      month-to-month basis until the Company raises sufficient funds to repay the
      notes.





On
      February 2, 2006, the Company entered into a Securities Purchase Agreement
      with
      Taurus, pursuant to which the Company issued 19,000 shares of the Company’s
      newly created Series A Convertible Preferred Stock, $.001 par value (the “Series
      A Preferred”). Each share of Series A Preferred has a stated value of $100.00.
      The Company utilized the proceeds ($1.9 million) to repurchase shares of its
      common stock from WHRT I Corp. (see above). The Series A Preferred has a
      cumulative annual dividend equal to five percent (5%), which is payable
      semi-annually in cash or common stock, at the election of the Company, and
      is convertible into shares of the Company’s common stock at any time at a price
      equal to $0.50 per share (subject to adjustments
      related to stock splits, reclassifications, combinations, dividends, change
      of
      control or the issuance of pari passu securities). In addition, the
      Series A Preferred has no voting rights, but has liquidation preferences and
      certain other privileges. All shares of Series A Preferred not previously
      converted shall be redeemed by the Company, in cash or common stock, at the
      election of Taurus, on February 1, 2011. Pursuant to the Securities Purchase
      Agreement, Taurus was also granted a warrant to purchase 1,900,000 shares of
      the
      Company’s common stock exercisable at a price of $0.60 per share (subject to
adjustments
      related to stock splits, reclassifications, combinations, dividends, change
      of
      control or the issuance of pari passu securities), exercisable for a
      period of five years.





Laurus





In
      August
      2004, we replaced our $3.0 million line of credit with North Fork Bank with
      a
      revolving line of credit with Laurus Master Fund, Ltd. (“Laurus”), whereby we
      had access to borrow up to $6.0 million based upon eligible accounts receivable.
      We paid $0.75 million in brokerage and transaction closing related costs.





On
      February 1, 2006, the Company restructured its financing with Laurus by entering
      into financing agreements with Laurus which removed all conversion features
      in
      the originally issued notes, pursuant to which it, among other things, (a)
      issued a secured non-convertible term note in the principal amount of $1 million
      to Laurus (the “Term Note”), (b) issued a secured non-convertible revolving note
      in the principal amount of $10 million to Laurus (the “Revolving Note”,
      collectively with the Term Note, the “Notes”), and (c) issued an option to
      purchase up to 3,080,000 shares of the Company's common stock to Laurus (the
      “Option”) at an exercise price of $.001 per share. We had no obligation to meet
      financial covenants under the notes. The proceeds from the issuance of the
      Notes
      were used to refinance the Company’s outstanding obligations under the existing
      facility with Laurus (originally entered into in August 2004 and subsequently
      amended in July 2005) at a 5% premium. The Notes bear an annual interest rate
      of
      prime (as reported in the Wall Street Journal, which was 7.25% as of January
      31,
      2006) plus 1.0%, with a floor of 5.0%. Payments and interest will be made in
      equal monthly amounts until maturity of the Notes on December 31, 2007, at
      which
      time the 5% premium will also be due. In addition, payments of principal on
      the
      Term Note will be made in equal monthly amounts until maturity of the Notes
      on
      December 31, 2007. A common stock purchase warrant issued to Laurus in August
      2004 provides Laurus with the right to purchase 800,000 shares of our common
      stock. The exercise price for the first 400,000 shares acquired under the
      warrant is $4.35 per share, the exercise price for the next 200,000 shares
      acquired under the warrant is $4.65 per share, and the exercise price for the
      final 200,000 shares acquired under the warrant is $5.25 per share. The common
      stock purchase warrant expires on August 15, 2011.




56


In
      connection with the Notes, the Company and Laurus entered into an Overadvance
      Letter Agreement, pursuant to which Laurus exercised its discretion granted
      to
      it pursuant to the Security Agreement entered into in August 2004 to make a
      loan
      to the Company in excess of the “Formula Amount” (as defined therein). The
      Company also entered into a Stock Pledge Agreement and Security Agreement
      securing its obligations to Laurus, both prior to and including the Notes,
      as
      well as a Registration Rights Agreement pursuant to which the Company agreed
      to
      file a registration statement to register the shares of the Company’s common
      stock underlying the Option, as well as the shares of the Company’s common stock
      and the shares of the Company’s common stock underlying the warrants held by
      Laurus, within 90 days. As of the date of this filing, Laurus owns approximately
      809,525 shares of the Company’s common stock, an option to purchase up to
      3,080,000 shares of the Company's common stock at an exercise price of $.001
      per
      share and the aforementioned warrant.





As
      a
      result of the issuance of warrants, the Company has recorded a discount on
      debt
      (valued at $2.2 million as of December 31, 2005) and a liability. The discount
      is being amortized over the remaining term of the debt instrument, and the
      liability is being adjusted to fair value using an option-pricing model.
      Additionally, the convertible notes contain an embedded derivative pertaining
      to
      the conversion feature in the notes, and the Company has recorded a discount
      and
      a liability to reflect this derivative.





Laidlaw/Sands





In
      September 2004, we issued to Sands Brothers Venture Capital LLC, Sands Brothers
      Venture Capital III LLC and Sands Brothers Venture Capital IV LLC (collectively,
      “Sands”) three subordinated secured convertible promissory notes equaling $1.0
      million (the “Notes”), each with an annual interest rate of 8% expiring
      September 22, 2005. The Notes were secured by substantially all corporate
      assets, subordinate to Laurus. The Notes are convertible into shares of our
      common stock at the election of Sands at any time following the consummation
      of
      a convertible debt or equity financing with gross proceeds of $5.0 million
      or
      greater (a “Qualified Financing”). The conversion price of the shares of our
      common stock issuable upon conversion of the Notes shall be equal to a price
      per
      share of common stock equal to forty percent (40%) of the price of the
      securities issued pursuant to a Qualified Financing. Since no Qualified
      Financing had been consummated by September 8, 2005, Sands is entitled to elect
      to convert the Notes at a fixed conversion price of $2.10 per share. In the
      event that we issue stock or derivatives convertible into our stock for a price
      less than the aforementioned fixed conversion price, then the fixed conversion
      price is reset using a weighted average dilution calculation. We also issued
      Sands three common stock purchase warrants (the “Warrants”) providing Sands with
      the right to purchase 400,000 shares of our common stock. The exercise price
      of
      the shares of our common stock issuable upon exercise of the Warrants shall
      be
      equal to a price per share of common stock equal to forty percent (40%) of
      the
      price of the securities issued pursuant to a Qualified Financing. The latest
      that the Warrants may expire is September 8, 2008.





57


On
      September 22, 2005, upon maturity of the September 2004 notes, the Company
      issued to Sands three amended subordinated secured convertible promissory notes
      equaling $1.08 million, each with an annual interest rate of 12% expiring on
      January 1, 2007. The Company also issued Sands three common stock purchase
      warrants (the “Additional Warrants”) providing Sands with the right to purchase
      400,000 shares of the Company’s common stock. The exercise price of the shares
      of the Company’s common stock issuable upon exercise of the Additional Warrants
      shall be equal to a price per share of common stock equal to one hundred twenty
      percent (120%) of the price of the securities issued pursuant to a Qualified
      Financing. If no Qualified Financing has been consummated by December 15, 2006,
      then Sands may elect to exercise the Additional Warrants at a fixed conversion
      price of $2.10 per share. The latest that the Warrants may expire is December
      15, 2009.





As
      of
      April 7, 2006, Mr. Scott Newman, President, Chief Executive Officer and
      Chairman, Mr. Glenn Peipert, Executive Vice President, Chief Operating Officer
      and Director, and Mr. Robert C. DeLeeuw, Senior Vice President, have agreed
      to
      personally support our cash requirements to enable us to fulfill our obligations
      through June 1, 2007, to the extent necessary, up to a maximum amount of $1.5
      million, based upon their ability to sell their Company common stock. Mr. Newman
      guaranties up to approximately $0.9 million, Mr. Peipert guaranties up to
      approximately $0.4 million and Mr. DeLeeuw guaranties approximately $0.2
      million. We believe that these written commitments provide us with the legal
      right to request and receive such advances from any of these officers. Any
      loan
      by Messrs. Newman, Peipert and DeLeeuw to the Company would bear interest at
      8%
      per annum. As of December 31, 2005, Mr. Newman’s outstanding loan balance to the
      Company was approximately $0.9 million, and Mr. Peipert’s outstanding loan
      balance to the Company was approximately $0.9 million. The unsecured loans
      by
      Mr. Newman and Mr. Peipert each accrue interest at a simple rate of 8% per
      annum, and each has a term expiring on April 30, 2007. As of the date of this
      filing, the entire $1.5 million was still available pursuant to the guaranties
      outlined above.





The
      following is a summary of the debt instruments outstanding as of March 31,
      2006








Lender
            Type
                of facility
            Outstanding
                as of March 31, 2006 (not including interest) (all numbers
                approximate)
            
            Remaining
                Availability (if applicable)Laurus
                Master Fund, Ltd.
            Line
                of Credit
            $5,752,000
            
            $0Laurus
                Master Fund, Ltd.
            Term
                Note
            $955,000
            
            $0Sands
                Brothers Venture Capital LLC
            Convertible
                Promissory Note
            $54,000
            
            $0Sands
                Brothers Venture Capital III LLC
            Convertible
                Promissory Note
            $918,000
            
            $0Sands
                Brothers Venture Capital IV LLC
            Convertible
                Promissory Note
            $108,000
            
            $0Taurus
                Advisory Group, LLC investors
            Convertible
                Promissory Note
            $3,500,000
            
            $0Taurus
                Advisory Group, LLC investors
            Series
                A Convertible Preferred Stock
            $1,900,000
            
            $0Scott
                Newman
            Promissory
                Note
            $
                863,000
            
            $0Glenn
                Peipert
            Promissory
                Note
            $
                909,000
            
            $0TOTAL
            
            $14,959,000
            
            $0





The
      Company has generated losses that exceeded expectations during 2004 and
      continued throughout 2005. To that extent, the Company has experienced continued
      negative cash flow which has created a liquidity issue for the Company. To
      address this issue, in addition to the various transactions above, in November
      2004, the Company entered into a Stock Purchase Agreement (the “Agreement”) with
      a private investor, CMKX-treme, Inc.  Pursuant to the Agreement,
      CMKX-treme, Inc. agreed to purchase 833,333 shares of common stock for a
      purchase price of $1.75 million.  Under the terms of the Agreement,
      CMKX-treme, Inc. initially purchased 238,095 shares of common stock for $0.5
      million, and it was required to purchase the remaining 595,238 shares of common
      stock for $1.25 million by December 31, 2004. As of March 17, 2005, CMKX-treme,
      Inc. remitted final payment for the remaining 595,238 shares.





In
      2004,
      the Company completed various financing transactions through the issuance of
      common stock, as well as the issuance of notes and warrants convertible into
      our
      common stock, while a registration statement was on file with the Securities
      and
      Exchange Commission but had not yet been declared effective. Those transactions
      were with the following entities:




·Taurus
                  Advisory Group, LLC
              $4.0
                  million·Laurus
                  Master Fund, Ltd.
              $11.0
                  million·Sands
                  Brothers International Ltd.(3
                  affiliated entities)
              $1.0
                  million




Even
      though all stockholders, noteholders and warrantholders have been advised of
      their rights to rescind those financing transactions and they each have waived
      their rights to rescind those transactions, there is a remote possibility that
      each of those transactions could be reversed. In such an event, the Company
      could be adversely affected and may have an obligation to fund such
      rescissions.




Although
      the Company has negative working capital at December 31, 2005 and March 31,
      2006, and has incurred significant operating losses, the Company believes
      existing cash plus funds provided by operations, borrowing capacity under the
      line of credit and projected borrowing against, or the guarantees of the primary
      stockholders should be sufficient to fund operations through January 1, 2007.
      Nevertheless, the Company is presently exploring various financing alternatives,
      including debt or additional sales of equity securities in order to finance
      the
      core business of the Company and help provide adequate working capital for
      operations. There is no assurance that funds will be provided by operations
      or
      that such additional financing will be available, or if available, will be
      available on acceptable terms. Should the Company experience significant
      shortfalls in planned revenues, or experience unforeseen fixed expenses, the
      Company believes it has the ability to make additional reductions to variable
      expenses to extend its capital. Any decision or ability to obtain financing
      through debt or through equity investment will depend on various factors,
      including, among others, financial market conditions, strategic acquisition
      and
      investment opportunities, and developments in the Company's markets. The sale
      of
      additional equity securities or future conversion of any convertible debt would
      result in additional dilution to the Company's
      stockholders.




58


***Off-balance
      sheet arrangements***





The
      Company does not have any transactions, agreements or other contractual
      arrangements that constitute off-balance sheet arrangements.




***Contractual
      Obligations***





At
      December 31, 2005, the Company had certain contractual cash obligations and
      other commercial commitments, as set forth in the following table (amounts
      in
      table are noted in millions):




Less
                  than 1Contractual
                  Obligations
              
              Total
              
              year
              
              1-3
                  years
              
              4-5
                  yearsLong-term
                  debt
              
              $
              3.9
              
              $
              0.5
              
              $
              1.4
              
              $
              2.0Related
                Party Debt
              
              
              1.8
              
              
              -
              
              
              1.8
              
              
              -Capital
                  lease obligations
              
              
              0.1
              
              
              0.1
              
              
              -
              
              
              -Operating
                  leases
              
              
              2.0
              
              
              0.5
              
              
              1.1
              
              
              0.4Employment
                  agreements
              
              
              3.9
              
              
              3.9
              
              
              -
              
              
              -Total
              
              $
              11.7
              
              
              5.0
              
              $
              4.3
              
              $
              2.4


**APPLICATION
      OF CRITICAL ACCOUNTING POLICIES**





***Revenue
      recognition***





Our
      revenue recognition policy is significant because revenues are a key component
      of our results from operations. In addition, revenue recognition determines
      the
      timing of certain expenses, such as incentive compensation. We follow very
      specific and detailed guidelines in measuring revenue; however, certain
      judgments and estimates affect the application of the revenue policy. Revenue
      results are difficult to predict and any shortfall in revenues or delay in
      recognizing revenues could cause operating results to vary significantly from
      quarter to quarter and could result in future operating losses or reduced net
      income.





***Services***





Revenue
      from consulting and professional services is recognized at the time the services
      are performed on a project by project basis. For projects charged on a time
      and
      materials basis, revenue is recognized based on the number of hours worked
      by
      consultants at an agreed-upon rate per hour. For large services projects where
      costs to complete the contract could reasonably be estimated, the Company
      undertakes projects on a fixed-fee basis and recognizes revenues on the
      percentage of completion method of accounting based on the evaluation of actual
      costs incurred to date compared to total estimated costs. Revenues recognized
      in
      excess of billings are recorded as costs in excess of billings. Billings in
      excess of revenues recognized are recorded as deferred revenues until revenue
      recognition criteria are met. Reimbursements, including those relating to travel
      and other out-of-pocket expenses, are included in revenues, and an equivalent
      amount of reimbursable expenses are included in cost of services.





59


***Business
      Combinations***





We
      are
      required to allocate the purchase price of acquired companies to the tangible
      and intangible assets acquired and liabilities assumed based on their estimated
      fair values. Such a valuation requires us to make significant estimates and
      assumptions, especially with respect to intangible assets. Critical estimates in
      valuing certain intangible assets include, but are not limited to, future
      expected cash flows from customer contracts, customer lists, distribution
      agreements and acquired developed technologies, and estimating cash flows from
      projects when completed
      and discount rates. Our estimates of fair value are based upon assumptions
      believed to be reasonable, but which are inherently uncertain and unpredictable
      and, as a result, actual results may differ from estimates. These estimates
      may
      change as additional information becomes available regarding the assets acquired
      and liabilities assumed. Additionally,
      in accordance with “EITF 99-12,” the Company values an acquisition based upon
      the market price of its common stock for a reasonable period before and after
      the date the terms of the acquisition are agreed to and announced.





***Impairment
      of Goodwill, Intangible Assets and Other Long-Lived
      Assets***





We
      evaluate our identifiable goodwill, intangible assets, and other long-lived
      assets for impairment on an annual basis and whenever events or changes in
      circumstances indicate that the carrying value of an asset may not be
      recoverable based on expected undiscounted cash flows attributable to that
      asset. Future impairment evaluations could result in impairment charges, which
      would result in an expense in the period of impairment and a reduction in the
      carrying value of these assets.





***Allowances
      for Doubtful Accounts***





We
      make
      judgments regarding our ability to collect outstanding receivables and provide
      allowances for the portion of receivables when collection becomes doubtful.
      Provisions are made based upon a specific review of all significant outstanding
      invoices. For those invoices not specifically reviewed, provisions are provided
      at differing rates, based upon the age of the receivable. In determining these
      percentages, we analyze our historical collection experience and current
      economic trends. If the historical data we use to calculate the allowance
      provided for doubtful accounts does not reflect the future ability to collect
      outstanding receivables, additional provisions for doubtful accounts may be
      needed and our future results of operations could be materially affected. During
      2005, $56,123 of uncollectible accounts receivable were written off of the
      accounts receivable against the allowance for doubtful accounts.


***Discount
        on Debt***
  The
        Company has allocated the proceeds received from convertible debt instruments
        between the underlying debt instruments and the detachable warrants, and
        has
        recorded the conversion feature as a liability in accordance with SFAS No.
        133.
        The conversion feature and certain other features that are considered embedded
        derivative instruments, such as a variable interest rate feature, a conversion
        reset provision and redemption option, have been recorded at their fair value
        within the terms of SFAS No. 133 as its fair value can be separated from
        the
        convertible note and its conversion is independent of the underlying note
        value.
        The conversion liability is marked to market each reporting period with the
        resulting gains or losses shown on the Statement of Operations. The Company
        has
        also recorded the resulting discount on debt related to the warrants and
        conversion feature and is amortizing the discount using the effective interest
        rate method over the life of the debt instruments. The discount is classified
        as
        a deferred financing cost.




***Financial
          Instruments***
  The
          carrying value of the Company’s financial instruments, including cash and cash
          equivalents, accounts receivable, note receivable, accounts payable and
          accrued
          liabilities approximate fair value because of the short maturities of those
          instruments. Based on borrowing rates currently available to the Company
          for
          loans with similar terms, the carrying value of convertible notes and notes
          payable are also approximate fair value.
  We
          review
          the terms of convertible debt and equity instruments we issued to determine
          whether there are embedded derivative instruments, including the embedded
          conversion option, that are required to be bifurcated and accounted for
          separately as a derivative financial instrument. Generally, where the ability
          to
          physical or net-share settle the conversion option is deemed to be not
          within
          the control of the company, the embedded conversion option is required
          to be
          bifurcated and accounted for as a derivative financial instrument
          liability.
  In
          connection with the sale of convertible debt and equity instruments, we
          may also
          issue freestanding options or warrants. Additionally, we may issue options
          or
          warrants to non-employees in connection with consulting or other services
          they
          provide. Although the terms of the options and warrants may not provide
          for
          net-cash settlement, in certain circumstances, physical or net-share settlement
          is deemed to not be within the control of the company and, accordingly,
          we are
          required to account for these freestanding options and warrants as derivative
          financial instrument liabilities, rather than as equity.
  Derivative
          financial instruments are initially measured at their fair value. For derivative
          financial instruments that are accounted for as liabilities, the derivative
          instrument is initially recorded at its fair value and is then re-valued
          at each
          reporting date, with changes in the fair value reported as charges or credits
          to
          income. For option-based derivative financial instruments, we use the
          Black-Scholes option pricing model to value the derivative
          instruments.
  In
          circumstances where the embedded conversion option in a convertible instrument
          is required to be bifurcated and there are also other embedded derivative
          instruments in the convertible instrument that are required to be bifurcated,
          the bifurcated derivative instruments are accounted for as a single, compound
          derivative instrument.
  If
          freestanding options or warrants were issued and will be accounted for
          as
          derivative instrument liabilities (rather than as equity), the proceeds
          are
          first allocated to the fair value of those instruments. When the embedded
          derivative instrument is to be bifurcated and accounted for as a liability,
          the
          remaining proceeds received are then allocated to the fair value of the
          bifurcated derivative instrument. The remaining proceeds, if any, are then
          allocated to the convertible instrument itself, usually resulting in that
          instrument being recorded at a discount from its face amount. In circumstances
          where a freestanding derivative instrument is to be accounted for as an
          equity
          instrument, the proceeds are allocated between the convertible instrument
          and
          the derivative equity instrument, based on their relative fair
          values.
  The
          discount from the face value of the convertible debt instrument resulting
          from
          the allocation of part of the proceeds to embedded derivative instruments
          and/or
          freestanding options or warrants is amortized over the life of the instrument
          through periodic charges to income, using the effective interest method.
  The
          classification of derivative instruments, including whether such instruments
          should be recorded as liabilities or as equity, is re-assessed at the end
          of
          each reporting period. Derivative instrument liabilities are classified
          in the
          balance sheet as current or non-current based on whether or not net-cash
          settlement of the derivative instrument is expected within 12 months of
          the
          balance sheet date.
 ***Equity
        investments***
 
 Prior
        to
        the Company’s acquisition of DeLeeuw in 2004, DeLeeuw had acquired a
        non-controlling interest in DeLeeuw International (a company formed under
        the
        laws of Turkey). The Company accounts for its share of the income (losses)
        of
        this investment under the equity method.




***Stock-based
      Compensation***





We
      issue
      stock options to our employees and provide our employees the right to purchase
      ordinary shares under employee stock purchase plans. We account for our
      stock-based compensation plans under the intrinsic value method of accounting
      as
      defined by Accounting Principles Board Opinion No. 25, “ *Accounting
      for Stock Issued to Employees* ”
      (“APB 25”) and related interpretations. For equity instruments under fixed
      plans, APB 25 does not require that any amount of expense to be recorded in
      the statement of income; however, SFAS No. 123, “ *Accounting
      for Stock-Based Compensation* ”
does
      require disclosure of these amounts in a pro forma table to the financial
      statements. In determining this disclosure the value of an option is estimated
      using the Black Scholes option valuation model. This model requires the input
      of
      highly subjective assumptions and a change in our assumptions could materially
      affect the fair value estimate, and thus the total calculated costs associated
      with the grant of stock options or issuance of stock under employee stock
      purchase plans. In addition, in disclosing the fair-value cost of stock-based
      compensation, we estimate that we will be able to obtain a 40% tax benefit
      on
      these costs. There is the potential that this tax benefit will not be obtained
      to this extent or at all, which directly impacts the level of expenses
      associated with stock-based compensation. We expect our accounting policies,
      regarding stock-based compensation to be materially affected by our adoption
      of
      SFAS123R, which is described under “Recent Pronouncements.” We have not yet
      determined what the impact of the adoption of SFAS123R will be on our
      compensation philosophy.





***Deferred
      Income Taxes***





Determining
      the consolidated provision for income tax expense, income tax liabilities and
      deferred tax assets and liabilities involves judgment.  We record a
      valuation allowance to reduce our deferred tax assets to the amount of future
      tax benefit that is more likely than not to be realized. We have considered
      future taxable income and prudent and feasible tax planning strategies in
      determining the need for a valuation allowance. A valuation allowance is
      maintained by the Company due to the impact of the current years net operating
      loss (NOL). In the event that we determine that we would not be able to realize
      all or part of our net deferred tax assets, an adjustment to the deferred tax
      assets would be charged to net income in the period such determination is made.
      Likewise, if we later determine that it is more likely than not that the net
      deferred tax assets would be realized, then the previously provided valuation
      allowance would be reversed. Our current valuation allowance relates
      predominately to benefits derived from the utilization of our
      NOL’s.





60


**Recent
      Pronouncements**





SFAS
      No. 123 (Revised 2004) (“SFAS No. 123R”), “Share-Based Payment,”
issued in December 2004, is a revision of FASB Statement 123, “Accounting for
      Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting
      for Stock Issued to Employees,” and its related implementation guidance. The
      Statement focuses primarily on accounting for transactions in which an entity
      obtains employee services in share-based payment transactions. SFAS
      No. 123R requires a public entity to measure the cost of employee services
      received in exchange for an award of equity instruments based on the grant-date
      fair value of the award (with limited exceptions). That cost will be recognized
      over the period during which an employee is required to provide service in
      exchange for the award. On March 29, 2005, the SEC issued Staff Accounting
      Bulletin No. 107 (“SAB No. 107”), which provides the Staff’s views
      regarding interactions between SFAS No. 123R and certain SEC rules and
      regulations and provides interpretations of the valuation of share-based
      payments for public companies.





SFAS
      No. 123(R) permits public companies to adopt its requirements using one of
      two methods:





(1)
      A
“modified prospective” method in which compensation cost is recognized beginning
      with the effective date (a) based on the requirements of SFAS
      No. 123(R) for all share-based payments granted after the effective date
      and (b) based on the requirements of SFAS No. 123 for all awards
      granted to employees prior to the effective date of SFAS No. 123(R) that
      remain unvested on the effective date.





(2)
      A
“modified retrospective” method which includes the requirements of the modified
      prospective method described above, but also permits entities to restate based
      on the amounts previously recognized under SFAS No. 123 for purposes of pro
      forma disclosures either (a) all prior periods presented or (b) prior
      interim periods of the year of adoption.





This
      statement is effective for the beginning of the first annual reporting period
      that begins after June 15, 2005, therefore, we will adopt the standard in
      the first quarter of fiscal 2006 using the modified prospective method. As
      permitted by SFAS No. 123, we currently account for share-based payments to
      employees using the intrinsic value method prescribed in APB Opinion 25 and,
      as
      such, generally recognize no compensation cost for employee stock options.
      Although we have not completed our assessment, we believe the impact on our
      consolidated financial position or results or operations will not be material
      given the current number of outstanding stock options. The effect on our results
      of operations of expensing stock options using the Black-Scholes method is
      presented in the disclosure of pro forma net income and earnings per share
      in
      Note 2. SFAS No. 123(R) also requires the benefits of tax deductions in
      excess of recognized compensation cost to be reported as a financing cash flow,
      rather than as an operating cash flow as required under current literature.
      This
      requirement will reduce net operating cash flows and increase net financing
      cash
      flows in periods after adoption.








**ITEM
      7.**  **FINANCIAL
      STATEMENTS.**




The
      Financial Statements of the Company and the accompanying notes thereto, and
      the
      independent auditor’s report required by this item are included as part of this
      Form 10-KSB and immediately follow the signatures page of this Form
      10-KSB.





61


**** **ITEM
      8.**  **CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE** **.**





On
      June
      1, 2004, Ehrenkrantz Sterling & Co., LLC (“Ehrenkrantz”) merged with the
      firm of Friedman Alpren & Green LLP. The new entity, Friedman LLP
      (“Friedman”), was retained by us, and our Board of Directors approved this
      decision on June 7, 2004. For the period since Ehrenkrantz's appointment through
      June 7, 2004, there have been no disagreements with Ehrenkrantz on any matter
      of
      accounting principles or practices, financial statement disclosure, or auditing
      scope or procedure, which disagreements if not resolved to the satisfaction
      of
      Ehrenkrantz would have caused them to make reference thereto in their report.
      In
      addition, for the period since Ehrenkrantz's appointment through June 7, 2004,
      we did not consult with Friedman regarding any matter that was the subject
      of a
      "disagreement" with Ehrenkrantz, as that term is defined in Item 304(a)(1)(iv)
      of Regulation S-K and the related instructions to Item 304 of Regulation S-K,
      or
      with regard to any "reportable event," as that term is defined in Item
      304(a)(1)(v) of Regulation S-K, except as such consultations as may have been
      made with former employees of Ehrenkrantz who are now employees of
      Friedman.





**ITEM
      8A. CONTROLS AND PROCEDURES**




**Evaluation
      of disclosure controls and procedures.**


Under
        the
        supervision and with the participation of our management, including our chief
        executive officer and our chief financial officer, we have assessed the
        effectiveness of the design and operation of our disclosure controls and
        procedures pursuant to Securities Exchange Act of 1934 Rule 13a-15(e) as
        of the
        end of the period covered by this report. Based on that assessment, our
        management has concluded that our internal control over financial reporting
        was
        not effective as of December 31, 2005 because of the material weaknesses
        identified and described below.
 
 Control
        Activities:
 
 1.
        The
        Company did not maintain effective controls over the accounting for embedded
        derivatives in certain financial instruments. Specifically the Company did
        not
        have controls designed and in place to ensure the completeness, accuracy
        and
        evaluation of embedded derivatives in its financing transactions with Laurus
        Master Fund, Ltd. and with three entities affiliated with Sands Brothers
        International Limited. The instruments included, among other things, convertible
        notes, freestanding warrant agreements and registration rights agreements.
        The
        warrant agreements are subject to registration rights agreements which require
        that the Company register the shares within a specified period of time and,
        in
        the event this is not done, provides for significant liquidated damages.
        In
        accordance with EITF 00-19 “Accounting for Derivative Financial Instruments
        Indexed to, and Potentially Settled in, a Company’s Own Stock,” the Company
        previously recorded a liability for these warrants. However, although the
        convertible notes are also subject to the registration rights agreements
        and are
        not “conventionally convertible,” the Company had not previously recorded a
        liability for the derivative associated with the conversion feature.
        Additionally, in July 2005, the Company renegotiated its financing with Laurus.
        As part of this transaction, the Company repaid $4.3 million to Laurus, issued
        an option to purchase Company stock at $0.015 per share and increased the
        availability under the revolving line of credit by $500,000. Since future
        cash
        flows under the new agreement with Laurus are more than 10% different than
        under
        the 2004 agreement with Laurus, it has been determined that this transaction
        should have been accounted for as an early extinguishment of debt as opposed
        to
        a modification of existing debt.
 
 The
        deficiency resulted in a restatement of its financial statements for the
        three
        and nine months ended September 30, 2004, the year ended December 31, 2004,
        the
        three months ended March 31, 2005, the three and six months ended June 30,
        2005
        and the three and nine months ended September 30, 2005 as appropriate to
        properly account for the above transactions.
 
 2.
        The
        Company did not maintain effective controls to ensure the completeness, accuracy
        and valuation over the accounting for business combinations, including the
        inability to prepare financial statements and footnotes in accordance with
        SEC
        rules and regulations and with our 2004 acquisitions of DeLeeuw Associates,
        Inc.
        and Evoke Software Corporation. We misapplied generally accepted accounting
        principles whereby we did not value the acquisitions and record the resulting
        purchase accounting in accordance with SFAS 141 and EITF 99-12. As a result,
        we
        were required in April 2005 to restate our financial statements for the three
        months ended March 31, 2004, for the three and six months ended June 30,
        2004
        and for the three and nine months ended September 30, 2004. Management
        determined that the disclosure controls and procedures for these three quarters
        were not effective.


62


3.
        The
        Company did not maintain effective controls over the period end financial
        reporting process. Specifically, controls were not designed and in place
        to
        ensure that to the Company identified certain transactions, primarily
        contractual, and accounted for them in the proper periods. This does not
        relate
        to the subject matter of the material weaknesses described above, yet combined
        with the above-referenced material weaknesses, constitute in the aggregate
        a
        material weakness in our internal control over financial reporting.
  4.
          The
          Company did not maintain effective controls over the accounting for income
          taxes
          to ensure amounts disclosed are accurately accounted for in accordance
          with
          GAAP. Specifically, the Company did not have controls designed and functioning
          to ensure that accounting personnel prepared the necessary disclosures
          required
          by FASB No. 109 “Accounting for Income Taxes.”
 Remediation
        of Material Weaknesses in Internal Control over Financial Reporting
 
 In
        light
        of the need for these restatements and the material weaknesses described
        above,
        management began in the second quarter of our 2005 fiscal year, and continuing
        through the period covered by this report, to undertake a review of our
        disclosure, financial information and internal controls and procedures regarding
        these areas for future complex financing transactions and acquisitions. This
        review has included efforts by our management and directors, as well as the
        use
        of additional outside resources, as follows:
 
 •
Senior
        accounting personnel and our chief financial officer will continue to review
        any
        complex financing transaction in order to evaluate, document and approve
        its
        accounting treatment in accordance with EITF 00-19 and EITF 00-27;
 
 •
Senior
        accounting personnel and our chief financial officer will continue to review
        any
        future acquisition or divestiture in order to evaluate, document and approve
        its
        accounting treatment in accordance with SFAS 141 and EITF 99-12;
 
 •
We
        will
        augment, as necessary, such procedures by obtaining concurrence with independent
        outside accounting experts prior to finalizing financial reporting for such
        transactions; and
 
 •
We
        will
        incorporate the applicable parts of the action plan described
        below.
 
 In
        conjunction with the measures outlined below, we believe these actions will
        strengthen our internal control over our review of complex financing
        transactions. We also believe these actions have sufficiently strengthened
        our
        internal control over our valuation and purchase accounting of acquisitions,
        and
        this material weakness should be resolved. Management does not anticipate
        any
        extra cost from this change over our review of complex financing transactions
        and in its valuation and purchase accounting of future acquisitions. Management
        established an action plan in the first quarter of 2005 that it believes
        will
        correct the aggregated material weaknesses described above. Our estimated
        costs
        related to the correction of these material weaknesses is approximately $0.25
        million, most notably related to our conversion to the Great Plains accounting
        system during the third quarter of 2004. Other measures included in our action
        plan are as follows:


63


•
Our
        Disclosure Committee, formed in the second quarter of 2005, consists of our
        chief executive officer, chief operating officer, senior vice president of
        sales, general counsel and controller, chaired by our chief financial officer.
        The Disclosure Committee is comprised of these key members of senior management
        who have knowledge of significant portions of our internal control system,
        as
        well as the business and competitive environment in which we operate. One
        of the
        key responsibilities of each Disclosure Committee member is to review quarterly
        reports, annual
        reports and registration statements to be filed with the SEC as each progress
        through the preparation process. Open lines of communication to financial
        reporting management exist for Disclosure Committee members to convey comments
        and suggestions;
 
 •
A
        process has been established whereby material agreements are reviewed by
        the
        legal and sales departments and an executive
        management member that includes determination of appropriate accounting and
        disclosure;
 
 •
Our
        accounting and legal departments are working closely and in conjunction to
        accurately account for period-end financial reporting and complex financing
        transactions;
 
 •
We
        are
        constantly assessing our existing environment and continue to make further
        changes, as appropriate, in our finance and accounting organization to create
        clearer segregation of responsibilities and supervision, and to increase
        the
        level of technical accounting expertise including the use of outside accounting
        experts;
 
 •
There
        has been closer monitoring of the preparation of our monthly and quarterly
        financial information. We have instituted regular quarterly meetings to review
        each department’s significant activities and respective disclosure controls and
        procedures;
 
 •
        Department managers have been tasked with tracking relevant non-financial
        operating metrics and other pertinent operating information and communicating
        their findings to a member of the Disclosure Committee; and
 
 •
We
        have
        conducted quarterly reviews of the effectiveness of our disclosure controls
        and
        procedures, and we have enhanced our quarterly close process to include detailed
        analysis in support of the financial accounts, and improved supervision over
        the
        process.


64


We
        believe that we will satisfactorily address the control deficiencies and
        material weakness relating to these matters by the end of the third quarter
        of
        2006, although there can be no assurance that we will do so.
 
 Given
        the
        presence of material weaknesses in our internal control over financial
        reporting, there is a more than a remote likelihood that a material misstatement
        of the annual or interim financial statements will not be prevented or detected.
        Our financial reporting process includes extensive procedures we undertake
        in
        order to obtain assurance regarding the reliability of our published financial
        statements, notwithstanding the material weaknesses in internal control.
        We have
        expanded our year-end closing procedures. We have expanded our review of
        embedded derivative in our financial instruments. We have expanded our review
        of
        accounting for business combinations. All of the above mentioned procedures
        have
        been designed to help compensate for our material weaknesses in order to
        provide
        assurance that the financial statements are free of material inaccuracies
        or
        omissions of material fact. As a result, management, to the best of its
        knowledge, believes that (i) the report does not contain any untrue statements
        of a material fact or omits any material fact and (ii) the consolidated
        financial statements and other financial information included in this report
        for
        the year ended December 31, 2005 have been prepared in conformity with GAAP
        and
        fairly present in all material aspects our financial condition, results of
        operations and cash flows.
 
 Management,
        including our chief executive officer and our chief financial officer, does
        not
        expect that our disclosure controls and internal controls will prevent all
        error
        or all fraud, even as the same are improved to address any deficiencies and/or
        weaknesses. A control system, no matter how well conceived and operated,
        can
        provide only reasonable, not absolute, assurance that the objectives of the
        control system are met. Over time, controls may become inadequate because
        of
        changes in conditions or deterioration in the degree of compliance with policies
        or procedures. Further, the design of a control system must reflect the fact
        that there are resource constraints, and the benefits of controls must be
        considered relative to their costs. Because of the inherent limitations in
        all
        control systems, no evaluation of controls can provide absolute assurance
        that
        all control issues and instances of fraud, if any, within the Company have
        been
        detected. These inherent limitations include the realities that judgments
        in
        decision-making can be faulty, and that breakdowns can occur because of simple
        error or mistake. Additionally, controls can be circumvented by the individual
        acts of some persons, by collusion of two or more people, or by management
        override of the control.
 
 **Changes
        in internal control over financial reporting.**
 
 We
        are in
        the process of developing a comprehensive remediation plan to address our
        deficiencies and expect that this plan will extend into the third quarter
        of the
        2006 fiscal year. The following list describes remedial actions that have
        been
        implemented since
        our
        last Annual Report:


65


•
Senior
        accounting personnel and our chief financial officer continue to review any
        complex financing transaction in order to evaluate, document and approve
        its
        accounting treatment in accordance with EITF 00-19 and EITF 00-27;
 
 •
Senior
        accounting personnel and our chief financial officer continue to review any
        future acquisition or divestiture in order to evaluate, document and approve
        its
        accounting treatment in accordance with SFAS 141 and EITF 99-12;
 
 •
We
        have
        augmented, as necessary, such procedures by obtaining concurrence with
        independent outside accounting experts prior to finalizing financial reporting
        for such transactions;
 
 •
Our
        Disclosure Committee meets at the end of every quarter;
 
 •
Our
        accounting and legal departments continue to work more closely and in
        conjunction to accurately account for period-end financial reporting and
        complex
        financing transactions;
 
 •
There
        has been closer monitoring of the preparation of our monthly and quarterly
        financial information. We have instituted regular quarterly meetings to review
        each department’s significant activities and respective disclosure controls and
        procedures; and
 
 •
        Department managers have been tasked with tracking relevant non-financial
        operating metrics and other pertinent operating information and communicating
        their findings to a member of the Disclosure Committee.


**ITEM
      8B.****OTHER
      INFORMATION**





Not
      applicable.


66




**PART
      III**





**ITEM
      9.**  **DIRECTORS,
      EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION
      16(A)
      OF THE EXCHANGE ACT** **.**





The
      following table sets forth the names and ages of our current directors and
      executive officers, the principal offices and positions with us held by each
      person and the date such person became a director or executive officer. Our
      Board of Directors elects our executive officers annually. Each year the
      stockholders elect the members of our Board of Directors.





Our
      directors and executive officers are as follows:





**Name**
            **Year
                First Elected As an Officer Or Director**
            **Age**
            **Position(s)
                Held**Scott
                Newman
            2004
            46
            President,
                Chief Executive Officer and ChairmanGlenn
                Peipert
            2004
            45
            Executive
                Vice President, Chief Operating Officer and DirectorMitchell
                Peipert
            2004
            47
            Vice
                President, Chief Financial Officer, Secretary and TreasurerRobert
                C. DeLeeuw
            2004
            49
            Senior
                Vice President and President of DeLeeuw Associates, LLCWilliam
                McKnight
            2005
            40
            Senior
                Vice President - Data WarehousingLawrence
                K. Reisman*
            2004
            46
            DirectorJoseph
                Santiso**
            2005
            61
            Director


*Chair
      of
      the Audit Committee, the Compensation Committee and the Nominating and Corporate
      Governance Committee.





**
      Member
      of the Audit Committee, the Compensation Committee and the Nominating and
      Corporate Governance Committee.




SCOTT
      NEWMAN has been our President, Chief Executive Officer and Chairman since
      January 2004. Mr. Newman founded the former Conversion Services International,
      Inc. in 1990 (before its merger with and into LCS Group, Inc.) and is our
      largest stockholder. He has over twenty years of experience providing technology
      solutions to major companies internationally. Mr. Newman has direct experience
      in strategic planning, analysis, design, testing and implementation of complex
      big-data solutions. He possesses a wide range of software and hardware
      architecture/discipline experience, including, client/server, data discovery,
      distributed systems, data warehousing, mainframe, scaleable solutions and
      e-business. Mr. Newman has been the architect and lead designer of several
      commercial software products used by Chase, Citibank, Merrill Lynch and Jaguar
      Cars. Mr. Newman advises and reviews data warehousing and business intelligence
      strategy on behalf of our Global 2000 clients, including AT&T Capital,
      Jaguar Cars, Cytec and Chase. Mr. Newman is a member of the Young Presidents
      Organization, a leadership organization that promotes the exchange of ideas,
      pursuit of learning and sharing strategies to achieve personal and professional
      growth and success. Mr. Newman received his B.S. from Brooklyn College in
      1980.





67


GLENN
      PEIPERT has been our Executive Vice President, Chief Operating Officer and
      Director since January 2004. Mr. Peipert held the same positions with the former
      Conversion Services International, Inc. since its inception in 1990 and is
      our
      second largest stockholder. Mr. Peipert has over two decades of experience
      consulting to major organizations about leveraging technology to enable
      strategic change. He has advised clients representing a broad cross-section
      of
      rapid growth industries worldwide. Mr. Peipert has hands on experience with
      the
      leading data warehousing products. His skills include architecture design,
      development and project management. He routinely participates in architecture
      reviews and recommendations for our Global 2000 clients. Mr. Peipert has managed
      major technology initiatives at Chase, Tiffany, Morgan Stanley, Cytec and the
      United States Tennis Association. He speaks nationally on applying data
      warehousing technologies to enhance business effectiveness and has authored
      multiple white papers regarding business intelligence. Mr. Peipert is a member
      of the Institute of Management Consultants, as well as TEC International, a
      leadership organization whose mission is to increase the effectiveness and
      enhance the lives of chief executives and those they influence. Mr. Peipert
      is
      the brother of Mitchell Peipert, our Vice President, Chief Financial Officer,
      Secretary and Treasurer. Mr. Peipert received his B.S. from Brooklyn College
      in
      1982.





MITCHELL
      PEIPERT has been our Vice President, Chief Financial Officer, Secretary and
      Treasurer since January 2004. Mr. Peipert is a Certified Public Accountant
      who
      held the same positions with the former Conversion Services International,
      Inc.
      from January 2001 to September 2002. From September 2002 to December 2003,
      Mr.
      Peipert was Senior Sales Executive for NIA Group and President of E3 Management
      Advisors. From April 1992 until January 2001, Mr. Peipert served as Senior
      Vice
      President of Operations and Controller of TSR Wireless LLC, where he directed
      the accounting, operations and human resources functions. He also assisted
      the
      chief executive officer in strategic planning, capital raising and acquisitions.
      Prior to his employment by TSR, he held various managerial roles for Anchin,
      Block & Anchin, certified public accountants, Merrill Lynch and Grant
      Thornton. Mr. Peipert is the brother of Glenn Peipert, our Executive Vice
      President, Chief Operating Officer and Director. Mr. Peipert received his B.S.
      from Brooklyn College in 1980 and received his M.B.A. in Finance from Pace
      University in 1986.





ROBERT
      C.
      DELEEUW has been our Senior Vice President and the President of our wholly
      owned
      subsidiary, DeLeeuw Associates, LLC, since March 2004 and is our third largest
      stockholder. Mr. DeLeeuw founded DeLeeuw Associates, LLC, formerly known as
      DeLeeuw Associates, Inc., in 1991. Mr. DeLeeuw has over twenty-five years
      experience in banking and consulting. During this time, he has managed and
      supported some of the largest merger projects in the history of the financial
      services industry and has implemented numerous large-scale business and process
      change programs for his clients. He has been published in American Banker,
      Mortgage Banking Magazine, The Journal of Consumer Lending and Bank Technology
      News where he has also served as a member of the Editorial Advisory Board.
      Mr.
      DeLeeuw received his B.S. from Rider University in 1979 and received his M.S.
      in
      Management from Stevens Institute of Technology in 1986.





68


WILLIAM
      MCKNIGHT has been our Senior Vice President - Data Warehousing since July 2005.
      Mr. McKnight founded McKnight Associates, Inc. in 1998. Prior to forming his
      company, from 1992-1998, Mr. McKnight held various information technology
      management positions at Visa, and Anthem Blue Cross Blue Shield. From 1990-1992,
      Mr. McKnight was a consultant for Platinum Technology, and he was a developer
      of
      the DB2 product at IBM from 1987-1990. Mr. McKnight received his B.S. in
      Computer Science from Southern College in 1987 and received his M.B.A. from
      Santa Clara University in 1994.





LAWRENCE
      K. REISMAN has been a Director of our company since February 2004 and is the
      Chair of the Audit Committee, the Compensation Committee and the Nominating
      and
      the Corporate Governance Committee. Mr. Reisman is a Certified Public Accountant
      who has been the principal of his own firm, The Accounting Offices of L.K.
      Reisman, since 1986. Prior to forming his company, Mr. Reisman was a tax manager
      at Coopers & Lybrand and Peat Marwick Mitchell. He routinely provides
      accounting services to small and medium-sized companies, which services include
      auditing, review and compilation of financial statements, corporate, partnership
      and individual taxation, designing accounting systems and management consulting
      services. Mr. Reisman received his B.S. and M.B.A. in Finance from St. John’s
      University in 1981 and 1985, respectively.





JOSEPH
      SANTISO has been a Director of our company since May 2005 and was appointed
      by
      the Board to sit on the Board's Audit Committee, Nominating and Corporate
      Governance Committee and Compensation Committee in May 2005. Mr. Santiso founded
      and is President of The BCI Group, which consists of Breakthrough Concepts
      Inc.,
      BCI Systems Inc. and BCI Knowledge Inc., since 1991. Prior to founding BCI,
      Mr.
      Santiso was the Chief Accounting Officer for Citibank Stock Transfer Services
      Division, a Financial Analyst in the Comptrollers Department of the Operational
      Services Division at Irving Trust and a Professor of Accounting at Jersey City
      State College. Mr. Santiso received his B.S. from Pace University in 1973 with
      a
      major in Accounting and Finance.





Directors
      do not receive compensation for their duties as directors.





**Code
      of Conduct and Ethics**





Our
      Board
      of Directors has adopted a Code of Conduct and Ethics which is applicable to
      all
      our directors, officers, employees, agents and representatives, including our
      principal executive officer and principal financial officer, principal
      accounting officer or controller, or other persons performing similar functions.
      We have made available on our website copies of our Code of Conduct and Ethics
      and charters for the committees of our Board and other information that may
      be
      of interest to investors.





69


**Director
      Independence**





The
      Board
      has reviewed each of the directors' relationships with the Company in
      conjunction with Section 121(A) of the listing standards of the American Stock
      Exchange ("AMEX") and has affirmatively determined that two of our directors,
      Lawrence K. Reisman and Joseph Santiso, are independent of management and free
      of any relationship that would interfere with the independent judgment as
      members of the Audit Committee. The
      Company is in the process of interviewing independent director candidates so
      the
      Board of Directors will have a majority of independent
      directors.





**Committees
      of the Board of Directors**





The
      Board
      of Directors has established three standing committees: (1) the Audit Committee,
      (2) the Compensation Committee and (3) the Nominating and Corporate Governance
      Committee. Each committee operates under a charter that has been approved by
      the
      Board. Copies of the Audit Committee, Compensation Committee and Nominating
      and
      Corporate Governance Committee's' charters are posted on the Company's website.
      Mr. Reisman and Mr. Santiso are the members of each of such committees. Mr.
      Reisman serves as the Chair of each of such committees.








**Audit
      Committee**





The
      Audit
      Committee was formed in April 2005. The Audit Committee has met once since
      its
      formation and each member of the Audit Committee was present at such meeting,
      and acted by unanimous written consent four times. The Audit Committee is
      responsible for matters relating to financial reporting, internal controls,
      risk
      management and compliance. These responsibilities include appointing,
      overseeing, evaluating and approving the fees of our independent auditors,
      reviewing financial information which is included in our Annual Report on Form
      10-KSB/A, discussions with management and the independent auditors the results
      of the annual audit and our quarterly financial statements, reviewing with
      management our system of internal controls and financial reporting process
      and
      monitoring our compliance program and system.





The
      Audit
      Committee operates pursuant to a written charter, which sets forth the functions
      and responsibilities of this committee. A copy of the charter can be viewed
      on
      our website. All members of this committee are independent directors under
      the
      SEC rules. The Board of Directors has determined that Lawrence K. Reisman,
      the
      committee’s chairman, meets the SEC criteria of an “audit committee financial
      expert”, as defined in Item 401(e) of Regulation S-B.





**Compensation
      Committee**





The
      Compensation Committee was formed in May 2005 and did not meet during fiscal
      2005. The Compensation Committee is responsible for matters relating to the
      development, attraction and retention of the Company’s management and for
      matters relating to the Company’s compensation and benefit programs. As part of
      its responsibilities, this committee evaluates the performance and determines
      the compensation of the Company’s Chief Executive Officer and approves the
      compensation of our senior officers.





70


The
      Compensation Committee operates under a written charter that sets forth the
      functions and responsibilities of this committee. A copy of the charter can
      be
      viewed on our website.





Pursuant
      to its charter, the Compensation Committee must be comprised of at least two
      (2)
      Directors who, in the opinion of the Board of Directors, must meet the
      definition of “independent director” within the rules and regulations of the
      SEC. The Board of Directors has determined that all members of this committee
      are independent directors under the SEC rules.





**Nominating
      and Corporate Governance Committee**





The
      Nominating and Corporate Governance Committee is responsible for providing
      oversight on a broad range of issues regarding our corporate governance
      practices and policies and the composition and operation of the Board of
      Directors. These responsibilities include reviewing potential candidates for
      membership on the Board and recommending to the Board nominees for election
      as
      directors of the Company. The Nominating and Corporate Governance Committee
      was
      formed in May 2005 and did not meet during fiscal 2005. A complete description
      of the Nominating and Corporate Governance Committee’s responsibilities is set
      forth in the Nominating and Corporate Governance written charter. A copy of
      the
      charter is available to stockholders on the Company’s website. All members of
      the Nominating and Corporate Governance Committee are independent directors
      as
      defined by the rules and regulations of the SEC. The Nominating and Corporate
      Governance Committee will consider director nominees recommended by
      stockholders. There are no minimum qualifications for consideration for
      nomination to be a director of the Company. The nominating committee will assess
      all director nominees using the same criteria. Nominations made by stockholders
      must be made by written notice received by the Secretary of the Company within
      30 days of the date on which notice of a meeting for the election of directors
      is first given to stockholders. The Nominating and Corporate Governance
      Committee and the Board of Directors carefully considers nominees regardless
      of
      whether they are nominated by stockholders, the Nominating and Corporate
      Governance Committee or existing board-members.





**Section
      16(a) Beneficial Ownership Reporting Compliance**





Section
      16(a) of the Securities Exchange Act of 1934, as amended, requires our officers,
      directors and persons who beneficially own more than 10% of a registered class
      of our equity securities (“ten percent stockholders”) to file reports of
      ownership and changes in ownership with the Securities and Exchange
      Commission.  Officers, directors and ten percent stockholders are charged
      by the SEC regulations to furnish us with copies of all Section 16(a) forms
      they
      file.




Based
      solely upon a review of Forms 3, 4 and 5 and amendments thereto furnished to
      us
      during the past fiscal year, and, if applicable, written representations that
      Form 5 was not required, we believe that all Section 16(a) filing requirements
      applicable to our officers, directors and ten percent stockholders were
      fulfilled.





71





**ITEM
      10.**  **EXECUTIVE
      COMPENSATION.**





The
      following table sets forth, for the fiscal years indicated, all compensation
      awarded to, paid to or earned by the following type of executive officers for
      the fiscal years ended December 31, 2005, 2004 and 2003: (i) individuals who
      served as, or acted in the capacity of, our principal executive officer for
      the
      fiscal year ended December 31, 2005; and (ii) our other most highly compensated
      executive officer, who together with the principal executive officer are our
      most highly compensated officers whose salary and bonus exceeded $100,000 with
      respect to the fiscal year ended December 31, 2005 and who were employed at
      the
      end of fiscal year 2005.








**SUMMARY
      COMPENSATION TABLE***


**Long
                  Term Compensation****Annual
                  Compensation(1)**
              **Awards**
              **Payouts****Name
                  and Principal Position**
              **Year**
              **Salary**
              **Bonus**
              **Other
                  Annual**
                **Compensation**
              **Restricted**
                **Stock**
                **Award(s)**
              **Securities**
                **Underlying**
                **Options/SARs**
              **LTIP**
                **Payouts**
              **All
                  Other**
                **Compensation****($)**
              **($)**
              **($)**
              **($)**
              **(#)**
              **($)**
              **($)**Scott
                  Newman
                President,
                  Chief Executive Officer and Chairman
              2005
              500,000
              —
              —
              —
              —
              —
              39,809
                  (2)2004
              500,000
              —
              —
              —
              —
              —
              38,054
                  (2)2003
              244,452
              —
              —
              —
              —
              —
              206,686
                  (3)Glenn
                  Peipert
                Executive
                  Vice President, Chief Operating Officer and Director
              2005
              375,000
              —
              —
              —
              250,000
              —
              40,779
                  (2)2004
              375,000
              —
              —
              —
              —
              —
              38,054
                  (2)2003
              223,016
              —
              —
              —
              —
              —
              171,309
                  (4)Mitchell
                  Peipert, Vice President, Chief Financial Officer, Treasurer and
                  Secretary
              2005
              209,375
              —
              —
              —
              150,000
              —
              24,129
                  (2)2004
              190,000
              —
              —
              —
              300,000
              —
              14,413
                  (2)2003
              10,000
              —
              —
              —
              —
              —
              1,133
                  (2)Robert
                  C. DeLeeuw, Senior Vice President
              2005
                2004
              350,000
                329,400
              —
                —
              56,695
                  (5)
                —
              —
                —
              250,000
                —
              —
                —
              17,736
                  (2)
                592
                  (6)William
                  McKnight, Senior Vice President -Data Warehousing
              2005
              125,047
              —
              —
              —
              
              —
              10,494
                  (2)


_________________________




*
            Salary
                reflects total compensation paid to these executives (both before
                and
                after the merger described in Item
                1).





(1)
            The
                annual amount of perquisites and other personal benefits, if any,
                did not
                exceed the lesser of $50,000 or 10% of the total annual salary reported
                for each named executive officer and has therefore been omitted,
                unless
                otherwise stated above.





(2)
            Amounts
                shown reflect payments related to medical, dental and life insurance
                and
                car payments.





72


(3)
            Amounts
                shown reflect distributions resulting from the operating entity’s past tax
                status as a Subchapter S corporation of $153,738 in 2003, as well
                as
                $66,262 in 2003 of expenses, which include auto, travel and equipment
                purchases paid for by the Company.





(4)
            Amounts
                shown reflect distributions resulting from the operating entity’s past tax
                status as a Subchapter S corporation of $101,988 in 2003, as well
                as
                $63,645 in 2003 of expenses, which include auto, travel and equipment
                purchases paid for by the Company.





(5)
            Incentive
                compensation received based on profibility of business units under
                Mr.
                DeLeeuw’s control.





(6)
            Amounts
                shown reflect payment related to life
                insurance.








**Option/SAR
      Grants During Fiscal 2005**








Name
            Number
                of securities underlying options/SARs granted (#) (1)
            Percent
                of total options/SARs granted to employees in fiscal year
            Exercise
                or base price ($/Sh)
            Expiration
                DateGlenn
                Peipert
            250,000
                (2)
            9.3%
            $0.83
            November
                15, 2010Robert
                C. DeLeeuw
            250,000
                (2)
            9.3%
            $0.83
            November
                15, 2010Mitchell
                Peipert
            100,000
                (3)
            3.7%
            $0.83
            November
                15, 2015





(1)  All
      options were granted under the Company's 2003 Incentive Plan. All of the above
      options were granted on November
      16, 2005 .





(2)  One-third
      of such options vest upon the one year month anniversary of the grant date,
      one-third vest on the two year anniversary of the grant date, and one-third
      vest
      on the three year anniversary of the grant date.





(3)  One-third
      of such options vest upon the six month anniversary of the grant date, one-third
      vest on the eighteen month anniversary of the grant date, and one-third vest
      on
      the thirty month anniversary of the grant date.








73




**AGGREGATE
                OPTIONS EXERCISEABLE IN LAST FISCAL YEAR**
              **AND
                FISCAL YEAR END OPTION VALUES**Number
                of Securities
              Underlying
                Unexercised
              Options
                at December 31, 2005 (1)
            Value
                of Unexercised
              In-the-Money
                Options
              at
                December 31, 2005 (1)Name
                and Principal Position
            Exercisable
            Unexercisable
            Exercisable
            UnexercisableGlenn
                Peipert,Executive
                Vice President, Chief Operating Officer and Director
            0
            250,000
            $0
            $0Robert
                C. DeLeeuw, Senior Vice President
            0
            250,000
            $0
            $0Mitchell
                Peipert
              Vice
                President , Chief Financial Officer,Secretary
                and Treasurer
            100,000
            350,000
            $0
            $0




(1)
      As of
      December 30, 2005 the market value of a share of common stock was $0.53. No
      shares were exercised by executive officers or directors in fiscal year ended
      December 31, 2005.







**2003
      Incentive Plan**





*General*





The
      2003
      Incentive Plan was approved at a special meeting of our stockholders on January
      23, 2004. The Plan authorizes us to issue 6,666,667 shares of common stock
      for
      issuance upon exercise of options, and such shares have been reserved. It also
      authorizes the issuance of stock appreciation rights, referred to herein as
      SARs. The Plan authorizes us to grant:





·
            incentive
                stock options to purchase shares of our common stock,


·
            non-qualified
                stock options to purchase shares of common stock, and


·
            SARs
                and shares of restricted common
                stock.





The
      Plan
      may be amended, terminated or modified by our Board of Directors or our Stock
      Option Committee at any time, subject to stockholder approval as required by
      law, rule or regulation. No such termination, modification or amendment may
      affect the rights of an optionee under an outstanding option or the grantee
      of
      an award.





*Objectives*





The
      objective of the Plan is to provide incentives to our officers, other key
      employees, consultants, professionals and non-employee directors to achieve
      financial results aimed at increasing stockholder value and attracting talented
      individuals to CSI. Persons eligible to be granted incentive stock options
      under
      the Plan will be those employees, consultants, professionals and non-employee
      directors whose performance, in the judgment of the Stock Option Committee
      of
      our Board of Directors, can have a significant effect on our
      success.





*Oversight*





The
      Stock
      Option Committee, consisting of our independent directors Lawrence K. Reisman
      (chairman) and Joseph Santiso, administers the Plan by making determinations
      regarding the persons to whom options should be granted and the amount, terms,
      conditions and restrictions of the awards. The Board or the Stock Option
      Committee also has the authority to interpret the provisions of the Plan and
      to
      establish and amend rules for its administration subject to the Plan’s
      limitations.





74


*Types
      of grants*





The
      Plan
      allows us to grant incentive stock options, non-qualified stock options, shares
      of restricted stock, SARs in connections with options and independent SARs.
      The
      Plan does not specify what portion of the awards may be in the form of any
      of
      the foregoing. Incentive stock options awarded to our employees are qualified
      stock options under the Internal Revenue Code.





*Eligibility*





Under
      the
      Plan, we may grant incentive stock options only to our officers and employees,
      and we may grant non-qualified options to officers and employees, as well as
      our
      directors, independent contractors and agents.





*Statutory
      Conditions on Stock Options*





*Exercise
      Price* .
      To the
      extent that Options designated as incentive stock options become exercisable
      by
      an optionee for the first time during any calendar year for common stock having
      a fair market value greater than One Hundred Thousand Dollars ($100,000), the
      portions of such options which exceed such amount shall be treated as
      nonqualified stock options. Incentive stock options granted to any person who
      owns, immediately after the grant, stock possessing more than 10% of the
      combined voting power of all classes of our stock, or of any parent or
      subsidiary of ours, must have an exercise price at least equal to 110% of the
      fair market value of common stock on the date of grant and the term of the
      option may not be longer than five years.





*Expiration
      Date* .
      Any
      option granted under the Plan will expire at the time fixed by the Board or
      the
      Stock Option Committee, which cannot be more than ten (10) years after the
      date
      it is granted or, in the case of any person who owns more than 10% of the
      combined voting power of all classes of our stock or of any parent or subsidiary
      corporation, not more than five years after the date of grant.





*Exerciseability* .
      The
      Board or its committee may also specify when all or part of an option becomes
      exercisable, but in the absence of such specification, the option will
      ordinarily be exercisable in whole or part at any time during its term. However,
      the Board or its committee may accelerate the exerciseability of any option
      at
      its discretion.





*Assignability.* Options
      granted under the Plan are not assignable, except by the laws of descent and
      distribution or as may be otherwise provided by the Board or its committee.





*Payment
      Upon Exercise Of Options*





Payment
      of the exercise price for any option may be in cash or by broker assisted
      exercise.





*Stock
      Appreciation Rights*





A
      Stock
      Appreciation Right is the right to benefit from appreciation in the value of
      common stock. A SAR holder, on exercise of the SAR, is entitled to receive
      from
      us in cash or common stock an amount equal to the excess of: (a) the fair market
      value of common stock covered by the exercised portion of the SAR, as of the
      date of such exercise, over (b) the fair market value of common stock covered
      by
      the exercised portion of the SAR as of the date on which the SAR was granted.





75


The
      Board
      or the Stock Option Committee may grant SARs in connection with all or any
      part
      of an option granted under the Plan, either concurrently with the grant of
      the
      option or at any time thereafter, and may also grant SARs independently of
      options.





*Tax
      Consequences*





An
      employee or director will not recognize income on the awarding of incentive
      stock options and nonstatutory options under the Plan.





An
      optionee will recognize ordinary income as the result of the exercise of a
      nonstatutory stock option in the amount of the excess of the fair market value
      of the stock on the day of exercise over the option exercise price.





An
      employee will not recognize income on the exercise of an incentive stock option,
      unless the option exercise price is paid with stock acquired on the exercise
      of
      an incentive stock option and the following holding period for such stock has
      not been satisfied. The employee will recognize long-term capital gain or loss
      on a sale of the shares acquired on exercise, provided the shares acquired
      are
      not sold or otherwise disposed of before the earlier of:





(i)
            two
                years from the date of award of the option, or





(ii)
            one
                year from the date of exercise.





If
      the
      shares are not held for the required period of time, the employee will recognize
      ordinary income to the extent the fair market value of the stock at the time
      the
      option is exercised exceeds the option price, but limited to the gain recognized
      on sale. The balance of any such gain will be a short-term capital gain.
      Exercise of an option with previously owned stock is not a taxable disposition
      of such stock. An employee generally must include in alternative minimum taxable
      income the amount by which the price such employee paid for an incentive stock
      option is exceeded by the option’s fair market value at the time his or her
      rights to the stock are freely transferable or are not subject to a substantial
      risk of forfeiture.





As
      of
      December 31, 2005, options to purchase a total of 4,883,114  shares
      of
      common stock were outstanding at exercise prices ranging from $0.825 to
      $3. 4 5
      per
      share. Generally, one-third of the options granted vest on the first
      anniversary, one-third of the options granted vest on the second anniversary
      and
      one-third of the options granted vest on the third anniversary. All options
      expire on the ten year anniversary of their grant date.





All
      options described above have been issued pursuant to the 2003 Incentive Plan
      described above.





76


**Employment
      Agreements**





Scott
      Newman, our President and Chief Executive Officer, agreed to a five-year
      employment agreement dated as of March 26, 2004. The agreement provides for
      an
      annual salary to Mr. Newman of $500,000 and an annual bonus to be awarded by
      our
      Compensation Committee. No bonus was awarded in 2005. The agreement also
      provides for health, life and disability insurance, as well as a monthly car
      allowance. In the event that Mr. Newman’s employment is terminated other than
      with good cause, he will receive a lump sum payment of 2.99 times his base
      salary.





Glenn
      Peipert, Executive Vice President and Chief Operating Officer, agreed to a
      five-year employment agreement dated as of March 26, 2004. The agreement
      provides for an annual salary to Mr. Peipert of $375,000 and an annual bonus
      to
      be awarded by our Compensation Committee. No bonus was awarded in 2005. The
      agreement also provides for health, life and disability insurance, as well
      as a
      monthly car allowance. In the event that Mr. Peipert’s employment is terminated
      other than with good cause, he will receive a lump sum payment of 2.99 times
      his
      base salary.





Mitchell
      Peipert, Vice President, Chief Financial Officer, Treasurer and Secretary,
      agreed to a three-year employment agreement dated as of March 26, 2004. The
      agreement provides for an annual salary to Mr. Peipert of $200,000 and an annual
      bonus to be awarded by our Compensation Committee. No bonus was awarded in
      2005.
      In August 2005, Mr. Peipert received an increase to his annual salary to
      $225,000. The agreement also provides for health, life and disability insurance,
      as well as a monthly car allowance. In the event that Mr. Peipert’s employment
      is terminated other than with good cause, he will receive a lump sum payment
      of
      2.99 times his base salary.





Robert
      C.
      DeLeeuw, Senior Vice President and President of our wholly owned subsidiary,
      DeLeeuw Associates, LLC, agreed to a three-year employment agreement dated
      as of
      February 27, 2004. The agreement provides for an annual salary to Mr. DeLeeuw
      of
      $350,000 and an annual bonus to be awarded by our Compensation Committee. No
      bonus was awarded in 2005. The agreement also provides for health, life and
      disability insurance. In the event that Mr. DeLeeuw’s employment is terminated
      other than with good cause, he will receive a lump sum payment of the longer
      of
      (1) one year's base salary or (2) the period from the date of termination
      through the expiration date.





William
      McKnight, Senior Vice President - Data Warehousing, agreed to a three-year
      employment agreement dated as of July 22, 2005. The agreement provides for
      an
      annual salary to Mr. McKnight of $250,000 and an annual bonus to be awarded
      by
      our Compensation Committee. No bonus was awarded in 2005. The agreement also
      provides for health, life and disability insurance. In the event that Mr.
      McKnight’s employment is terminated other than with good cause, he will receive
      a lump sum payment of the longer of (1) one year's base salary or (2) the period
      from the date of termination through the expiration date.





77


**ITEM
      11.**  **SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
      MATTERS**




The
      following table sets forth certain information regarding the beneficial
      ownership of our common stock, our only class of outstanding voting securities
      as of March 31, 2006, based on 49,997,834 aggregate shares of common stock
      outstanding as of such date, by: (i) each person who is known by us to own
      beneficially more than 5% of our outstanding common stock with the address
      of
      each such person, (ii) each of our present directors and officers, and (iii)
      all
      officers and directors as a group:





**Name
                and Address of**
              **Beneficial
                Owner****(1)(2)**
            **Amount
                of Common**
              **Stock
                Beneficially Owned**
            **Percentage
                of Outstanding**
              **Common
                Stock Beneficially Owned**Scott
                Newman(3)
            19,613,056
            39.2%Glenn
                Peipert(4)
            9,346,032
            18.7%Mitchell
                Peipert(5)
            250,000
            *Robert
                C. DeLeeuw(6)
            5,333,334
            10.7%William
                McKnight(7)
            909,091
            1.8%Lawrence
                K. Reisman(8)
            20,000
            *Joseph
                Santiso(9)
            0All
                directors and officers as a group (7 persons)
            35,471,513
            70.6%





*
            Represents
                less than 1% of the issued and outstanding Common
                Stock.




(1)
            Each
                stockholder, director and executive officer has sole voting power
                and sole
                dispositive power with respect to all shares beneficially owned by
                him,
                unless otherwise indicated.




(2)
            All
                addresses are c/o Conversion Services International, Inc.,100
                Eagle Rock Avenue, East Hanover, New Jersey
                07936.




(3)
            Mr.
                Newman is the Company’s President, Chief Executive Officer and Chairman of
                the Board.




(4)
            Mr.
                Glenn Peipert is the Company’s Executive Vice President, Chief Operating
                Officer and Director. Does not include an option to purchase 250,000
                shares of common stock granted on November 16, 2005 and expiring
                on
                November 16, 2010 at an exercise price of $.83 per share, which vest
                as
                follows: (i) 83,333 on November 16, 2006; (ii) 83,333 on November
                16,
                2007; (iii) 83,334 on November 16, 2008.




(5)
            Mr.
                Mitchell Peipert is the Company’s Vice President, Chief Financial Officer,
                Secretary and Treasurer. Consists of an option to purchase 300,000
                shares
                of common stock granted on March 29, 2004 at an exercise price of
                $2.475
                per share, 200,000 of which have vested and 100,000 of which shall
                vest on
                March 29, 2007.****The
                option grant expires on March 28, 2014. Consists of an option to
                purchase
                150,000 shares of common stock granted on November 16, 2005 at an
                exercise
                price of $.83 per share, 50,000 of which have vested, 50,000 of which
                vest
                on May 16, 2007 and 50,000 of which vest on May 16, 2008.




(6)
            Mr.
                DeLeeuw is the Company’s Senior Vice President and the President of the
                Company’s wholly owned subsidiary, DeLeeuw Associates, LLC. Does not
                include an option to purchase 250,000 shares of common stock granted
                on
                November 16, 2005 and expiring on November 16, 2010 at an exercise
                price
                of $.83 per share, which vest as follows: (i) 83,333 on November
                16, 2006;
                (ii) 83,333 on November 16, 2007; (iii) 83,334 on November 16, 2008.
                Does
                not include an option to purchase 1,000,000 shares of common stock
                granted
                on January 9, 2006 and expiring on January 9, 2011 at an exercise
                price of
                $.46 per share, which vest as follows: (i) 333,333 on January 9,
                2007;
                (ii) 333,333 on January 9, 2008; (iii) 333,334 on January 9,
                2009.




78





(7)
            Mr.
                McKnight is the Company’s Senior Vice President - Data
                Warehousing.





(8)
            Mr.
                Reisman is a Director. Consists of an option to purchase 20,000 shares
                of
                common stock granted on May 28, 2004 at an exercise price of $3.00
                per
                share, 10,000 of which have vested and 10,000 of which vest on May
                28,
                2006.****Does
                not include an option to purchase 10,000 shares of common stock granted
                on
                May 28, 2004 at an exercise price of $3.00 per share, which vest
                on May
                28, 2007. The option grant expires on May 27, 2014. Does not include
                an
                portion to purchase 20,000 shares of common stock granted on November
                16,
                2005 at an exercise price of $.83 which vest as follows: (i) 6,666
                on
                November 16, 2006; (ii) 6,667 on November 16, 2007; (iii) 6,667 on
                November 16, 2008




(9)
            Mr.
                Santiso is a Director.Does
                not include an option to purchase 10,000 shares of common stock granted
                on
                November 16, 2005 at an exercise price of $0.83 per share, which
                vest as
                follows: (i) 3,333 onNovember
                16, 2006;
                (ii) 3,333 onNovember
                16, 2007;
                (iii) 3,334 onNovember
                16, 2008.







**Equity
      Compensation Plan Disclosure**




The
      following table sets forth certain information as of December 31, 2005 regarding
      securities :




**Plan
                  Category**
              
              **Number
                  of securities to be issued upon exercise of outstanding options,
                  warrants
                  and rights**
              
              **Weighted-average
                  exercise price of outstanding options, warrants and rights**
              
              **Number
                  of securities remaining available for future issuance under equity
                  compensation plans**Equity
                  Compensation Plans Approved by Security Holders
              
              
              4,883,114
              
              $
              1.43
              
              
              1,783,553Equity
                  Compensation Plans Not Approved by Security Holders
              
              
              -
              
              
              -
              
              
              -Total
              
              
              4,883,114
              
              $
              1.43
              
              
              1,783,553


**ITEM
      12.**  **CERTAIN
      RELATIONSHIPS AND RELATED PARTY TRANSACTIONS** ****








On
      November 8, 2004, Mr. Scott Newman entered into a stock purchase agreement
      with
      a private investor, CMKX-treme, Inc.  Pursuant to the agreement,
      CMKX-treme, Inc. agreed to purchase 188,889 shares of common stock for a
      purchase price of $250,000.  As of April 10, 2006, the shares have not been
      issued to CMKX-treme, Inc. because it has not yet remitted payment for the
      shares.





On
      November 8, 2004, Mr. Glenn Peipert entered into a stock purchase agreement
      with
      a private investor, CMKX-treme, Inc.  Pursuant to the agreement,
      CMKX-treme, Inc. agreed to purchase 377,778 shares of common stock for a
      purchase price of $500,000.  As of June 9, 2005, CMKX-treme, Inc. remitted
      final payment for the shares.





79


On
      November 10, 2004, the Company and Dr. Michael Mitchell, the former President,
      Chief Executive Officer and sole director of LCS, executed a one-year consulting
      agreement whereby Dr. Mitchell would perform certain consulting services on
      behalf of the Company. Dr. Mitchell will receive an aggregate amount of $0.25
      million as compensation for services provided to the Company. During 2005,
      an
      aggregate amount of $175,000 was paid to Mr. Mitchell for services provided
      under this consulting agreement.





As
      of
      November 16, 2004, Mr. Newman and Mr. Peipert repaid in full to the Company
      loans in the aggregate of approximately $0.2 million, including accrued
      interest. These loans bore interest at 3% per annum and were due and payable
      by
      December 31, 2005.





As
      of
      April 7, 2006, Mr. Scott Newman, President, Chief Executive Officer and
      Chairman, Mr. Glenn Peipert, Executive Vice President, Chief Operating Officer
      and Director, and Mr. Robert C. DeLeeuw, Senior Vice President, have agreed
      to
      personally support our cash requirements to enable us to fulfill our obligations
      through June 1, 2007, to the extent necessary, up to a maximum amount of $1.5
      million, based upon their ability to sell their Company common stock. Mr. Newman
      guaranties up to approximately $0.9 million, Mr. Peipert guaranties up to
      approximately $0.4 million and Mr. DeLeeuw guaranties approximately $0.2
      million. We believe that these written commitments provide us with the legal
      right to request and receive such advances from any of these officers. Any
      loan
      by Messrs. Newman, Peipert and DeLeeuw to the Company would bear interest at
      8%
      per annum. As of December 31, 2005, Mr. Newman’s outstanding loan balance to the
      Company was $0.9 million, and Mr. Peipert’s outstanding loan balance to the
      Company was $0.9 million. The unsecured loans by Mr. Newman and Mr. Peipert
      each
      accrue interest at a simple rate of 8% per annum, and each has a term expiring
      on April 30, 2007. As of the date of this filing, the entire $1.5 million was
      still available pursuant to the guaranties outlined above.




Other
      than those described above, during the last two fiscal years, we have no
      material transactions which involved or are planned to involve a direct or
      indirect interest of a director, executive officer, greater than 5% stockholder
      or any family of such parties.


80
 **ITEM
        13.**  **EXHIBITS**




2.1  Agreement
      and Plan of Reorganization, dated August 21, 2003, among the Company, LCS
      Acquisition Corp., Conversion Services International, Inc. and certain
      affiliated stockholders of Conversion Services International, Inc. (filed as
      Appendix A on Schedule 14A on January 5, 2004).


2.2  First
        Amendment to Agreement and Plan of Reorganization, dated November 28, 2003,
        among the Company, LCS Acquisition Corp., Conversion Services International,
        Inc. and certain affiliated stockholders of Conversion Services International,
        Inc. (filed as Appendix A on Schedule 14A on January 5, 2004).
 
 2.4  Acquisition
        Agreement, dated February 27, 2004, among the Company, DeLeeuw Associates,
        Inc.
        and Robert C. DeLeeuw (filed as Exhibit 2.1 on Form 8-K on March 16,
        2004).
 
 2.5  Plan
        and
        Agreement of Merger and Reorganization, dated February 27, 2004, among the
        Company, DeLeeuw Associates, Inc. and DeLeeuw Conversion LLC filed as Exhibit
        2.1 on Form 8-K on March 16, 2004).
 
 2.6  Asset
        Purchase Agreement, dated May 26, 2004, among the Registrant, Evoke Asset
        Purchase Corp. and Evoke Software Corporation (filed as Exhibit 2.1 on Form
        8-K
        on July 13, 2004).
 
 2.7  Asset
        Purchase Agreement, dated July 18, 2005 by and among the registrant, Similarity
        Vector Technologies (Sivtech) Limited (d/b/a Similarity Systems), Similarity
        Systems Inc. and Evoke Software Corporation (filed as Exhibit 2.1 on Form
        8-K on
        September 27, 2004).
 
 2.8  Agreement
        and Plan of Merger, dated July 22, 2005 among the Registrant., McKnight
        Associates, Inc., McKnight Associates, Inc. and William McKnight (filed as
        Exhibit 2 on Form 8-K on July 28, 2005).
 
 2.9  Agreement
        and Plan of Merger, dated July 29, 2005 by and among the Registrant, ISI
        Merger
        Corp., Integrated Strategies, Inc., ISI Consulting LLC, Adam Hock and Larry
        Hock
        (filed as Exhibit 2 on Form 8-K on August 3, 2005).
 
 3.1  Certificate
        of Incorporation, as amended (filed as Exhibit 3.1 on Form 10-SB on December
        9,
        1999).
 
 3.2  Certificate
        of Amendment to the Company's Certificate of incorporation, dated January
        27,
        2004, amending, among other things, the authorized shares of common and
        preferred stock (filed as Exhibit 3.1 on Form 8-K on February 17,
        2004).
 
 81
 3.3  Certificate
        of Amendment to the Company's Certificate of Incorporation, dated January
        30,
        2004, changing the name of the Company from LCS Group, Inc. to Conversion
        Services International, Inc. (filed as Exhibit 3.2 on Form 8-K on February
        17,
        2004).
 
 3.4  Certificate
        of Merger, dated January 30, 2004, relating to the merger of LCS Acquisition
        Corp. and Conversion Services International, Inc. (filed as Exhibit 2.3 on
        Form
        8-K on February 17, 2004).
 
 3.5  Amended
        and Restated Bylaws (filed as Exhibit 3.3 on Form 8-K on February 17,
        2004).
 
 3.6  Certificate
        of Merger (Delaware) of McKnight Associates, Inc. (filed as Exhibit 3.1 on
        Form
        8-K on July 28, 2005).
 
 3.7  Articles
        of Merger (Texas) of McKnight Associates, Inc. (filed as Exhibit 3.1 on Form
        8-K
        on July 28, 2005).
 
 3.8  Certificate
        of Merger of Integrated Strategies, Inc. and ISI Consulting, LLC with and
        into
        ISI Merger Corp. (filed as Exhibit 3.1 on Form 8-K on August 3,
        2005).
 
 4.1  Common
        Stock Purchase Warrant, dated August 16, 2004, in favor of Laurus Master
        Fund,
        Ltd. (filed as Exhibit 4.7 on Form 10-QSB on August 23, 2004).
 
 4.2  Secured
        Convertible Minimum Borrowing Note, dated August 16, 2004 (filed as Exhibit
        4.4
        on Form 10-QSB on August 23, 2004).
 
 4.3  Secured
        Revolving Note, dated August 16, 2004 (filed as Exhibit 4.5 on Form 10-QSB
        on
        August 23, 2004).
 
 4.4  Secured
        Convertible Term Note, dated August 16, 2004 (filed as Exhibit 4.6 on Form
        10-QSB on August 23, 2004).
  4.5  Senior
        Subordinated Secured Convertible Promissory Note, dated September 22, 2004,
        in
        favor of Sands Brothers Venture Capital LLC (filed as Exhibit 10.1 on Form
        8-K
        on September 27, 2004).
 
 4.6  Senior
        Subordinated Secured Convertible Promissory Note, dated September 22, 2004,
        in
        favor of Sands Brothers Venture Capital III LLC (filed as Exhibit 10.2 on
        Form
        8-K on September 27, 2004).
 
 4.7  Senior
        Subordinated Secured Convertible Promissory Note, dated September 22, 2004,
        in
        favor of Sands Brothers Venture Capital IV LLC (filed as Exhibit 10.3 on
        Form
        8-K on September 27, 2004).
 
 82
 4.8  Common
        Stock Purchase Warrant, dated September 22, 2004, in favor of Sands Brothers
        Venture Capital LLC (filed as Exhibit 4.1 on Form 8-K on September 27,
        2004).
  4.9  Common
        Stock Purchase Warrant, dated September 22, 2004, in favor of Sands Brothers
        Venture Capital III LLC (filed as Exhibit 4.2 on Form 8-K on September 27,
        2004).
 
 4.10  Common
        Stock Purchase Warrant, dated September 22, 2004, in favor of Sands Brothers
        Venture Capital IV LLC (filed as Exhibit 4.3 on Form 8-K on September 27,
        2004).
 
 4.11  Promissory
        Note, dated July 29, 2005, in favor of Adam Hock and Larry Hock (filed as
        Exhibit 10.1 on Form 8-K on August 3, 2005)
 
 4.12  Subordinated
        Promissory Note, dated July 29, 2005, in favor of Adam Hock and Larry Hock
        (filed as Exhibit 10.2 on Form 8-K on August 3, 2005)
 
 4.13  Option
        to
        purchase shares of common stock, dated July 28, 2005, (filed as Exhibit 4.1
        on
        Form 8-K on August 3, 2005).
 
 4.14  Amended
        and Restated Revolving Note, dated August 16, 2004, in favor of Laurus Master
        Fund, Ltd. (filed as Exhibit 10.1 on Form 8-K on August 3, 2005).
 
 4.15  Amended
        and Restated Secured Convertible Term Note, dated August 16, 2004, in favor
        of
        Laurus Master Fund, Ltd. (filed as Exhibit 10.2 on Form 8-K on August 3,
        2005).
 
 4.16  Amended
        and Restated Secured Revolving Note, dated August 16, 2004, as amended and
        restated on July 28, 2005 in favor of Laurus Master Fund, Ltd (filed as Exhibit
        10.1 on Form 8-K on December 6, 2005).
 
 4.17  Amended
        and Restated Secured Convertible Term Note, dated August 16, 2004, as amended
        and restated on July 28, 2005 in favor of Laurus Master Fund, Ltd (filed
        as
        Exhibit 10.2 on Form 8-K on December 6, 2005).
 
 4.18  Amended
        and Restated Secured Convertible Minimum Borrowing Note, dated August 16,
        2004,
        as amended and restated on July 28, 2005 in favor of Laurus Master Fund,
        Ltd
        (filed as Exhibit 10.3 on Form 8-K on December 6, 2005).
  4.19  Option
        to
        purchase shares of common stock, dated February 1, 2006 (filed as Exhibit
        4.1 on
        Form 8-K on February 7, 2006).
 
 4.20  Secured
        Non-Convertible Revolving Note, dated February 1, 2006, in favor of Laurus
        Master Fund, Ltd (filed as Exhibit 10.1 on Form 8-K on February 7,
        2006).
 
 83
 4.21  Certificate
        of Designations of Preferences, Rights and Limitations of Series A Convertible
        Preferred Stock of the Registrant (filed as Exhibit 4.1 on Form 8-K on February
        8, 2006).
 
 4.22  Common
        Stock Purchase Warrant, dated February 2, 2006 (filed as Exhibit 10.3 on
        Form
        8-K on February 8, 2006).
 
 10.1  Employment
        Agreement among the Company and Scott Newman, dated March 26, 2004 (filed
        as
        Exhibit 10.1 on Form 8-K/A on April 1, 2004).
 
 10.2  Employment
        Agreement among the Company and Glenn Peipert, dated March 26, 2004 (filed
        as
        Exhibit 10.2 on Form 8-K/A on April 1, 2004).
 
 10.3  Employment
        Agreement among the Company and Mitchell Peipert, dated March 26, 2004 (filed
        as
        Exhibit 10.3 on Form 8-K/A on April 1, 2004).
 
 10.4  Employment
        Agreement among the Company and Robert DeLeeuw, dated March 26, 2004 (filed
        as
        Exhibit 10.4 on Form SB-2/A on September 30, 2004).
 
 10.5  2003
        Incentive Plan (filed as Exhibit 4.1 to Form S-8 filed on November 11,
        2005).
 
 10.6  Security
        Agreement, dated August 16, 2004, among the Registrant, DeLeeuw Associates,
        LLC,
        CSI Sub Corp. (DE), Evoke Software Corporation and Laurus Master Fund, Ltd.
        (filed as Exhibit 4.1 on Form 10-QSB on August 23, 2004).
 
 10.7  Stock
        Pledge Agreement, dated August 16, 2004, among the Registrant and Laurus
        Master
        Fund, Ltd. (filed as Exhibit 4.8 on Form 10-QSB on August 23,
        2004).
 
 10.8  Securities
        Purchase Agreement, dated August 16, 2004, among the Registrant and Laurus
        Master Fund, Ltd. (filed as Exhibit 4.2 on Form 10-QSB on August 23,
        2004).
 
 10.9  Registration
        Rights Agreement, dated August 16, 2004, among the Registrant and Laurus
        Master
        Fund, Ltd. (filed as Exhibit 4.3 on Form 10-QSB on August 23,
        2004).
 
 10.10  Security
        Agreement, dated September 22, 2004, among the Registrant, Sands Brothers
        Venture Capital LLC, Sands Brothers Venture Capital III LLC and Sands Brothers
        Venture Capital IV LLC (filed as Exhibit 10.4 on Form 8-K on September 27,
        2004).
 
 10.11  Subordination
        Agreement, dated September 22, 2004, among the Registrant, Sands Brothers
        Venture Capital LLC, Sands Brothers Venture Capital III LLC, Sands Brothers
        Venture Capital IV LLC and Laurus Master Fund, Ltd. (filed as Exhibit 10.5
        on
        Form 8-K on September 27, 2004).
 
 84
 10.12  Registration
        Rights Agreement, dated September 22, 2004, among the Company, Sands Brothers
        Venture Capital LLC, Sands Brothers Venture Capital III LLC and Sands Brothers
        Venture Capital IV LLC (filed as Exhibit 4.4 on Form 8-K on September 27,
        2004).
  10.13  Consulting
        Agreement with Morgan Stanley & Co., Incorporated (filed as Exhibit 10.18 on
        Form SB-2/A on January 19, 2005).
 
 10.14  Consulting
        Agreement with Cellco Partnership (now known as Verizon Wireless) (filed
        as
        Exhibit 10.19 on Form SB-2/A on January 19, 2005).
 
 10.15  Restricted
        Account Agreement by and among the Registrant, North Fork Bank and Laurus
        Master
        Fund, Ltd. (filed as Exhibit 10.11 on Form 10-KSB/A on July 26,
        2005).
 
 10.16  Employment
        Agreement dated July 22, 2005 by and between the Registrant and William McKnight
        (filed as Exhibit 10.1 on Form 8-K on July 28, 2005).
 
 10.17  Omnibus
        Amendment, dated July 28, 2005 (filed as Exhibit 10.3 on Form 8-K on August
        3,
        2005).
 
 10.18  Joinder,
        dated July 28, 2005 (filed as Exhibit 10.4 on Form 8-K on August 3,
        2005).
 
 10.19  Reaffirmation
        and Ratification Agreement, dated July 28, 2005 (filed as Exhibit 10.5 on
        Form
        8-K on August 3, 2005).
 
 10.20  Overadvance
        Letter, dated July 28, 2005 (filed as Exhibit 10.6 on Form 8-K on August
        3,
        2005).
 
 10.21  Omnibus
        Amendment, dated November 30, 2005 (filed as Exhibit 10.4 on Form 8-K on
        December 6, 2005).
 
 10.22  Reaffirmation
        and Ratification Agreement, dated November 30, 2005 (filed as Exhibit 10.5
        on
        Form 8-K on December 6, 2005).
 
 10.23  Security
        Agreement dated February 1, 2006 by and among Laurus Master Fund, Ltd., the
        Registrant, DeLeeuw Associates, LLC, CSI Sub Corp. (DE), Integrated Strategies,
        Inc., CSI Sub Corp. II (DE), and McKnight Associates, Inc. (filed as Exhibit
        10.3 on Form 8-K on February 7, 2006).
 
 10.24  Stock
        Pledge Agreement, dated February 1, 2006 (filed as Exhibit 10.4 on Form 8-K
        on
        February 7, 2006).
 
 85
 10.25  Overadvance
        Side Letter dated February 1, 2006 (filed as Exhibit 10.5 on Form 8-K on
        February 7, 2006).
 
 10.26  Stock
        Purchase Agreement dated February 2, 2006 by and between the Registrant and
        Taurus Advisory Group, LLC (filed as Exhibit 10.1 on Form 8-K on February
        8,
        2006).
 
 10.27  Registration
        Rights Agreement dated February 2, 2006 by and between the Registrant and
        Taurus
        Advisory Group, LLC (filed as Exhibit 10.1 on Form 8-K on February 8,
        2006).
  14.1  Code
        of
        Conduct and Ethics (filed as Exhibit 14 on Form SB-2, filed on November 24,
        2004).
 
 21*  Subsidiaries
        of the Company.
 
 23.1*  Consent
        of Friedman LLP, Independent Registered Public Accounting Firm.
 
 31.1*
        Certification of the Company's Chief Executive Officer pursuant to Rule
        13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
 
 31.2*
        Certification of the Company's Chief Financial Officer pursuant to Rule
        13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
 
 32.1*
        Certification of the Company's Chief Executive Officer pursuant to Rule
        13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C.
        Section
        1350.
 
 32.2*
        Certification of the Company's Chief Financial Officer pursuant to Rule
        13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C.
        Section
        1350.
 ____________________
 *
        filed
        herewith
 
 86










**ITEM
      14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.**





The
      following table sets forth fees billed to us by our independent registered
      public accounting firms during the fiscal years ended December 31, 2005 and
      December 31, 2004 for: (i) services rendered for the audit of our annual
      financial statements and the review of our quarterly financial statements;
      (ii)
      services by our independent registered public accounting firms that are
      reasonably related to the performance of the audit or review of our financial
      statements and that are not reported as Audit Fees; (iii) services rendered
      in
      connection with tax compliance, tax advice and tax planning; and (iv) all other
      fees for services rendered.




December
                  31, 2005
              
              
              December
                  31, 2004Audit
                  Fees
              
              $
              319,748
              
              $
              281,975Audit
                  Related Fees
              
              $
              8,700
              
              $
              212,480Tax
                  Fees
              
              $
              78,850
              
              $
              36,799All
                  Other Fees
              
              $
              -
              
              $
              -$
              407,298
              
              $
              531,254


Audit
      Committee Policies




The
      board
      of directors is solely responsible for the approval in advance of all audit
      and
      permitted non-audit services to be provided by the independent auditors
      (including the fees and other terms thereof), subject to the de minimus
      exceptions for non-audit services provided by Section 10A(i)(1)(B) of the
      Exchange Act, which services are subsequently approved by the board of directors
      prior to the completion of the audit. None of the fees listed above are for
      services rendered pursuant to such de minimus exceptions.




87




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**











The
      Board
      of Directors and Stockholders


Conversion
      Services International, Inc. and Subsidiaries


East
      Hanover, New Jersey





We
      have
      audited the accompanying consolidated balance sheets of Conversion Services
      International, Inc. and Subsidiaries as of December 31, 2005 and 2004, and
      the
      related consolidated statements of operations, stockholders' equity, and cash
      flows for the two years then ended. These consolidated 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 financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of Conversion Services
      International, Inc. and Subsidiaries as of December 31, 2005 and 2004, and
      the
      consolidated results of its operations and its cash flows for the two years
      then
      ended, in conformity with accounting principles generally accepted in the United
      States of America.





As
      discussed in Notes 1 and 22 to the consolidated financial statements, the
      Company has restated its consolidated financial statements for the year ended
      December 31, 2004.




As
      discussed in Note 24 to the consolidated financial
      statements, the Company has restated its consolidated financial statements
      for
      the year ended December 31, 2005.  The Company used an incorrect stock
      price and, therefore, incorrectly valued the derivative liability relating
      to
      common stock warrants and compound embedded derivatives as of December 31,
      2005.
      As a result, the Company restated its financial instrument liability and the
      gain on financial instruments.





/s/
      Friedman LLP




East
      Hanover, New Jersey


April
      20,
      2006,


except
      for Notes 1, 2, 4, 12, 14, 17, 24 as to which the
      date is May 22, 2006






88


**CONVERSION
                SERVICES INTERNATIONAL, INC.****AND
                SUBSIDIARIES****CONSOLIDATED
                BALANCE SHEETS****DECEMBER
                31,****2005**
            
            **2004**ASSETS
            
            (as
                Restated)
            
            (as
                Restated, see Notes 1 and 22 )CURRENT
                ASSETSCash
            
            $
            176,073
            
            $
            1,028,146Restricted
                cash
            
            
            -
            
            
            83,375Accounts
                receivable, net of allowance for doubtful accounts of $489,070 and
                $209,582 in 2005 and 2004, respectively
            
            
            3,194,375
            
            
            4,349,229Accounts
                receivable from related parties; (Note 21)
            
            
            569,908
            
            
            781,100Prepaid
                expenses
            
            
            142,432
            
            
            309,459TOTAL
                CURRENT ASSETS
            
            
            4,082,788
            
            
            6,551,309PROPERTY
                AND EQUIPMENT, at cost, net; (Note 6)
            
            
            417,469
            
            
            587,575OTHER
                ASSETSRestricted
                cash
            
            
            -
            
            
            4,269,377Goodwill
            
            
            7,239,566
            
            
            4,690,972Intangible
                assets, net of accumulated amortization of $740,350 and $911,142
                in 2005
                and 2004, respectively; (Note 7)
            
            
            1,862,964
            
            
            3,627,096Deferred
                financing costs, net of accumulated amortization of $467,604 and
                $126,767
                in 2005 and 2004, respectively; (Note 8)
            
            
            425,705
            
            
            766,542Discount
                on debt issued, net of accumulated amortization of $678,917 and $941,212
                in 2005 and 2004, respectively; (Note 9)
            
            
            4,177,428
            
            
            8,217,278Equity
                investments
            
            
            149,117
            
            
            144,460Other
                assets
            
            
            123,432
            
            
            13,42013,978,212
            
            
            21,729,145Total
                Assets
            
            $
            18,478,469
            
            $
            28,868,029LIABILITIES
                AND STOCKHOLDERS' EQUITYCURRENT
                LIABILITIESLine
                of credit; (Note 10)
            
            $
            4,713,312
            
            $
            3,733,403Current
                portion of long-term debt
            
            
            495,122
            
            
            120,834Accounts
                payable and accrued expenses
            
            
            2,519,446
            
            
            3,777,940Short
                term note payable; (Note 11)
            
            
            1,063,990
            
            
            1,000,000Deferred
                revenue
            
            
            41,121
            
            
            1,327,222Financial
                instruments; (Note 12)
            
            
            2,837,657
            
            
            10,515,091TOTAL
                CURRENT LIABILITIES
            
            
            11,670,648
            
            
            20,474,490LONG-TERM
                DEBT, net of current portion, (Note 13)
            
            
            3,042,914
            
            
            6,659,449RELATED
                PARTY NOTE PAYABLE; (Note 21)
            
            
            1,772,368
            
            
            307,981DEFERRED
                TAXES
            
            
            363,400
            
            
            -Total
                Liabilities
            
            
            16,849,330
            
            
            27,441,920MINORITY
                INTEREST
            
            
            -
            
            
            131,587COMMITMENTS
                AND CONTINGENCIES; (Note 20)
            
            
            -
            
            
            -STOCKHOLDERS'
                EQUITYCommon
                stock, $0.001 par value, 85,000,000 shares
                authorized;54,093,916
                and 51,472,140 issued and outstanding in 2005 and 2004,
                respectively
            
            
            54,094
            
            
            51,472Additional
                paid in capital
            
            
            42,264,407
            
            
            36,814,064Accumulated
                deficit
            
            
            (40,689,362
            )
            
            (35,576,312
            )Accumulated
                other comprehensive income
            
            
            -
            
            
            5,298Total
                Stockholders' Equity
            
            
            1,629,139
            
            
            1,294,522Total
                Liabilities and Stockholders' Equity
            
            $
            18,478,469
            
            $
            28,868,029




See
      Notes
      to Consolidated Financial Statements.




89




**CONVERSION
                  SERVICES INTERNATIONAL, INC.****AND
                  SUBSIDIARIES****CONSOLIDATED
                  STATEMENTS OF OPERATIONS****FOR
                  THE YEARS ENDED DECEMBER 31,**2005
              
              2004(as
                    Restated)
              
              (as
                  Restated, see Notes 1 and 22)REVENUE:Services
              
              $
              23,392,464
              
              $
              19,755,370Related
                  party services
              
              
              3,731,198
              
              
              3,837,065Software
              
              
              123,198
              
              
              184,882Support
                  and maintenance
              
              
              225,133
              
              
              42,979Other
              
              
              157,916
              
              
              72,81027,629,909
              
              
              23,893,106COST
                  OF REVENUE:Services
                  (inclusive of stock-based compensation of zero and $1.4 million
                  at
                  December 31, 2005 and 2004, respectively)
              
              
              17,316,494
              
              
              15,367,477Related
                  party services
              
              
              3,215,909
              
              
              3,345,318Software
              
              
              -
              
              
              134,182Support
                  and maintenance
              
              
              -
              
              
              -Other
              
              
              -
              
              
              -20,532,403
              
              
              18,846,977GROSS
                  PROFIT
              
              
              7,097,506
              
              
              5,046,129OPERATING
                  EXPENSESSelling
                  and marketing
              
              
              4,521,054
              
              
              3,210,790General
                  and administrative (inclusive of stock-based compensation of $0.5
                  million
                  and $0.1 million at December 31, 2005 and 2004,
                  respectively)
              
              
              6,418,245
              
              
              6,086,017Goodwill
                  and intangibles impairment
              
              
              1,321,543
              
              
              12,247,234Depreciation
                  and amortization
              
              
              911,772
              
              
              468,23513,172,614
              
              
              22,012,276LOSS
                  FROM OPERATIONS
              
              
              (6,075,108
              )
              
              (16,966,147
              )OTHER
                  INCOME (EXPENSE)Equity
                  in earnings from investments
              
              
              4,657
              
              
              5,684Financial
                  instruments
              
              
              7,796,569
              
              
              (551,241
              )Loss
                  on early extinguishment of debt
              
              
              (1,607,763
              )
              
              -Other
                  income
              
              
              -
              
              
              7,300Interest
                  income
              
              
              69,166
              
              
              22,355Interest
                  expense
              
              
              (4,201,823
              )
              
              (5,024,449
              )2,060,806
              
              
              (5,540,351
              )LOSS
                  BEFORE INCOME TAXES AND DISCONTINUED OPERATIONS
              
              
              (4,014,302
              )
              
              (22,506,498
              )INCOME
                  TAXES
              
              
              -
              
              
              190,800NET
                  LOSS FROM CONTINUING OPERATIONS
              
              
              (4,014,302
              )
              
              (22,697,298
              )DISCONTINUED
                  OPERATIONS (Note 4):Gain
                  on disposal of discontinued operations
              
              $
              49,148
              
              $
              -Loss
                  from discontinued operations
              
              
              (1,153,119
              )
              
              (12,650,908
              )(1,103,971
              )
              
              (12,650,908
              )NET
                  LOSS
              
              $
              (5,118,273
              )
              $
              (35,348,206
              )Basic
                  net loss per share from continuing operations
              
              $
              (0.08
              )
              $
              (0.49
              )Basic
                  net loss per share from discontinued operations
              
              $
              (0.02
              )
              $
              (0.27
              )Basic
                  net loss per share
              
              $
              (0.10
              )
              $
              (0.76
              )Diluted
                  net loss per share from continuing operations
              
              $
              (0.08
              )
              $
              (0.49
              )Diluted
                  net loss per share from discontinued operations
              
              $
              (0.02
              )
              $
              (0.27
              )Diluted
                  net loss per share
              
              $
              (0.10
              )
              $
              (0.76
              )Weighted
                  average shares used to compute net loss per share:Basic
              
              
              52,919,340
              
              
              46,548,065Diluted
              
              
              52,919,340
              
              
              46,548,065


See
      Notes
      to Consolidated Financial Statements.


90


**CONVERSION
                  SERVICES INTERNATIONAL, INC.****AND
                  SUBSIDIARIES****CONSOLIDATED
                  STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY**AccumulatedAdditional
              
              Retained
              
              Other
              
              TotalCommon
              
              Capital
              
              Paid-in
              
              Earnings
              
              Comprehensive
              
              Stockholders'
              
              ComprehensiveShares
              
              Stock
              
              Capital
              
              (Deficit)
              
              Income
              
              Equity
              
              Loss(as
                  Restated)
              
              
              
              (as
                  Restated)
              
              (as
                  Restated)Balance,
                  December 31, 2003
              
              
              66,667
              
              $
              67
              
              $
              1,447,183
              
              $
              (228,106
              )
              $
              -
              
              $
              1,219,144Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (35,348,206
              )
              
              
              
              
              (35,348,206
              )
              
              (35,348,206
              )Foreign
                  currency translation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              5,298
              
              
              5,298
              
              
              5,298Effect
                  of Conversion Services International recapitalization
              
              
              (66,667
              )
              
              (67
              )
              
              67
              
              
              -
              
              
              -
              
              
              -Relative
                  fair value of warrants issued
              
              
              -
              
              
              -
              
              
              500,000
              
              
              -
              
              
              -
              
              
              500,000Issuance
                  of Common Stock in connection with the reverse merger into LCS
                  Golf.
              
              
              39,533,333
              
              
              39,533
              
              
              (39,533
              )
              
              -
              
              
              -
              
              
              -Issuance
                  of Common Stock in connection with the acquisition of DeLeeuw Associates,
                  Inc.
              
              
              5,333,333
              
              
              5,333
              
              
              15,834,667
              
              
              -
              
              
              -
              
              
              15,840,000Issuance
                  of Common Stock in connection with the conversion of debt into
                  Company
                  stock.
              
              
              1,269,841
              
              
              1,270
              
              
              1,998,730
              
              
              -
              
              
              -
              
              
              2,000,000Issuance
                  of Common Stock in connection with the acquisition of Evoke Software
                  Corporation.
              
              
              5,097,537
              
              
              5,098
              
              
              12,379,000
              
              
              -
              
              
              -
              
              
              12,384,098Issuance
                  of Common Stock in connection with a stock purchase
                  agreement.
              
              
              238,095
              
              
              238
              
              
              499,762
              
              
              -
              
              
              -
              
              
              500,000Compensation
                  expense for stock and stock option grants
              
              
              -
              
              
              -
              
              
              1,479,902
              
              
              -
              
              
              -
              
              
              1,479,902Discount
                  on debt issued
              
              
              -
              
              
              -
              
              
              1,500,000
              
              
              -
              
              
              -
              
              
              1,500,000Unsecured
                  convertible line of credit beneficial conversion feature
              
              
              -
              
              
              -
              
              
              1,214,286
              
              
              -
              
              
              -
              
              
              1,214,286Total
                  comprehensive loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (35,342,908
              )Balance,
                  December 31, 2004, as restated (See Notes 1 and 22)
              
              
              51,472,139
              
              $
              51,472
              
              $
              36,814,064
              
              $
              (35,576,312
              )
              $
              5,298
              
              $
              1,294,522Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (5,118,273
              )
              
              -
              
              
              (5,118,273
              )
              
              (5,118,273
              )Foreign
                  currency translation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (75
              )
              
              (75
              )
              
              (75
              )Sale
                  of Evoke Software Corp.
              
              
              -
              
              
              -
              
              
              -
              
              
              5,223
              
              
              (5,223
              )
              
              -Issuance
                  of Common Stock in connection with a stock purchase
                  agreement.
              
              
              595,238
              
              
              595
              
              
              1,249,405
              
              
              -
              
              
              -
              
              
              1,250,000Issuance
                  of Common Stock in connection with a conversion of debt to
                  equity.
              
              
              476,190
              
              
              476
              
              
              999,524
              
              
              -
              
              
              -
              
              
              1,000,000Issuance
                  of Common Stock in connection with a legal settlement.
              
              
              21,368
              
              
              21
              
              
              80,107
              
              
              -
              
              
              -
              
              
              80,128Issuance
                  of Common Stock in connection with the Evoke Software Corp.
                  acquisition.
              
              
              286,204
              
              
              287
              
              
              429,019
              
              
              -
              
              
              -
              
              
              429,306Issuance
                  of Common Stock in connection with the acquisition of McKnight
                  Associates
              
              
              909,091
              
              
              909
              
              
              1,771,818
              
              
              -
              
              
              -
              
              
              1,772,727Issuance
                  of Common Stock in connection with a stock option
                  exercise.
              
              
              333,334
              
              
              334
              
              
              776,333
              
              
              -
              
              
              -
              
              
              776,667Issuance
                  of fractional shares resulting from the 1:15 reverse stock
                  split.
              
              
              352
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Compensation
                  expense for stock and stock option grants.
              
              
              -
              
              
              -
              
              
              33,026
              
              
              -
              
              
              -
              
              
              33,026Relative
                  fair value of warrants issued.
              
              
              -
              
              
              -
              
              
              111,111
              
              
              -
              
              
              -
              
              
              111,111Total
                  comprehensive loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (5,118,348
              )Balance,
                  December 31, 2005
              
              
              54,093,916
              
              $
              54,094
              
              $
              42,264,407
              
              $
              (40,689,362
              )
              $
              -
              
              $
              1,629,139




See
      Notes
      to Consolidated Financial Statements.





91




**CONVERSION
                  SERVICES INTERNATIONAL, INC.****AND
                  SUBSIDIARIES****CONSOLIDATED
                  STATEMENTS OF CASH FLOWS****FOR
                  THE YEARS ENDED DECEMBER 31,**2005
              
              2004(as
                  Restated)
              
              (as
                  Restated, see Notes 1 and 22)CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  loss
              
              $
              (5,118,273
              )
              $
              (35,348,205
              )Net
                  loss from discontinued operations
              
              
              (1,103,971
              )
              $
              (12,650,908
              )**Net
                  loss from continuing operations**
              
              $
              (4,014,302
              )
              $
              (22,697,297
              )Adjustments
                  to reconcile net loss from continuing operations to net cash used
                  in
                  operating activities:Depreciation
                  and amortization of leasehold improvements
              
              
              137,798
              
              
              132,890Amortizaton
                  of intangible assets
              
              
              433,137
              
              
              217,503Amortization
                  of discount on debt
              
              
              2,873,617
              
              
              941,212Amortization
                  of relative fair value of warrants issued
              
              
              110,105
              
              
              60,652Amortization
                  of deferred financing costs
              
              
              340,837
              
              
              134,402Excess
                  of derivative value over notional amount of debt
              
              
              449,275
              
              
              2,305,360Beneficial
                  conversion feature associated with convertible debt
                  instruments
              
              
              -
              
              
              1,214,286Deferred
                  taxes
              
              
              -
              
              
              190,800Goodwill
                  impairment
              
              
              1,321,543
              
              
              12,247,235Stock
                  and stock option based compensation
              
              
              542,460
              
              
              1,479,902(Gain)
                  loss on change in fair value of financial instruments
              
              
              (7,796,569
              )
              
              551,240Loss
                  on early extinguishment of debt
              
              
              1,607,763
              
              
              -Allowance
                  for doubtful accounts
              
              
              92,862
              
              
              91,823Write-off
                  deferred loan costs
              
              
              -
              
              
              45,213Loss
                  on disposal of equipment
              
              
              -
              
              
              88,190Income
                  from equity investments
              
              
              (4,657
              )
              
              (5,684
              )Changes
                  in operating assets and liabilities:(Increase)
                  decrease in accounts receivable
              
              
              1,042,245
              
              
              (1,040,154
              )(Increase)
                  decrease in accounts receivable from related parties
              
              
              211,192
              
              
              (388,100
              )(Increase)
                  decrease in prepaid expenses
              
              
              69,419
              
              
              (95,574
              )(Increase)
                  decrease in other assets
              
              
              (108,375
              )
              
              14,721Increase
                  (decrease) in accounts payable and accrued expenses
              
              
              (550,502
              )
              
              1,639,815Increase
                  (decrease) in deferred revenue
              
              
              (75,546
              )
              
              116,667**Net
                  cash used in operating activities of continuing
                  operations**
              
              
              (3,317,698
              )
              
              (2,754,898
              )Net
                  cash used in operating activities of discontinued
                  operations
              
              
              (302,260
              )
              
              (1,692,381
              )**Net
                  cash used in operating activities**
              
              
              (3,619,958
              )
              
              (4,447,279
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Acquisition
                  of property and equipment
              
              
              (31,498
              )
              
              (143,582
              )Investment
                  in DeLeeuw Associates, net of cash acquired
              
              
              -
              
              
              (2,010,266
              )Investment
                  in Evoke Software Corp., net of cash acquired
              
              
              -
              
              
              334,073Investment
                  in McKnight Associates, Inc., net of cash acquired
              
              
              (946,412
              )Investment
                  in Integrated Strategies, Inc., net of cash acquired
              
              
              (2,175,820
              )Equity
                  investment in Leading Edge Communications Corp.
              
              
              -
              
              
              (83,000
              )**Net
                  cash used in investing activities of continuing
                  operations**
              
              
              (3,153,730
              )
              
              (1,902,775
              )Net
                  cash used in investing activities of discontinued
                  operations
              
              
              -
              
              
              (4,251
              )Net
                  proceeds from the sale of discontinued operations
              
              
              644,958
              
              
              -**Net
                  cash used in investing activities**
              
              
              (2,508,772
              )
              
              (1,907,026
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Net
                  advances under line of credit
              
              
              1,838,307
              
              
              1,950,704Principal
                  payment on short-term notes
              
              
              (76,054
              )Issuance
                  of short-term note payable
              
              
              1,000,000
              
              
              1,000,000Issuance
                  of long-term note payable
              
              
              -
              
              
              4,730,623Issuance
                  of long-term note payable to stockholders
              
              
              1,767,914
              
              
              307,981Deferred
                  loan costs
              
              
              -
              
              
              (893,309
              )Principal
                  payments on long-term debt
              
              
              (4,348,695
              )
              
              (665,085
              )Proceeds
                  from sale of Company common stock
              
              
              1,255,000
              
              
              500,000Principal
                  payments on capital lease obligations
              
              
              (117,778
              )
              
              (85,595
              )Proceeds
                  from repayment of stockholder loans
              
              
              -
              
              
              203,623Principal
                  payments on stockholder loans
              
              
              (381,561
              )
              
              -Restricted
                  cash
              
              
              4,334,375
              
              
              (83,375
              )**Net
                  cash provided by financing activities**
              
              
              5,271,508
              
              
              6,965,567Effect
                  of exchange rate changes on cash and cash equivalents
              
              
              5,149
              
              
              5,298NET
                  (DECREASE) INCREASE IN CASH
              
              
              (852,073
              )
              
              616,560CASH,
                  beginning of period
              
              
              1,028,146
              
              
              411,586CASH,
                  end of period
              
              $
              176,073
              
              $
              1,028,146




See
      Notes
      to Consolidated Financial Statements.




92


**CONVERSION
                SERVICES INTERNATIONAL, INC.****AND
                SUBSIDIARIES****CONSOLIDATED
                STATEMENTS OF CASH FLOWS****FOR
                THE YEARS ENDED DECEMBER 31,**2005
            
            2004(as
                Restated, see Notes 1 and 22)SUPPLEMENTAL
                DISCLOSURE OF CASH FLOW INFORMATION:Cash
                paid for interest
            
            $
            558,419
            
            $
            276,680Cash
                paid for income taxes
            
            
            -
            
            
            -SUPPLEMENTAL
                DISCLOSURE OF NON-CASH ACTIVITIES:During
                2005 and 2004, the Company entered into various capital lease arrangements
                for computer and trade show equipment in the amount of $55,782 and
                $249,241, respectively.On
                March 4, 2004, the Company acquired DeLeeuw Associates, Inc. The
                components and allocations of the purchase price were based on the
                fair
                value of assets and liabilities acquired as of the acquisition date.
                The
                following assets and liabilities were obtained as a result of the
                acquisition.Accounts
                receivable
            
            $
            -
            
            $
            975,000Approved
                vendor status
            
            
            -
            
            
            539,000Tradename
            
            
            -
            
            
            722,000Goodwill
            
            
            -
            
            
            15,844,000Investment
                in limited liability company
            
            
            -
            
            
            56,000Current
                liabilities
            
            
            -
            
            
            (286,000
            )On
                June 28, 2004, the Company acquired substantially all of the assets
                and
                liabilities of Evoke Software Corporation. The components and allocations
                of the purchase price were based on the fair value of assets and
                liabilities acquired as of the acquisition date. The following assets
                and
                liabilities were obtained as a result of the
                acquisition.Cash
            
            $
            -
            
            $
            497,000Accounts
                receivable
            
            
            -
            
            
            580,000Customer
                contracts (six year life)
            
            
            -
            
            
            1,962,000Tradename
                (indefinite life)
            
            
            -
            
            
            651,000Computer
                software (three year life)
            
            
            -
            
            
            1,381,000Goodwill
            
            
            -
            
            
            10,269,000Prepaid
                expenses
            
            
            -
            
            
            78,000Other
                assets
            
            
            -
            
            
            11,000Furniture
                and equipment
            
            
            -
            
            
            184,000Deferred
                revenue
            
            
            -
            
            
            (1,254,000
            )Deferred
                compensation
            
            
            -
            
            
            (443,000
            )Other
                liabilities
            
            
            -
            
            
            (1,302,000
            )Minority
                interest
            
            
            -
            
            
            (199,000
            )On
                July 18, 2005, the company sold certain assets and liabilities of
                Evoke to
                Similarity Systems. The following assets and liabilities of Evoke
                were
                sold to Similarity Systems:Cash
            
            $
            8,000
            
            $
            -Accounts
                receivable, net
            
            
            692,000
            
            
            -Prepaid
                expenses
            
            
            100,000
            
            
            -Property
                and equipment, net
            
            
            77,000
            
            
            -Other
                assets
            
            
            5,000
            
            
            -Deferred
                revenue
            
            
            (1,649,995
            )
            
            -Accrued
                expenses
            
            
            (163,000
            )
            
            -On
                July 22, 2005, the Company acquired all of the outstanding shares
                of
                McKnight Associates, Inc. The components and allocations of the purchase
                price were based on the fair value of the assets and liabilities
                acquired
                as of the acquisition date. The following assets and liabilities
                were
                obtained as a result of the acquisition.Cash
            
            $
            116,000
            
            $
            -Accounts
                receivable
            
            
            298,000
            
            
            -Customer
                relationships (2.5 year life)
            
            
            685,000
            
            
            -Order
                backlog (5 month life)
            
            
            50,000
            
            
            -Proprietary
                presentation format (3 year life)
            
            
            173,000
            
            
            -Goodwill
            
            
            1,865,000
            
            
            -Accounts
                payable and accrued expenses
            
            
            (105,000
            )
            
            -Deferred
                tax liability
            
            
            (363,000
            )
            
            -On
                July 29, 2005, the Company acquired all of the outstanding shares
                of
                Integrated Strategies, Inc. The components and allocations of the
                purchase
                price were based on the fair value of the assets and liabilities
                acquired
                as of the acquisition date. The following assets and liabilities
                were
                obtained as a result of the acquisition.Cash
            
            $
            119,000
            
            $
            -Accounts
                receivable
            
            
            661,000
            
            
            -Prepaid
                expenses
            
            
            2,000
            
            
            -Fixed
                assets
            
            
            2,000
            
            
            -Other
                assets
            
            
            13,000
            
            
            -Goodwill
            
            
            1,800,000
            
            
            -Accounts
                payable and accrued expenses
            
            
            (173,000
            )
            
            -Notes
                payable
            
            
            (241,000
            )


See
      Notes
      to Consolidated Financial Statements.




93


**CONVERSION
      SERVICES INTERNATIONAL, INC.**


**AND
      SUBSIDIARIES**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      1 - Accounting Policies**




***Organization
      and Business***




Conversion
      Services International, Inc. (“CSI”) was incorporated in the State of Delaware
      and has been conducting business since 1990. CSI and its wholly owned
      subsidiaries (together the “Company”) are principally engaged in the information
      technology services industry in the following areas: strategic consulting,
      business intelligence, data warehousing, and data management, on credit, to
      its
      customers principally located in the northeastern United States.


·
            On
                November 1, 2002, the Company acquired the operations of Scosys,
                Inc.
                (“Scosys”). Scosys is engaged in the information technology services
                industry.


·
            On
                January 30, 2004, the Company became a public company through its
                merger
                with a wholly owned subsidiary of LCS Group, Inc. Although LCS Group,
                Inc.
                (now known as Conversion Services International, Inc.) was the legal
                survivor in the merger and remains the Registrant with the Securities
                and
                Exchange Commission, the merger was accounted for as a reverse
                acquisition, whereby the Company was considered the accounting “acquirer”
                of LCS Group, Inc. for financial reporting purposes, as the Company’s
                stockholders controlled approximately 76% of the post transaction
                combined
                company. Among other matters, reverse merger accounting requires
                LCS
                Group, Inc. to present in all financial statements and other public
                filings, prior historical and other information of the Company, and
                a
                retroactive restatement of the Company’s historical stockholders’ equity.
                The retroactive restatement took place subsequent to the merger on
                January
                30, 2004.


·
            On
                March 4, 2004, the Company acquired DeLeeuw Associates, Inc. and
                merged
                the company into DeLeeuw Associates, LLC (“DeLeeuw”), a subsidiary of CSI.
                DeLeeuw is a management consulting firm specializing in integration,
                reengineering and project management.


·
            On
                May 1, 2004, the Company acquired a 49% interest in Leading Edge
                Communications Corporation (“LEC”), a provider of enterprise software and
                services solutions for technology infrastructure management.


·
            On
                June 28, 2004, the Company acquired substantially all the assets
                of Evoke
                Software Corporation and the stock of Evoke’s foreign subsidiaries
                (“Evoke”), a provider of data discovery, profiling and quality management
                software. On July 18, 2005, the Company sold certain assets and
                liabilities of Evoke to Similarity Systems. See Note 5 of the Notes
                to the
                Consolidated Financial Statements for further
                discussion.


·
            On
                July 22, 2005, the Company acquired McKnight Associates, Inc. and
                merged
                the company into McKnight Associates, Inc. (“McKnight”), a subsidiary of
                CSI. McKnight is a management consulting firm specializing in data
                warehousing projects for a variety of clients
                worldwide.


·
            On
                July 29, 2005, the Company acquired Integrated Strategies, Inc. and
                merged
                the company into Integrated Strategies, Inc. (“ISI”), a subsidiary of CSI.
                ISI is a management consulting firm specializing in integration and
                project management.


·
            Doorways,
                Inc. is a wholly owned subsidiary of the Company that is currently
                dormant.


·
            LEC
                Corporation of NJ is a wholly owned subsidiary of the Company that
                incurs
                an insignificant amount of payroll expense and has no other
                operations.


·
            CSI
                Sub Corp. (DE) is a wholly owned subsidiary of the Company and is
                the
                primary operating entity for the
                Company.





***Principles
      of Consolidation***





The
      accompanying consolidated financial statements include the accounts of the
      Company and its subsidiaries, Doorways, Inc., DeLeeuw, Integrated Strategies,
      Inc., McKnight Associates, LEC Corporation of NJ, and CSI Sub Corp. (DE). All
      intercompany transactions and balances have been eliminated in the
      consolidation. Investments in business entities in which the Company does not
      have control, but has the ability to exercise significant influence (generally
      20-50% ownership), are accounted for by the equity method. The results of Evoke
      Software Corporation (formerly known as Evoke Asset Purchase Corp. and now
      known
      as CSI Sub Corp. II (DE)) have been included in these consolidated financial
      statements as a component of discontinued operations. Substantially all assets
      of Evoke were sold to Similarity Systems in July 2005. See Note 5 of the Notes
      to the Consolidated Financial Statements for further discussion.





94


***Revenue
      recognition***





Revenue
      from consulting and professional services is recognized at the time the services
      are performed on a project by project basis. For projects charged on a time
      and
      materials basis, revenue is recognized based on the number of hours worked
      by
      consultants at an agreed-upon rate per hour. For large services projects where
      costs to complete the contract could reasonably be estimated, the Company
      undertakes projects on a fixed-fee basis and recognizes revenues on the
      percentage of completion method of accounting based on the evaluation of actual
      costs incurred to date compared to total estimated costs. Revenues recognized
      in
      excess of billings are recorded as costs in excess of billings. Billings in
      excess of revenues recognized are recorded as deferred revenues until revenue
      recognition criteria are met. Reimbursements, including those relating to travel
      and other out-of-pocket expenses, are included in revenues, and an equivalent
      amount of reimbursable expenses are included in cost of services and are
      immaterial.





***Business
      Combinations***





Business
      combinations are accounted for in accordance with SFAS No. 141,
“ *Business
      Combinations* ”
      (“SFAS 141”), which requires the purchase method of accounting for business
      combinations be followed and in accordance with EITF No. 99-12 “ *Determination
      of the Measurement Date for the Market Price of Acquirer Securities Issued
      in a
      Purchase Business Combination”* (“EITF
      99-12”) *.* In
      accordance with SFAS 141, the Company determines the recognition of
      intangible assets based on the following criteria: (i) the intangible asset
      arises from contractual or other rights; or (ii) the intangible is
      separable or divisible from the acquired entity and capable of being sold,
      transferred, licensed, returned or exchanged. In accordance with SFAS 141,
      the Company allocates the purchase price of its business combinations to the
      tangible assets, liabilities and intangible assets acquired based on their
      estimated fair values. The excess purchase price over those fair values is
      recorded as goodwill. Additionally, in accordance with EITF 99-12, the Company
      values an acquisition based upon the market price of its common stock for a
      reasonable period before and after the date the terms of the acquisition are
      agreed to and announced.





***Accounts
      receivable***





The
      Company carries its accounts receivable at cost less an allowance for doubtful
      accounts. On a periodic basis, the Company evaluates its accounts receivable
      and
      adjusts the allowance for doubtful accounts, when deemed necessary, based upon
      its history of past write-offs and collections, contractual terms and current
      credit conditions. During 2005 and 2004, $56,123 and $114,785 of uncollectible
      accounts receivable were written off against the allowance for doubtful
      accounts, respectively.





***Property
      and equipment***





Property
      and equipment are stated at cost and includes equipment held under capital
      lease
      arrangements. Depreciation is computed principally by an accelerated method
      and
      is based on the estimated useful lives of the various assets ranging from three
      to seven years. Leasehold improvements are amortized over the shorter of the
      asset life or the remaining lease term on a straight-line basis. When assets
      are
      sold or retired, the cost and accumulated depreciation are removed from the
      accounts and any gain or loss is included in operations.





Expenditures
      for maintenance and repairs have been charged to operations. Major renewals
      and
      betterments have been capitalized.





95


***Goodwill
      and intangible assets***





Goodwill
      and intangible assets are accounted for in accordance with
      SFAS No. 142 “ *Goodwill
      and Other Intangible Assets* ”
      (“SFAS 142”). Under SFAS 142, goodwill and indefinite lived intangible
      assets are not amortized but instead are reviewed annually for impairment,
      or
      more frequently if impairment indicators arise. Separable intangible assets
      that
      are not deemed to have an indefinite life will continue to be amortized over
      their estimated useful lives. The Company tests for impairment whenever events
      or changes in circumstances indicate that the carrying amount of goodwill or
      other intangible assets may not be recoverable, or at least annually at December
      31 of each year. These tests are performed at the reporting unit level using
      a
      two-step, fair-value based approach. The first step compares the fair value
      of
      the reporting unit with its carrying amount, including goodwill. If the fair
      value of the reporting unit is less than its carrying amount, a second step
      is
      performed to measure the amount of impairment loss. The second step allocates
      the fair value of the reporting unit to the Company’s tangible and intangible
      assets and liabilities. This derives an implied fair value for the reporting
      unit’s goodwill. If the carrying amount of the reporting unit’s goodwill exceeds
      the implied fair value of that goodwill, an impairment loss is recognized equal
      to that excess. In the event that the Company determines that the value of
      goodwill or other intangible assets have become impaired, the Company will
      incur
      a charge for the amount of the impairment during the fiscal quarter in which
      the
      determination is made.





Goodwill
      represents the amounts paid in connection with the acquisitions of Scosys,
      DeLeeuw, Integrated Strategies and McKnight Associates. Additionally, as part
      of
      the Scosys, DeLeeuw and McKnight acquisitions, the Company acquired identifiable
      intangible assets. The Company performed its annual impairment review as of
      December 31, 2005 and has determined that goodwill related to both the
      Integrated Strategies and McKnight Associates acquisitions was impaired at
      that
      date and, accordingly, recorded impairment charges of approximately $836,000
      and
      $485,000, respectively. The Company performed its annual impairment review
      as of
      December 31, 2004 and determined that goodwill and certain intangible assets
      were impaired at that date and, accordingly, recorded an impairment charge
      of
      approximately $12,247,000 primarily relating to goodwill associated with the
      DeLeeuw acquisition.





Acquired
      contracts are amortized over a period that approximates the estimated life
      of
      the contracts, based upon the estimated annual cash flows obtained from those
      contracts, generally five years. The approved vendor status intangible asset
      is
      being amortized over an estimated life of forty months. The proprietary
      presentation format intangible asset is being amortized over an estimated life
      of three years. The customer relationship intangible asset is being amortized
      over an estimated life of thirty months. The order backlog intangible asset
      is
      being amortized over an estimated life of five months.





***Deferred
      financing costs***





The
      Company capitalizes costs associated with the issuance of debt instruments.
      These costs are amortized on a straight-line basis over the term of the related
      debt instruments, which currently range from one to three years.





***Discount
      on debt***





The
      Company has allocated the proceeds received from convertible debt instruments
      between the underlying debt instruments and the detachable warrants, and has
      recorded the conversion feature as a liability in accordance with SFAS No.
      133.
      The conversion feature and certain other features that are considered embedded
      derivative instruments, such as a variable interest rate feature, a conversion
      reset provision and redemption option, have been recorded at their fair value
      within the terms of SFAS No. 133 as its fair value can be separated from the
      convertible note and its conversion is independent of the underlying note value.
      The conversion liability is marked to market each reporting period with the
      resulting gains or losses shown on the Statement of Operations. The Company
      has
      also recorded the resulting discount on debt related to the warrants and
      conversion feature and is amortizing the discount using the effective interest
      rate method over the life of the debt instruments. The discount is classified
      as
      a deferred financing cost.





***Stock
      compensation***





The
      Company follows Accounting Principles Board Opinion No. 25, “Accounting for
      Stock Issued to Employees” (“APB 25”) in accounting for its employee stock
      options. Under APB 25, because the exercise of the Company’s employee stock
      option equals the market price of the underlying stock on the date of grant,
      no
      compensation expense is recognized in the Company’s consolidated statements of
      operations. The Company is required under Statement of Financial Accounting
      Standards (SFAS) 123, “Accounting for Stock-Based Compensation”, which
      established a fair value based method of accounting for stock compensation
      plans
      with employees and others to disclose pro forma financial information regarding
      option grants made to its employees.





96


The
      Company follows EITF No. 96-18, “Accounting for Equity Instruments That Are
      Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
      Goods or Services” (“EITF 96-18”) in accounting for stock options issued to
      non-employees. Under EITF 96-18, the equity instruments should be measured at
      the fair value of the equity instrument issued. During the year ended December
      31, 2004, the Company granted 650,000 stock options to non-employee recipients.
      In compliance with EITF 96-18, the fair value of these options was determined
      using the Black-Scholes option pricing model. The Company is recognizing the
      fair value of these options as expense over the three year vesting period of
      the
      options.





Had
      the
      Company determined compensation cost based upon the fair value at the grant
      date
      for its stock options under SFAS No. 123, the Company’s net loss would have
      changed to the pro forma amounts indicated below:




Year
                  ended
              
              Year
                  endedDecember
                  31, 2005
              
              December
                  31, 2004Net loss:
              
              (as
                  Restated)As
                  reported
              
              $
              (5,118,273
              )
              $
              (35,348,206
              )Add:
                  Stock based compensation expense recorded
              
              
              33,026
              
              
              1,466,777Less:
                  Compensation expense per SFAS 123
              
              
              (1,243,073
              )
              
              (2,998,232
              )Pro
                  forma
              
              $
              (6,328,320
              )
              $
              (36,879,661
              )Net loss
                  per share:As
                  reportedBasic
              
              $
              (0.10
              )
              $
              (0.76
              )Diluted
              
              
              (0.10
              )
              
              (0.76
              )Pro
                  formaBasic
              
              $
              (0.12
              )
              $
              (0.79
              )Diluted
              
              
              (0.12
              )
              
              (0.79
              )





There
      were no options granted prior to 2004. The per share weighted average fair
      value
      of stock options granted during 2004 was $0.16 per share on the date of grant
      using the Black-Scholes option-pricing model with the following weighted average
      assumptions:





Expected
                  dividend yield
              
              
              0.0
              %Risk-free
                  interest rate
              
              
              2.5
              %Expected
                  volatility
              
              
              148.0
              %Expected
                  option life (years)
              
              
              3.0





The
      per
      share weighted average fair value of stock options granted during 2005 was
      $0.71
      per share on the date of grant using the Black-Scholes option-pricing model
      with
      the following weighted average assumptions:





Expected
                  dividend yield
              
              
              0.0
              %Risk-free
                  interest rate
              
              
              4.34
              %Expected
                  volatility
              
              
              186.6
              %Expected
                  option life (years)
              
              
              3.0


Pro
      forma
      information regarding net loss and net loss per share is required by
      SFAS 123, as amended by SFAS 148, and has been determined as if the
      Company had accounted for its employee stock options under the fair-value
      method. The Black-Scholes option pricing model used in this valuation was
      developed for use in estimating the fair value of traded options, which have
      no
      vesting restrictions and are fully transferable. Option valuation models require
      the input of highly subjective assumptions. The Company’s stock-based
      compensation has characteristics significantly different from those of traded
      options, and changes in the assumptions used can materially affect the fair
      value estimate.





97


***Concentrations
      of credit risk***





Financial
      instruments which potentially subject the Company to concentrations of credit
      risk are cash and accounts receivable arising from its normal business
      activities. The Company routinely assesses the financial strength of its
      customers, based upon factors surrounding their credit risk, establishes an
      allowance for doubtful accounts, and as a consequence believes that its accounts
      receivable credit risk exposure beyond such allowances is limited. At December
      31, 2005, LEC and Comsys accounted for approximately 14% and 12% of the
      Company’s accounts receivable balance, respectively.





The
      Company maintains its cash with a high credit quality financial institution.
      Each account is secured by the Federal Deposit Insurance Corporation up to
      $100,000.





***Advertising***





The
      Company expenses advertising costs as incurred. Advertising costs amounted
      to
      approximately $380,000 and $152,000 for the years ended December 31, 2005 and
      2004, respectively.





***Income
      taxes***





The
      Company accounts for income taxes, in accordance with SFAS No. 109, “Accounting
      for Income Taxes” (“SFAS 109”) and related interpretations, under an asset and
      liability approach that requires the recognition of deferred tax assets and
      liabilities for the expected future tax consequences of events that have been
      recognized in the Company’s financial statements or tax returns. In estimating
      future tax consequences, the Company generally considers all expected future
      events other than enactments of changes in the tax laws or rates.





The
      Company records a valuation allowance to reduce the deferred tax assets to
      the
      amount that is more likely than not to be realized. The Company’s current
      valuation allowance primarily relates to benefits from the Company’s
      NOL’s.




***Derivatives***





The
      Company accounts for derivatives in accordance with SFAS No. 133,
“ *Accounting
      for Derivative Instruments and Hedging Activities* ”
      (“SFAS 133”) and related interpretations. SFAS 133, as amended,
      requires companies to recognize all derivative instruments as either assets
      or
      liabilities in the balance sheet at fair value. The accounting for changes
      in
      the fair value of a derivative instrument depends on: (i) whether the
      derivative has been designated and qualifies as part of a hedging relationship,
      and (ii) the type of hedging relationship. For those derivative instruments
      that are designated and qualify as hedging instruments, a company must designate
      the hedging instrument based upon the exposure being hedged as either a fair
      value hedge, cash flow hedge or hedge of a net investment in a foreign
      operation. At December 31, 2005, the Company had not entered into any
      transactions which were considered hedges under SFAS 133.




***Financial
        Instruments***
  The
        carrying value of the Company’s financial instruments, including cash and cash
        equivalents, accounts receivable, note receivable, accounts payable and accrued
        liabilities approximate fair value because of the short maturities of those
        instruments. Based on borrowing rates currently available to the Company
        for
        loans with similar terms, the carrying value of convertible notes and notes
        payable are also approximate fair value.
  We
        review
        the terms of convertible debt and equity instruments we issued to determine
        whether there are embedded derivative instruments, including the embedded
        conversion option, that are required to be bifurcated and accounted for
        separately as a derivative financial instrument. Generally, where the ability
        to
        physical or net-share settle the conversion option is deemed to be not within
        the control of the company, the embedded conversion option is required to
        be
        bifurcated and accounted for as a derivative financial instrument
        liability.
  In
        connection with the sale of convertible debt and equity instruments, we may
        also
        issue freestanding options or warrants. Additionally, we may issue options
        or
        warrants to non-employees in connection with consulting or other services
        they
        provide. Although the terms of the options and warrants may not provide for
        net-cash settlement, in certain circumstances, physical or net-share settlement
        is deemed to not be within the control of the company and, accordingly, we
        are
        required to account for these freestanding options and warrants as derivative
        financial instrument liabilities, rather than as equity.
  Derivative
        financial instruments are initially measured at their fair value. For derivative
        financial instruments that are accounted for as liabilities, the derivative
        instrument is initially recorded at its fair value and is then re-valued
        at each
        reporting date, with changes in the fair value reported as charges or credits
        to
        income. For option-based derivative financial instruments, we use the
        Black-Scholes option pricing model to value the derivative
        instruments.
  In
        circumstances where the embedded conversion option in a convertible instrument
        is required to be bifurcated and there are also other embedded derivative
        instruments in the convertible instrument that are required to be bifurcated,
        the bifurcated derivative instruments are accounted for as a single, compound
        derivative instrument.
  If
        freestanding options or warrants were issued and will be accounted for as
        derivative instrument liabilities (rather than as equity), the proceeds are
        first allocated to the fair value of those instruments. When the embedded
        derivative instrument is to be bifurcated and accounted for as a liability,
        the
        remaining proceeds received are then allocated to the fair value of the
        bifurcated derivative instrument. The remaining proceeds, if any, are then
        allocated to the convertible instrument itself, usually resulting in that
        instrument being recorded at a discount from its face amount. In circumstances
        where a freestanding derivative instrument is to be accounted for as an equity
        instrument, the proceeds are allocated between the convertible instrument
        and
        the derivative equity instrument, based on their relative fair
        values.
  The
        discount from the face value of the convertible debt instrument resulting
        from
        the allocation of part of the proceeds to embedded derivative instruments
        and/or
        freestanding options or warrants is amortized over the life of the instrument
        through periodic charges to income, using the effective interest method.
  The
        classification of derivative instruments, including whether such instruments
        should be recorded as liabilities or as equity, is re-assessed at the end
        of
        each reporting period. Derivative instrument liabilities are classified in
        the
        balance sheet as current or non-current based on whether or not net-cash
        settlement of the derivative instrument is expected within 12 months of the
        balance sheet date.


***Equity
      investments***





Prior
      to
      the Company’s acquisition of DeLeeuw in 2004, DeLeeuw had acquired a
      non-controlling interest in DeLeeuw International (a company formed under the
      laws of Turkey). The Company accounts for its share of the income (losses)
      of
      this investment under the equity method.





98


The
      Company acquired 49% of all issued and outstanding shares of common stock of
      LEC
      as of May 1, 2004. The acquisition was completed through a Stock Purchase
      Agreement between the Company and the sole stockholder of LEC. In connection
      with the acquisition, the Company (i) repaid a bank loan on behalf of the seller
      in the amount of $35,000; (ii) repaid an LEC bank loan in the amount of $38,000;
      and (iii) satisfied an LEC obligation for $10,000 of prior compensation to
      an
      employee. The Company accounts for its share of the income (losses) of this
      investment under the equity method.





***Foreign
      Currency Translation***





Local
      currencies are the functional currencies for Evoke’s foreign subsidiaries.
      Assets and liabilities are translated using the exchange rates in effect at
      the
      balance sheet date. Income and expenses are translated at the average exchange
      rates during the period. Translation gains and losses not reflected in earnings
      are reported as a component of stockholders’ equity. Foreign currency
      translation gains (losses) are included as a component of the gain (loss) from
      discontinued operations.





***Comprehensive
      Income***





Accumulated
      other comprehensive income is comprised of foreign currency translation gains
      and losses which have been excluded from net income. The Company has reported
      the components of comprehensive income on the consolidated statements of
      stockholders’ equity.





***Restatement
      of Previously Issued Financial Statements***


We
        have
        amended the annual reports for the year ended December 31, 2004 and quarterly
        reports of the quarters ended September 30, 2004, March 31, 2005, June 30,
        2005
        and September 30, 2005 to revise the accounting for the convertible term
        note,
        warrants and options and related registration rights in connection with our
        financing transaction entered into with Laurus
        Master Funds, Ltd. (“Laurus”) and Sands Brothers Venture Capital LLC, Sands
        Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
        (collectively “Sands”) during 2004.
  As
        a
        result of the restatement, warrants and options have been reclassified as
        derivative liabilities. The warrants and options had previously been measured
        based on a relative fair method and are now measured at their full fair value
        and will be marked to market on each balance sheet date.
  Embedded
        derivatives contained in the convertible debenture and the secured line of
        credit are now bifurcated from the host debt and measured at fair value and
        classified as derivative liabilities. These embedded derivatives will also
        be
        marked to market on each balance sheet date.
  The
        resulting debt discount will be amortized over the period of the convertible
        debt and the secured line of credit as interest and other expenses in our
        accompanying consolidated statements of operations.
  The
        effect on our accompanying consolidated balance sheet as of December 31,
        2004
        was an increase in liabilities by $6,555,091 and corresponding decrease in
        stockholders' equity of $6,748,621. The effect on our consolidated statements
        of
        operations for the year ended December 31, 2004 was an increase in our net
        loss
        of $2,077,192. Basic and diluted earning per share for the year ended December
        31, 2004 changed from loss per share $0.71 to $0.76, which gives effect to
        the
        1:15 reverse stock split on September 21, 2005.
  For
        the
        impact of the restatement for the periods noted above, see Note 22 of the
        Consolidated Financial Statements.
  ***Reclassification***





Certain
      amounts in prior periods have been reclassified to conform to the 2005 financial
      statement presentation.





***Use
      of estimates***





The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the reported amounts of assets and liabilities and disclosures of
      contingent assets and liabilities ****** at
      the
      date of the financial statements and the reported amounts of revenues and
      expenses during the reporting period. Actual results could differ from those
      estimates.





99


**Note
      2:** **Liquidity**





The
      Company has incurred net losses and negative cash flows from operating
      activities for the three months ended March 31, 2006 and the years ended
      December 31, 2005 and 2004, and has an accumulated deficit of $40.7 million
      at
      December 31, 2005.


As
        of
        December 31, 2005, the Company had a cash balance of approximately $0.2 million.
        As of March 31, 2006, Company had cash on hand and amounts available under
        its
        line of credit of approximately $2.7 million.
  Our
        primary liquidity needs are for working capital and debt service (see Notes
        11,
        12 and 13 to the consolidated financial statements). Our primary sources
        of
        liquidity are cash flows from operations, borrowings under our revolving
        credit
        facility, and various short and long term financings. Certain short term
        note
        holders have agreed to extend their maturity dates of the Notes on a
        month-to-month basis until the Company raises sufficient funds to pay the
        Notes
        in full. Amounts outstanding under the Notes at December 31, 2005 was $1.5
        million. In addition, Mr. Scott Newman, Mr. Glenn Peipert and Mr. Robert
        C.
        Deleeuw have agreed to personally support our cash requirements to enable
        us to
        fufill our obligations through June 1, 2007, to the extent necessary, up
        to $1.5
        million based on their ability to sell their Company common stock in order
        to
        provide the necessary financing.


100





Although
      the Company has negative working capital at December 31, 2005 and March 31,
      2006, and has incurred significant operating losses, the Company believes
      existing cash plus funds provided by operations, borrowing capacity under the
      line of credit and projected borrowing against, or the guarantees of the primary
      stockholders should be sufficient to fund operations through January 1, 2007.
      Nevertheless, the Company is presently exploring various financing alternatives,
      including debt or additional sales of equity securities in order to finance
      the
      core business of the Company and help provide adequate working capital for
      operations. There is no assurance that funds will be provided by operations
      or
      that such additional financing will be available, or if available, will be
      available on acceptable terms. Should the Company experience significant
      shortfalls in planned revenues, or experience unforeseen fixed expenses, the
      Company believes it has the ability to make additional reductions to variable
      expenses to extend its capital. Any decision or ability to obtain financing
      through debt or through equity investment will depend on various factors,
      including, among others, financial market conditions, strategic acquisition
      and
      investment opportunities, and developments in the Company's markets. The sale
      of
      additional equity securities or future conversion of any convertible debt would
      result in additional dilution to the Company's stockholders.





**Note
      3:**  **Recently
      Issued Accounting Pronouncements**





SFAS
      No. 123 (Revised 2004) (“SFAS No. 123R”), “Share-Based Payment,”
issued in December 2004, is a revision of FASB Statement 123, “Accounting for
      Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting
      for Stock Issued to Employees,” and its related implementation guidance. The
      Statement focuses primarily on accounting for transactions in which an entity
      obtains employee services in share-based payment transactions. SFAS
      No. 123R requires a public entity to measure the cost of employee services
      received in exchange for an award of equity instruments based on the grant-date
      fair value of the award (with limited exceptions). That cost will be recognized
      over the period during which an employee is required to provide service in
      exchange for the award. On March 29, 2005, the SEC issued Staff Accounting
      Bulletin No. 107 (“SAB No. 107”), which provides the Staff’s views
      regarding interactions between SFAS No. 123R and certain SEC rules and
      regulations and provides interpretations of the valuation of share-based
      payments for public companies.





SFAS
      No. 123(R) permits public companies to adopt its requirements using one of
      two methods:




(1)
      A
“modified prospective” method in which compensation cost is recognized beginning
      with the effective date (a) based on the requirements of SFAS
      No. 123(R) for all share-based payments granted after the effective date
      and (b) based on the requirements of SFAS No. 123 for all awards
      granted to employees prior to the effective date of SFAS No. 123(R) that
      remain unvested on the effective date.




(2)
      A
“modified retrospective” method which includes the requirements of the modified
      prospective method described above, but also permits entities to restate based
      on the amounts previously recognized under SFAS No. 123 for purposes of pro
      forma disclosures either (a) all prior periods presented or (b) prior
      interim periods of the year of adoption.




101


This
      statement is effective for the beginning of the first annual reporting period
      that begins after June 15, 2005, therefore, we will adopt the standard in
      the first quarter of fiscal 2006 using the modified prospective method. As
      permitted by SFAS No. 123, we currently account for share-based payments to
      employees using the intrinsic value method prescribed in APB Opinion 25 and,
      as
      such, generally recognize no compensation cost for employee stock options.
      Although we have not completed our assessment, we believe the impact on our
      consolidated financial position or results or operations will not be material
      given the current number of outstanding stock options. The effect on our results
      of operations of expensing stock options using the Black-Scholes method is
      presented in the disclosure of pro forma net income and earnings per share
      in
      Note 1 – Accounting Policies. SFAS No. 123(R) also requires the benefits of
      tax deductions in excess of recognized compensation cost to be reported as
      a
      financing cash flow, rather than as an operating cash flow as required under
      current literature. This requirement will reduce net operating cash flows and
      increase net financing cash flows in periods after adoption.




In
      December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary
      Assets *”* ,
      an
      amendment of APB Opinion No. 29. SFAS 153 eliminates the exception from
      fair value measurement for nonmonetary exchanges of similar productive assets
      in
      paragraph 21 (b) of APB Opinion No. 29, “Accounting for Nonmonetary
      Transactions” (““APB 29”), and replaces it with an exception for exchanges that
      do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange
      has commercial substance if the future cash flows of the entity are expected
      to
      change significantly as a result of the exchange. SFAS 153 is effective for
      the
      fiscal periods beginning after June 15, 2005 and the Company will adopt
      this Statement in the first quarter of 2006. The Company currently does not
      anticipate that the effects of the statement will materially affect its
      consolidated financial position or consolidated results of operations upon
      adoption.




In
      May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
      Corrections - A Replacement of APB Opinion No. 20 and FASB Statement
      No. 3 *”* (“SFAS
      No. 154”) *.* SFAS
      No. 154 requires the retrospective application to prior periods’ financial
      statements of changes in accounting principle, unless it is impractible to
      determine either the period-specific effects or cumulative effect of the
      accounting change. SFAS No. 154 also requires that a change in
      depreciation, amortization, or depletion method for long-lived non-financial
      assets be accounted for as a change in accounting estimate affected by a change
      in accounting principle. SFAS No. 154 is effective for accounting changes
      and corrections of errors made in fiscal years beginning after December 15,
      2004 and we will adopt this provision, as applicable, during fiscal year 2006.


In
        February 2006, the FASB issued SFAS 155 - “Accounting for Certain Hybrid
        Financial Instruments—an amendment of FASB Statements No. 133 and 140.” 
This Statement amends FASB Statements No. 133, Accounting for Derivative
        Instruments and Hedging Activities, and No. 140, Accounting for Transfers
        and
        Servicing of Financial Assets and Extinguishments of Liabilities. This Statement
        resolves issues addressed in Statement 133 Implementation Issue No. D1,
“Application of Statement 133 to Beneficial Interests in Securitized Financial
        Assets.”  This Statement:
 
 a.
              Permits
                  fair value remeasurement for any hybrid financial instrument that
                  contains
                  an embedded derivative that otherwise would require
                  bifurcation
 
 b.
              Clarifies
                  which interest-only strips and principal-only strips are not subject
                  to
                  the requirements of Statement 133
 
 c.
              Establishes
                  a requirement to evaluate interests in securitized financial assets
                  to
                  identify interests that are freestanding derivatives or that are
                  hybrid
                  financial instruments that contain an embedded derivative requiring
                  bifurcation
 
 d.
              Clarifies
                  that concentrations of credit risk in the form of subordination
                  are not
                  embedded derivatives
 
 e.
              Amends
                  Statement 140 to eliminate the prohibition on a qualifying special-purpose
                  entity from holding a derivative financial instrument that pertains
                  to a
                  beneficial interest other than another derivative financial
                  instrument.
 
 This
        Statement is effective for all financial instruments acquired or issued after
        the beginning of our first fiscal year that begins after September 15,
        2006.  The fair value election provided for in paragraph 4(c) of this
        Statement may also be applied upon adoption of this Statement for hybrid
        financial instruments that had been bifurcated under paragraph 12 of Statement
        133 prior to the adoption of this Statement. Earlier adoption is permitted
        as of
        the beginning of our fiscal year, provided we have not yet issued financial
        statements, including financial statements for any interim period, for that
        fiscal year. Provisions of this Statement may be applied to instruments that
        we
        hold at the date of adoption on an instrument-by-instrument basis.  The
        Company is currently reviewing the effects of adoption of this statement
        but it
        is not expected to have a material impact on our financial
        statements.
  In
        March
        2005, the FASB issued FIN No. 47, “Accounting for Conditional Asset
        Retirement Obligations - an interpretation of FASB Statement No. 143
“Accounting for Asset Retirement Obligations (“SFAS No. 143”)” (“FIN 47”).
        FIN 47 clarifies that the term *conditional
        asset retirement obligation* as used
        in SFAS No. 143, refers to a legal obligation to perform an asset
        retirement activity in which the timing and (or) method of settlement are
        conditional on a future event that may or may not be within the control of
        the
        entity. Accordingly, an entity is required to recognize a liability for the
        fair
        value of a conditional asset retirement obligation if the fair value of the
        liability can be reasonably estimated. The liability for the conditional
        asset
        retirement obligation should be recognized when incurred. This Interpretation
        also clarifies when an entity would have sufficient information to reasonably
        estimate the fair value of an asset retirement obligation. FIN 47 is effective
        for fiscal periods beginning after December 15, 2005, and we will adopt
        this provision, as applicable, during fiscal year 2006.





**Note
      4 - Mergers and acquisitions**





***Acquisition
      of McKnight Associates***





On
      July
      22, 2005, the Company entered into (and simultaneously consummated) a merger
      agreement with McKnight Associates. In consideration of this merger agreement,
      the Company paid the following consideration: $500,000 in cash, the commitment
      to pay an additional $250,000, in cash, by June 2006 (the Company paid Mr.
      McKnight $125,000 in March 2006), the issuance of 909,091 shares of the Company
      common stock, plus the assumption of substantially all of the liabilities of
      McKnight.





The
      components of the purchase price were allocated to the various assets and
      liabilities of McKnight Associates as follows:


COMPONENTS
        OF PURCHASE PRICE (in thousands):
 
 Value
                  of common stock
              
              $
              1,773Cash
                  consideration
              
              
              922Acquisition
                  costs
              
              
              24$
              2,719
 
 ALLOCATION
        OF PURCHASE PRICE (in thousands):
 
 Cash
              
              
              (116
              )Accounts
                  receivable
              
              
              (298
              )Goodwill
              
              
              (1,865
              )
              
              (indefinite
                  life)Customer
                  relationship
              
              
              (685
              )
              
              (2.5
                  year estimated life)Order
                  backlog
              
              
              (50
              )
              
              (5
                  month estimated life)Proprietary
                  presentation format
              
              
              (173
              )
              
              (3
                  year estimated life)Deferred
                  tax liability
              
              
              363Accounts
                  payable and accrued expenses
              
              
              105$
              -


***Acquisition
      of Integrated Strategies***





On
      July
      29, 2005 the Company, entered into (and simultaneously consummated) an agreement
      and plan of merger (the "Agreement") among ISI Merger Corp., a Delaware
      corporation and wholly owned subsidiary of the Company ("Merger Sub"),
      Integrated Strategies, Inc., a Delaware corporation ("ISI"), ISI Consulting,
      LLC, a Delaware limited liability company ("LLC"), and Adam and Larry Hock,
      individual majority stockholders and members of ISI and LLC, respectively (the
      "Majority Stockholders"). Pursuant to the Agreement, ISI and LLC merged with
      and
      into Merger Sub and the Company and Merger Sub paid the following consideration:
      $2,050,000 in cash (reduced by certain amounts), the issuance by Merger Sub
      of a
      promissory note in the amount of $580,000 (which was later reduced), the
      issuance by the Company of a subordinated promissory note in the amount of
      $165,000, and the assumption of substantially all the liabilities of ISI and
      LLC. The Agreement also provides for the commitment, subject to certain revenue
      and profit thresholds (as described in the Agreement), to pay additional cash
      and issue shares of the Company common stock. On August 1, 2005, Merger Sub
      changed its name to Integrated Strategies, Inc.





Exclusive
      of contingent consideration, the components of the purchase price were allocated
      to the various assets and liabilities of Integrated Strategies as
      follows:




COMPONENTS
        OF PURCHASE PRICE (in thousands):
 
 Cash
              
              $
              2,148Promissory
                  notes
              
              
              241Acquisition
                  costs
              
              
              28$
              2,417ALLOCATION
                  OF PURCHASE PRICE (in thousands):Cash
              
              
              (119
              )Accounts
                  receivable
              
              
              (661
              )Prepaid
                  expenses
              
              
              (3
              )Property
                  and equipment, net
              
              
              (2
              )Goodwill
              
              
              (1,792
              )
              
              (Indefinite
                  life)Other
                  assets
              
              
              (13
              )Accounts
                  payable and accrued expenses
              
              
              173$
              -
  102


The
      pro
      forma consolidated statements of operations for the years ended December 31,
      2004 and 2005, respectively, set forth below gives effect to the acquisitions
      of
      McKnight Associates, Inc. and Integrated Strategies, Inc. as if they occurred
      on
      January 1, 2004.





Year
                  ended
              
              Year
                  endedDecember
                  31, 2005
              
              December
                  31, 2004(as
                  Restated)Revenues
              
              $
              32,440,262
              
              $
              32,083,229Net Loss
              
              $
              (4,115,076
              )
              $
              (22,449,341
              )Net Loss
                  per share
              
              $
              (0.08
              )
              $
              (0.48
              )











**Note
      5 - Discontinued Operations**





In
      July
      2005, the Board of Directors approved, and the Company completed, the sale
      of
      substantially all of the assets of Evoke Software Corporation and received
      aggregate consideration of $645,000 cash, the assumption by Similarity Systems
      and Similarity Vector Technologies, Ltd. of certain liabilities, 821,053 shares
      which are issuable by Similarity subject to the Company’s satisfactory
      completion of certain post-closing obligations, and an earnout in an amount
      equal to 13% of certain Similarity revenues. The maximum earnout consideration
      to which the Company is entitled under this agreement is $1,400,000 and would
      be
      received over a three year period. CSI changed the name of its “Evoke Software
      Corporation” subsidiary to “CSI Sub Corp II (DE)” in August 2005.





The
      821,053 shares and the earnout noted above as consideration to be received
      by
      the Company are both contingent upon certain post-closing events. However,
      as a
      result of Informatica Corporation’s acquisition of Similarity Systems in
      February 2006, the Company received $2,050,000 as a final payment on all future
      consideration related to our agreement with Similarity.





Total
      assets and liabilities of Evoke, as of the date of the sale, were as
      follows:




Cash
              
              $
              35,026Accounts
                  receivable, net
              
              
              692,459Prepaid
                  expenses
              
              
              101,115Property
                  and equipment, net
              
              
              77,878Intangible
                  assets, net
              
              
              1,694,044Other
                  assets
              
              
              4,850$
              2,605,372Accounts
                  payable and accrued expenses
              
              $
              (503,238
              )Deferred
                  revenue
              
              
              (1,649,995
              )Due
                  to CSI
              
              
              (1,482,312
              )Minority
                  interest
              
              
              (75,067
              )$
              (3,710,612
              )


The
      Company is liquidating the portion of Evoke that was not acquired by Similarity
      Systems. As a result of the divestiture and liquidation of the Evoke subsidiary,
      the Company recorded a charge for uncollectible intercompany receivables to
      Evoke amounting to $1,482,312 .
      Transaction costs related to the sale were $44,000. The Company reported a
      gain
      on disposal of the Evoke subsidiary of $49,148 which is included as a component
      of other income (expense).





103


The
      Evoke
      revenue by line of business, and loss from discontinued operations is as
      follows:





For
                  the year ended December 31,2005
              
              2004Services
              
              $
              58,184
              
              $
              132,834Software
              
              
              646,269
              
              
              108,623Support
                  and maintenance
              
              
              862,118
              
              
              1,031,953Other
              
              
              5,512$
              1,572,083
              
              $
              1,273,410Net
                  loss
              
              $
              (1,153,119
              )
              $
              (12,650,908
              )
  **Note
                  6 - Property and equipment**Property
                  and equipment consisted of the following:December
                  31,
              
              December
                  31,2005
              
              2004Computer
                  equipment
              
              $
              998,339
              
              $
              979,494Furniture
                  and fixtures
              
              
              161,543
              
              
              232,648Leasehold
                  improvements
              
              
              92,459
              
              
              216,3061,252,341
              
              
              1,428,448Accumulated
                  depreciation
              
              
              (834,872
              )
              
              (840,873
              )$
              417,469
              
              $
              587,575




Depreciation
      and amortization expense related to property and equipment totaled $0.1 million
      and $0.1 million for 2005 and 2004, respectively.





**Note
      7 - Intangible assets**




December
                  31,
              
              December
                  31,
              
              Amortization2005
              
              2004
              
              periodCustomer
                  contracts
              
              $
              414,000
              
              $
              1,876,424
              
              
              5
                  yearsComputer
                  software
              
              
              -
              
              
              1,381,000
              
              
              3
                  yearsApproved
                  vendor status
              
              
              538,814
              
              
              538,814
              
              
              40
                  monthsCustomer
                  relationships
              
              
              685,000
              
              
              -
              
              
              2.5
                  yearsTradename
              
              
              722,000
              
              
              722,000
              
              
              IndefiniteProprietary
                  presentation format
              
              
              173,000
              
              
              -
              
              
              3
                  yearsOrder
                  backlog
              
              
              50,500
              
              
              -
              
              
              5
                  monthsProprietary
                  rights and rights to the name of Scosys, Inc.
              
              
              20,000
              
              
              20,000
              
              
              Indefinite2,603,314
              
              
              4,538,238Accumulated
                  amortization
              
              
              (740,350
              )
              
              (911,142
              )$
              1,862,964
              
              $
              3,627,096





The
      estimated amortization expense for the next five years related to other
      finite-lived intangible assets is estimated to be as follows:





104


Amortization
                  of Intangible
                  assets2006
              
              576,1072007
              
              488,3852008
              
              56,472Thereafter
              
              -$
              1,120,964




**Note
      8 - Deferred financing costs**





The
      Company has incurred and capitalized financing costs in connection with two
      financing transactions consummated during 2004. These costs were deferred and
      are being amortized over the life of the related financing agreement. The
      following illustrates the components of the deferred financing
      costs:





Year
                  Ended
              
              Year
                  EndedDecember
                  31,
              
              December
                  31,2005
              
              2004Laurus
                  Master Fund
              
              $
              766,270
              
              $
              766,270Sands
                  Brothers
              
              
              127,039
              
              
              127,039$
              893,309
              
              $
              893,309Accumulated
                  amortization
              
              
              (467,604
              )
              
              (126,767
              )$
              425,705
              
              $
              766,542





**Note
      9 - Discount on debt**





The
      Company has recorded the discounts on its debt instruments due to both warrant
      issuances and embedded derivatives contained in convertible notes as deferred
      charges. These deferred charges are being amortized to interest expense over
      the
      life of the related debt instruments, which currently range from one to five
      years. The following illustrates the components of the discount on debt and
      their applicable amortization period:




December
                  31,
              
              December
                  31,2005
              
              2004
              
              Amortization
                  periodLaurus
                  Master Fund
              
              $
              2,276,345
              
              $
              6,658,490
              
              
              36
                  monthsSands
                  Brothers
              
              
              1,080,000
              
              
              1,000,000
              
              
              12-15
                  monthsTaurus
                  Advisory Group
              
              
              1,500,000
              
              
              1,500,000
              
              
              5
                  years4,856,345
              
              
              9,158,490Accumulated
                  amortization
              
              
              (678,917
              )
              
              (941,212
              )$
              4,177,428
              
              $
              8,217,278





**Note
      10 - Line of credit**





In
      August
      2004, we replaced our $3.0 million line of credit with North Fork Bank with
      a
      revolving line of credit with Laurus Master Fund, Ltd. (“Laurus”), whereby we
      had access to borrow up to $6.0 million based upon eligible accounts receivable.
      A portion of Laurus’s revolving line of credit was used to pay off all
      outstanding borrowings from North Fork Bank. This revolving line, effectuated
      through a $2.0 million convertible minimum borrowing note and a $4.0 million
      revolving note, provided for advances at an advance rate of 90% against eligible
      accounts receivable, with an annual interest rate of prime rate (as reported
      in
      the Wall Street Journal) plus 1%, and matured in three years. We had no
      obligation to meet financial covenants under the $2.0 million convertible
      minimum borrowing note or the $4.0 million revolving note. This line of credit
      is secured by substantially all the corporate assets. Both the $2.0 million
      convertible minimum borrowing note and the $4.0 million revolving note provided
      for conversion at the option of the holder of the amounts outstanding into
      our
      common stock at a fixed conversion price of $2.10 per share.





105


Additionally,
      in exchange for a $5,000,000 secured convertible term note bearing interest
      at
      prime rate (as reported in the Wall Street Journal) plus 1%, Laurus had
      established a $5.0 million account to be used only for acquisition targets
      identified by us that were approved by Laurus in Laurus’ sole discretion. We had
      no obligation to meet financial covenants under the $5.0 million secured
      convertible term note. This note was convertible into our common stock at a
      fixed conversion price of $2.10 per share. This note was to mature in three
      years. We issued Laurus a common stock purchase warrant that provided Laurus
      with the right to purchase 800,000 shares of our common stock. The exercise
      price for the first 400,000 shares acquired under the warrant is $4.35 per
      share, the exercise price for the next 200,000 shares acquired under the warrant
      is $4.65 per share, and the exercise price for the final 200,000 shares acquired
      under the warrant is $5.25 per share. The common stock purchase warrant expires
      on August 15, 2011. We paid $0.75 million in brokerage and transaction closing
      related costs. These costs were deducted from the $5.0 million restricted cash
      balance being provided to us by Laurus.





In
      May
      2005, Laurus elected to convert $1,000,000 of debt underlying the minimum
      borrowing note into the Company’s common stock. As a result of this conversion,
      the Company obtained $1,000,000 of additional borrowing capacity under its
      revolving line of credit and in return, issued 476,191  shares
      of
      Company common stock to Laurus.





In
      July
      2005, the Company entered into amendments of the notes dated August 16, 2004
      between the Company and Laurus. Pursuant to the amendment, the Company released
      $4,327,295 (the “Funds”) to Laurus, which was being held in the Restricted
      Account (which was available to the Company for acquisitions) and issued an
      amended and restated convertible note in the principal amount of $749,000.
      In
      satisfaction of the balance of the accrued interest and any liquidated damages
      to which it was entitled pursuant the Registration Rights Agreement entered
      into
      in August 2004, the Company issued an option to purchase 333,334 shares of
      the
      Company’s common stock at a purchase price of $0.015 per share. Laurus fully
      exercised this option to purchase Company stock on August 1, 2005. Laurus also
      agreed to extend the required filing date and effective date of the Registration
      Statement. For accounting purposes, the Company recorded this transaction as
      an
      early extinguishment of debt and recognized the remaining discount on debt
      and
      liability as a component of other income (expense).





The
      Company also issued an amended and restated convertible secured revolving note
      in the principal amount of $4.5 million in favor of Laurus which amended the
      $4
      million Revolving Note executed in August 2004. In connection with this note,
      the Company and Laurus entered into an Overadvance Letter Agreement, pursuant
      to
      which Laurus made a loan to the Company in excess of the amount available using
      the Company accounts receivable as collateral in the principal amount of $2.7
      million. The Company utilized the $2.7 million which was advanced to it by
      Laurus to acquire McKnight Associates, Inc., Integrated Strategies, Inc. and
      ISI
      Consulting, LLC. Except as noted above, all terms of the August 2004 agreements
      continued to remain in effect.





On
      November 30, 2005, the Company (i) amended and restated the convertible
      term note in the principal amount of $749,000 by reducing the conversion rate
      of
      such note from $2.10 to $1.00, (ii) amended and restated the secured
      revolving convertible note by increasing the principal amount available from
      $4,500,000 to $5,500,000 and reducing the conversion rate from $2.10 to $1.00,
      and (iii) amended and restated the secured convertible minimum borrowing
      note in the principal amount of $2,000,000 by reducing the fixed conversion
      price from $2.10 to $0.65.





As
      a
      result of the issuance of warrants, the Company has recorded a discount on
      debt
      (valued at $2.2 million as of December 31, 2005) and a liability. The discount
      is being amortized over the remaining term of the debt instrument, and the
      liability is being adjusted to fair value using an option-pricing model.
      Additionally, the convertible notes contain embedded derivatives pertaining
      to the conversion feature, conversion reset provision, redemption option and
      variable interest rate feature in the notes, and the Company has recorded a
      discount on debt and a liability to reflect the fair value of these
      derivatives.




106
 
  The
          note
          and related agreements contain several events of default which
          include:


·
            failure
                to pay interest, principal payments or other fees when
                due;


·
            failure
                to pay taxes when due unless such taxes are being contested in good
                faith;


·
            breach
                by us of any material covenant or term or condition of the notes
                or any
                agreements made in connection
                therewith;


·
            default
                on any indebtedness to which we or our subsidiaries are a
                party;


·
            breach
                by us of any material representation or warranty made in the notes
                or in
                any agreements made in connection
                therewith;


·
            attachment
                is made or levy upon collateral securing the Laurus debt which is
                valued
                at more than $150,000 and is not timely
                mitigated.


·
            any
                lien created under the notes and agreements is not valid and perfected
                having a first priority interest;


·
            assignment
                for the benefit of our creditors, or a receiver or trustee is appointed
                for us;


·
            bankruptcy
                or insolvency proceeding instituted by or against us and not dismissed
                within 30 days;


·
            the
                inability to pay debts as they become due or cease business
                operations;


·
            sale,
                assignment, transfer or conveyance of any assets except as
                permitted;


·
            a
                person or group becomes beneficial owner of 35% on fully diluted
                basis of
                the outstanding voting equity interest or the present directors cease
                to
                be the majority on the Board of
                Directors;


·
            indictment
                or threatened criminal indictment, or commencement of threatened
                commencement of any criminal or civil proceeding against the Company
                or
                any executive officer; and


·
            common
                stock suspension for five consecutive days or five days during any
                10
                consecutive days from a principal market, provided that we are unable
                to
                cure such suspension within 30 days or list our common stock on another
                principal market within 60 days.




If
      we
      default on the notes and the holder demands all payments due and payable, the
      cash required to pay such amounts would most likely come out of working capital,
      which may not be sufficient to repay the amounts due. The default payment shall
      be 130% of the outstanding principal amount of the note (reduced to 115% in
      February 2006), plus accrued but unpaid interest, all other fees then remaining
      unpaid, and all other amounts payable thereunder. In addition, since we rely
      on
      our working capital for our day to day operations, such a default on the note
      could materially adversely affect our business, operating results or financial
      condition to such extent that we are forced to restructure, file for bankruptcy,
      sell assets or cease operations. Further, our obligations under the notes are
      secured by substantially all of our assets. Failure to fulfill our obligations
      under the notes and related agreements could lead to loss of these assets,
      which
      would be detrimental to our operations. As of April 17, 2006, the Company does
      not believe that it is in default of any of the provisions of the Laurus
      agreements.




As
      of
      December 31, 2005, approximately $4.7 million was outstanding under the
      revolving line of credit and Overadvance Letter Agreement. The interest rate
      on
      the revolving line and the overadvance letter was 8.25% as of December 31,
      2005.





**Note
      11 - Short Term Notes Payable**





In
      July
      2005, the Company obtained two $250,000 short term loans from certain investors
      represented by Taurus. Both notes bear interest at 8% per annum. The first
      note
      is dated July 6, 2005 and initially matured on September 5, 2005. The maturity
      date for this note has been extended to May 6, 2006. The second note is
      dated July 22, 2005 and originally matured on September 22, 2005. The maturity
      date for this note has been extended to April 22, 2006. These
      short term note holders have agreed to extend their maturity date on a
      month-to-month basis until the Company raises sufficient funds to repay the
      notes.




In
      July
      2005, in conjunction with the acquisition of Integrated Strategies, the Company
      issued a short term note in the principal amount of $165,000 payable to Adam
      Hock and Larry Hock, the former principle stockholders of Integrated Strategies.
      This note bears interest at 5% per annum and matures on October 28,
      2006.





107




In
      December 2005, the Company obtained a $1,000,000 short term loan from certain
      investors represented by Taurus. This note bears interest at 8% per annum.
      The
      note is dated December 19, 2005 and initially matured on January 31, 2006.
      The
      maturity date for this note has been extended to June 1, 2006. These investors
      received a warrant to purchase 277,777 shares of our common stock with an
      exercise price of $0.675 per share. The warrant expires in December 2008. As
      of
      December 31, 2005, the Company had borrowed $500,000 under this note. These
      short term note holders have agreed to extend their maturity date on a
      month-to-month basis until the Company raises sufficient funds to repay the
      notes.





Using
      the
      Black-Scholes option pricing model, the Company calculated the relative fair
      value of the warrant to purchase 277,777 shares of Company common stock to
      be
      $111,111. This relative fair value has been recorded as a reduction of the
      $1,000,000 liability and an addition to additional paid-in capital. This amount
      is being amortized to interest expense over the term of the debt instrument.
      The
      assumptions used in the relative fair value calculation are as follows: Company
      stock price on December 19, 2005 of $0.54 per share; exercise price of the
      warrants of $0.675 per share; three year term; volatility of 162.52%; annual
      rate of dividends of 0%; and a risk free interest rate of 4.5%.





**Note
      12 - Financial Instruments**




Laurus




The
        Notes
        are hybrid instruments which contain both freestanding derivative financial
        instruments and more than one embedded derivative feature which would
        individually warrant separate accounting as a derivative instrument under
        SFAS
        No. 133. The freestanding derivative financial instruments include the warrant,
        which was valued individually, and totaled $2,394,000 at the date of inception.
        The various embedded derivative features have been bundled together as a
        single,
        compound embedded derivative instrument that has been bifurcated from the
        debt
        host contract, referred to as the “Compound Embedded Derivative Liability”. The
        single compound embedded derivative features include the conversion feature
        within the notes, the conversion reset feature, the early redemption option
        and
        the interest rate adjustments. The value of the single compound embedded
        derivative liability was bifurcated from the debt host contract and recorded
        as
        a derivative liability, which resulted in a reduction of the initial carrying
        amount (as unamortized discount) of the notes. The unamortized discount is
        amortized to interest expense using the effective interest method over the
        life
        of the notes, or 36 months.
 
 In
        order
        to correct the consolidated financial statements so that they comply with
        US
        generally accepted accounting principles, the Company previously restated
        the
        consolidated financial statements as of December 31, 2004 to reclassify the
        Laurus warrants from additional paid in capital to liabilities and interest
        expense effective September 2004 to reflect that the registration rights
        agreement into which the Company entered in connection with its issuance
        of the
        warrants requires the Company to pay liquidated damages, which in some cases
        could exceed a reasonable discount for delivering unregistered shares and
        thus
        would require the warrants to be classified as a liability until the earlier
        of
        the date the warrants are exercised or expire. In accordance with EITF 00-19, *“Accounting
        for Derivative Financial Instruments Indexed To, and Potentially Settled
        In, a
        Company’s Own Stock”,* the
        Company has allocated a portion of the offering proceeds to the warrants
        based
        on their fair value. EITF 00-19 also requires that the Company revalue the
        warrants as a derivative instrument periodically to compute the value in
        connection with changes in the underlying stock price and other assumptions,
        with the change in value recorded as other expense or other income.
 
 In
        conjunction with the Laurus credit facility, Laurus was paid a fee of $749,000,
        in August 2004, and received a seven-year warrant to purchase up to 800,000
        shares of the Company’s common stock at prices ranging from $4.35 to $5.25 per
        share. The warrant, which is exercisable immediately, was valued at $2,394,000
        using a Black-Scholes option pricing model. The value of the warrant and
        the
        fees paid to Laurus were recorded as a discount to the note and are being
        amortized over the term of the loan using the effective interest
        method.
 
 In
        order
        to correct the financial statements so that they comply with US generally
        accepted accounting principles, the Company has restated the consolidated
        financial statements and the July 2005 amendment to the note was accounted
        for
        as an extinguishment of debt in accordance with EITF 96-19 *“Debtor’s
        Accounting for a Modification or Exchange of Debt Instruments.”* Accordingly, the unamortized discounts, of the warrants and the compound
        embedded derivatives, aggregating $4,954,482 and the fair value of the 333,333
        options to purchase Company common stock issued in connection with the
        amendment, amounting to approximately $772,000, were included in the Company’s
        determination of the debt extinguishment recorded in the third quarter of
        fiscal
        year 2005. The $244,000 aggregate gain from these transactions accounted
        for as
        an early extinguishment of debt included in other income (expense) for the
        year
        ended December 31, 2005.





108




The
        Laurus agreements were amended again in November 2005 and this amendment
        was
        treated as an early extinguishment of debt by the Company. The unamortized
        discounts aggregating $3,291,000 and the fair value of the warrant and embedded
        derivative liability amounting to $1,439,000 were included in the Company’s
        determination of the debt extinguishment recorded in the fourth quarter of
        fiscal 2005. The aggregate loss of $1,852,000 from these transactions were
        accounted for as an extinguishment of debt is included in other expenses
        for the
        year ended December 31, 2005.
 
 The
        Company determined the fair value of the warrants as of the following issuance
        dates:
 
 As
        of
        August 16, 2004, the Company used the Black-Scholes option-pricing model
        with
        the following assumptions: an expected life equal to the contractual term
        of the
        warrants (seven years); no dividends; a risk free rate of return of 3.89%;
        and a
        volatility of 150.0%. Using these assumptions, the Black-Scholes option-pricing
        model yielded a value of $1,199,000 for the warrants with a $4.35 exercise
        price, $598,000 for the warrants with a $4.65 exercise price, and $597,000
        for
        the warrants with a $5.25 exercise price for an aggregate fair value of
        $2,394,000.
 
 The
        Company performed the same calculation as of September 30, 2004 to revalue
        the
        warrants as of that date. In using the Black-Scholes option-pricing model,
        the
        Company used an
        expected life of 6.87 years; an underlying stock price of $3.45 per share;
        no
        dividends; a risk free rate of 3.79% and volatility of 150.0%. The resulting
        aggregate allocated value of the warrants as of September 30, 2004 equaled
        $2,622,000.
 
 The
        Company performed the same calculation as of December 31, 2004 to revalue
        the
        warrants as of that date. In using the Black-Scholes option-pricing model,
        the
        Company used an expected life of 6.62 years; an underlying stock price of
        $3.67
        per share; no dividends; a risk free rate of 3.94% and volatility of 150.0%.
        The
        resulting aggregate allocated value of the warrants as of December 31, 2004
        equaled $2,781,000. The change in fair value of the warrants resulted in
        an
        amount of $387,000 and included as part of financial instruments for the
        year
        ended December 31, 2004.
 
 For
        the
        year ended December 31, 2005, the Company performed the Black-Scholes
        calculation to revalue the warrants as of that date. In using this model,
        the
        Company used an expected life of 5.62 years; an underlying stock price of
        $0.53
        per share; no dividends; a risk free rate of 4.36% and volatility of 150.0%.
        The
        resulting aggregate allocated value of the warrants as of December 31, 2005
        equaled $349,000. The change in fair value of the warrants resulted in an
        amount
        of ($2,432,000) and is included as a charge to financial instruments for
        the
        year ended December 31, 2005.
 
 Upon
        the
        earlier of the warrant exercise or the expiration date, the warrant liability
        will be reclassified into stockholders’ equity. Until that time, the warrant
        liability will be recorded at fair value based on the methodology described
        above. Changes in the fair value during each period will be recorded as other
        income or other expense. Liquidated damages under the registration rights
        agreement will be expensed as incurred and will be included in operating
        expenses.
 
 The
        Company is also restating the consolidated financial statements to record
        an
        embedded derivative liability rather than the beneficial conversion feature
        previously recorded of $4,100,000 as of December 31, 2004.
 
 Using
        a
        probability-weighted discounted cash flow model, the fair value of the Compound
        Embedded Derivative Liability was computed at $4,265,000, $4,519,000 and
        $1,267,500 at August 16, 2004 (date of inception), December 31, 2004 and
        December 31, 2005, respectively. The model replicated the economics of the
        notes
        and applied different events based on various conditions likely to occur
        over
        the life of the note. Multiple scenarios were used in the model and the
        underlying assumptions below were applied. The value of this single, compound
        embedded derivative instrument was bifurcated from the debt host contract
        and
        recorded as a derivative liability which resulted in a reduction of the initial
        carrying amount (as unamortized discount) to the notional amounts of the
        convertible notes.





109





Sands




The
      Notes
      are hybrid instruments which contain both freestanding derivative financial
      instruments and more than one embedded derivative feature which would
      individually warrant separate accounting as a derivative instrument under SFAS
      No. 133. The freestanding derivative financial instruments include the warrant,
      which was valued individually, and totaled $1,563,000 at the date of inception.
      The various embedded derivative features have been bundled together as a single,
      compound embedded derivative instrument that has been bifurcated from the debt
      host contract, referred to as the “Compound Embedded Derivative Liability”. The
      single compound embedded derivative features include the conversion feature
      within the notes, the conversion reset feature, the early redemption option,
      and
      the interest rate adjustments. The value of the single compound embedded
      derivative liability was bifurcated from the debt host contract and recorded
      as
      a derivative liability, which resulted in a reduction of the initial carrying
      amount (as unamortized discount) of the notes. The unamortized discount is
      amortized to interest expense using the effective interest method over the
      life
      of the notes, or 12 months.


In
        order
        to correct the financial statements so that they comply with US generally
        accepted accounting principles, the Company previously restated the consolidated
        financial statements as of December 31, 2004 to reclassify the Sands warrants
        from additional paid in capital to liabilities and interest expense effective
        September 2004 to reflect the registration rights agreement into which the
        Company entered in connection with its issuance of the warrants requires
        the
        Company to pay liquidated damages, which in some cases could exceed a reasonable
        discount for delivering unregistered shares and thus would require the warrants
        to be classified as a liability until the earlier of the date the warrants
        are
        exercised or expire. In accordance with EITF 00-19, *“Accounting
        for Derivative Financial Instruments Indexed To, and Potentially Settled
        In, a
        Company’s Own Stock”* the
        Company revalued the warrants as a derivative instrument periodically to
        compute
        the value in connection with changes in the underlying stock price and other
        assumptions, with the change in value recorded as other expense or other
        income.
 
 In
        conjunction with the Sands transaction, in September 2004, Sands received
        a
        three-year warrant to purchase up to 400,000 shares of the Company’s common
        stock at $2.10 per share. The warrant, which is exercisable immediately,
        was
        valued at $1,742,000 using a Black-Scholes option pricing model. The value
        of
        the warrant was recorded as a discount to the note and is being amortized
        over
        the term of the loan using the effective interest method.
 
 The
        Company determined the fair value of the warrants as of the following issuance
        dates:
 
 As
        of
        September 22, 2004, the Company used the Black-Scholes option-pricing model
        with
        the following assumptions: an expected life equal to the contractual term
        of the
        warrants (three years); an underlying stock price of $3.30 per share; no
        dividends; a risk free rate of return of 2.78%; and a volatility of 150.0%.
        Using these assumptions, the Black-Scholes option-pricing model yielded a
        fair
        value of $1,742,000 for the warrants.
 
 The
        Company performed the same calculation as of September 30, 2004 to revalue
        the
        warrants as of that date. In using the Black-Scholes option-pricing model,
        the
        Company used an expected life of 3.00 years; an underlying stock price of
        $3.45
        per share; no dividends; a risk free rate of 2.89% and volatility of 150.0%.
        The
        resulting aggregate allocated value of the warrants as of September 30, 2004
        equaled $1,828,000.
 
 The
        Company performed the same calculation as of December 31, 2004 to revalue
        the
        warrants as of that date. In using the Black-Scholes option-pricing model,
        the
        Company used an expected life of 3.00 years; an underlying stock price of
        $3.67
        per share; no dividends; a risk free rate of 3.25% and volatility of 150.0%.
        The
        resulting aggregate allocated value of the warrants as of December 31, 2004
        equaled $1,788,000. The change in fair value of the warrants resulted in
        an
        amount of was $46,000 and is included as a component of financial instruments
        for the year ended December 31, 2004.
 
 For
        the
        year ended December 31, 2005, the Company performed the Black-Scholes
        calculation to revalue the warrants as of that date. In using this model,
        the
        Company used an expected life of 2.69 years; an underlying stock price of
        $0.53
        per share; no dividends; a risk free rate of 4.37% and volatility of 150.0%.
        The
        resulting aggregate allocated value of the warrants as of December 31, 2005
        equaled $142,000. The change in fair value of the warrants resulted in a
        decrease of the liability of ($1,646,000) and is included as a component
        of
        financial instruments for the year ended December 31, 2005.
 
 Upon
        the
        earlier of the warrant exercise or the expiration date, the warrant liability
        will be reclassified into stockholders’ equity. Until that time, the warrant
        liability will be recorded at fair value based on the methodology described
        above. Changes in the fair value during each period will be recorded as other
        income or other expense. Liquidated damages under the registration rights
        agreement will be expensed as incurred and will be included in operating
        expenses.




110




The
        Company is also restating the consolidated financial statements to record
        embedded derivatives rather than the beneficial conversion features previously
        recorded of $571,000 as of September 22, 2004.
 
 Using
        a
        probability-weighted discounted cash flow model, the fair value of the Compound
        Embedded Derivative Liability was computed at $1,563,000 and $1,428,000 at
        September 22, 2004 (date of inception) and December 31, 2004, respectively.
        The
        note matured on September 22, 2005 and a new note was executed with Sands.
        Using
        the probability-weighted discounted cash flow model, the fair value of the
        Compound Embedded Derivative Liability was computed at $962,000 and $889,000
        at
        September 22, 2005 (date of inception) and December 31, 2005, respectively.
        The
        model replicated the economics of the notes and applied different events
        based
        on various conditions likely to occur over the life of the note. Multiple
        scenarios were used in the model and the underlying assumptions below were
        applied. The value of this single, compound embedded derivative instrument
        was
        bifurcated from the debt host contract and recorded as a derivative liability
        which resulted in a reduction of the initial carrying amount (as unamortized
        discount) to the notional amounts of the Convertible Notes.




Probability-Weighted
      Expected Cash Flow
      Methodology


LiabilityDecember
                  31,
              
              
              December
                  31,Assumption
              
              
              2005
              
              
              2004Risk-free
                  interest rate
              
              
              4.41
              %
              
              3.25
              %Prime
                  Rate
              
              
              7.25
              %
              
              5.25
              %Increasing
                  .25% each quarterRegistration
                  Default
              
              
              0
              %
              
              0
              %Increasing
                  1% monthly up to 5%Default
                  status
              
              
              5
              %
              
              5
              %Increasing
                  .1% monthlyAlternative
                  financing available
              
              
              0
              %
              
              0
              %Increasing
                  2.5% monthly up to 25%Trading
                  volume, gross 22 day volume
              
              $
              541,800
              
              $
              363,610Monthly
                  increase
              
              
              1
              %
              
              2
              %Annual
                  growth rate of stock price
              
              
              31.485
              %
              
              31.725
              %Future
                  projected volatility
              
              
              150
              %
              
              150
              %Reset
                  Provisions occurring
              
              
              50
              %
              
              40
              %Weighted
                  Average Conversion Reset Price
              
              
              0.59
              
              
              1.52





111


**Note
      13 - Long Term Debt**





Long-term
                  debt consisted of the following:December
                  31,
              
              December
                  31,2005
              
              2004Secured
                  convertible term note with a maturity date of August 16, 2007 unless
                  converted into common stock at the note holder's option. The initial
                  conversion price is $2.10 per share, however, was reduced to $1.00
                  per
                  share on November 30, 2005. Interest accrues at a rate of prime
                  plus one
                  percent. As of December 31, 2005, the interest rate on this note
                  was
                  8.25%. See note 10 - Line of credit, for further description of this
                  transaction.
              
              $
              651,305
              
              $
              5,000,000Convertible
                  line of credit note with a maturity date of June 6, 2009 unless
                  converted
                  into common stock at the Company or the note holder’s option. Interest
                  accrues at 7% per annum. The original conversion price to shares
                  of common
                  stock is equal to 75% of the average trading price for the prior
                  ten
                  trading days. In September 2004, the price was reset to $1.58 per
                  share. A
                  warrant to purchase 277,778 shares of Company common stock was
                  also
                  issued. The exercise price of the warrant is $2.10 per share and
                  the
                  warrant expires on June 6, 2009. An allocation of the relative
                  fair value
                  of the warrant and the debt instrument was performed. The relative
                  fair
                  value of the warrant was determined to be $500,000 and is being
                  amortized
                  to interest expense over the life of the note. A discount on debt
                  issued
                  of $1,500,000 was recorded in September 2004 based on the reset
                  conversion
                  terms.
              
              
              2,000,000
              
              
              2,000,000Senior
                  subordinated secured convertible promissory note with a maturity
                  date of
                  January 1, 2007 unless converted into common stock at the note
                  holder's
                  option. Interest accrues at 12% per annum. A warrant to purchase
                  400,000
                  shares of Company common stock was also issued. The exercise price
                  of the
                  warrant is $2.10 per share and the warrant expires on December
                  15,
                  2009.
              
              
              1,080,000
              
              
              -Notes
                  payable under capital lease obligations payable to various finance
                  companies for equipment at varying rates of interest, ranging from
                  18% to
                  33% as of December 31, 2005, and have maturity dates through 2008.
              
              
              148,393
              
              
              221,9493,879,698
              
              
              7,221,949Relative
                  fair values, at issuance, ascribed to warrants associated with
                  the above
                  debt agreements. This amount is being accreted to the debt instrument
                  over
                  the 5 year term of the related debt agreement.
              
              
              (341,662
              )
              
              (441,666
              )Subtotal
              
              
              3,538,036
              
              
              6,780,283Less:
                  Current portion of long-term debt, including obligations under
                  capital
                  leases of $104,342 and current portion of long term debt of $390,780
                  as of
                  December 31, 2005 and current portion of capital leases of $120,834
                  as of
                  December 31, 2004.
              
              
              (495,122
              )
              
              (120,834
              )$
              3,042,914
              
              $
              6,659,449
  Future
                  annual payments of long-term debt is as follows:Years
                  Ending December 31,2005
              
              $
              -
              
              $
              120,8342006
              
              
              495,122
              
              
              87,5532007
              
              
              1,373,756
              
              
              5,013,5622008
              
              
              10,820
              
              
              -2009
              
              
              2,000,000
              
              
              2,000,000$
              3,879,698
              
              $
              7,221,949





112


Obligations
      under Capital Leases





The
      Company has entered into various capital leases that are collateralized by
      computer equipment and a trade show booth with an original cost of approximately
      $411,000.





The
      following schedule lists future minimum lease payments under the capital leases
      with their present value as of December 31, 2005:






December
                31, 2005
            
            December
                31, 2004Years
                Ending December 31,2005
            
            $
            -
            
            $
            160,2312006
            
            
            122,125
            
            
            98,9072007
            
            
            37,451
            
            
            14,2332008
            
            
            11,523
            
            
            -171,099
            
            
            273,371Less:
                Amount representing interest
            
            
            (22,706
            )
            
            (51,422
            )$
            148,393
            
            $
            221,949




During
      2005, the Company recorded depreciation expense related to equipment under
      capital leases of approximately $105,000.





On
      October 29, 2003, the Company made arrangements to obtain a $2.0 million
      Unsecured Convertible Line of Credit Note. The terms of this note provide for
      interest accruing on advances at 7% per annum with a maturity date of October
      28, 2008, unless converted into Common Stock at the Company’s or the Note
      holder’s option. In February 2004, the Company borrowed the entire $2.0 million
      available under this line of credit. In May 2004, pursuant to the complete
      conversion of this unsecured convertible line of credit note, the participating
      investor received 1,111,111 shares of our common stock, plus interest. Due
      to an
      adjustment in the conversion price in September 2004, participating investors
      received an additional 158,730 shares of common stock. As a result of the
      initial conversion and the adjustment, we recorded a beneficial conversion
      charge of $1.2 million. Further in May 2004, we raised an additional $2.0
      million pursuant to a new five-year unsecured promissory note with the same
      investor. In June 2004, we replaced the May 2004 note by issuing a five-year
      $2.0 million unsecured convertible line of credit note with the same investor.
      The note accrues at an annual interest rate of 7%, and the conversion price
      of
      the shares of common stock issuable under the note is equal to $1.58 per share.
      In addition, such investor received a warrant to purchase 277,778 shares of
      our
      common stock at an exercise price of $1.58 per share. This warrant expires
      in
      June 2009. This note also contains beneficial conversion features, and as a
      result, we recorded a beneficial conversion charge of $1.5 million which is
      being amortized into income over the life of the debt instrument. Additionally,
      using the Black-Scholes option pricing model, we determined the fair value
      of
      the warrant to be $0.5 million. The Company valued the warrant in accordance
      with EITF 00-27 using the Black-Scholes option pricing model and the following
      assumptions: contractual term of five years, an average risk free interest
      rate
      of 1.33%, a dividend yield of 0%, and volatility of 138.62%. The relative fair
      value attributed to the warrant issued is amortized over the note’s maturity
      period (60 months) as interest expense.





In
      September 2004, the Company issued to Sands Brothers Venture Capital LLC, Sands
      Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
      (collectively, “Sands”) three subordinated secured convertible promissory notes
      equaling $1.0 million (the “Notes”), each with an annual interest rate of 8%
      expiring September 22, 2005. The Notes were secured by substantially all
      corporate assets, but subordinate to Laurus. The Notes were convertible into
      shares of the Company’s common stock at the election of Sands at any time
      following the consummation of a convertible debt or equity financing with gross
      proceeds of $5 million or greater (a “Qualified Financing”). The Company also
      issued Sands three common stock purchase warrants (the “Warrants”) providing
      Sands with the right to purchase 400,000 shares of the Company’s common stock.
      The exercise price of the shares of the Company’s common stock issuable upon
      exercise of the Warrants shall be equal to a price per share of common stock
      equal to forty percent (40%) of the price of the securities issued pursuant
      to a
      Qualified Financing. If no Qualified Financing has been consummated by September
      8, 2005, then Sands may elect to exercise the Warrants at a fixed conversion
      price of $2.10 per share. The latest that the Warrants may expire is September
      8, 2008.





113


On
      September 22, 2005, upon maturity of the September 2004 notes, the Company
      issued to Sands three new subordinated secured convertible promissory notes
      equaling $1.080 million, each with an annual interest rate of 12% expiring
      on
      January 1, 2007. The Company also issued Sands three common stock purchase
      warrants (the “Warrants”) providing Sands with the right to purchase 400,000
      shares of the Company’s common stock. The exercise price of the shares of the
      Company’s common stock issuable upon exercise of the Warrants shall be equal to
      a price per share of common stock equal to one hundred twenty percent (120%)
      of
      the price of the securities issued pursuant to a Qualified Financing. If no
      Qualified Financing has been consummated by December 15, 2006, then Sands may
      elect to exercise the Warrants at a fixed conversion price of $2.10 per share.
      The latest that the Warrants may expire is December 15, 2009.




The
      Sands notes
      contain the following default provisions:




·
            failure
                to pay interest, principal payments or other fees when
                due;


·
            default
                in the payment when due of any obligation in excess of
                $100,000;


·
            default
                of covenant in notes remains uncured for 30
                days;


·
            breach
                by us of any material representation or warranty made in the notes
                or in
                any agreements made in connection
                therewith;


·
            the
                notes and agreements are no longer a binding obligation of the Company
                or
                any lien created under the notes and agreements is not valid and
                perfected;


·
            judgments
                against the Company in excess of $100,000 are not vacated, satisfied
                or
                discharged within 30 days;


·
            violation
                of any law or regulation for more than 30 days after written notice
                and
                has a material adverse effect on the Company;
                and


·
            suspension
                of Company operations and such suspension would reasonably be expected
                to
                have a material adverse effect on the
                Company.






In
      an
      event of default under the Sands notes, Sands may declare all obligations
      immediately due and payable and will have the right to take possession of the
      Collateral. Further, if an
      event
      of default
      occurs and is continuing beyond any applicable grace period, theunpaid
      balance of principal and interest from the date of default shall begin and
      continue to accrue until the payment in full of all unpaid principal and accrued
      interest hereunder at a default rate equal to 13%. As of April 17, 2006, the
      Company believes that it is in compliance with all provisions of the Sands
      notes.




**Note
      14 - Income Taxes**





The
      Company provides for federal and state income taxes in accordance with current
      rates applied to accounting income before taxes. The provision for income taxes
      is as follows:





Years
                  ended December 31,2005
              
              2004Current
                  - Federal
              
              $
              -
              
              $
              -Current
                  - State
              
              
              -
              
              
              -Deferred
                  - Federal
              
              
              -
              
              
              147,800Deferred
                  - State
              
              
              -
              
              
              43,000$
              -
              
              $
              190,800


The
      Company’s provision for income taxes is based on estimated effective annual
      income tax rates. The provision may differ from income taxes currently payable
      because certain items of income and expense are recognized in different periods
      for financial statement purposes than for tax return purposes.





The
      company has $10.0 million of capital loss carry-forwards expiring in 2010 and
      $12.5 million of net operating loss carry-forwards for both federal and state
      purposes expiring between 2023 and 2025.





114


December
                  31,2005
              
              
              2004(as
                  Restated)
              
              
              (as
                  Restated)Net
                  operating losses
              
              $
              4,997,000
              
              $
              1,880,000Capital
                loss
                carryforwards
              
              
              4,000,000
              
              
              -Accounts
                  receivable
              
              
              196,000
              
              
              84,000Property
                  and equipment
              
              
              (1,000
              )
              
              (16,000
              )Accounts
                  payable and accrued expenses
              
              
              3,000
              
              
              32,000Long-term
                  debt
              
              
              (143,000
              )
              
              1,743,000Goodwill
              
              
              (34,000
              )
              
              2,779,000Intangible
                  assets
              
              
              (517,000
              )
              
              620,000Stock
                based compensation
              
              
              605,000
              
              
              605,000$
              9,106,000
              
              
              7,727,000Valuation
                  allowance
              
              
              (9,106,000
              )
              
              (7,727,000
              )$
              -
              
              $
              -





The
      Company evaluates the amount of deferred tax assets that are recorded against
      expected taxable income over its forecasting cycle which is currently two years.
      As a result of this evaluation, the Company has recorded a valuation allowance
      of $9,106,000 and $7,727,000 for the years ended December 31, 2005 and 2004,
      respectively, representing a current year change in the valuation allowance
      of
      ($1,128,000). This allowance was recorded because, based on the weight of
      available evidence, it is more likely than not that some, or all, of the
      deferred tax asset may not be realized.





Income
      taxes computed at the federal statutory rate differ from the amounts provided
      as
      follows:


For
                  the year ended December 31,2005
              
              
              2004(as
                  Restated)Provision
                    for Federal taxes at statutory rate (34%)
              
              
              (34.0
              )%
              
              (34.0
              )%State
                  taxes, net of Federal benefit
              
              
              (4.0
              )%
              
              (2.9
              )%Permanent
                    difference due to non-deductible items
              
              
              (11.1
              )%
              
              17.1
              %Foreign
                  income taxed at different rates
              
              
              0.0
              %
              
              0.4
              %Valuation
                    allowance applied against income tax benefit
              
              
              26.9
              %
              
              20.0
              %Income
                  tax provision
              
              
              0.0
              %
              
              0.6
              %


**Note
      15 - Common Stock Warrants**





On
      June
      7, 2004, the Company granted a warrant to purchase 277,778 shares of the
      Company’s common stock to the Taurus Advisory Group LLC in connection with the
      issuance of an unsecured convertible line of credit note at an exercise price
      of
      $2.10 per share and an expiration date of June 6, 2009. See Note 13 for further
      discussion regarding this transaction.





On
      August
      16, 2004, the Company granted a warrant to purchase an aggregate of 800,000
      shares of the Company’s common stock to Laurus Master Fund, Ltd. in connection
      with a secured convertible term note, a secured revolving note, and a secured
      convertible minimum borrowing note. The first 400,000 shares acquired under
      the
      warrant have an exercise price of $4.35 per share, the next 200,000 shares
      acquired have an exercise price of $4.65 per share, and the final 200,000 shares
      have an exercise price of $5.25 per share. The expiration date of the warrant
      is
      August 16, 2011. See Note 10 for further discussion of this
      transaction.





115


On
      September 22, 2004, the Company granted a warrant to purchase an aggregate
      of
      400,000 shares of the Company’s common stock to three affiliates of Sands
      Brothers Venture Capital. Sands Brothers Venture Capital III LLC received a
      warrant to purchase 340,000 shares of Company common stock, Sands Brothers
      Venture Capital LLC received a warrant to purchase 20,000 shares of Company
      common stock, and Sands Brothers Venture Capital IV LLC received a warrant
      to
      purchase 40,000 shares of Company common stock. Each warrant provides for an
      exercise price equal to forty percent (40%) of the price per share of common
      stock received by the Company in connection with a financing in excess of a
      predetermined amount. In the event that the Company does not consummate a
      financing at this level on or before September 7, 2005, the exercise price
      adjusts to $2.10 per share. The warrants expire on September 7, 2008. See Note
      13 for further discussion of this transaction.





On
      September 22, 2005, the Company granted a warrant to purchase an aggregate
      of
      400,000 shares of the Company’s common stock to three affiliates of Sands
      Brothers Venture Capital. Sands Brothers Venture Capital III LLC received a
      warrant to purchase 340,000 shares of Company common stock, Sands Brothers
      Venture Capital LLC received a warrant to purchase 20,000 shares of Company
      common stock, and Sands Brothers Venture Capital IV LLC received a warrant
      to
      purchase 40,000 shares of Company common stock. Each warrant provides for an
      exercise price equal to forty percent (40%) of the price per share of Common
      Stock received by the Company in connection with the first Qualified Financing
      occurring after the date of the warrant agreement. In the event the Company
      does
      not consummate a Qualified Financing on or before December 15, 2006, the
      conversion price adjusts to $2.10 per share. The warrants expire on December
      15,
      2009. See Note 13 for further discussion of the transaction.





On
      December 19, 2005, the Company granted a warrant to purchase an aggregate of
      277,777 shares of the Company’s common stock to Taurus Advisory Group, LLC. The
      warrant has an exercise price of $0.675 per share. The warrant expires in
      December 2008. See Note 11 for further discussion of this
      transaction.





**Note
      16 - Stock Based Compensation**





The
      2003
      Incentive Plan (“2003 Plan”) authorizes the issuance of up to 6,666,667 shares
      of common stock for issuance upon exercise of options. It also authorizes the
      issuance of stock appreciation rights. The options granted may be a combination
      of both incentive and nonstatutory options, generally
      vest over a three year period from the date of grant, and expire ten years
      from
      the date of grant.





To
      the
      extent that CSI derives a tax benefit from options exercised by employees,
      such
      benefit will be credited to additional paid-in capital when realized on the
      Company’s income tax return. There were no tax benefits realized by the Company
      during 2005 or 2004.





The
      following summarizes the stock option transactions under the 2003 Plan during
      2005:


Weighted
                  averageShares
              
              exercise
                  priceOptions
                  outstanding at December 31, 2004
              
              
              2,751,063
              
              $
              0.15Options
                  granted
              
              
              2,694,500
              
              
              0.82Options
                  exercised
              
              
              -
              
              
              -Options
                  canceled
              
              
              (562,449
              )
              
              2.71Options
                  outstanding at December 31, 2005
              
              
              4,883,114
              
              $
              1.43





The
      following table summarizes information concerning outstanding and exercisable
      Company common stock options at December 31, 2005:


Weighted
              
              Weighted
                  average
              
              
              
              WeightedRange
                  of exercise
              
              Options
              
              average
              
              remaining
              
              Options
              
              averageprices
              
              outstanding
              
              exercise
                  price
              
              contractual
                  life
              
              exercisable
              
              exercise
                  price$0.600
              
              
              130,000
              
              $
              0.600
              
              
              10.0
              
              
              -
              
              $
              0.600$0.825-0.830
              
              
              3,142,899
              
              
              0.830
              
              
              9.7
              
              
              593,399
              
              
              0.825$2.475-3.45
              
              
              1,610,215
              
              
              2.680
              
              
              8.3
              
              
              542,178
              
              
              2.6804,883,114
              
              
              
              
              
              
              
              
              1,135,577





On
      October 18, 2004, options to purchase 593,399 shares of our common stock were
      granted to several employees below fair market value at an exercise price of
      $0.825 per share, when the fair market value on date of grant was $3.15. These
      options are non-qualified stock options, are all immediately vested, and expire
      ten years from the date of grant. As a result of this issuance of stock options
      at a price below fair market value on the date of grant, the Company has
      recorded a stock-based compensation charge of approximately $1,380,000 during
      the fourth quarter of 2004.





**Note
      17 - Loss Per Share**




Basic
      loss per share is computed on the basis of the weighted average number of common
      shares outstanding. Diluted loss per share is computed on the basis of the
      weighted average number of common shares outstanding plus the effect of
      outstanding stock options using the “treasury stock” method.




Basic
      and
      diluted loss per share were determined as follows:




For
                  the years ended December 31,2005
              
              
              2004(as
                  Restated)Net
                  loss from continuing operations (A)
              
              $
              (4,014,302
              )
              $
              (22,697,298
              )Net
                  loss from discontinued operations (B)
              
              $
              (1,103,971
              )
              $
              (12,650,908
              )Net
                  loss (C)
              
              $
              (5,118,273
              )
              $
              (35,348,206
              )Weighted
                  average outstanding shares of common stock (D)
              
              
              52,919,340
              
              
              46,548,065Common
                  stock and common stock equivalents (E)
              
              
              52,919,340
              
              
              46,548,065
  Basic
                  loss per share:From
                  continuing operations (A/D)
              
              $
              (0.08
              )
              $
              (0.49
              )From
                  discontinued operations (B/D)
              
              $
              (0.02
              )
              $
              (0.27
              )Net
                  loss per share (C/D)
              
              $
              (0.10
              )
              $
              (0.76
              )Diluted
                  loss per share:From
                  continuing operations (A/E)
              
              $
              (0.08
              )
              $
              (0.49
              )From
                  discontinued operations (B/E)
              
              $
              (0.02
              )
              $
              (0.27
              )Net
                  loss per share (C/E)
              
              $
              (0.10
              )
              $
              (0.76
              )


For
      the
      year ended December 31, 2005, 4,883,114 shares attributable to outstanding
      stock
      options were excluded from the calculation of diluted loss per share because
      the
      effect was antidilutive. Additionally, the effect of 2,155,555 warrants which
      were issued on June 7, 2004, August 16, 2004, September 22, 2004, September
      22,
      2005 and December 19, 2005 were excluded from the calculation of diluted loss
      per share for the years ended December 31, 2005 and December 31, 2004 because
      the effect was antidilutive.





**Note
      18 - Major Customers**





During
      2005, the Company had sales to two major customers, LEC, a related party (13.4%)
      and Bank of America (27.2%), which totaled approximately $11,232,000. Amounts
      due from these customers included in accounts receivable were approximately
      $885,000 at December 31, 2005. As of December 31, 2005, LEC and Bank of America
      accounted for approximately 14.0% and 7.7% of the Company’s accounts receivable
      balance, respectively.





116


During
      2004, the Company had sales to two major customers, LEC, a related party (16.1%)
      and Bank of America (16.7%), which totaled approximately $7,828,000. Amounts
      due
      from these customers included in accounts receivable were approximately
      $1,292,000 at December 31, 2004. As of December 31, 2004, LEC and Bank of
      America accounted for approximately 19.3% and 10.4% of the Company’s accounts
      receivable balance, respectively.





**Note
      19 - Employee Benefit Plan**





The
      Company has a defined contribution profit sharing plan under Section 401(k)
      of
      the Internal Revenue Code that covers substantially all employees. Eligible
      employees may contribute on a tax deferred basis a percentage of compensation
      up
      to the maximum allowable amount. Although the plan does not require a matching
      contribution by the Company, the Company may make a contribution. The Company’s
      contributions to the plan for the years ended December 31, 2005 and 2004 were
      approximately $81,000 and $44,000, respectively.





**Note
      20 - Commitments and Contingencies**





***Legal
      Proceedings***





On
      August
      1, 2005, Sridhar Bhupatiraju and Scosys, Inc. commenced legal action against
      the
      Company in the Superior Court of New Jersey. The complaint alleges, among other
      things, the Company’s failure to make certain payments pursuant to an asset
      purchase agreement with Scosys, Inc. and the Company’s failure to make certain
      payments to Sridhar Bhupatiraju in accordance with his employment agreement
      with
      the Company. The plaintiffs are seeking unspecified compensatory damages,
      punitive damages, fees and other costs. On September 30, 2005, the Company
      filed
      its answer to complaint and third-party complaint against Scorpio Systems,
      alleging that Mr. Bhupatiraju embarked on a scheme to circumvent his contractual
      obligations under the asset purchase agreement, his non-compete agreement with
      the Company, and in violation of his duties of loyalty and fidelity to his
      employer (the Company) via Scorpio Systems, among other things. Notwithstanding
      Mr. Bhupatiraju’s contractual obligations, the Company alleges that he sold the
      assets of Scosys while at the same time operating and/or owning a competing
      business, Scorpio Systems. Management believes the suit against the Company
      to
      be without merit and intends to vigorously defend the Company against this
      action and pursue its countersuit.





***Employment
      Agreements*** ****





Scott
      Newman, our President and Chief Executive Officer, agreed to a five-year
      employment agreement dated as of March 26, 2004. The agreement provides for
      an
      annual salary to Mr. Newman of $500,000 and an annual bonus to be awarded by
      the
      Compensation Committee. The agreement also provides for health, life and
      disability insurance, as well as a monthly car allowance. In the event that
      Mr.
      Newman’s employment is terminated other than with good cause, he will receive a
      lump sum payment of 2.99 times his base salary.





Glenn
      Peipert, Executive Vice President and Chief Operating Officer, agreed to a
      five-year employment agreement dated as of March 26, 2004. The agreement
      provides for an annual salary to Mr. Peipert of $375,000 and an annual bonus
      to
      be awarded by the Compensation Committee. The agreement also provides for
      health, life and disability insurance, as well as a monthly car allowance.
      In
      the event that Mr. Peipert’s employment is terminated other than with good
      cause, he will receive a lump sum payment of 2.99 times his base
      salary.





Mitchell
      Peipert, Vice President, Chief Financial Officer, Treasurer and Secretary,
      agreed to a three-year employment agreement dated as of March 26, 2004. The
      agreement provides for an annual salary to Mr. Peipert of $200,000 and an annual
      bonus to be awarded by the Compensation Committee. In August 2005, Mr. Peipert
      received an increase to his annual salary to $225,000. The agreement also
      provides for health, life and disability insurance, as well as a monthly car
      allowance. In the event that Mr. Peipert’s employment is terminated other than
      with good cause, he will receive a lump sum payment of 2.99 times his base
      salary.





117


Robert
      C.
      DeLeeuw, Senior Vice President and President of our wholly owned subsidiary,
      DeLeeuw Associates, LLC, agreed to a three-year employment agreement dated
      as of
      February 27, 2004. The agreement provides for an annual salary to Mr. DeLeeuw
      of
      $350,000 and an annual bonus to be awarded by the Compensation Committee. The
      agreement also provides for health, life and disability insurance. In the event
      that Mr. DeLeeuw’s employment is terminated other than with good cause, he will
      receive a lump sum payment of the longer of (1) one year's base salary or (2)
      the period from the date of termination through the expiration
      date.





William
      McKnight, Senior Vice President - Data Warehousing, agreed to a three-year
      employment agreement dated as of July 22, 2005. The agreement provides for
      an
      annual salary to Mr. McKnight of $250,000 and an annual bonus to be awarded
      by
      the Compensation Committee. The agreement also provides for health, life and
      disability insurance. In the event that Mr. McKnight’s employment is terminated
      other than with good cause, he will receive a lump sum payment of the longer
      of
      (1) one year's base salary or (2) the period from the date of termination
      through the expiration date.





*Lease
      Commitments*





The
      Company's corporate headquarters are located at 100 Eagle Rock Avenue, East
      Hanover, New Jersey 07936, where it operates under an amended lease agreement
      expiring December 31, 2010.  Our monthly rent with respect to our East
      Hanover, New Jersey facility is $26,290. In addition to minimum rentals,
      the Company is liable for its proportionate share of real estate taxes and
      operating expenses, as defined.  DeLeeuw Associates, LLC has an office at
      Suite 1460, Charlotte Plaza, 201 South College Street, Charlotte, North Carolina
      28244.  DeLeeuw leases this space which had an original expiration date of
      December 31, 2005, but has been extended until December 31, 2010.  Our
      monthly rent with respect to our Charlotte, North Carolina facility is
      $2,382.





The
      Company also leases office space at 11 Penn Plaza, New York, NY 10001. The
      monthly lease payment is approximately $5,000 per month. The current lease
      expiration date is March 31, 2006, however, this has been extended until March
      31, 2007. The monthly lease payment during the lease extension period is
      approximately $4,300 per month.




Rent
      expense, including automobile rentals, totaled approximately $462,000 and
      $420,000 in 2005 and 2004, respectively.





The
      Company is committed under several operating leases for automobiles that expire
      during 2007.





Future
      minimum lease payments due under all operating lease agreements as of December
      31, 2005 are as follows:


Years
                  Ending December 31
              
              Office
              
              Automobiles
              
              Total2006
              
              $
              414,788
              
              $
              48,729
              
              $
              463,5172007
              
              
              358,178
              
              
              17,161
              
              
              375,3392008
              
              
              354,694
              
              
              –
              
              
              354,6942009
              
              
              355,931
              
              
              –
              
              
              355,9312010
              
              
              373,821
              
              
              –
              
              
              373,821Thereafter
              
              
              –
              
              
              0
              
              
              –$
              1,857,412
              
              $
              65,890
              
              $
              1,923,302







**Note
      21 - Related Party Transactions**





In
      November 2003, the Company executed an Independent Contractor Agreement with
      LEC, whereby the Company agreed to be a subcontractor for LEC, and to provide
      consultants as required to LEC. In return for these services, the Company
      receives a fee from LEC based on the hourly rates established for consultants
      subcontracted to LEC. In May 2004, the Company acquired 49% of all issued and
      outstanding shares of common stock of LEC. For the years ended December 31,
      2005
      and 2004, the Company invoiced LEC $3,731,198 and $3,837,065, respectively,
      for
      the services of consultants subcontracted to LEC by the Company. As of December
      31, 2005 and 2004, the Company had accounts receivable due from LEC of
      approximately $570,000 and $781,000, respectively. There are no known collection
      problems with respect to LEC. The majority of their billing is derived from
      Fortune 1000 clients. The collection process is slow as these clients require
      separate approval on their own internal systems, which extends the payment
      cycle. The Company feels confident in the collectibility of these accounts
      receivable as the majority of the revenues from LEC derive from Fortune 1000
      clients.





118


On
      November 8, 2004, Mr. Newman entered into a stock purchase agreement with a
      private investor, CMKX-treme, Inc.  Pursuant to the agreement, CMKX-treme,
      Inc. agreed to purchase 188,889 shares of common stock for a purchase price
      of
      $250,000.  As of April 2, 2006, the shares have not been issued to
      CMKX-treme, Inc. because it has not yet remitted payment for the
      shares.





On
      November 8, 2004, Mr. Peipert entered into a stock purchase agreement with
      a
      private investor, CMKX-treme, Inc.  Pursuant to the agreement, CMKX-treme,
      Inc. agreed to purchase 377,778 shares of common stock for a purchase price
      of
      $500,000.  As of June 9, 2005, CMKX-treme, Inc. remitted final payment for
      the shares.





On
      November 10, 2004, the Company and Dr. Michael Mitchell, the former President,
      Chief Executive Officer and sole director of LCS, executed a one-year consulting
      agreement whereby Dr. Mitchell would perform certain consulting services on
      behalf of the Company. Dr. Mitchell will receive an aggregate amount of $250,000
      as compensation for services provided to the Company. During 2005, an aggregate
      amount of $175,000 was paid to Mr. Mitchell for services provided under this
      consulting agreement.





As
      of
      April 7, 2006, Mr. Scott Newman, President, Chief Executive Officer and
      Chairman, Mr. Glenn Peipert, Executive Vice President, Chief Operating Officer
      and Director, and Mr. Robert C. DeLeeuw, Senior Vice President, have agreed
      to
      personally support our cash requirements to enable us to fulfill our obligations
      through June 1, 2007, to the extent necessary, up to a maximum amount of
      $1,500,000, based upon their ability to sell their Company common stock. Mr.
      Newman guaranties up to $858,000, Mr. Peipert guaranties up to $409,500 and
      Mr.
      DeLeeuw guaranties approximately $232,500. We believe that our reliance on
      such
      commitments is reasonable and that Messrs. Newman, Peipert and DeLeeuw have
      sufficient liquidity and net worth to honor such commitments. We believe that
      these written commitments provide us with the legal right to request and receive
      such advances from any of these officers. Any loan by Messrs. Newman, Peipert
      and DeLeeuw to the Company would bear interest at 8% per annum. As of December
      31, 2005, Mr. Newman’s outstanding loan balance to the Company was $900,000, and
      Mr. Peipert’s outstanding loan balance to the Company was $900,000. The
      unsecured loans by Mr. Newman and Mr. Peipert each accrue interest at a simple
      rate of 8% per annum, and each has a term expiring on April 30, 2007.





**Note
      22 - Restatements of Previously Reported Financial
      Information**





During
      2004, the Company consummated financing transactions with Laurus and with Sands.
      The documents included, among other things, convertible notes, freestanding
      warrant agreements and registration rights agreements. The warrant agreements
      are subject to the registration rights agreement which require that the Company
      register the shares within a specified period of time and, in the event this
      is
      not done, provides for significant liquidated damages. In accordance with EITF
      00-19 “Accounting for Derivative Financial Instruments Indexed to, and
      Potentially Settled in, a Company’s Own Stock”, the Company previously recorded
      a liability for these warrants. However, although the convertible notes are
      also
      subject to the registration rights agreement and are not “conventionally
      convertible”, the Company has not previously recorded a liability for the
      derivative associated with the conversion feature.





Additionally,
      in July 2005, the Company renegotiated its financing with Laurus. As part of
      this transaction, the Company repaid $4,300,000 to Laurus, issued an option
      to
      purchase Company stock at $0.015 per share, and increased the availability
      under
      the revolving line of credit by $500,000. Since future cash flows under the
      new
      agreement with Laurus are more than 10% different than under the old agreement
      with Laurus, it has been determined that this transaction should have been
      accounted for as an early extinguishment of debt as opposed to a modification
      of
      existing debt.





119


The
      Board
      of Directors of the Company determined that the Company would restate its
      financial statements for the three and nine months ended September 30, 2004,
      the
      year ended December 31, 2004, the three months ended March 31, 2005, the three
      and six months ended June 30, 2005 and the three and nine months ended September
      30, 2005 as appropriate to properly account for the above
      transactions.





CONVERSION
                  SERVICES INTERNATIONAL,
                  INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  BALANCE
                  SHEETSeptember
                  30,2004Previously
              
              RestatementReported
                  (1)
              
              Adjustment
              
              Restated
                  TotalASSETSCURRENT
                  ASSETSCash
              
              $
              882,986
              
              $
              –
              
              $
              882,986Restricted
                  cash
              
              
              83,375
              
              
              –
              
              
              83,375Accounts
                  receivable, net of allowance for doubtful accounts of
                  $150,755
              
              
              4,216,357
              
              
              –
              
              
              4,216,357Accounts
                  receivable from related parties
              
              
              900,942
              
              
              –
              
              
              900,942Prepaid
                  expenses
              
              
              188,513
              
              
              –
              
              
              188,513Costs
                  in excess of billings
              
              
              139,565
              
              
              –
              
              
              139,565Deferred
                  tax asset
              
              
              63,938
              
              
              –
              
              
              63,938Total
                  Current Assets
              
              
              6,475,676
              
              
              –
              
              
              6,475,676PROPERTY
                  AND EQUIPMENT, at cost, net
              
              
              697,399
              
              
              –
              
              
              697,399OTHER
                  ASSETSRestricted
                  Cash
              
              
              4,251,000
              
              
              –
              
              
              4,251,000Due
                  from stockholders, including accrued interest of $25,696
              
              
              207,719
              
              
              –
              
              
              207,719Goodwill
              
              
              27,327,899
              
              
              –
              
              
              27,327,899Intangible
                  assets, net of accumulated amortization of $548,065
              
              
              5,140,749
              
              
              –
              
              
              5,140,749Deferred
                  Financing costs, net of accumulated amortization of
                  $30,881
              
              
              850,539
              
              
              –
              
              
              850,539Discount
                  on Debt issued , net of accumulated amortization of $248,122
                  (2)
              
              
              9,464,397
              
              
              (554,029
              )
              
              8,910,368Equity
                  investments
              
              
              113,876
              
              
              –
              
              
              113,876Other
                  assets
              
              
              4,433
              
              
              –
              
              
              4,43347,360,612
              
              
              (554,029
              )
              
              46,806,583Total
                  Assets
              
              $
              54,533,687
              
              $
              (554,029
              )
              $
              53,979,658LIABILITIES
                  AND STOCKHOLDERS EQUITYCURRENT
                  LIABILITIESLine
                  of Credit
              
              $
              3,200,000
              
              $
              –
              
              $
              3,200,000Current
                  portion of long-term debt
              
              
              110,622
              
              
              –
              
              
              110,622Accounts
                  payable and accrued expenses
              
              
              3,947,987
              
              
              –
              
              
              3,947,987Short
                  term note payable
              
              
              1,000,000
              
              
              –
              
              
              1,000,000Deferred
                  revenue
              
              
              1,057,533
              
              
              –
              
              
              1,057,533Financial
                  Instruments (3)
              
              
              3,840,000
              
              
              6,645,071
              
              
              10,485,071TOTAL
                  CURRENT LIABILITIES
              
              
              13,156,142
              
              
              6,645,071
              
              
              19,801,213LONG-TERM
                  DEBT, net of current portion
              
              
              6,670,187
              
              
              –
              
              
              6,670,187DEFERRED
                  TAXES
              
              
              36,900
              
              
              –
              
              
              36,900Total
                  Liabilities
              
              
              19,863,229
              
              
              6,645,071
              
              
              26,508,300MINORITY
                  INTEREST
              
              
              157,104
              
              
              –
              
              
              157,104COMMITMENTS
                  AND CONTINGENCIESSTOCKHOLDERS
                  EQUITYCommon
                  Stock, $0.001 par value, 85,000,000 shares authorized;51,234,045
                  issued and outstanding (4)
              
              
              768,511
              
              
              (717,277
              )
              
              51,234Additional
                  paid in capital (5)
              
              
              38,883,178
              
              
              (3,954,152
              )
              
              34,929,026Accumulated
                  deficit
              
              
              (5,138,335
              )
              
              (2,527,671
              )
              
              (7,666,006
              )Total
                  Stockholders Equity
              
              
              34,513,354
              
              
              (7,199,100
              )
              
              27,314,254Total
                  Liabilities and Stockholders Equity
              
              $
              54,533,687
              
              $
              (554,029
              )
              $
              53,979,658








Explanatory
      Notes: September 2004 Balance sheet





(1)
            As
                previously reported in the Company’s quarterly report on form 10-QSB/A for
                the period ended September 30, 2004 and filed with the Securities
                and
                Exchange Commission on November 21,
                2005.


(2)
            Discount
                on debt:Reflects
                the reversal of the Laurus beneficial conversion feature charges
                for the
                conversion feature in the convertible notes and the related amortization,
                recording the new Laurus discount and amortization based upon the
                calculation of the embedded derivative for the conversion feature,
                and
                reversing the discount for the Sands warrants and then recording
                the new
                amount based upon the derivative
                calculation.


(3)
            Financial
                Instruments:Reflects
                the reversal of the liability and fair value adjustment previously
                recorded for the Sands warrants, recording the new liability and
                fair
                value adjustment for the Sands warrants, and recording the liability
                and
                fair value adjustment related to the embedded derivative for the
                conversion feature of the Laurus
                note.


(4)
            Common
                Stock:Reflects
                the effect of the 1:15 reverse stock split that occurred on September
                21,
                2005.


(5)
              Additional
                  paid-in capital:Reflects
                  the reversal of the beneficial conversion feature related to the
                  conversion feature in the Laurus convertible note and the reverse
                  stock
                  split..





120


CONVERSION
                  SERVICES INTERNATIONAL, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF OPERATIONSSeptember
                  30, 2004Three
                  Months Ended September 30, 2004
              
              Nine
                  Months Ended September 30, 2004Previously
                  Reported
                    (1)
              
              Restatement
                Adjustment
              
              Restated
                Total
              
              Previously
                Reported
                  (1)
              
              Restatement
                Adjustment
              
              Restated
                TotalREVENUE
              
              $
              6,877,872
              
              $
              –
              
              $
              6,877,872
              
              $
              18,655,937
              
              $
              –
              
              $
              18,655,937COST
                  OF SERVICES
              
              
              4,585,407
              
              
              –
              
              
              4,585,407
              
              
              12,804,332
              
              
              –
              
              
              12,804,332GROSS
                  PROFIT
              
              
              2,292,465
              
              
              –
              
              
              2,292,465
              
              
              5,851,605
              
              
              –
              
              
              5,851,605OPERATING
                  EXPENSESSelling
                  and marketing
              
              
              1,378,434
              
              
              –
              
              
              1,378,434
              
              
              2,745,802
              
              
              –
              
              
              2,745,802General
                  and administrative
              
              
              1,761,592
              
              
              –
              
              
              1,761,592
              
              
              4,956,671
              
              
              –
              
              
              4,956,671Research
                  and development
              
              
              270,976
              
              
              –
              
              
              270,976
              
              
              270,976
              
              
              –
              
              
              270,976Depreciation
                  and amortization
              
              
              458,059
              
              
              –
              
              
              458,059
              
              
              610,411
              
              
              –
              
              
              610,4113,869,061
              
              
              –
              
              
              3,869,061
              
              
              8,583,860
              
              
              –
              
              
              8,583,860LOSS
                  FROM OPERATIONS
              
              
              (1,576,596
              )
              
              –
              
              
              (1,576,596
              )
              
              (2,732,255
              )
              
              –
              
              
              (2,732,255
              )OTHER
                  INCOME (EXPENSE)Equity
                  in losses from investments
              
              
              (8,812
              )
              
              –
              
              
              (8,812
              )
              
              (24,900
              )
              
              –
              
              
              (24,900
              )Other
                  income
              
              
              289
              
              
              –
              
              
              289
              
              
              7,295
              
              
              –
              
              
              7,295Loss
                  on Financial Instruments (2)
              
              
              (240,000
              )
              
              (281,221
              )
              
              (521,221
              )
              
              (240,000
              )
              
              (281,221
              )
              
              (521,221
              )Interest
                  income
              
              
              1,519
              
              
              –
              
              
              1,519
              
              
              3,391
              
              
              –
              
              
              3,391Interest
                  expense (3)
              
              
              (997,545
              )
              
              (2,246,450
              )
              
              (3,243,995
              )
              
              (1,802,326
              )
              
              (2,246,450
              )
              
              (4,048,776
              )(1,244,549
              )
              
              (2,527,671
              )
              
              (3,772,220
              )
              
              (2,056,540
              )
              
              (2,527,671
              )
              
              (4,584,211
              )LOSS
                  BEFORE INCOME TAXES AND MINORITY INTEREST
              
              
              (2,821,145
              )
              
              (2,527,671
              )
              
              (5,348,816
              )
              
              (4,788,795
              )
              
              (2,527,671
              )
              
              (7,316,466
              )INCOME
                  TAXES
              
              
              623,608
              
              
              –
              
              
              623,608
              
              
              163,730
              
              
              –
              
              
              163,730LOSS
                  BEFORE MINORITY INTEREST
              
              
              (3,444,753
              )
              
              (2,527,671
              )
              
              (5,972,424
              )
              
              (4,952,525
              )
              
              (2,527,671
              )
              
              (7,480,196
              )MINORITY
                  INTEREST
              
              
              42,296
              
              
              –
              
              
              42,296
              
              
              42,296
              
              
              –
              
              
              42,296NET
                  LOSS
              
              $
              (3,402,457
              )
              $
              (2,527,671
              )
              $
              (5,930,128
              )
              $
              (4,910,229
              )
              $
              (2,527,671
              )
              $
              (7,437,900
              )Net
                  Loss per share:Basic
              
              
              ($0.07
              )
              
              –
              
              
              ($0.12
              )
              
              ($0.01
              )
              
              –
              
              
              ($0.17
              )Diluted
              
              
              ($0.07
              )
              
              –
              
              
              ($0.12
              )
              
              ($0.01
              )
              
              –
              
              
              ($0.17
              )Shares
                  used to compute net loss per share (4):Basic
              
              
              51,113,272
              
              
              
              
              
              51,113,272
              
              
              44,939,912
              
              
              
              
              
              44,939,912Diluted
              
              
              51,113,272
              
              
              
              
              
              51,113,272
              
              
              44,939,912
              
              
              
              
              
              44,939,912





Explanatory
      Notes: September 2004 Income Statement





(1)
            As
                previously reported in the Company’s quarterly report on form 10-QSB/A for
                the period ended September 30, 2004 and filed with the Securities
                and
                Exchange Commission on November 21,
                2005.


(2)
            Loss
                on financial instruments:Record
                the loss on financial instruments related to both the fair value
                adjustment for the outstanding warrants and the embedded derivative
                related to the conversion feature in the convertible
                notes.


(3)
            Interest
                expense:Record
                adjustments to interest expense for the revised amortization of the
                discount on debt for both the warrants and the embedded
                derivatives.


(4)
            Shares
                used to compute net loss per share:Reflects
                the effect of the 1:15 reverse stock split that occurred on September
                21,
                2005.





121




CONVERSION
                  SERVICES INTERNATIONAL, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  BALANCE SHEETDecember
                  31,2004Previously
              
              RestatementReported
                  (1)
              
              Adjustment
              
              Restated
                  TotalASSETSCURRENT
                  ASSETSCash
              
              $
              1,028,146
              
              $
              –
              
              $
              1,028,146Restricted
                  cash
              
              
              83,375
              
              
              –
              
              
              83,375Accounts
                  receivable, net of allowance for doubtful accounts of
                  $290,582
              
              
              4,349,229
              
              
              –
              
              
              4,349,229Accounts
                  receivable from related parties
              
              
              781,100
              
              
              –
              
              
              781,100Prepaid
                  expenses
              
              
              309,459
              
              
              –
              
              
              309,459Total
                  Current Assets
              
              
              6,551,309
              
              
              –
              
              
              6,551,309PROPERTY
                  AND EQUIPMENT, at cost, net
              
              
              587,575
              
              
              –
              
              
              587,575OTHER
                  ASSETSRestricted
                  Cash
              
              
              4,269,377
              
              
              –
              
              
              4,269,377Goodwill
              
              
              4,690,972
              
              
              –
              
              
              4,690,972Intangible
                  assets, net of accumulated amortization of $911,142
              
              
              3,627,096
              
              
              –
              
              
              3,627,096Deferred
                  Financing costs, net of accumulated amortization of
                  $126,767
              
              
              766,542
              
              
              –
              
              
              766,542Discount
                  on Debt issued , net of accumulated amortization of $941,211
                  (2)
              
              
              8,410,808
              
              
              (193,530
              )
              
              8,217,278Equity
                  investments
              
              
              144,460
              
              
              –
              
              
              144,460Other
                  assets
              
              
              13,420
              
              
              –
              
              
              13,42021,922,675
              
              
              (193,530
              )
              
              21,729,145Total
                  Assets
              
              $
              29,061,559
              
              $
              (193,530
              )
              $
              28,868,029LIABILITIES
                  AND STOCKHOLDERS EQUITYCURRENT
                  LIABILITIESLine
                  of Credit
              
              $
              3,733,403
              
              $
              –
              
              $
              3,733,403Current
                  portion of long-term debt
              
              
              120,834
              
              
              –
              
              
              120,834Accounts
                  payable and accrued expenses
              
              
              3,777,941
              
              
              –
              
              
              3,777,941Short
                  term note payable
              
              
              1,000,000
              
              
              –
              
              
              1,000,000Deferred
                  revenue
              
              
              1,327,222
              
              
              –
              
              
              1,327,222Financial
                  Instruments (3)
              
              
              3,960,000
              
              
              6,555,091
              
              
              10,515,091TOTAL
                  CURRENT LIABILITIES
              
              
              13,919,400
              
              
              6,555,091
              
              
              20,474,491LONG-TERM
                  DEBT, net of current portion
              
              
              6,967,430
              
              
              –
              
              
              6,967,430Total
                  Liabilities
              
              
              20,886,830
              
              
              6,555,091
              
              
              27,441,921MINORITY
                  INTEREST
              
              
              131,587
              
              
              –
              
              
              131,587COMMITMENTS
                  AND CONTINGENCIESSTOCKHOLDERS
                  EQUITYCommon
                  Stock, $0.001 par value, 85,000,000 shares authorized;51,472,140
                  issued and outstanding (4)
              
              
              772,082
              
              
              (720,610
              )
              
              51,472Additional
                  paid in capital (5)
              
              
              40,764,881
              
              
              (3,950,819
              )
              
              36,814,062Accumulated
                  deficit
              
              
              (33,499,119
              )
              
              (2,077,192
              )
              
              (35,576,311
              )Accumulated
                  other comprehensive income
              
              
              5,298
              
              
              –
              
              
              5,298Total
                  Stockholders Equity
              
              
              8,043,142
              
              
              (6,748,621
              )
              
              1,294,521Total
                  Liabilities and Stockholders Equity
              
              $
              29,061,559
              
              $
              (193,530
              )
              $
              28,868,029





Explanatory
      Notes: December 2004 Balance sheet





(1)
            As
                previously reported in the Company’s annual report on form 10-KSB/A for
                the period ended December 31, 2004 and filed with the Securities
                and
                Exchange Commission on November 21,
                2005.


(2)
            Discount
                on debt:Reflects
                the reversal of the Laurus beneficial conversion feature charges
                for the
                conversion feature in the convertible notes and the related amortization,
                recording the new Laurus discount and amortization based upon the
                calculation of the embedded derivative for the conversion feature,
                and
                reversing the discount for the original Sands warrants (dated 9/22/2004)
                and then recording the new amount based upon the derivative calculation.


(3)
            Financial
                Instruments:Reflects
                the reversal of the liability and fair value adjustment previously
                recorded for the Sands warrants, recording the new liability and
                fair
                value adjustment for the Sands warrants, and recording the liability
                and
                fair value adjustment related to the embedded derivative for the
                conversion feature of the Laurus
                note.


(4)
            Common
                Stock:Reflects
                the effect of the 1:15 reverse stock split that occurred on September
                21,
                2005.


(5)
            Additional
                paid-in capital:Reflects
                the reversal of the beneficial conversion feature related to the
                conversion feature in the Laurus convertible note and the effect
                of the
                reverse stock split.





122


CONVERSION
        SERVICES INTERNATIONAL, INC.
 AND
        SUBSIDIARIES
 CONSOLIDATED
        STATEMENTS OF OPERATIONS
 For
        the
        year ended December 31, 2004
 Previously
              
              RestatementReported
                  (1)
              
              Adjustment
              
              Restated
                  TotalREVENUE:Services
              
              $
              19,888,205
              
              $
              –
              
              $
              19,888,205Related
                  party services
              
              
              3,837,065
              
              
              –
              
              
              3,837,065Software
              
              
              293,504
              
              
              –
              
              
              293,504Support
                  and maintenance
              
              
              1,074,933
              
              
              –
              
              
              1,074,933Other
              
              
              72,810
              
              
              –
              
              
              72,81025,166,517
              
              
              –
              
              
              25,166,517COST
                  OF SERVICESServices
                  ( inclusive of stock based compensation of $1.4 million at December
                  31,
                  2004)
              
              
              15,451,392
              
              
              –
              
              
              15,451,392Related
                  party services
              
              
              3,345,318
              
              
              –
              
              
              3,345,318Software
              
              
              185,688
              
              
              –
              
              
              185,688Support
                  and maintenance
              
              
              31,127
              
              
              –
              
              
              31,127Other
              
              
              –
              
              
              –
              
              
              –19,013,525
              
              
              –
              
              
              19,013,525GROSS
                  PROFIT
              
              
              6,152,992
              
              
              –
              
              
              6,152,992OPERATING
                  EXPENSESSelling
                  and marketing
              
              
              4,087,617
              
              
              –
              
              
              4,087,617General
                  and administrative ( inclusive of stock–based compensation of $0.1
                  milliion at December 31, 2004)
              
              
              6,819,039
              
              
              –
              
              
              6,819,039Research
                  and development
              
              
              516,425
              
              
              –
              
              
              516,425Goodwill
                  and intangible impairment
              
              
              23,298,810
              
              
              –
              
              
              23,298,810Depreciation
                  and amortization
              
              
              1,117,209
              
              
              –
              
              
              1,117,20935,839,100
              
              
              –
              
              
              35,839,100LOSS
                  FROM OPERATIONS
              
              
              (29,686,108
              )
              
              –
              
              
              (29,686,108
              )OTHER
                  INCOME (EXPENSE)Equity
                  in income (losses) from investments
              
              
              5,684
              
              
              –
              
              
              5,684Other
                  income
              
              
              8,531
              
              
              –
              
              
              8,531Loss
                  on Financial Instruments (2)
              
              
              (360,000
              )
              
              (191,241
              )
              
              (551,241
              )Interest
                  income
              
              
              22,388
              
              
              –
              
              
              22,388Interest
                  expense (3)
              
              
              (3,138,521
              )
              
              (1,885,951
              )
              
              (5,024,472
              )(3,461,918
              )
              
              (2,077,192
              )
              
              (5,539,110
              )LOSS
                  BEFORE INCOME TAXES AND MINORITY INTEREST
              
              
              (33,148,026
              )
              
              (2,077,192
              )
              
              (35,225,218
              )INCOME
                  TAXES
              
              
              190,800
              
              
              –
              
              
              190,800LOSS
                  BEFORE MINORITY INTEREST
              
              
              (33,338,826
              )
              
              (2,077,192
              )
              
              (35,416,018
              )MINORITY
                  INTEREST
              
              
              67,813
              
              
              –
              
              
              67,813NET
                  LOSS
              
              $
              (33,271,013
              )
              $
              (2,077,192
              )
              $
              (35,348,205
              )Net
                  Loss per share:Basic
              
              
              ($0.71
              )
              
              
              
              
              ($0.76
              )Diluted
              
              
              ($0.71
              )
              
              
              
              
              ($0.76
              )Shares
                  used to compute net loss per share (4):Basic
              
              
              46,548,065
              
              
              
              
              
              46,548,065Diluted
              
              
              46,548,065
              
              
              
              
              
              46,548,065





Explanatory
      Notes: December 2004 Income Statement


(1)
              As
                  previously reported in the Company’s annual report on form 10-KSB/A for
                  the period ended December 31, 2004 and filed with the Securities
                  and
                  Exchange Commission on November 21, 2005.(2)
              Loss
                  on financial instruments: Record the loss on financial instruments
                  related to both the fair value adjustment for the outstanding warrants
                  and
                  the embedded derivative related to the conversion feature in the
                  convertible notes.
 (3)
              Interest
                  expense:  Record adjustments to interest expense for the revised
                  amortization of the discount on debt for both the warrants and
                  the
                  embedded derivatives.(4)
              Shares
                  used to compute net loss per share: Reflects the effect of the 1:15
                  reverse stock split that occurred on September 21,
                  2005.


123


CONVERSION
                  SERVICES INTERNATIONAL, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  BALANCE SHEETMarch
                  31, 2005Previously
              
              RestatementReported
                  (1)
              
              Adjustment
              
              Restated
                  TotalASSETSCURRENT
                  ASSETSCash
              
              $
              1,205,172
              
              $
              –
              
              $
              1,205,172Accounts
                  receivable, net of allowance for doubtful accounts of
                  $259,147
              
              
              3,676,742
              
              
              –
              
              
              3,676,742Accounts
                  receivable from related parties
              
              
              782,830
              
              
              –
              
              
              782,830Prepaid
                  expenses
              
              
              263,114
              
              
              –
              
              
              263,114Total
                  Current Assets
              
              
              5,927,858
              
              
              –
              
              
              5,927,858PROPERTY
                  AND EQUIPMENT, at cost, net
              
              
              564,697
              
              
              –
              
              
              564,697OTHER
                  ASSETSRestricted
                  Cash
              
              
              4,293,569
              
              
              –
              
              
              4,293,569Goodwill
              
              
              4,690,972
              
              
              –
              
              
              4,690,972Intangible
                  assets, net of accumulated amortization of $1,191,031
              
              
              3,347,207
              
              
              –
              
              
              3,347,207Deferred
                  Financing costs, net of accumulated amortization of
                  $222,653
              
              
              670,656
              
              
              –
              
              
              670,656Discount
                  on Debt issued , net of accumulated amortization of $1,674,264
                  (2)
              
              
              7,347,336
              
              
              136,889
              
              
              7,484,225Equity
                  investments
              
              
              188,184
              
              
              –
              
              
              188,184Other
                  assets
              
              
              80,088
              
              
              –
              
              
              80,08820,618,012
              
              
              136,889
              
              
              20,754,901Total
                  Assets
              
              $
              27,110,567
              
              $
              136,889
              
              $
              27,247,456LIABILITIES
                  AND STOCKHOLDERS EQUITYCURRENT
                  LIABILITIESLine
                  of Credit
              
              $
              3,784,623
              
              $
              –
              
              $
              3,784,623Current
                  portion of long-term debt
              
              
              129,890
              
              
              –
              
              
              129,890Accounts
                  payable and accrued expenses
              
              
              3,314,514
              
              
              –
              
              
              3,314,514Short
                  term note payable
              
              
              1,000,000
              
              
              –
              
              
              1,000,000Related
                  party short term note payable
              
              
              299,554
              
              
              –
              
              
              299,554Deferred
                  revenue
              
              
              1,783,097
              
              
              –
              
              
              1,783,097Financial
                  Instruments (3)
              
              
              4,260,000
              
              
              6,197,169
              
              
              10,457,169TOTAL
                  CURRENT LIABILITIES
              
              
              14,571,678
              
              
              6,197,169
              
              
              20,768,847LONG-TERM
                  DEBT, net of current portion
              
              
              6,660,087
              
              
              –
              
              
              6,660,087Total
                  Liabilities
              
              
              21,231,765
              
              
              6,197,169
              
              
              27,428,934MINORITY
                  INTEREST
              
              
              100,885
              
              
              –
              
              
              100,885COMMITMENTS
                  AND CONTINGENCIESSTOCKHOLDERS
                  EQUITYCommon
                  Stock, $0.001 par value, 85,000,000 shares authorized;52,067,378
                  issued and outstanding (4)
              
              
              781,011
              
              
              (728,944
              )
              
              52,067Additional
                  paid in capital (5)
              
              
              42,021,747
              
              
              (3,942,485
              )
              
              38,079,262Accumulated
                  deficit
              
              
              (37,027,539
              )
              
              (1,388,851
              )
              
              (38,416,390
              )Accumulated
                  other comprehensive income
              
              
              2,698
              
              
              –
              
              
              2,698Total
                  Stockholders Equity
              
              
              5,777,917
              
              
              (6,060,280
              )
              
              (282,363
              )Total
                  Liabilities and Stockholders Equity
              
              $
              27,110,567
              
              $
              136,889
              
              $
              27,247,456





Explanatory
      Notes: March 2005 Balance Sheet





(1)
            As
                previously reported in the Company’s quarterly report on form 10-QSB/A for
                the period ended March 31, 2005 and filed with the Securities and
                Exchange
                Commission on November 21, 2005.


(2)
            Discount
                on debt:Reflects
                the reversal of the Laurus beneficial conversion feature charges
                for the
                conversion feature in the convertible notes and the related amortization,
                recording the new Laurus discount and amortization based upon the
                calculation of the embedded derivative for the conversion feature,
                and
                reversing the discount for the original Sands warrants (dated 9/22/2004)
                and then recording the new amount based upon the derivative
                calculation.


(3)
            Financial
                Instruments:Reflects
                the reversal of the liability and fair value adjustment previously
                recorded for the Sands warrants, recording the new liability and
                fair
                value adjustment for the Sands warrants, and recording the liability
                and
                fair value adjustment related to the embedded derivative for the
                conversion feature of the Laurus
                note.


(4)
            Common
                Stock:Reflects
                the effect of the 1:15 reverse stock split that occurred on September
                21,
                2005.


(5)
            Additional
                paid-in capital:Reflects
                the reversal of the beneficial conversion feature related to the
                conversion feature in the Laurus convertible note and the effect
                of the
                reverse stock split.





124
 
 CONVERSION
                    SERVICES INTERNATIONAL, INC.AND
                    SUBSIDIARIESCONSOLIDATED
                    STATEMENTS OF OPERATIONSMarch
                    31, 2005Previously
                
                RestatementReported
                    (1)
                
                Adjustment
                
                Restated
                    TotalREVENUE:Services
                
                $
                5,015,293
                
                $
                –
                
                $
                5,015,293Related
                    party services
                
                
                1,096,402
                
                
                –
                
                
                1,096,402Software
                
                
                293,368
                
                
                –
                
                
                293,368Support
                    and maintenance
                
                
                432,005
                
                
                –
                
                
                432,005Other
                
                
                35,470
                
                
                –
                
                
                35,4706,872,538
                
                
                –
                
                
                6,872,538COST
                    OF SERVICESServices
                
                
                3,528,596
                
                
                –
                
                
                3,528,596Related
                    party services
                
                
                1,011,858
                
                
                –
                
                
                1,011,858Software
                
                
                44,450
                
                
                –
                
                
                44,450Support
                    and maintenance
                
                
                13,068
                
                
                –
                
                
                13,068Other
                
                
                –
                
                
                –
                
                
                –4,597,972
                
                
                –
                
                
                4,597,972GROSS
                    PROFIT
                
                
                2,274,566
                
                
                –
                
                
                2,274,566OPERATING
                    EXPENSESSelling
                    and marketing
                
                
                1,527,223
                
                
                –
                
                
                1,527,223General
                    and administrative
                
                
                1,940,135
                
                
                –
                
                
                1,940,135Research
                    and development
                
                
                241,676
                
                
                –
                
                
                241,676Depreciation
                    and amortization
                
                
                431,456
                
                
                –
                
                
                431,4564,140,490
                
                
                –
                
                
                4,140,490LOSS
                    FROM OPERATIONS
                
                
                (1,865,924
                )
                
                –
                
                
                (1,865,924
                )OTHER
                    INCOME (EXPENSE)Equity
                    in income from investments
                
                
                43,292
                
                
                –
                
                
                43,292Other
                    expense
                
                
                (2,191
                )
                
                –
                
                
                (2,191
                )Loss
                    on Financial Instrument (2)
                
                
                (300,000
                )
                
                357,922
                
                
                57,922Interest
                    income
                
                
                24,192
                
                
                –
                
                
                24,192Interest
                    expense (3)
                
                
                (1,458,490
                )
                
                330,419
                
                
                (1,128,071
                )(1,693,197
                )
                
                688,341
                
                
                (1,004,856
                )LOSS
                    BEFORE INCOME TAXES AND MINORITY INTEREST
                
                
                (3,559,121
                )
                
                688,341
                
                
                (2,870,780
                )INCOME
                    TAXES
                
                
                –
                
                
                –
                
                
                –LOSS
                    BEFORE MINORITY INTEREST
                
                
                (3,559,121
                )
                
                688,341
                
                
                (2,870,780
                )MINORITY
                    INTEREST
                
                
                30,702
                
                
                –
                
                
                30,702NET
                    LOSS
                
                $
                (3,528,419
                )
                $
                688,341
                
                $
                (2,840,078
                )Basic
                
                
                ($0.07
                )
                
                –
                
                
                ($0.06
                )Diluted
                
                
                ($0.07
                )
                
                –
                
                
                ($0.06
                )Shares
                    used to compute net loss per share (4):Basic
                
                
                51,531,664
                
                
                
                
                
                51,531,664Diluted
                
                
                51,531,664
                
                
                
                
                
                51,531,664





Explanatory
      Notes: March 2005 Income Statement








(1)
            As
                previously reported in the Company’s quarterly report on form 10-QSB/A for
                the period ended March 31, 2005 and filed with the Securities and
                Exchange
                Commission on November 21, 2005.


(2)
            Loss
                on financial instruments:Record
                the loss on financial instruments related to both the fair value
                adjustment for the outstanding warrants and the embedded derivative
                related to the conversion feature in the convertible
                notes.


(3)
            Interest
                expense:Record
                adjustments to interest expense for the revised amortization of the
                discount on debt for both the warrants and the embedded
                derivatives.


(4)
            Shares
                used to compute net loss per share:Reflects
                the effect of the 1:15 reverse stock split that occurred on September
                21,
                2005.





125
 
 CONVERSION
                    SERVICES INTERNATIONAL, INC.AND
                    SUBSIDIARIESCONSOLIDATED
                    BALANCE SHEETJune
                    30, 2005Previously
                
                RestatementReported
                    (1)
                
                Adjustment
                
                Restated
                    TotalASSETSCURRENT
                    ASSETSCash
                
                $
                646,006
                
                $
                –
                
                $
                646,006Accounts
                    receivable, net of allowance for doubtful accounts of
                    $216,437
                
                
                4,305,995
                
                
                –
                
                
                4,305,995Accounts
                    receivable from related parties
                
                
                1,060,053
                
                
                –
                
                
                1,060,053Prepaid
                    expenses
                
                
                376,813
                
                
                –
                
                
                376,813Total
                    Current Assets
                
                
                6,388,867
                
                
                –
                
                
                6,388,867PROPERTY
                    AND EQUIPMENT, at cost, net
                
                
                539,702
                
                
                –
                
                
                539,702OTHER
                    ASSETSRestricted
                    Cash
                
                
                4,327,295
                
                
                –
                
                
                4,327,295Goodwill
                
                
                4,690,972
                
                
                –
                
                
                4,690,972Intangible
                    assets, net of accumulated amortization of $1,542,122
                
                
                2,996,116
                
                
                –
                
                
                2,996,116Deferred
                    Financing costs, net of accumulated amortization of
                    $318,539
                
                
                574,770
                
                
                –
                
                
                574,770Discount
                    on Debt issued , net of accumulated amortization of $2,474,271
                    (2)
                
                
                6,283,865
                
                
                400,353
                
                
                6,684,218Equity
                    investments
                
                
                191,578
                
                
                –
                
                
                191,578Other
                    assets
                
                
                115,295
                
                
                –
                
                
                115,29519,179,891
                
                
                400,353
                
                
                19,580,244Total
                    Assets
                
                $
                26,108,460
                
                $
                400,353
                
                $
                26,508,813LIABILITIES
                    AND STOCKHOLDERS EQUITYCURRENT
                    LIABILITIESLine
                    of Credit
                
                $
                3,413,830
                
                $
                –
                
                $
                3,413,830Current
                    portion of long-term debt
                
                
                133,527
                
                
                –
                
                
                133,527Accounts
                    payable and accrued expenses
                
                
                3,189,132
                
                
                –
                
                
                3,189,132Short
                    term note payable
                
                
                1,000,000
                
                
                –
                
                
                1,000,000Related
                    party short term note payable
                
                
                1,632,325
                
                
                –
                
                
                1,632,325Deferred
                    revenue
                
                
                1,759,205
                
                
                –
                
                
                1,759,205Financial
                    Instruments (3)
                
                
                1,920,000
                
                
                3,998,436
                
                
                5,918,436TOTAL
                    CURRENT LIABILITIES
                
                
                13,048,019
                
                
                3,998,436
                
                
                17,046,455LONG-TERM
                    DEBT, net of current portion
                
                
                6,671,140
                
                
                –
                
                
                6,671,140Total
                    Liabilities
                
                
                19,719,159
                
                
                3,998,436
                
                
                23,717,595MINORITY
                    INTEREST
                
                
                79,943
                
                
                –
                
                
                79,943COMMITMENTS
                    AND CONTINGENCIESSTOCKHOLDERS
                    EQUITYCommon
                    Stock, $0.001 par value, 85,000,000 shares authorized;52,564,936
                    issued and outstanding (4)
                
                
                788,474
                
                
                (735,909
                )
                
                52,565Additional
                    paid in capital (5)
                
                
                43,019,484
                
                
                (3,935,520
                )
                
                39,083,964Accumulated
                    deficit
                
                
                (37,502,640
                )
                
                1,073,346
                
                
                (36,429,294
                )Accumulated
                    other comprehensive income
                
                
                4,040
                
                
                –
                
                
                4,040Total
                    Stockholders Equity
                
                
                6,309,358
                
                
                (3,598,083
                )
                
                2,711,275Total
                    Liabilities and Stockholders Equity
                
                $
                26,108,460
                
                $
                400,353
                
                $
                26,508,813





Explanatory
      Notes: June 2005 Balance Sheet





(1)
            As
                previously reported in the Company’s quarterly report on form 10-QSB/A for
                the period ended June 30, 2005 and filed with the Securities and
                Exchange
                Commission on November 21, 2005.


(2)
            Discount
                on debt:Reflects
                the reversal of the Laurus beneficial conversion feature charges
                for the
                conversion feature in the convertible notes and the related amortization,
                recording the new Laurus discount and amortization based upon the
                calculation of the embedded derivative for the conversion feature,
                and
                reversing the discount for the original Sands warrants (dated 9/22/2004)
                and then recording the new amount based upon the derivative
                calculation.


(3)
            Financial
                Instruments:Reflects
                the reversal of the liability and fair value adjustment previously
                recorded for the Sands warrants, recording the new liability and
                fair
                value adjustment for the Sands warrants, and recording the liability
                and
                fair value adjustment related to the embedded derivative for the
                conversion feature of the Laurus
                note.


(4)
            Common
                Stock:Reflects
                the effect of the 1:15 reverse stock split that occurred on September
                21,
                2005.


(5)
            Additional
                paid-in capital:Reflects
                the reversal of the beneficial conversion feature related to the
                conversion feature in the Laurus convertible note and the effect
                of the
                reverse stock split.





126


CONVERSION
                  SERVICES INTERNATIONAL, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF OPERATIONSJune
                  30, 2005Three
                  Months Ended June 30,2005
              
              Six
                  Months Ended June 30,2005Previously
                    Reported
                      (1)
              
              Restatement
                Adjustment
              
              Restated
                Total
              
              Previously
                Reported
                  (1)
              
              Restatement
                Adjustment
              
              Restated
                TotalREVENUE:Services
              
              $
              5,417,199
              
              $
              –
              
              $
              5,417,199
              
              $
              10,432,492
              
              $
              –
              
              $
              10,432,492Related
                  party services
              
              
              1,075,235
              
              
              –
              
              
              1,075,235
              
              
              2,171,637
              
              
              –
              
              
              2,171,637Software
              
              
              387,560
              
              
              –
              
              
              387,560
              
              
              680,928
              
              
              –
              
              
              680,928Support
                  and maintenance
              
              
              496,003
              
              
              –
              
              
              496,003
              
              
              928,008
              
              
              –
              
              
              928,008Other
              
              
              30,250
              
              
              –
              
              
              30,250
              
              
              65,720
              
              
              –
              
              
              65,7207,406,247
              
              
              –
              
              
              7,406,247
              
              
              14,278,785
              
              
              –
              
              
              14,278,785COST
                  OF SERVICESServices
              
              
              3,860,470
              
              
              –
              
              
              3,860,470
              
              
              7,389,066
              
              
              –
              
              
              7,389,066Related
                  party services
              
              
              923,596
              
              
              –
              
              
              923,596
              
              
              1,935,454
              
              
              –
              
              
              1,935,454Software
              
              
              51,512
              
              
              –
              
              
              51,512
              
              
              95,962
              
              
              –
              
              
              95,962Support
                  and maintenance
              
              
              13,068
              
              
              –
              
              
              13,068
              
              
              26,136
              
              
              –
              
              
              26,136Other
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –4,848,646
              
              
              –
              
              
              4,848,646
              
              
              9,446,618
              
              
              –
              
              
              9,446,618GROSS
                  PROFIT
              
              
              2,557,601
              
              
              –
              
              
              2,557,601
              
              
              4,832,167
              
              
              –
              
              
              4,832,167OPERATING
                  EXPENSESSelling
                  and marketing
              
              
              1,566,764
              
              
              –
              
              
              1,566,764
              
              
              3,093,987
              
              
              –
              
              
              3,093,987General
                  and administrative
              
              
              1,622,275
              
              
              –
              
              
              1,622,275
              
              
              3,562,410
              
              
              –
              
              
              3,562,410Research
                  and development
              
              
              234,445
              
              
              –
              
              
              234,445
              
              
              476,121
              
              
              –
              
              
              476,121Depreciation
                  and amortization
              
              
              503,906
              
              
              –
              
              
              503,906
              
              
              935,362
              
              
              –
              
              
              935,3623,927,390
              
              
              –
              
              
              3,927,390
              
              
              8,067,880
              
              
              –
              
              
              8,067,880LOSS
                  FROM OPERATIONS
              
              
              (1,369,789
              )
              
              –
              
              
              (1,369,789
              )
              
              (3,235,713
              )
              
              –
              
              
              (3,235,713
              )OTHER
                  INCOME (EXPENSE)Equity
                  in income from investments
              
              
              3,393
              
              
              –
              
              
              3,393
              
              
              46,685
              
              
              –
              
              
              46,685Other
                  expense
              
              
              (6,335
              )
              
              –
              
              
              (6,335
              )
              
              (8,526
              )
              
              –
              
              
              (8,526
              )Gain on
                  Financial Instruments (2)
              
              
              2,340,000
              
              
              2,198,733
              
              
              4,538,733
              
              
              2,040,000
              
              
              2,556,655
              
              
              4,596,655Interest
                  income
              
              
              33,726
              
              
              –
              
              
              33,726
              
              
              57,918
              
              
              –
              
              
              57,918Interest
                  expense (3)
              
              
              (1,497,038
              )
              
              263,464
              
              
              (1,233,574
              )
              
              (2,955,528
              )
              
              593,883
              
              
              (2,361,645
              )873,746
              
              
              2,462,197
              
              
              3,335,943
              
              
              (819,451
              )
              
              3,150,538
              
              
              2,331,087INCOME
                  (LOSS) BEFORE MINORITY INTEREST
              
              
              (496,043
              )
              
              2,462,197
              
              
              1,966,154
              
              
              (4,055,164
              )
              
              3,150,538
              
              
              (904,626
              )MINORITY
                  INTEREST
              
              
              20,942
              
              
              –
              
              
              20,942
              
              
              51,644
              
              
              –
              
              
              51,644NET
                  INCOME (LOSS)
              
              $
              (475,101
              )
              $
              2,462,197
              
              $
              1,987,096
              
              $
              (4,003,520
              )
              $
              3,150,538
              
              $
              (852,982
              )Basic
              
              
              ($0.01
              )
              
              –
              
              
              $0.04
              
              
              ($0.08
              )
              
              
              
              
              ($0.02
              )Diluted
              
              
              ($0.01
              )
              
              
              
              
              $0.04
              
              
              ($0.08
              )
              
              
              
              
              ($0.02
              )Shares
                  used to compute net income (loss) per share (4):Basic
              
              
              52,344,049
              
              
              
              
              
              52,344,049
              
              
              51,937,351
              
              
              
              
              
              51,937,351Diluted
              
              
              52,344,049
              
              
              
              
              
              52,344,049
              
              
              51,937,351
              
              
              
              
              
              51,937,351





Explanatory
      Notes: June 2005 Income Statement





(1)
            As
                previously reported in the Company’s quarterly report on form 10-QSB/A for
                the period ended June 30, 2005 and filed with the Securities and
                Exchange
                Commission on November 21, 2005.


(2)
            Gain
                (Loss) on financial instruments:Record
                the gain (loss) on financial instruments related to both the fair
                value
                adjustment for the outstanding warrants and the embedded derivative
                related to the conversion feature in the convertible
                notes.


(3)
            Interest
                expense:Record
                adjustments to interest expense for the revised amortization of the
                discount on debt for both the warrants and the embedded
                derivatives.


(4)
            Shares
                used to compute net income (loss) per share:Reflects
                the effect of the 1:15 reverse stock split that occurred on September
                21,
                2005.





127


CONVERSION
                  SERVICES INTERNATIONAL, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  BALANCE SHEETSeptember
                  30, 2005Previously
              
              RestatementReported
                  (1)
              
              Adjustment
              
              Restated
                  TotalASSETSCURRENT
                  ASSETSCash
              
              $
              306,035
              
              $
              –
              
              $
              306,035Accounts
                  receivable, net of allowance for doubtful accounts of
                  $482,864
              
              
              4,552,728
              
              
              –
              
              
              4,552,728Accounts
                  receivable from related parties
              
              
              557,559
              
              
              –
              
              
              557,559Prepaid
                  expenses
              
              
              149,164
              
              
              –
              
              
              149,164Total
                  Current Assets
              
              
              5,565,486
              
              
              –
              
              
              5,565,486PROPERTY
                  AND EQUIPMENT, at cost, net
              
              
              433,583
              
              
              –
              
              
              433,583OTHER
                  ASSETSGoodwill
              
              
              8,348,130
              
              
              –
              
              
              8,348,130Intangible
                  assets, net of accumulated amortization of $573,780
              
              
              2,029,534
              
              
              –
              
              
              2,029,534Deferred
                  financing costs, net of accumulated amortization of
                  $403,748
              
              
              489,561
              
              
              –
              
              
              489,561Discount
                  on debt issued , net of accumulated amortization of $568,270
                  (2)
              
              
              3,575,142
              
              
              2,159,970
              
              
              5,735,112Equity
                  investments
              
              
              189,921
              
              
              –
              
              
              189,921Other
                  assets
              
              
              123,432
              
              
              –
              
              
              123,43214,755,720
              
              
              2,159,970
              
              
              16,915,690Total
                  Assets
              
              $
              20,754,789
              
              $
              2,159,970
              
              $
              22,914,759LIABILITIES
                  AND STOCKHOLDERS EQUITYCURRENT
                  LIABILITIESLine
                  of credit
              
              $
              5,322,714
              
              $
              –
              
              $
              5,322,714Current
                  portion of long-term debt
              
              
              510,304
              
              
              –
              
              
              510,304Accounts
                  payable and accrued expenses
              
              
              2,775,971
              
              
              –
              
              
              2,775,971Short
                  term note payable
              
              
              576,054
              
              
              –
              
              
              576,054Related
                  party short term note payable
              
              
              1,511,848
              
              
              –
              
              
              1,511,848Deferred
                  revenue
              
              
              26,709
              
              
              –
              
              
              26,709Financial
                  Instruments (3)
              
              
              3,064,000
              
              
              4,939,289
              
              
              8,003,289TOTAL
                  CURRENT LIABILITIES
              
              
              13,787,600
              
              
              4,939,289
              
              
              18,726,889LONG-TERM
                  DEBT, net of current portion
              
              
              3,280,159
              
              
              –
              
              
              3,280,159Deferred
                  Taxes
              
              
              363,400
              
              
              –
              
              
              363,400Total
                  Liabilities
              
              
              17,431,159
              
              
              4,939,289
              
              
              22,370,448COMMITMENTS
                  AND CONTINGENCIES
              
              
              –
              
              
              –
              
              
              –STOCKHOLDERS
                  EQUITYCommon
                  Stock, $0.001 par value, 85,000,000 shares authorized;54,093,745
                  issued and outstanding
              
              
              54,094
              
              
              –
              
              
              54,094Additional
                  paid in capital (4)
              
              
              44,425,073
              
              
              (2,278,184
              )
              
              42,146,889Accumulated
                  deficit
              
              
              (41,160,760
              )
              
              (501,135
              )
              
              (41,661,895
              )Accumulated
                  other comprehensive income
              
              
              5,223
              
              
              –
              
              
              5,223Total
                  Stockholders Equity
              
              
              3,323,630
              
              
              (2,779,319
              )
              
              544,311Total
                  Liabilities and Stockholders Equity
              
              $
              20,754,789
              
              $
              2,159,970
              
              $
              22,914,759





Explanatory
      Notes: September 2005 Balance Sheet





(1)
            As
                previously reported in the Company’s quarterly report on form 10-QSB for
                the period ended September 30, 2005 and filed with the Securities
                and
                Exchange Commission on November 21,
                2005.


(2)
            Discount
                on debt:Reflects
                the reversal of the Laurus beneficial conversion feature charges
                for the
                conversion feature in the convertible notes and the related amortization,
                recording the new Laurus discount and amortization based upon the
                calculation of the embedded derivative for the conversion feature,
                and
                reversing the discount for the original Sands warrants (dated 9/22/2004)
                and then recording the new amount based upon the derivative calculation.
                Additionally, the Company recorded the value of the embedded derivative
                for the new Sands note (dated 9/22/2005) and the early extinguishment
                of
                debt due to the renegotiation of the Laurus debt instruments on July
                28,
                2005.


(3)
            Financial
                Instruments:Reflects
                the reversal of the liability and fair value adjustment previously
                recorded for the Sands warrants, recording the new liability and
                fair
                value adjustment for the Sands warrants, recording the liability
                and fair
                value adjustment related to the embedded derivative for the conversion
                feature of the Laurus note, and recording the liabilities for both
                the
                fair value of the warrants issued and the embedded derivative for
                the new
                Sands note (dated 9/22/2005).


(4)
            Additional
                paid-in capital:Reflects
                the reversal of the beneficial conversion feature related to the
                conversion feature in the Laurus convertible
                note.





128


CONVERSION
                  SERVICES INTERNATIONAL, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF OPERATIONSSeptember
                  30, 2005Three
                  Months Ended September 30,2005
              
              Nine
                  Months Ended September 30,2005Previously
                    Reported
                      (1)
              
              Restatement
                Adjustment
              
              Restated
                Total
              
              Previously
                Reported
                  (1)
              
              Restatement
                Adjustment
              
              Restated
                TotalREVENUE:Services
              
              $
              6,721,841
              
              $
              –
              
              $
              6,721,841
              
              $
              17,105,033
              
              $
              –
              
              $
              17,105,033Related
                  party services
              
              
              899,142
              
              
              –
              
              
              899,142
              
              
              3,070,779
              
              
              –
              
              
              3,070,779Software
              
              
              –
              
              
              –
              
              
              –
              
              
              81,249
              
              
              –
              
              
              81,249Support
                  and maintenance
              
              
              46,800
              
              
              –
              
              
              46,800
              
              
              178,333
              
              
              –
              
              
              178,333Other
              
              
              32,640
              
              
              –
              
              
              32,640
              
              
              93,982
              
              
              –
              
              
              93,9827,700,423
              
              
              –
              
              
              7,700,423
              
              
              20,529,376
              
              
              –
              
              
              20,529,376COST
                  OF SERVICESServices
              
              
              5,045,004
              
              
              –
              
              
              5,045,004
              
              
              12,416,571
              
              
              –
              
              
              12,416,571Related
                  party services
              
              
              739,770
              
              
              –
              
              
              739,770
              
              
              2,675,224
              
              
              –
              
              
              2,675,2245,784,774
              
              
              –
              
              
              5,784,774
              
              
              15,091,795
              
              
              –
              
              
              15,091,795GROSS
                  PROFIT
              
              
              1,915,649
              
              
              –
              
              
              1,915,649
              
              
              5,437,581
              
              
              –
              
              
              5,437,581OPERATING
                  EXPENSESSelling
                  and marketing
              
              
              1,122,239
              
              
              –
              
              
              1,122,239
              
              
              3,353,306
              
              
              –
              
              
              3,353,306General
                  and administrative (2)
              
              
              2,144,261
              
              
              (771,667
              )
              
              1,372,594
              
              
              5,292,449
              
              
              (771,667
              )
              
              4,520,782Depreciation
                  and amortization
              
              
              256,205
              
              
              –
              
              
              256,205
              
              
              642,691
              
              
              –
              
              
              642,6913,522,705
              
              
              (771,667
              )
              
              2,751,038
              
              
              9,288,446
              
              
              (771,667
              )
              
              8,516,779LOSS
                  FROM OPERATIONS
              
              
              (1,607,056
              )
              
              771,667
              
              
              (835,389
              )
              
              (3,850,865
              )
              
              771,667
              
              
              (3,079,198
              )OTHER
                  INCOME (EXPENSE)Equity
                  in income (losses) from investments
              
              
              (1,657
              )
              
              –
              
              
              (1,657
              )
              
              45,028
              
              
              –
              
              
              45,028Gain
                  (Loss) on Financial Instruments (3)
              
              
              (540,000
              )
              
              (2,262,611
              )
              
              (2,802,611
              )
              
              1,500,000
              
              
              294,044
              
              
              1,794,044Gain
                  on early extinguishment of debt (4)
              
              
              0
              
              
              244,265
              
              
              244,265
              
              
              –
              
              
              244,265
              
              
              244,265Interest
                  income
              
              
              11,247
              
              
              –
              
              
              11,247
              
              
              69,165
              
              
              –
              
              
              69,165Interest
                  expense (5)
              
              
              (1,373,927
              )
              
              (327,802
              )
              
              (1,701,729
              )
              
              (4,329,455
              )
              
              266,081
              
              
              (4,063,374
              )(1,904,337
              )
              
              (2,346,148
              )
              
              (4,250,485
              )
              
              (2,715,262
              )
              
              804,390
              
              
              (1,910,872
              )NET
                  LOSS FROM CONTINUING OPERATIONS
              
              
              (3,511,393
              )
              
              (1,574,481
              )
              
              (5,085,874
              )
              
              (6,566,127
              )
              
              1,576,057
              
              
              (4,990,070
              )DISCONTINUED
                  OPERATIONSGain
                  on disposal of discontinued operations
              
              
              24,910
              
              
              –
              
              
              24,910
              
              
              24,910
              
              
              –
              
              
              24,910Net
                  loss from discontinued operations
              
              
              (171,637
              )
              
              –
              
              
              (171,637
              )
              
              (1,120,423
              )
              
              –
              
              
              (1,120,423
              )(146,727
              )
              
              –
              
              
              (146,727
              )
              
              (1,095,513
              )
              
              –
              
              
              (1,095,513
              )NET
                  LOSS
              
              
              ($3,658,120
              )
              
              ($1,574,481
              )
              
              ($5,232,601
              )
              
              ($7,661,640
              )
              $
              1,576,057
              
              
              ($6,085,583
              )Basic
                  net loss per share from continuing operations
              
              
              ($0.07
              )
              
              
              
              
              ($0.10
              )
              
              ($0.13
              )
              
              
              
              
              ($0.10
              )Basic
                  net loss per share from discontinued operations
              
              
              $0.00
              
              
              
              
              
              $0.00
              
              
              ($0.02
              )
              
              
              
              
              ($0.02
              )Basic
                  net loss per share
              
              
              ($0.07
              )
              
              
              
              
              ($0.10
              )
              
              ($0.15
              )
              
              
              
              
              ($0.12
              )Diluted
                  net loss per share from continuing operations
              
              
              ($0.07
              )
              
              
              
              
              ($0.10
              )
              
              ($0.13
              )
              
              
              
              
              ($0.10
              )Diluted
                  net loss per share from discontinued operations
              
              
              $0.00
              
              
              
              
              
              $0.00
              
              
              ($0.02
              )
              
              
              
              
              ($0.02
              )Diluted
                  net loss per share
              
              
              ($0.07
              )
              
              
              
              
              ($0.10
              )
              
              ($0.15
              )
              
              
              
              
              ($0.12
              )Weighted
                  average shares used to compute net loss per share:Basic
              
              
              53,676,751
              
              
              
              
              
              53,676,751
              
              
              52,523,523
              
              
              
              
              
              52,523,523Diluted
              
              
              53,676,751
              
              
              
              
              
              53,676,751
              
              
              52,523,523
              
              
              
              
              
              52,523,523





Explanatory
      Notes: September 2005 Income Statement





(1)
              As
                  previously reported in the Company’s quarterly report on form 10-QSB for
                  the period ended September 30, 2005 and filed with the Securities
                  and
                  Exchange Commission on November 21,
                  2005.
 (2)
              Reclassification of charge from general and
                administrative expense to gain on early extinguishment of
                debt.


(3)
            Gain
                (Loss) on financial instruments:Record
                the gain (loss) on financial instruments related to both the fair
                value
                adjustment for the outstanding warrants and the embedded derivative
                related to the conversion feature in the convertible
                notes.


(4)
            Gain
                on early extinguishment of debt:To
                record the gain associated with the early extinguishment of debt
                generated
                by the renegotiation of the Laurus debt instruments on July 28,
                2005.


(5)
            Interest
                expense:Record
                adjustments to interest expense for the revised amortization of the
                discount on debt for both the warrants and the embedded
                derivatives.





129


**Note
      23 - Subsequent Events**





On
      February 1, 2006, the Company restructured its financing with Laurus again
      by
      entering into financing agreements with Laurus, pursuant to which it, among
      other things, (a) issued a secured non-convertible term note in the principal
      amount of $1,000,000 to Laurus (the “Term Note”), (b) issued a secured
      non-convertible revolving note in the principal amount of $10,000,000 to Laurus
      (the “Revolving Note”, collectively with the Term Note, the “Notes”), and (c)
      issued an option to purchase up to 3,080,000 shares of the Company's common
      stock to Laurus (the “Option”) at an exercise price of $.001 per share. The
      proceeds from the issuance of the Notes were used to refinance the Company’s
      outstanding obligations under the existing facility with Laurus (originally
      entered into in August 2004 and subsequently amended in July 2005) at a 5%
      premium. The Notes bear an annual interest rate of prime (as reported in the
      Wall Street Journal, which was 7.25% as of January 31, 2006) plus 1.0%, with
      a
      floor of 5.0%. Payments of principal and interest will be made in equal monthly
      amounts until maturity of both notes on December 31, 2007, at which time the
      5%
      premium will also be due.




In
      connection with the Notes, the Company and Laurus entered into an Overadvance
      Letter Agreement, pursuant to which Laurus exercised its discretion granted
      to
      it pursuant to the Security Agreement entered into in August 2004 to make a
      loan
      to the Company in excess of the “Formula Amount” (as defined therein). The
      Company also entered into a Stock Pledge Agreement and Security Agreement
      securing its obligations to Laurus, both prior to and including the Notes,
      as
      well as a Registration Rights Agreement pursuant to which the Company agreed
      to
      file a registration statement to register the shares of the Company’s common
      stock underlying the Option, as well as the shares of the Company’s common stock
      and the shares of the Company’s common stock underlying the warrants held by
      Laurus, within 90 days. As of the date of this filing, Laurus owns approximately
      809,525 shares of the Company’s common stock, an option to purchase up to
      3,080,000 shares of the Company's common stock at an exercise price of $.001
      per
      share and warrants to purchase 400,000 shares of the Company’s common stock at
      $4.35 per share, 200,000 shares of the Company’s common stock at $4.65 per share
      and 200,000 shares of the Company’s common stock at $5.25 per
      share.





In
      February 2006, the Company entered into a Securities Purchase Agreement with
      Taurus Advisory Group LLC, pursuant to which it issued 19,000 shares of the
      Company’s newly created Series A Convertible Preferred Stock, $0.001 par value.
      Each shares of Series A preferred stock has a stated value of $100.00. The
      Company also granted Taurus a warrant to purchase 1,900,000 shares of the
      Company’s common stock exercisable at a price of $0.60 per share (subject to
adjustments
      related to stock splits, reclassifications, combinations, dividends, change
      of
      control or the issuance of pari passu securities). The warrant is
      exercisable for a period of five years.





In
      February 2006, the Company repurchased 3,892,355 shares of its common stock
      from
      the Company’s largest non-affiliated stockholder, WHRT I Corp. for
      $1,848,868.80, and such shares were placed back into the Company’s treasury. An
      additional 253,027 shares of our common stock relating to the escrowed shares
      were also placed back into treasury. The Company utilized the proceeds from
      its
      issuance of its Series A Convertible Preferred Stock in order to finance this
      common stock repurchase.





In
      February 2006, the Company received $2,050,000 as a result of Informatica
      Corporation’s acquisition of Similarity Systems. In July 2005, the Company sold
      substantially all the assets of its subsidiary, Evoke Software Corporation,
      to
      Similarity Systems for cash and future consideration.





In
      January 2006, the Company granted a stock option to purchase 1,000,000 shares
      of
      Company common stock to an executive. The exercise price is $0.46 per share,
      the
      options vest over a three year period from the date of grant, expire five
      years from the date of grant and had a fair value on the grant date of $430,000.
      Additionally, in April 2006, incentive stock options to purchase 130,000 shares
      of Company common stock were granted to employees. The exercise price for this
      grant is $1.05 per share, the options vest over a three year period from the
      date of grant, expire ten years from the date of grant and had a fair value
      on
      the grant date of $135,200.





In
      December 2005, the Company obtained a $1,000,000 short term loan from certain
      investors represented by Taurus. This note bears interest at 8% per annum.
      The
      note is dated December 19, 2005 and initially matured on January 31, 2006.
      The
      maturity date for this note has been extended to June 1, 2006. These
      short term note holders have agreed to extend their maturity date on a
      month-to-month basis until the Company raises sufficient funds to repay the
      notes. As of December 31, 2005, $500,000 had been drawn down on this
      loan. The Company obtained the remaining $500,000 available under this loan
      in
      January 2006. In conjunction with this note, these investors received a warrant
      to purchase 277,777 shares of our common stock with an exercise price of $0.675
      per share in December 2005, a warrant to purchase 277,777 shares of our common
      stock with an exercise price of $0.75 per share in February 2006 and a
      warrant to purchase 554,000 shares of our common stock with an exercise price
      of
      $1.30 per share in March 2006. These warrants expire in December
      2008, January 2009 and February 2009, respectively.





In
      July
      2005, the Company obtained two $250,000 short term loans from certain investors
      represented by Taurus. Both notes bear interest at 8% per annum. The first
      note
      is dated July 6, 2005 and initially matured on September 5, 2005. The maturity
      date for this note has been extended to May 6, 2006. The second note is dated
      July 22, 2005 and originally matured on September 22, 2005. The maturity date
      for this note has been extended to April 22, 2006. These
      short term note holders have agreed to extend their maturity date on a
      month-to-month basis until the Company raises sufficient funds to repay the
      notes.




On
        April
        18, 2006, the Company received a letter from the American Stock Exchange
        related
        to its late filing of this Form 10-KSB. The late filing was in violation
        of the
        continued listing standards of the American Stock Exchange. The letter requires
        the Company to become compliant with the continued listing standards of the
        American Stock Exchange by June 16, 2006, and the Company believes that it
        became compliant upon the filing of this Form 10-KSB.
 **Note
          24 - Restatement of Previously Reported Financial
          Information**
 
 At
          December 31, 2005 the Company restated its financial statements to adjust
          previously reported amounts to properly reflect the recording of the financial
          instrument liability as of December 31, 2005. The Company had previously
          used an
          incorrect year end Company stock price in calculating the valuation of
          the
          Laurus common stock warrant and the compound embedded derivative liability
          as of
          December 31, 2005.
 
 A
          summary
          of the balance sheet and income statement effects of the restatement for
          the
          year ended December 31, 2005 is as follows:
  As
                      of December 31, 2005As
                      reported
                  
                  RestatedFinancial
                      instruments
                  
                  $
                  2,209,733
                  
                  $
                  2,837,657Total
                      current liabilities
                  
                  
                  11,042,724
                  
                  
                  11,670,648Total
                      liabilities
                  
                  
                  16,221,406
                  
                  
                  16,849,330Accumulated
                      deficit
                  
                  
                  (40,061,438
                  )
                  
                  (40,689,362
                  )Total
                      stockholders' equity
                  
                  
                  2,257,063
                  
                  
                  1,629,139For
                      the year ended December 31, 2005As
                      reported
                  
                  
                  RestatedFinancial
                      instruments
                  
                  $
                  8,424,493
                  
                  $
                  7,796,569Loss
                      before income taxes and discontinued operations
                  
                  
                  (3,386,378
                  )
                  
                  (4,014,302
                  )Net
                      loss from continuing operations
                  
                  
                  (3,386,378
                  )
                  
                  (4,014,302
                  )Net
                      loss
                  
                  
                  (4,490,349
                  )
                  
                  (5,118,273
                  )Basic
                      net loss per share from continuing operations
                  
                  $
                  (0.06
                  )
                  $
                  (0.08
                  )Basic
                      net loss per share
                  
                  $
                  (0.08
                  )
                  $
                  (0.10
                  )Diluted
                      net loss per share from continuing operations
                  
                  $
                  (0.06
                  )
                  $
                  (0.08
                  )Diluted
                      net loss per share
                  
                  $
                  (0.08
                  )
                  $
                  (0.10
                  )




130


**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:
      May 22, 2006








/s/
      Scott Newman


Scott
      Newman


President,
      Chief Executive Officer and Chairman





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the Registrant and in the
      capacities and on the dates indicated.








Signature
            Title
            Date/s/
                Scott Newman
              Scott
                Newman
            President,
                Chief Executive Officer and Chairman
            May
                22, 2006/s/
                Mitchell Peipert
              Mitchell
                Peipert
            Vice
                President, Chief Financial Officer, Secretary and
                Treasurer
            May
                22, 2006/s/
                Glenn Peipert
              Glenn
                Peipert
            Executive
                Vice President, Chief Operating Officer and Director
            May
                22, 2006/s/
                Lawrence K. Reisman
              Lawrence
                K. Reisman
            Director
            May
                22, 2006/s/
                Joseph Santiso
              Joseph
                Santiso
            Director
            May
                22, 2006




131