Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**Mark One**

 

**x  QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For The Quarterly Period Ended  September 30, 2010**

 

**o****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the Transition Periodfrom               to               **

 

**Commission File Number 001-33521**

 

**INFOLOGIX, INC.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                   | ** ** | **20-1983837**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization) |       | (IRS Employer Identification Number) |
| ** **                                                     | ** ** | ** **                           |
| **101 E. County Line Road  Hatboro, PA**                       | ** ** | **19040**                            |
| (Address of principal executive offices)                       |       | (Zip code)                           |

 

**(215) 604-0691**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer”,“accelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act.

 
| Large accelerated filero                      |   | Accelerated filero         |
|-----------------------------------------------|--------|----------------------------|
|                                          |   |                       |
| Non-accelerated filerx                        |   | Smaller reporting companyo |
| (Do not check if a smaller reporting company) |   |                       |

 

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

 

Thenumber of shares outstanding of each of the issuer’s classes of common stock asof the latest practicable date

 
| **Class**                                      | ** ** | **Outstanding at November  11, 2010** |
|------------------------------------------------|------------|----------------------------------------------------------------|
| **Common Stock, $0.00001 par value per share** | ** ** | **6,428,694** **Shares**                                  |

 

 

 

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**TABLE OF CONTENTS**

 
| **PART I — FINANCIAL INFORMATION** | ** **                                                                                                                          |
|----------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------|
|                                         |                                                                                                                                |   |
| Item 1.                                      | Financial Statements                                                                                                                | 3 |
|                                         |                                                                                                                                |   |
|                                         | Condensed Consolidated Balance Sheets as of September  30, 2010 (unaudited) and December 31, 2009                              | 3 |
|                                         |                                                                                                                                |   |
|                                         | Condensed Consolidated Statements of Operations  (unaudited) for the three and  nine  months ended September 30, 2010 and 2009 | 4 |
|                                         |                                                                                                                                |   |
|                                         | Condensed Consolidated Statements of Cash Flows  (unaudited) for the nine months ended September 30, 2010 and 2009                  | 5 |
|                                         |                                                                                                                                |   |
|                                         | Condensed Consolidated Statement of Stockholders’  Deficit (unaudited) for the nine months ended September 30, 2010            | 6 |
|                                         |                                                                                                                                |   |
|                                         | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                   | 7 |
|                                         |                                                                                                                                |   |
| Item 2.                                      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                         | 18 |
|                                         |                                                                                                                                |   |
| Item 3.                                      | Quantitative  and Qualitative Disclosures About Market Risk                                                                         | 36 |
|                                         |                                                                                                                                |   |
| Item 4.                                      | Controls  and Procedures                                                                                                            | 37 |
|                                         | ** **                                                                                                                          |   |
| **PART II  — OTHER INFORMATION**   | ** **                                                                                                                          |
|                                         |                                                                                                                                |   |
| Item 1.                                      | Legal  Proceedings                                                                                                                  | 38 |
|                                         |                                                                                                                                |   |
| Item 1A.                                     | Risk Factors                                                                                                                        | 38 |
|                                         |                                                                                                                                |   |
| Item 2.                                      | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                        | 40 |
|                                         |                                                                                                                                |   |
| Item 3.                                      | Defaults  Upon Senior Securities                                                                                                    | 40 |
|                                         |                                                                                                                                |   |
| Item 4.                                      | Reserved                                                                                                                            | 40 |
|                                         |                                                                                                                                |   |
| Item 5.                                      | Other  Information                                                                                                                  | 40 |
|                                         |                                                                                                                                |   |
| Item 6.                                      | Exhibits                                                                                                                            | 40 |
|                                         |                                                                                                                                |   |
|                                         | Signatures                                                                                                                          | 42 |

 

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**PART I- FINANCIAL INFORMATION**

 

**Item 1.        Financial Statements**

 

**INFOLOGIX,INC.**

**CondensedConsolidated Balance Sheets**

**(in thousands, except share amounts)**

 
| ** **                                                                                                                                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                               | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                               | ** ** | ** **             |       |                  |       |
| Current assets:                                                                                                                                                                          |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                |       | $                      | 152        |                  | $          | 1,018 |   |
| Accounts and other receivables (net of allowance  for doubtful accounts in the amount of $81 and $2 as of September 30, 2010  and December 31, 2009, respectively)                       |       | 8,589                  |       | 14,158                |       |
| Unbilled revenue                                                                                                                                                                         |       | 897                    |       | 252                   |       |
| Inventory                                                                                                                                                                                |       | 2,892                  |       | 1,089                 |       |
| Inventory deposits                                                                                                                                                                       |       | 532                    |       | —                |       |
| Prepaid expenses and other current assets                                                                                                                                                |       | 821                    |       | 674                   |       |
| Total current assets                                                                                                                                                                     |       | 13,883                 |       | 17,191                |       |
| Property and equipment, net                                                                                                                                                              |       | 413                    |       | 600                   |       |
| Intangible assets, net                                                                                                                                                                   |       | 6,288                  |       | 7,343                 |       |
| Goodwill                                                                                                                                                                                 |       | 10,907                 |       | 10,337                |       |
| Deferred financing costs                                                                                                                                                                 |       | 228                    |       | 471                   |       |
| Total assets                                                                                                                                                                             |       | $                      | 31,719     |                  | $          | 35,942 |   |
|                                                                                                                                                                                     |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ DEFICIT**                                                                                                                                          | ** ** | ** **             |       |                  |       |
| Current liabilities:                                                                                                                                                                     |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                         |       | $                      | 5,865      |                  | $          | 7,624 |   |
| Line of credit                                                                                                                                                                           |       | 8,013                  |       | 7,559                 |       |
| Current portion of notes payable                                                                                                                                                         |       | 13,303                 |       | 12,336                |       |
| Current portion of capital lease obligations                                                                                                                                             |       | 51                     |       | 81                    |       |
| Accrued expenses                                                                                                                                                                         |       | 2,952                  |       | 3,150                 |       |
| Accrued earn out payable                                                                                                                                                                 |       | 2,528                  |       | 1,958                 |       |
| Deferred revenue                                                                                                                                                                         |       | 477                    |       | 1,690                 |       |
| Other liabilities                                                                                                                                                                        |       | 31                     |       | 276                   |       |
| Total current liabilities                                                                                                                                                                |       | 33,220                 |       | 34,674                |       |
| Notes payable, net of current maturities                                                                                                                                                 |       | 164                    |       | 231                   |       |
| Capital lease obligations, net of current  maturities                                                                                                                                    |       | 83                     |       | 114                   |       |
| Derivative liabilities                                                                                                                                                                   |       | 442                    |       | 2,762                 |       |
| Deferred income taxes                                                                                                                                                                    |       | 767                    |       | 592                   |       |
| Other liabilities                                                                                                                                                                        |       | —                 |       | 113                   |       |
| Total liabilities                                                                                                                                                                        |       | 34,676                 |       | 38,486                |       |
| Commitments and contingencies                                                                                                                                                            |       |                   |       |                  |       |
| Stockholders’ deficit:                                                                                                                                                              |       |                   |       |                  |       |
| Preferred stock, par value $.00001; authorized  10,000,000 shares; none issued or outstanding                                                                                            |       | —                 |       | —                |       |
| Common stock, par value $.00001; authorized  100,000,000 shares; issued and outstanding 6,428,694 shares and 3,722,156  shares at September 30, 2010 and December 31, 2009, respectively |       | —                 |       | —                |       |
| Additional paid in capital                                                                                                                                                               |       | 44,504                 |       | 38,132                |       |
| Accumulated deficit                                                                                                                                                                      |       | (47,461                | )          | (40,676               | )          |
|                                                                                                                                                                                     |       |                   |       |                  |       |
| Total stockholders’ deficit                                                                                                                                                         |       | (2,957                 | )          | (2,544                | )          |
|                                                                                                                                                                                     |       |                   |       |                  |       |
| Total liabilities and stockholders’ deficit                                                                                                                                         |       | $                      | 31,719     |                  | $          | 35,942 |   |

 

The accompanying notes are an integral part of these unauditedcondensed consolidated financial statements.

 

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**INFOLOGIX,INC.**

**CondensedConsolidated Statements of Operations (Unaudited)**

**(in thousands, except share and per share amounts)**

 
| ** **                                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                               | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Net revenues                                             |       | $                                                        | 12,001     |                                                    | $          | 22,345 |   | $ | 42,237 |   | $ | 65,568 |   |
| Cost of revenues                                         |       | 9,605                                                    |       | 16,399                                                  |       | 30,731 |   | 50,909 |   |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Gross profit                                             |       | 2,396                                                    |       | 5,946                                                   |       | 11,506 |   | 14,659 |   |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Selling, general and administrative expenses             |       | 5,891                                                    |       | 6,534                                                   |       | 17,512 |   | 21,945 |   |
| Gain on sale of intangible assets                        |       | —                                                   |       | —                                                  |       | (1,863 | ) | — |   |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating income (loss)                                  |       | (3,495                                                   | )          | (588                                                    | )          | (4,143 | ) | (7,286 | ) |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest expense                                         |       | (1,231                                                   | )          | (1,469                                                  | )          | (3,494 | ) | (3,803 | ) |
| Interest income                                          |       | —                                                   |       | 2                                                       |       | — |   | 17 |   |
| Loss on extinguishment of debt                           |       | —                                                   |       | —                                                  |       | — |   | (420 | ) |
| Gain on fair value of derivative liabilities             |       | 276                                                      |       | —                                                  |       | 1,040 |   | — |   |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Loss before income tax expense                           |       | (4,450                                                   | )          | (2,055                                                  | )          | (6,597 | ) | (11,492 | ) |
| Income tax expense                                       |       | (83                                                      | )          | (7                                                      | )          | (188 | ) | (21 | ) |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Net loss                                                 |       | (4,533                                                   | )          | $                                                       | (2,062     | ) | $ | (6,785 | ) | $ | (11,513 | ) |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Loss per share - basic and diluted                       |       | $                                                        | (0.87      | )                                                       | $          | (2.00 | ) | $ | (1.82 | ) | $ | (11.21 | ) |
|                                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average shares outstanding - basic and  diluted |       | 5,180,667                                                |       | 1,030,365                                               |       | 3,728,016 |   | 1,027,299 |   |

 

The accompanying notes are an integral part of these unauditedcondensed consolidated financial statements.

 

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**INFOLOGIX,INC.**

**CondensedConsolidated Statements of Cash Flows (Unaudited)**

**(in thousands)**

 
| ** **                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                           | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| Operating activities:                                |       |                                                    |       |   |   |
| Net cash used in operating activities                |       | $                                                       | (6,629     | ) | $ | (866 | ) |
|                                                 |       |                                                    |       |   |   |
| Investing activities:                                |       |                                                    |       |   |   |
| Acquisition of property, software and equipment      |       | (134                                                    | )          | (411 | ) |
| Proceeds from sale of patent                         |       | 1,980                                                   |       | — |   |
| Net cash provided by (used in) investing  activities |       | 1,846                                                   |       | (411 | ) |
|                                                 |       |                                                    |       |   |   |
| Financing activities:                                |       |                                                    |       |   |   |
| Proceeds from employee stock purchases               |       | —                                                  |       | 65 |   |
| Proceeds from issuance of warrants                   |       | —                                                  |       | 78 |   |
| Payment of deferred financing costs                  |       | (68                                                     | )          | (90 | ) |
| Repayment of long-term debt and capital leases       |       | (173                                                    | )          | (263 | ) |
| Proceeds from Equipment Loan                         |       | 2,250                                                   |       | — |   |
| Proceeds from Term Loan C                            |       | 1,350                                                   |       | — |   |
| Net borrowings from line of credit                   |       | 558                                                     |       | 46 |   |
| Net cash provided by (used in) financing  activities |       | 3,917                                                   |       | (164 | ) |
|                                                 |       |                                                    |       |   |   |
| Net decrease in cash and cash equivalents            |       | (866                                                    | )          | (1,441 | ) |
|                                                 |       |                                                    |       |   |   |
| Cash and cash equivalents at beginning of period     |       | 1,018                                                   |       | 3,037 |   |
|                                                 |       |                                                    |       |   |   |
| Cash and cash equivalents at end of period           |       | $                                                       | 152        |   | $ | 1,596 |   |

 

The accompanying notes are an integral part of these unauditedcondensed consolidated financial statements.

 

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**INFOLOGIX, INC.**

**CondensedConsolidated Statements of Stockholders’ Deficit (Unaudited)**

**(in thousands, except per share amounts****)**

** **
| ** **                                                      | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **             | ** ** | **Total**   | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|-------------|------------|
| ** **                                                      | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                                      | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**            | ** ** | **Deficit** | ** ** |
|                                                            |       |                  |       |        |       |            |       |                   |       |        |       |
| Balance, January 1, 2010                                        |       | 3,722,156             |       | $           | —     |            | $          | 38,132                 |       | $           | (40,676    | ) | $ | (2,544 | ) |
| Stock based compensation                                        | ** ** | **—**            |       | —      |       | 918             | ** ** | **—**             |       | 918         |       |
| Fractional shares resulting from reverse stock  split           |       | (55                   | )          | —      |       | —          | ** ** | **—**             |       | —      |       |
| Warrant exercise                                                |       | 14,803                |       | —      |       | —          |       | —                 |       | —      |       |
| Allocated finance costs                                         |       | —                |       | —      |       | 12              |       | —                 |       | 12          |       |
| Beneficial conversion feature associated with  convertible debt |       | —                |       | —      |       | 945             |       | —                 |       | 945         |       |
| Adjustment of convertible debt discount (see Note  O)           |       | —                |       | —      |       | (2,514          | )          | —                 |       | (2,514      | )          |
| Reclassification of warrant liability                           |       | —                |       | —      |       | 2,818           |       | —                 |       | 2,818       |       |
| Conversion of Term Loan B                                       |       | 2,691,790             |       |        |       | 4,193           |       |                   |       | 4,193       |       |
| Net loss                                                        |       | —                |       | —      |       | —          |       | (6,785                 | )          | (6,785      | )          |
| Balance, September 30, 2010                                     |       | 6,428,694             |       | $           | —     |            | $          | 44,504                 |       | $           | (47,461    | ) | $ | (2,957 | ) |
|                                                                 |            |                       |            |             |            |                 |            |                        |            |             |            |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these unauditedcondensed consolidated financial statements**.**

 

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**INFOLOGIX, INC.Notes to Condensed Consolidated Financial Statements (Unaudited)**

**(in thousands, except share information)**

 

**NOTEA—Nature of Business, Basis of Presentation and Liquidity**

 

***Nature ofbusiness***

 

InfoLogix, Inc.and its subsidiaries (collectively, the “Company”) provide enterprise mobilitysolutions for the healthcare and commercial markets. The Company’ssolutions are designed to allow the real time usage of data throughout anenterprise in order to enhance workflow, improve customer service, increaserevenue and reduce costs.  The solutionscombine products and services, including consulting, business software applications,mobile managed services, mobile devices, and wireless infrastructure.

 

OnNovember 20, 2009, the Company completed a restructuring transaction withHercules Technology Growth Capital, Inc. (“Hercules”) and HerculesTechnology I, LLC (“HTI”), a wholly-owned subsidiary of Hercules, pursuant towhich $5,000 of the Company’s outstanding debt was converted into shares ofcommon stock and a warrant to purchase shares of the Company’s common stock,and the remaining outstanding debt with Hercules was otherwise restructured(the “Hercules Restructuring”).  As a result of the HerculesRestructuring, the Company experienced a change in control and under the termsof the Debt Conversion Agreement, HTI has certain corporate governance andother rights with respect to the Company. See Note G.

 

***Basis of presentation***

 

Theaccompanying condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted  in the United States for interim financialreporting and with the instructions for Form 10-Q and Article 10 ofRegulation S-X. They do not include all of the disclosures normally made in theconsolidated financial statements contained in the Company’s Annual Report onForm 10-K. In management’s opinion, all adjustments considered necessaryfor a fair presentation of the consolidated results of operations, financialposition and cash flows for the periods shown have been made.  All such adjustments are of a normal andrecurring nature. The notes to the consolidated financial statements containedin the Annual Report on Form 10-K for the year ended December 31,2009 should be read in conjunction with these condensed consolidated financialstatements.  Operating results for thethree months and nine months ended September 30, 2010 are not necessarilyindicative of the results that may be expected for the year endingDecember 31, 2010.

 

Thecondensed consolidated financial statements include the accounts ofInfoLogix, Inc. and its wholly-owned subsidiaries: InfoLogix SystemsCorporation, OPT Acquisition, LLC, Embedded Technologies, LLC, andInfoLogix—DDMS, Inc. All significant intercompany balances andtransactions have been eliminated in consolidation.

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the amounts reported in the consolidated financialstatements and the accompanying notes. Management considers materiality anduses the information available to prepare the consolidated financial statementsincluding the Company’s history, industry standards and the current economicenvironment, among other factors, in forming its estimates and judgments.Because of the uncertainty inherent in such estimates, actual results maydiffer from these estimates.

 

OnJanuary 5, 2010, the Company completed a reverse stock split of its issuedand outstanding common stock by a ratio of one-for-twenty-five. All share andper share amounts in the accompanying consolidated financial statements havebeen adjusted to retroactively reflect the reverse stock split.

 

***Liquidity***

 

Theaccompanying financial statements for the three and nine months ended September 30,2010 have been prepared on a going concern basis, which contemplates continuingoperations, securing additional debt or equity financing, restructuringexisting debt, effecting one or more strategic transactions, and realizingassets and liabilities in the ordinary course of business. However, the Companyhas incurred significant net losses from 2006 through the third quarter of2010, including a net loss in the first nine months of 2010 of $6,785. TheCompany’s losses are attributable to its transition over the last several yearsfrom being primarily a seller of infrastructure and hardware to becoming aprovider of comprehensive enterprise mobility solutions, its shift fromsupplying mobile workstations to launching a new product and relatedtechnology, tightened credit terms with the Company’s vendors, and thedifficult economic conditions under which it continues to operate.

 

As a result of the Company’s capital and debtstructure and recurring losses, it has substantial near-term liquidityrequirements 

 

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related to the repayment of the equipment loan, termloans and the revolving line of credit that are currently due as a result ofdefault and earn out payments for past acquisitions. The Company also iscurrently in default under a promissory note issued to a seller in connectionwith an acquisition and is in discussions with the holder.  As of  September 30,2010, the Company has a working capital deficit of $19,337. The Company doesnot currently expect to generate sufficient cash flow from operations to fundthose obligations. As a result, these factors raise substantial doubt as to theCompany’s ability to continue as a going concern. See Note P for debttransactions in October 2010.

 

The Company has undertaken a series of actions toreduce costs and is actively pursuing various initiatives to continue as agoing concern and provide for its future success. The Company’s plan to improveliquidity contemplates additional cost control measures and may also includeadditional financing, further restructuring of its debt and effecting one ormore strategic transactions. The Company’s ability to implement these planssuccessfully is dependent on the Company’s ability to execute on its transitionto a new line of mobile workstations and on many circumstances outside of itsdirect control, including, the general economic conditions and the financialstrength of its customers. The Company has increased it borrowings from itslender, Hercules, a number of times over the past nine months, and anyadditional financing the Company is able to secure will likely be subject to anumber of conditions and involve additional costs. In addition, the Company’scommon stock was delisted from trading on The Nasdaq Stock Market as a resultof the Company’s failure to meet continued listing requirements of Nasdaq.  Although the Company’s stock is quoted on theelectronic quotation service for securities traded over-the-counter, thedelisting could have an adverse affect on the Company’s ability to obtainfinancing.  As a consequence and giventhe current negative conditions in the economy generally and the credit marketsin particular, there is uncertainty as to whether the Company will be able togenerate sufficient liquidity to meet its working capital needs, to repay itsoutstanding debt and to make its earn out payments. If the Company is unable toimprove its liquidity position, it may not be able to continue as a goingconcern.

 

**NOTE B—Recent Accounting Pronouncements**

 

InJuly 2010, the Financial Accounting Standards Board (“FASB”) issuedAccounting Standards Update (“ASU”) 2010-20, which amends Accounting StandardsCodification (“ASC”) 310 by requiring more robust and disaggregated disclosuresabout the credit quality of an entity’s financing receivables and its allowancefor credit losses. The objective of enhancing these disclosures is to improvefinancial statement users’ understanding of (a) the nature of an entity’scredit risk associated with its financing receivables and (b) the entity’sassessment of that risk in estimating its allowance for credit losses as wellas changes in the allowance and the reasons for those changes. The guidance iseffective for the first reporting period beginning after December 15,2010. The Company does not expect that the adoption of these new disclosurerequirements will have a material impact on its consolidated financialstatements.

 

InJanuary 2010, the FASB issued ASU No. 2010-06, *“*ImprovingDisclosures About Fair Value Measurements,” which added disclosurerequirements about an entity’s use of fair value measurements. Among theserequirements, entities will be required to provide enhanced disclosures abouttransfers into and out of the Level 1 (fair value determined based on quotedprices in active markets for identical assets and liabilities) and Level 2(fair value determined based on significant other observable inputs)classifications, provide separate disclosures about purchases, sales, issuancesand settlements relating to the tabular reconciliation of beginning and endingbalances of the Level 3 (fair value determined based on significantunobservable inputs) classification and provide greater disaggregation for eachclass of assets and liabilities that use fair value measurements. Except forthe detailed Level 3 roll-forward disclosures, the new standard was effectivefor the Company for interim and annual reporting periods beginning after December 31,2009. The adoption of this accounting standards amendment did not have amaterial impact on the Company’s consolidated financial statements. Therequirement to provide detailed disclosures about the purchases, sales,issuances and settlements in the roll-forward activity for Level 3 fair valuemeasurements is effective for the Company for interim and annual reportingperiods beginning after December 31, 2010. The Company does not expectthat the adoption of these new disclosure requirements will have a materialimpact on its consolidated financial statements.

 

InOctober 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition(Topic 605) - Multiple-Deliverable Revenue Arrangements.” ASU No. 2009-13provides additional guidance on the accounting for revenue recognition formultiple-deliverable arrangements to enable vendors to account for products orservices (deliverables) separately rather than as a combined unit. Thisguidance establishes a selling price hierarchy for determining the selling priceof a deliverable, which is based on: (a) vendor-specific objectiveevidence; (b) third-party evidence; or (c) estimates. This guidancealso eliminates the residual method of allocation and requires that arrangementconsideration be allocated at the inception of the arrangement to alldeliverables using the relative selling price method. In addition, thisguidance significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements. ASU No. 2009-13 is effectiveprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010 and early adoption ispermitted. A company may elect, but will not be required, to adopt theamendments in ASU No. 2009-13 retrospectively for all prior periods. TheCompany does not expect the provisions of ASU 2009-13 to have a material effecton the financial position, results of operations, or cash flows of the Company.

 

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**NOTE C—Inventory**

 

Inventory consists of the following:

 
| ** **       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------|------------|------------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **       | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| Finished goods   |       | $                      | 2,892      |                  | $          | 1,009 |   |
| Work in progress |       | —                 |       | 80                    |       |
|             |       |                   |       |                  |       |
| Total inventory  |       | $                      | 2,892      |                  | $          | 1,089 |   |

 

Inventorydeposits of $532 at September 30, 2010 represent amounts paid to date tovendors as advances on future purchases of power management systems inventoryand are not included in the table above.

 

**NOTE D—Intangible assets**

 

Intangibleassets consist primarily of non-contractual customer relationships, salescontracts, patents, technology and trademarks and trade names. Intangibleassets that have a definite life are amortized on a straight—line basis overtheir estimated useful lives or contract periods, generally ranging from 2 to16 years.

 

Intangibleassets at September 30, 2010 and December 31, 2009 consist of thefollowing:

 
| ** **                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                   | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| Patents                      |       | $                      | 2,696      |                  | $          | 2,824 |   |
| Computer software            |       | 2,146                  |       | 2,063                 |       |
| Developed technology         |       | 890                    |       | 890                   |       |
| Customer lists               |       | 4,285                  |       | 4,285                 |       |
| Non compete agreements       |       | 289                    |       | 289                   |       |
| Trademarks and trade names   |       | 1,471                  |       | 1,469                 |       |
|                         |       | 11,777                 |       | 11,820                |       |
| Less accumlated amortization |       | (5,489                 | )          | (4,477                | )          |
|                         |       |                   |       |                  |       |
| Total net intangible assets  |       | $                      | 6,288      |                  | $          | 7,343 |   |

 

InJune 2010, the Company completed the sale of a U.S. and correspondingKorean patent that it believes is not essential to its business, for $2,200,providing net proceeds of $1,980 after commissions. The Company has retained aworldwide, non-exclusive, royalty-free license to use the technology covered bythe patent for all of its current and future products. In connection withthis sale, the Company recorded a gain of $1,863 during the nine months ended September 30,2010.

 

Amortizationexpense for the three months ended September 30, 2010 and 2009 was $304and $365, respectively, and $983 and $1,094 for the nine months ended September 30,2010 and 2009, respectively.

 

**NOTE E—****Goodwill**

 

Goodwill is the excess of the purchase price paid over the fair valueof the net assets of businesses acquired. In conjunction with the acquisitionof substantially all of the assets of Delta Health Systems, Inc. (“Delta”)in May 2008, the Company entered into an earn out agreement with Delta inwhich Delta is eligible to earn additional consideration in the subsequent twoyear period after the closing of the transaction. During the three months endedSeptember 30, 2010 and the nine months ended September 30, 2010, theCompany recorded additional goodwill of $70 and $570, respectively, pursuant tothe earn out agreement.

 

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**NOTEF—Customer and Vendor Concentrations**

 

Forthe three and nine months ended September 30, 2010, there were noindividual customers that comprised 10% or more of net revenues.

 

Forthe three and nine months ended September 30, 2009, there was one customerthat represented approximately 13% and 19%, respectively, of net revenues and17% of net accounts receivable at September 30, 2010.

 

Forthe three months ended September 30, 2010 and 2009, the Company had oneand three vendors, respectively, that individually comprised 12% and 57%,respectively, of the cost of sales.  Forthe nine months ended September 30, 2010 and 2009, the Company had twovendors that comprised 26% and 53%, respectively, of the cost of sales.

 

**NOTEG—Debt**

 

OnMay 1, 2008, the Company entered into a loan and security agreement withHercules (“Loan and Security Agreement”), which provided the Company with arevolving credit facility and a term loan facility.  The Loan and Security Agreement wassubsequently amended in November 2008 and May 2009, and the Companyand Hercules entered into a forbearance agreement with respect to certaindefaults under the Loan and Security Agreement in July 2009, and theparties entered into five amendments to the forbearance agreement over thecourse of August through October 2009.  In connection with the Hercules Restructuringthat closed on November 20, 2009, the Company entered into an amended loanagreement with Hercules (“Amended Loan Agreement”), which amended and restatedthe Loan and Security Agreement. The Hercules Restructuring also provided theCompany with up to $5,000 in additional availability under a revolving creditfacility with Hercules. In connection with the Hercules Restructuring, theCompany entered into a Debt Conversion Agreement with HTI (“Debt ConversionAgreement”), pursuant to which HTI exchanged $5,000 in existing indebtednessfor (i) 2,691,790 shares of common stock, and (ii) a warrant topurchase 672,948 shares of common stock. The description of the Amended LoanAgreement below reflects the terms in place since November 20, 2009, andas amended on February 19, 2010, April 6, 2010 and June 18,2010.  At September 30, 2010, theCompany’s indebtedness to Hercules consisted of a $5,500 term loan (“Term LoanA”), a $760 convertible note (“Term Loan B”), a $1,350 convertible note (“TermLoan C”), a $12,000 revolving line of credit facility, of which $8,117 wasoutstanding at September 30, 2010, and an equipment loan with anoutstanding balance of $2,201 (“Equipment Loan”). The Company entered into anamendment to the Amended Loan Agreement on October 28, 2010 (See Note P).

 

TermLoan A has a 48-month term, with principal amortization of approximately $153per month beginning December 1, 2010. The outstanding principal balance on Term Loan A bears interest payablemonthly at 12% per annum for the initial year; 18% per annum for the subsequenttwelve months and 15% per annum thereafter.

 

TermLoan B has a 60-month term and can be converted, at Hercules’ option or automaticallyif the 90 day value weighted adjusted trading price exceeds five times theconversion price, into shares of the Company’s common stock at $1.8575 pershare. If not converted, the outstanding principal balance of Term Loan B isdue on November 1, 2014. The outstanding principal balance on Term Loan Bbears interest at 14.5% per annum for the initial twelve months followingclosing of the arrangement; 20.5% per annum for the subsequent twelve monthsand 17.5% per annum thereafter. A portion (2.5%) of the interest rate on TermLoan B is to be “paid in kind” (“PIK”) compounded monthly. Pursuant toAmendment 2, as discussed below, Hercules has the option, at its solediscretion, to require any and all interest on Term Loan B to be payable incash, paid in kind (“PIK”) or in shares of common stock of the Company. IfHercules elects to be paid in shares, the number of shares into which accruedinterest will be converted will be determined based on 70% of the adjusted60-day average trading price of the Company’s common stock on the date ofHercules’ election to convert the interest into shares. On August 13,2010, Hercules converted $5,000 of the aggregate principal amount of Term LoanB at the conversion price of $1.8575 per share, for an issuance of 2,691,790shares of the Company’s common stock. In accordance with ASC 470, the Companyreclassified the unamortized deferred financing costs of $75 and theunamortized debt discounts of $732 associated with the converted amount toequity. The remaining carrying amount of the debt converted of $4,193 wasrecorded to additional paid-in capital upon conversion.  As a result of the conversion, the principalbalance at September 30, 2010 of $760 represents PIK interest that was notconverted. Hercules continues to have the ability to convert the outstandingprincipal balance into shares of the Company’s common stock. Both Term Loans Aand B will be assessed a prepayment charge between 1% and 5% of the total termloan commitment depending on when paid.

 

Therevolving credit facility expires on May 1, 2011, but may be extended atthe Company’s option for six months if there is then no existing event ofdefault. Any advances under the revolving credit facility bear interestinitially at 12% per annum until the Term Loans are repaid in full, at whichtime the interest rate on outstanding advances will be prime plus 4%. Theborrowing capacity under the revolving credit facility is limited to the lesserof the maximum availability or 85% of the Company’s eligible accounts receivableas defined in the Amended Loan Agreement. Borrowings under the revolving creditfacility include an over advance provision of up to $500, which will be due 28days after the over advance is drawn. Over advances bear interest at 15% perannum. On September 13, 

 

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2010,Hercules advanced to the Company an additional $500 (See Note P), which wassubsequently paid with the proceeds of Term Loan D. The advance increased theoutstanding indebtedness on the revolving line of credit to $8,117, and wasprovided as an extension above the Company’s eligible borrowing base. Therevolving credit facility is reflected on the balance sheet net of unamortizeddebt discount of $104 (see Note O).

 

OnFebruary 19, 2010, the Company entered into Amendment No. 1 (“Amendment1”) to the Amended Loan Agreement, which provided the Company with an EquipmentLoan allowing the Company to request up to $3,000 in borrowings for use inpurchasing equipment. The Company was permitted to borrow in minimum incrementsof $250 under the Equipment Loan, subject to valid, verified purchase ordersacceptable to Hercules from suppliers approved by Hercules in its solediscretion.  In connection with anyadvances, the Company is charged a fee of 3% of the purchase price identifiedin the relevant purchase orders. All customer receipts related to sales of productsfinanced by the Equipment Loan are placed in a lockbox account under theexclusive control of Hercules and customer receipts are applied first topayment of the Equipment Loan fee, second, to the outstanding principal on theEquipment Loan and third, to all other obligations existing under the EquipmentLoan. After such application, the excess in the lockbox account will bereturned to the Company, unless an event of default exists or could reasonablybe expected to exist, in which case, Hercules may apply the excess in thelockbox account to any obligation under the Amended Loan Agreement. TheEquipment Loan bears interest at a rate of 1.5% per month and is due on December 31,2010. Hercules’ commitment to make additional equipment advances terminated on June 30,2010, which was extended from the original commitment termination date of April 30,2010.

 

OnApril 6, 2010, the Company entered into Amendment No. 2 (“Amendment 2”)to the Amended Loan Agreement with Hercules. Pursuant to Amendment 2, Herculesfunded Term Loan C in an original principal amount of $1,350. The proceeds ofTerm Loan C were used to repay outstanding over advances under the revolvingcredit facility. Interest on Term Loan C accrues at a rate of 8% per annum and,at the discretion of Hercules, is payable either in cash or in kind by addingthe accrued interest to the principal of Term Loan C. All principal outstandingon Term Loan C is due and payable on April 1, 2013. Term Loan C may beconverted into shares of the Company’s common stock at a price of $3.276 pershare at any time at Hercules’ option. The Company may prepay Term Loan Cwithout incurring a prepayment penalty charge. The Company also entered into aregistration rights agreement with Hercules whereby it agreed to register theshares underlying Term Loan C and certain interest that may be paid in shares.

 

TermLoan C conversion rights are considered a beneficial conversion feature as theywere in the money on the commitment date. In accordance with ASC 470-20, “Debtwith Conversion and other Options,” the Company separately accounted for theliability and equity components of this instrument by allocating the proceedsfrom issuance of the instrument between the liability component and theconversion option. The value ascribed to the beneficial conversion option, $945,was based upon the intrinsic value of the option on the commitment date and wasreported as a debt discount. The debt discount is being amortized as additionalinterest expense over the instrument’s expected life.

 

In connection with Amendment 2, the Company enteredinto a registration rights agreement with Hercules and subsequent letteragreement whereby the Company agreed to file a shelf registration statementwith the SEC covering the resale of the shares of common stock that may beissued to Hercules upon the conversion of Term Loan C or in payment of defaultrate interest with respect to the revolving credit facility, Term Loan A, TermLoan B, Term Loan C and the Equipment Loan. The Company has agreed to use its best efforts to have the registrationstatement declared effective by the SEC no later than September 30, 2010,subject to a 60 day extension in the event of SEC review.  As of September 30, 2010, the Companyhas not filed the contemplated registration statement.

 

OnJune 18, 2010, the Company entered into Amendment No. 3 (“Amendment 3”)to the Amended Loan Agreement with Hercules. Pursuant to Amendment 3, Herculesagreed to release its security interest in a U.S. and corresponding Koreanpatent to allow the sale as a permitted transfer under the Amended LoanAgreement.  The cash proceeds of $1,980from the sale of the patent were applied to reduce the outstanding balanceunder the revolving credit facility.

 

TheAmended Loan Agreement contains certain negative covenants and otherstipulations associated with the arrangement, including covenants that restrictthe Company’s ability to incur indebtedness, make investments, make payments inrespect of its capital stock, including dividends and repurchases of commonstock, sell or license its assets, and engage in acquisitions without the priorsatisfaction of certain conditions. Additionally, the Amended Loan Agreementcontains the following financial covenants (i) minimum consolidatedadjusted EBITDA measured on a three month rolling basis as of the last day ofeach month of between $150 and $2,000, until December 31, 2011 andthereafter when $3,000 of consolidated adjusted EBITDA is required, (ii) maximumleverage ratio measured on a rolling twelve month basis as of the last day ofeach fiscal quarter commencing June 30, 2010 of 6.0 to 1.0 decreasing to1.5 to 1.0 by the quarter ending June 30, 2012, (iii) minimumconsolidated fixed charge coverage ratio measured on a rolling twelve monthbasis as of the last day of a fiscal quarter commencing June 30, 2010 of0.75 to 1.0 increasing to 2.0 to 1.0 by the quarter ending June 30, 2012,and (iv) at least $1,000 in unrestricted cash at all times. Failure to maintainthe financial covenants, as well as certain other events including a change incontrol, are events of default under the Amended Loan Agreement. Upon an eventof default under the Amended Loan Agreement, Hercules may opt to accelerate anddemand payment of all or any part of our obligations. 

 

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Underthe terms of the Amended Loan Agreement, late fees are equal to 5% of the pastdue amount and default rate interest is equal to the applicable regularinterest rate plus 3%. Hercules may elect to have default rate interest payablein cash, in kind or in shares of the Company’s common stock. All default rateinterest paid in kind will be added to the outstanding principal amount on TermLoan B, notwithstanding on which loan the interest has accrued. If Herculeselects to have default rate interest paid in shares, the number of shares intowhich such accrued default rate interest will be converted will be determinedbased on the adjusted 60-day average price discounted by 30%, on the date ofHercules’ election to convert the interest into shares.

 

Inconjunction with Hercules ability to elect to have default interest paid inshares at a discounted price, the Company recorded additional debt discount andan embedded derivate liability totaling $748 at April 6, 2010, as furtherdiscussed in Note N. The debt discount was determined based on the fair valueof this embedded derivate and was allocated to Term Loans A, B and C. The debtdiscount is being amortized to interest expense using the effective interestmethod over the expected life of the related loan.

 

OnFebruary 10, 2010, Hercules sent the Company a letter notifying theCompany of an event of default as of February 5, 2010 and charging theCompany a default interest rate of an additional 3% to the applicable regularinterest rate for the period starting February 5, 2010. Events of defaultare continuing and default rate interest will be payable monthly on the samedate as regular interest unless Hercules chooses to demand payment of defaultinterest on another date. As of September 30, 2010, the Company was not incompliance with the borrowing base requirement related to the revolver, theminimum cash and EBITDA requirement, Total Leverage Ratio and Fixed ChargeCoverage ratio. As a result of the above defaults, all balances outstandingunder the Amended Loan Agreement at September 30, 2010 have beenclassified as current in the accompanying consolidated balance sheet.  Hercules has not chosen to accelerate theCompany’s obligations under the Amended Loan Agreement, but has expressly notwaived any events of default or any of its remedies. The Company does not haveadequate liquidity to repay all outstanding amounts under the credit facilityand payment acceleration would have a material adverse effect on the Company’sliquidity, business, financial condition and results of operations.

 

In September 2007, the Company issued aconvertible promissory note (the “Note”) to Healthcare Informatics Associates, Inc.(“HIA”) for $3,500 as part of the consideration for the acquisition of HIA. TheNote bears interest at a rate of 9% per annum, which compounds annually, fromthe date of the Note until the principal amount is paid in full. Theoutstanding unpaid principal amount of the Note is convertible at the option ofHIA into unregistered shares of the Company’s common stock at a conversionprice of $135.50 per share. The principal amount of the Note and all accruedinterest was payable in full on September 30, 2010. As of September 30,2010, the Company owed $4, 533 in principal and interest on the note and is indefault on the Note for nonpayment of principal and accrued interest on itsmaturity date and as a consequence, HIA, at its sole discretion, may charge theCompany a default interest rate of an additional 2.5% until such time thatdefault is cured. The Note is subject to a Subordination Agreement by and amongHercules, HIA and the Company (the “Subordination Agreement”), under which theCompany is restricted in its ability to make payments under the Note and HIA isrestricted in its ability to take action against the Company to enforce itsobligations, including bringing an enforcement action during the standstillperiod, which is 180 days from the date HIA gives Hercules notice of a defaultunder the Note.  Under the SubordinationAgreement, an event of default under the Note also results in an event ofdefault under the Amended Loan Agreement with Hercules.  The Company is currently in discussions withHIA regarding the Note.

 

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Notespayable consist of the following:

 
| ** **                                                                                                                                                                                                                                                                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                                                                                                                | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| Term Loan A note payable to Hercules. At  September 30, 2010 and December 31, 2009, the outstanding principal  balance was $5,500 and $5,500, respectively, net of unamortized discount of  $323 and zero, respectively. See Note O.                            |       | $                      | 5,177      |                  | $          | 5,500 |   |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Convertible Term Loan B note payable to Hercules.  At September 30, 2010 and December 31, 2009, the outstanding  principal balance, including PIK, was $760 and $5,015, respectively, net of  unamortized discount of $13 and $2,514, respectively. See Note O. |       | 747                    |       | 2,501                 |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Convertible Term Loan C note payable to Hercules.  At September 30, 2010 and December 31, 2009, the outstanding  principal balance was $1,350 and zero, respectively, net of unamortized  discount of $793 and zero, respectively.                              |       | 557                    |       | —                |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Note payable to Hercules pursuant to the Equipment  Loan.                                                                                                                                                                                                                 |       | 2,201                  |       | —                |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Convertible note payable pursuant to an asset  purchase agreement with HIA. Principal and accrued interest at 9.0% per annum  was due September 30, 2010.                                                                                                            |       | 4,533                  |       | 4,252                 |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Note payable pursuant to an asset purchase  agreement with AMT Systems, Inc. in monthly installments of $9 including  interest at 7.84%, maturing May 31, 2013.                                                                                                 |       | 252                    |       | 314                   |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Total notes payable                                                                                                                                                                                                                                                       |       | 13,467                 |       | 12,567                |       |
|                                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Less current maturities                                                                                                                                                                                                                                                   |       | (13,303                | )          | (12,336               | )          |
|                                                                                                                                                                                                                                                                      |       | $                      | 164        |                  | $          | 231 |   |

 

**NOTE H—Related Party Transactions**

 

*NotesPayable - Stockholder*

 

Asa result of the Hercules Restructuring, Hercules became the Company’s majoritystockholder through its wholly-owned subsidiary, HTI. During the three monthsended September 30, 2010 and 2009, Hercules charged the Company intereston outstanding debt of $793 and $1,240, respectively, and $2,377 and $3,031 forthe nine months ended September 30, 2010 and 2009, respectively, whichincludes PIK and default interest.

 

OnAugust 13, 2010, Hercules converted $5,000 of the aggregate principalamount of Term Loan B at the conversion price of $1.8575 per share, for an issuanceof 2,691,790 shares of the Company’s common stock. (See Note G)

 

*Professional recruiting services*

 

TheCompany maintains a business relationship with Gulian & Associates,which is owned by the wife of David T. Gulian, the Company’s President and ChiefExecutive Officer and a director and stockholder of the Company.  Under the terms of the arrangement, Gulian & Associates provides theCompany with retainer-based professional recruiting services on a non-exclusivebasis.  Gulian & Associates is paid a fee of 20% of a newly hiredperson’s annual base salary for employees it introduces to the Company.  One-third of the estimated fee is due at thetime the hiring request is made.  Theremainder is due upon successful placement of a candidate into the role. Duringthe three months ended September 30, 2010 and 2009, Gulian &Associates charged fees to the Company of $70 and $11, respectively. During thenine months ended September 30, 2010 and 2009, Gulian &Associates charged the Company fees of $193 and $113, respectively.

 

*Transactioncommission*

 

Duringthe nine months ended September 30, 2010, the Company made a one-timecommission payment of $220 to The SAGE Group (“SAGE”), a company in whichThomas Miller, a member of the Company’s board of directors, is a partner. SAGE

 

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providedassistance in identifying a buyer for the Company’s patent sale in June 2010(as described in Note D). No further payments are required to be made to SAGE.

 

**NOTEI—Commitments and Contingencies**

 

*Litigation*

 

TheCompany is involved in disputes or legal actions arising in the ordinary courseof business. Management does not believe the outcome of such legal actions willhave a material adverse effect on the Company’s financial position, results ofoperations or cash flows.

 

*Vendorcommitments*

 

Underthe terms of a master service agreement, the Company granted exclusive rightsto a vendor to provide certain outsourcing services to support the Company’soperations. The Company has a minimum annual commitment to purchase supportservices in an aggregate amount of $1,500 per year through 2013. The minimumannual commitment was waived by the vendor for the calendar year 2010. TheCompany incurred costs of $195 and $589 for the three months ended September 30,2010 and 2009, respectively, and $449 and $1,634 of costs for the nine monthsended September 30, 2010 and 2009, respectively.

 

**NOTEJ—Income Taxes**

 

TheCompany has net operating loss carryforwards available for federal and certainstate tax obligations.  Because theCompany experienced a change in control as a result of the HerculesRestructuring, future utilization of the net operating losses is limited under Section 382of the Internal Revenue Code. The Company has determined that it is more likelythan not that it will not be able to use the net operating losses and otherdeferred tax assets and has recorded a full valuation allowance at September 30,2010.  Income tax expense of $83 and $7for the three months ended September 30, 2010 and 2009, respectively, and$188 and $21 for the nine months ended September 30, 2010 and 2009,respectively, results from a deferred tax provision for the difference betweenbook and tax amortization of indefinite lived assets and miscellaneous statetaxes.

 

**NOTEK—2008 Employee Stock Purchase Plan**

 

TheCompany has an employee stock purchase plan (“ESPP”). The ESPP provides theCompany’s employees the opportunity to purchase common stock throughaccumulated payroll deductions.  TheCompany has reserved 40,000 shares for use in the ESPP. The ESPP hasconsecutive three month offering periods commencing on the first trading day ofeach calendar quarter. The Company’s Board of Directors suspended the ESPPindefinitely effective July 1, 2009.

 

Forthe three months and nine months ended September 30, 2010, the Company didnot issue any shares under the ESPP. For the three months ended September 30,2009, the Company did not issue any shares under the ESPP. During the ninemonths ended September 30, 2009, the Company issued 6, 275 shares inconnection with the ESPP and received $65 in cash proceeds**.**

 

**NOTEL—Stock Based Compensation**

 

Forthe three months ended September 30, 2010 and 2009, the Company recognizedcompensation cost for stock options granted of $276 and $182, respectively, andfor the nine months ended September 30, 2010 and 2009, the Companyrecognized compensation cost for stock options granted of $918 and $712,respectively. Option awards generally vest over a 3 to 4 year period ofcontinuous service and have a ten year contractual term.  The fairvalue of each option is amortized on a straight-line basis over the option’svesting period.  The fair value of each option is estimated on thedate of grant using the Black-Scholes option valuation model. As of September 30,2010, the total unrecognized compensation cost related to options amounted toapproximately $1,524 which is expected to be recognized over the options’average remaining vesting period of 2.1 years.

 

Duringthe three months ended September 30, 2010 and 2009, the Company did notgrant any stock options.  During the ninemonths ended September 30, 2010 and 2009, the Company granted 719,706 and18,085 options, respectively.

 

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** **

**NOTE M— Operating Segments**

 

The Company has two reportable operatingsegments: healthcare and commercial. Each of the reportable segments providessimilar products and services, with a focus on primary vertical markets. The implementationand support organizations in both the healthcare and commercial segmentsprovide solutions that include consulting, business software applications,mobile managed services, mobile workstations and devices, and wirelessinfrastructure.  The Company evaluates the performance of itsoperating segments based on gross profit and does not allocate assets amongsegments. Although there is no intersegment sales or transfers, the Company sharessupport, development and administration across both of its segments.

 
| ** **       | ** ** | **Three months ended September 30, 2010** | ** ** | **Nine months ended September 30, 2010** | ** ** |
|------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **       | ** ** | **Healthcare**                                                     | ** ** | **Commercial**                                                    | ** ** | **Total** | ** ** | **Healthcare** | ** ** | **Commercial** | ** ** | **Total** | ** ** |
| Net revenues     |       | $                                                                  | 8,736      |                                                              | $          | 3,265 |   | $ | 12,001 |   | $ | 29,294 |   | $ | 12,943 |   | $ | 42,237 |   |
| Cost of revenues |       | 6,894                                                              |       | 2,711                                                             |       | 9,605 |   | 20,694 |   | 10,037 |   | 30,731 |   |
| Gross profit     |       | $                                                                  | 1,842      |                                                              | $          | 554 |   | $ | 2,396 |   | $ | 8,600 |   | $ | 2,906 |   | $ | 11,506 |   |
| Gross margin     |       | 21                                                                 | %          | 17                                                                | %          | 20 | % | 29 | % | 22 | % | 27 | % |

 
| ** **       | ** ** | **Three months ended September 30, 2009** | ** ** | **Nine months ended September 30, 2009** | ** ** |
|------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **       | ** ** | **Healthcare**                                                     | ** ** | **Commercial**                                                    | ** ** | **Total** | ** ** | **Healthcare** | ** ** | **Commercial** | ** ** | **Total** | ** ** |
| Net revenues     |       | $                                                                  | 12,859     |                                                              | $          | 9,486 |   | $ | 22,345 |   | $ | 38,417 |   | $ | 27,151 |   | $ | 65,568 |   |
| Cost of revenues |       | 8,713                                                              |       | 7,686                                                             |       | 16,399 |   | 27,742 |   | 23,167 |   | 50,909 |   |
| Gross profit     |       | $                                                                  | 4,146      |                                                              | $          | 1,800 |   | $ | 5,946 |   | $ | 10,675 |   | $ | 3,984 |   | $ | 14,659 |   |
| Gross margin     |       | 32                                                                 | %          | 19                                                                | %          | 27 | % | 28 | % | 15 | % | 22 | % |

 

**NOTE N- Fair value measurements**

 

TheCompany categorizes its financial instruments into a three-level fair valuehierarchy that prioritizes the inputs to valuation techniques used to measurefair value into three broad levels. The fair value hierarchy gives the highestpriority to quoted prices in active markets for identical assets or liabilities(Level 1) and the lowest priority to unobservable inputs (Level 3).  Ifthe inputs used to measure fair value fall within different levels of thehierarchy, the category level is based on the lowest priority level input thatis significant to the fair value measurement of the instrument. Financialassets and liabilities recorded at fair value on the Company’s consolidatedbalance sheets are categorized as follows:

 

Level1- Observable inputs such as quoted prices (unadjusted) for identicalassets or liabilities in active markets

 

Level2- Inputs, other than quoted prices in active markets that are observableeither directly or indirectly

 

Level 3- Unobservable inputs for which there islittle or no market activity, which require the Company to develop its ownassumptions

 

Thefair value hierarchy also requires an entity to maximize the use of observableinputs and minimize the use of unobservable inputs when measuring fair value.The fair value of the Company’s warrant derivative instruments is estimatedusing the Black-Scholes valuation model with observable inputs as discussedfurther in Note O. The fair value of the embedded derivatives associated withthe Company’s term loans is estimated using a Monte Carlo simulation model.

 

TheCompany recognizes all derivatives as assets or liabilities on its condensedconsolidated balance sheets at fair value with changes in fair value recognizedin current period earnings.

 

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Thefollowing table summarizes the components of the derivative liabilities:

 
| ** **                    | ** ** | **Fair Value Measurement at September 30, 2010** | ** ** |
|-------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                    | ** ** | **Level 1**                                                               | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Embedded derivative liability |       | —                                                                         |       | — |   | 442 |   |
| Warrant liability             |       | —                                                                         |       | — |   | — |   |
|                          |       | $                                                                              | —     |   | $ | — |   | $ | 442 |   |
|                               |            |                                                                                |            |  |  |  |  |  |  |  |

 
| ** **                    | ** ** | **Fair Value Measurement at December 31, 2009** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                    | ** ** | **Level 1**                                                              | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Embedded derivative liability |       | —                                                                        |       | — |   | — |   |
| Warrant liability             |       | —                                                                        |       | 2,762 |   | — |   |
|                          |       | $                                                                             | —     |   | $ | 2,762 |   | $ | — |   |
|                               |            |                                                                               |            |  |  |  |  |  |  |  |

 

*Embeddedderivative*

 

OnApril 6, 2010, the Company entered into Amendment 2 to its Amended LoanAgreement with Hercules as disclosed in Note G. The amendment changed the termsof interest payment such that interest on Term Loan B, as well as the defaultinterest on the revolving credit facility, Term Loans A, B and C, and theEquipment Loan, at the sole discretion of Hercules, can be paid in cash, PIK orin shares of common stock of the Company at 70% of the value of the commonstock using a 60-day average.  This feature is considered to be anembedded derivative under ASC 815-10. The fair value of the embeddedderivative was determined to be $748 as of April 6, 2010 using a valuationmodel that considered the projected stock price on the interest payment datesand the impact that the stock price would have on the form of interestpayment.  Future stock prices were projected using a Monte Carlosimulation model.  Key inputs into the model include the spot price of thecommon stock, estimated risk free rate, term and volatility of the commonstock. The Company has classified this embedded derivative within level 3 ofthe fair value hierarchy.

 

Therange of assumptions used in the Monte Carlo simulation model to calculate thefair value of the financial instruments was as follows:

 
| Spot  Rate      |   | $4.23-$4.45     |   |
|-----------------|--------|-----------------|--------|
|            |   |            |   |
| Term            |   | 0.58-4.60 years |   |
|            |   |            |   |
| Volatility      |   | 250.00%         |   |
|            |   |            |   |
| Risk  free rate |   | 3.00%           |   |

 

Thefollowing tables summarize the changes in financial instruments measured atfair value for which the Company has used Level 3 inputs to determine fairvalue. Total realized and unrealized gains and losses recorded for Level 3instruments are included in the condensed consolidated statement of operationsas a component of the gain on fair value adjustment on derivative liabilities.

 
| ** **                                                                      | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                      | ** ** | **September  30,**     | ** ** | **September  30,**    | ** ** |
| ** **                                                                      | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| Balance, beginning of period                                                    |       | $                                | 668        |                            | $          | — |   | $ | — |   | $ | — |   |
| Transfers in (out) of level 3, net                                              |       | —                           |       | —                          |       | — |   | — |   |
| Originations, net                                                               |       | —                           |       | —                          |       | 748 |   | — |   |
| Change in unrealized gains (losses) included in  earnings at the reporting date |       | 226                              |       | —                          |       | 306 |   | — |   |
| Balance, end of period                                                          |       | $                                | 442        |                            | $          | — |   | $ | 442 |   | $ | — |   |

 

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**NOTE O—Financial instruments**

 

Inaccordance with ASC Topic 815-40, “Derivatives and Hedging”, warrantsoutstanding at December 31, 2009 were recorded as derivative liabilitiesbecause the warrants did not meet the criteria for equity classification.  The liabilities were marked to market at theend of each reporting period until such time as the Company met therequirements for equity classification. During the three months endedMarch 31, 2010, the Company changed certain assumptions related tovolatility and dilution used in the valuation of its warrant liabilities andcorrected the calculation used in the valuation of its warrant liabilities atDecember 31, 2009.  As a result, the Company recorded a charge of$787 during the first quarter of 2010 to reflect the impact of the change inassumptions on the fair value of the warrant liabilities at December 31,2009. During the three months ended June 30, 2010, the Company determinedthat it met the criteria for equity classification of the warrants as ofJanuary 5, 2010.  As a result, the Company recorded a charge of $141during the second quarter of 2010 to appropriately reflect the change in fairvalue on the effective date of the reclassification. The Company hasreclassified the fair value of the warrants to equity as additional paid incapital.  During the nine months ended September 30,2010, the Company recorded a net charge of $57 related to the change in fairvalue of the warrant liabilities including the adjustments noted above.

 

Duringthe three months ended June 30, 2010, the Company determined that theinitially recognized debt discount on Term Loan B entered into inNovember 2009 (see Note G) had been overstated by $2,217, the debtdiscount on Term Loan A and the revolving line of credit was understated by$235 and $258, respectively, that Term Loan B contained embedded derivativeliabilities that had been understated by $297 and that additional paid incapital had been overstated by a corresponding $2,514. The aggregate value ofall  embedded derivative liabilities inNovember and December 2009 was approximately $790 and $740 at March 31,2010.  On April 6, 2010, in connection with Amendment 2 to its loanagreement with Hercules (see Note G), the value of these embedded derivativeliabilities became zero.  In order to correctly state its balance sheet,during the nine months ended September 30, 2010, the Company reducedadditional paid in capital by $2,514, decreased the debt discount on Term LoanB by $2,217, increased the debt discount on Term Loan A and the Revolver by$235 and $258, respectively, and recorded a gain of $790 due to the change inthe fair value of these derivative liabilities.

 

Thecorrection of the above items did not have any impact on the Company’sconsolidated statements of cash flows. Management evaluated the quantitativeand qualitative aspects of the adjustments on 2009 as well as for each of thethree quarters of 2010 and concluded these adjustments were not material to theCompany’s consolidated financial statements.

 

Thefair value of warrant liabilities was calculated under the Black-Scholespricing model using the Company’s stock price on the date of the warrant grant,the expected volatility, and the risk-free interest rate matched to thewarrants’ expected life, adjusted for the impact of dilution. The Company doesnot anticipate paying dividends during the term of the warrants. The Companyuses historical data to estimate volatility assumptions used in the valuationmodel. The expected term of warrants is derived from an analysis thatrepresents the period of time that warrants are expected to be outstanding. Therisk-free rate for periods within the contractual life of the warrant is basedon the U.S. Treasury yield curve in effect at the time of grant.

 

On March 1, 2010, the Companyissued to Hercules 7,546 common shares upon the cashless exercise of a warrantto acquire up to 10,000 underlying shares. On September 10, 2010, the Company issued 7,257 common shares uponthe cashless exercise of a warrant to acquire up to 12,000 underlying shares.

 

Thefollowing table details warrant activity during the nine-month period ended September 30,2010:

 
| Outstanding as of December 31, 2009  |   | 788,948 |   |
|-------------------------------------------|--------|---------|--------|
| Issued                                    |   | —  |   |
| Exercised                                 |   | 22,000  |   |
| Forfeited                                 |   | —  |   |
| Outstanding as of September 30, 2010 |   | 766,948 |   |

 

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| **Expiration Date**   | ** ** | **Number of  Shares  Underlying  Warrants** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                 | ** ** | ** **                                       | ** ** | ** **                             | ** ** |
| 2010                       |       | —                                           |       | —                                 |       |
| 2011                       |       | 94,000                                           |       | $                                      | 11.59      |   |
| 2012                       |       | —                                           |       | —                                 |       |
| 2013                       |       | —                                           |       | —                                 |       |
| 2014                       |       | 672,948                                          |       | $                                      | 1.86       |   |
|                       |       |                                             |       |                                   |       |
| Total warrants outstanding |       | 766,948                                          |       | $                                      | 3.05       |   |

 

Alloutstanding warrants expire no later than November 19, 2014.

 

Therange of assumptions used in the Black-Scholes pricing model to calculate thefair value of the financial instruments was as follows:

 
| Exercise price |   | $1.86-$50.00    |   |
|----------------|--------|-----------------|--------|
|           |   |            |   |
| Estimated life |   | 0.90-4.89 years |   |
|           |   |            |   |
| Volatility     |   | 100.03%-145.36% |   |
|           |   |            |   |
| Risk free rate |   | 0.29%-2.20%     |   |
|           |   |            |   |
| Dividend rate  |   | 0%              |   |

 

**NOTE P****—****Subsequent Events**

 

We have evaluated all events subsequent to the balancesheet date of September 30, 2010 through the date of issuance of thesecondensed consolidated financial statements and have determined that except asset forth below, there are no subsequent events that require disclosure underASC 855.

 

On October 1, 2010, October 8, 2010 and October 28,2010, Hercules advanced the Company discretionary credit under its revolvingcredit facility pursuant to the Amended Loan Agreement in the amount of $500,$1,000 and $1,400, respectively. The discretionary credit bears interest at therate of interest applicable to overadvances, is repayable on demand andconstitutes an overadvance for all purposes under the Amended Loan Agreement(See Note G).

 

On October 28, 2010, the Company entered intoAmendment No. 4 (“Amendment 4”) to the Amended Loan Agreement withHercules. Pursuant to Amendment 4, Hercules funded a term loan in an originalprincipal amount of $500 (“Term Loan D”). The proceeds of Term Loan D were usedto repay a portion of the outstanding overadvances under the revolving creditfacility. Interest on Term Loan D will accrue at a rate of 18% per annum,payable 10% in cash and 8% in PIK by adding such amount to the principal amountof Term Loan D. All principal outstanding on Term Loan D will be due andpayable on September 13, 2011. Term Loan D may be converted into shares ofthe Company’s common stock at a price of $3.30 at any time at Hercules’ option.Amendment 4 also eliminated the $500 maximum limit on outstanding over advancesunder the revolving line of credit. The Company may prepay Term Loan D withoutincurring a repayment penalty charge. The Company also entered into aRegistration Rights Agreement with Hercules whereby it agreed to register theshares underlying Term Loan D and certain interest on the revolving line ofcredit, Term Loan A, Term Loan C, Term Loan D, and the Equipment Loan that maybe paid in shares.

 

**Item 2.       ****Management’sDiscussion****and Analysis of Financial Condition andResults of Operations**

 

**ForwardLooking Statements**

 

Thisreport contains “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended, that are based on our currentexpectations, estimates, forecasts and projections about our company and ourindustry. These forward-looking statements reflect our current views aboutfuture events and can be identified by terms such as “will,” “may,” “believe,” “anticipate,”“intend,” “estimate,” “expect,” “should,” “project,” 

 

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“plan”and similar expressions, although not all forward-looking statements containsuch identifying words. You are cautioned not to place undue reliance on theseforward-looking statements. These forward-looking statements are not guaranteesof future events and involve risks and uncertainties that are difficult topredict and are based upon assumptions that may prove to be incorrect. Ouractual results could differ materially and adversely from those anticipated insuch forward-looking statements as a result of certain factors, including butnot limited to, for example:

 

·                  our ability to identify, pursue and enterinto strategic transactions, while continuing to operate our business

·                  our ability to refinance, replace orrestructure our current indebtedness and to comply with the financial covenantsand other terms and conditions contained in the agreements governing ourindebtedness or any replacement indebtedness;

·                  our ability to operate profitably and managegrowth of our business;

·                  our ability to introduce new products andservices and maintain products and service quality;

·                  our ability to implement our business plan indifficult economic conditions and to adapt to changes in economic, political,business or industry conditions;

·                  our ability to find additional financingnecessary to support our operations and or strategic objectives while alsomaintaining our focus on operating and developing our business;

·                  our ability to retain, replace and hireexperienced senior management;

·                  our relationships with our customers, keyindustry relationships and other third parties on which we rely;

·                  competition in the industries in which wecompete;

·                  our ability to protect our intellectualproperty rights;

·                  restrictions on our operations contained inour loan and security agreement or agreement for any replacement indebtedness;and

·                  our ability to improve our internal controlsover financial reporting.

 

Wehave disclosed important factors that could cause our actual results to differmaterially from our expectations under “Risk Factors” in our Annual Report onForm 10-K for the year ended December 31, 2009, our Quarterly Reporton Form 10-Q for the quarterly periods ended March 31, 2010 and June 30,2010, and elsewhere in this report. These cautionary statements qualify allforward-looking statements attributable to us or persons acting on our behalf.We do not undertake any obligation to update or revise any forward-lookingstatements to reflect new information, future events or otherwise, except asrequired by federal securities laws.

 

**Overview**

 

Thefollowing discussion and analysis of our financial condition and results ofoperations is intended to assist you in understanding our financial conditionand results of operations. This discussion and analysis should be read inconjunction with our financial statements and the notes thereto included inItem 1 of this quarterly report, and “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations” included in ourAnnual Report on Form 10-K for the year ended December 31, 2009. Manyof the amounts and percentages presented in this discussion and analysis havebeen rounded for convenience of presentation, and all dollar amounts, exceptper share data, are presented in thousands.

 

**Recent Developments**

 

*Reverse Stock Split*

 

OnJanuary 5, 2010, we effected a one-for-twenty-five reverse stock split ofour issued and outstanding shares of common stock, par value $0.00001 pershare. Unless otherwise indicated, all share amounts discussed herein reflectthe post-split number of shares of our common stock.

 

*Hercules Restructuring Transactions*

 

OnNovember 20, 2009, we completed a restructuring transaction with oursenior lender Hercules Technology Growth Capital, Inc. (“Hercules”) andits wholly-owned subsidiary Hercules Technology I, LLC (“HTI”), pursuant towhich $5,000 of our outstanding debt to Hercules was converted into shares ofour common stock and a warrant to purchase shares of our common stock, and theremaining outstanding debt with Hercules was otherwise restructured (the “HerculesRestructuring”). As a result of the Hercules Restructuring, we experienced achange in control and (i) HTI owns 2,691,790 shares or 72% of ouroutstanding common stock, as well as a warrant to acquire up to an additional672,948 shares of our common stock, and (ii) Hercules may convert aportion of our remaining indebtedness to Hercules into an additional 2,691,790shares of our common stock, see August 13, 2010 discussion below, and hasthe option to convert certain term loan interest into an indeterminate numberof shares of our common stock. In addition, on March 1, 2010, Herculesexercised a warrant initially received on June 19, 2009 by which itacquired 7,546 shares of our common stock. As a result of Amendment 2 to ourAmended Loan Agreement on April 6, 2010, Hercules may convert theprincipal of Term 

 

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LoanC (defined below) into an additional 412,087 shares of our common stock and hasthe option to convert default rate interest into an indeterminate number ofshares of our common stock.

 

Inconnection with the Hercules Restructuring, on November 20, 2009, we andHercules entered into an Amended and Restated Loan and Security Agreement (“AmendedLoan Agreement”), whereby we and Hercules agreed to restructure our remainingdebt not converted into shares of common stock and a warrant. The Amended LoanAgreement amended and restated our prior loan and security agreement withHercules.

 

OnFebruary 10, 2010, Hercules sent us a letter notifying us of an event ofdefault because our borrowings under the revolving credit facility exceeded ourborrowing base as of February 5, 2010 and charging us a default interestrate of an additional 3% to the applicable regular interest rate for the periodstarting February 5, 2010. Events of default are continuing and defaultrate interest will be payable monthly on the same date as regular interestunless Hercules chooses to demand payment of default interest on another date.Hercules may elect to have default rate interest paid in cash, in kind or inshares of our common stock.

 

OnFebruary 19, 2010, we entered into Amendment No. 1 (“Amendment 1”) tothe Amended Loan Agreement.  Under theEquipment Loan provided by Amendment 1, we may request up to $3,000 for use inpurchasing equipment (the “Equipment Loan”) subject to valid, verified purchaseorders acceptable to Hercules from suppliers approved by Hercules in its solediscretion.

 

OnMarch 25, 2010, Hercules advanced to us an additional $1,350, initiallyapplied to the outstanding balance on our revolving line of credit facilityunder the Amended Loan Agreement. The advance increased our outstandingindebtedness on the revolving line of credit to $8,909, and was provided as anextension above our eligible borrowing base provided in the Amended LoanAgreement.

 

On April 6, 2010, we entered into Amendment No. 2(“Amendment 2”) to the Amended Loan Agreement. Pursuant to AmendmentNo. 2, Hercules funded a term loan in an original principal amount of$1,350 (“Term Loan C”). The proceeds of Term Loan C were used, in part, torepay outstanding over advances under the revolving credit facility. Intereston Term Loan C accrues at a rate of 8% per annum and, at the discretion ofHercules, is payable either in cash or in kind by adding the accrued interestto the principal of Term Loan C. All principal outstanding on Term Loan C willbe due and payable on April 1, 2013. Term Loan C may be converted intoshares of our common stock at a price of $3.276 per share at any time atHercules’ option. We may prepay Term Loan C without incurring a prepaymentpenalty charge. We also entered into a registration rights agreement andsubsequent letter agreement with Hercules whereby we agreed to file a shelfregistration statement with the SEC covering the resale of the shares of commonstock that may be issued to Hercules upon the conversion of Term Loan C or inpayment of default rate interest with respect to the revolving credit facility,Term Loan A, Term Loan B, Term Loan C and the Equipment Loan.  We have agreed to use our best efforts tohave the registration statement declared effective by the SEC no later than September 30,2010, subject to a 60 day extension in the event of SEC review.  As of September 30, 2010, we have notfiled the contemplated registration statement.

 

OnJune 18, 2010, we entered into Amendment No. 3 (“Amendment 3”) to theAmended Loan Agreement with Hercules. Pursuant to Amendment 3, Hercules agreedto release its security interest in a U.S. and corresponding Korean patent toallow the sale of that asset as a permitted transfer under the Amended LoanAgreement.  In June 2010, wecompleted the sale of the patents, which management believes are non-essentialto our business, for $2,200, providing net proceeds of $1,980 aftercommissions. The one time commission payment of $220 was paid to The SAGEGroup, a company in which Thomas Miller, a member of our board of directors, isa partner. We have retained a worldwide, non exclusive, royalty-free license touse the technology covered by the patent for all current and futureproducts. The cash proceeds of $1,980 from the sale of these patents wereapplied to reduce the outstanding balance under our revolving credit facility.

 

OnJune 30, 2010, Hercules advanced us an additional $1,500, which wasapplied to the outstanding balance on our revolving line of credit. The advanceincreased our outstanding indebtedness on the revolving line of credit, to$8,097, and was provided as an extension above our eligible borrowing base.

 

On August 12, 2010, Hercules notified us of itselection to convert $5,000 of aggregate principal amount of Term Loan B intoshares of our common stock at the conversion price of $1.8575 per share, for anissuance of 2,691,790 shares of common stock, effective August 13,2010.  As a result of the conversion, on August 13,2010, our outstanding balance on Term Loan B, which includes PIK, was$662,185.  Hercules continues to have theability to acquire (i) 356,492 shares of our common stock upon conversionof the Term Loan B principal, (ii) 412,087 shares of our common stock uponconversion of the Term Loan C principal and (iii)151,515 shares of our commonstock upon the conversion of the Term Loan D (discussed below) principal (iv) anindeterminate number of shares upon conversion of a portion of the interest onour indebtedness to Hercules. As of September 30, 2010, Hercules owned4,505,668 shares of common stock, which includes those issued to Hercules uponthe conversion of Term Loan B.

 

On September 13, 2010, October 1, 2010, October 8,2010 and October 28, 2010, Hercules advanced us extended discretionarycredit under the revolving credit facility in the amount of $500, $500, $1,000and $1,400, respectively. The discretionary credit bears interest at the rateof interest applicable to overadvances, is repayable on demand and constitutesan overadvance for all purposes 

 

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under the Amended Loan agreement.

 

On October 28, 2010, we entered into Amendment No. 4(“Amendment 4”) to the Amended Loan Agreement with Hercules. Pursuant toAmendment 4, Hercules funded a term loan in an original principal amount of$500 (“Term Loan D”). The proceeds of Term Loan D were used to repay a portionof the outstanding overadvances under the revolving credit facility. Intereston Term Loan D will accrue at a rate of 18% per annum, payable 10% in cash and8% in PIK by adding such amount to the principal amount of Term Loan D. Allprincipal outstanding on Term Loan D will be due and payable on September 13,2011. Term Loan D may be converted into shares of our common stock at a priceof $3.30 per share at any time at Hercules’ option. We may prepay Term Loan Dwithout incurring a repayment penalty charge. We also entered into aRegistration Rights Agreement with Hercules (“the Registration Rights Agreement”)whereby we agree to register the shares underlying Term Loan D and defaultinterest on the revolving line of credit, Term Loan A, Term Loan C, Term LoanD, and the Equipment Loan that may be paid in shares by filing any resaleregistration statement with the Securities and Exchange Commission (the “SEC”).  We have agreed to use our best efforts tohave the registration statement declared effective by the SEC no later than April 30,2011, subject to a 75 day extension in the event of review by the SEC, and willbe liable to Hercules for liquidated damages under the Registration RightsAgreement subject to a few limited exceptions, if the registration statement isnot declared effective by May 21, 2011, the registration statement ceasesto be effective or usable at any time during the effectiveness  period, or under certain circumstances ifHercules is not permitted to utilize the prospectus in the registration statementto sell the shares.  We have also grantedHercules piggyback registration rights for certain shares not covered by theregistration statement or sold under Rule 144 of the Securities Act of1933, subject to standard underwriting cut backs.

 

Herculeshas not chosen to accelerate our obligations under the Amended Loan Agreement,but has expressly not waived any events of default or any of its remedies. Wedo not have adequate liquidity to repay all outstanding amounts under thecredit facility and payment acceleration would have a material adverse effecton our liquidity, business, financial condition and results of operations.

 

*Changein Trading Market*

 

On October 21, 2010, our common stock becameeligible for trading under the symbol IFLG in the electronic quotation servicefor securities traded over-the-counter operated (“OTCQB”) by Pink OTC MarketsInc.  Prior to October 21, 2010, ourcommon stock had been listed on The Nasdaq Capital Market.  However, we were unable to continue to meetlisting requirements, including (a) maintaining a minimum of $2,500 instockholders’ equity, (b) having a minimum of $35,000 of market value oflisted securities, or (c) having net income from continuing operations ofat least $500 in the most recently completed fiscal year or in two of the threemost recently completed fiscal years, as required under Nasdaq listing rule 5550(b).Since receiving the initial letter from the Nasdaq Stock Market on August 19,2009 notifying us of our failure to comply with Nasdaq Listing Rule 5550(b),we have worked with Nasdaq to regain compliance with the listing rules. Since August 2009,we had intermittently regained compliance, however, on April 20, 2010,Nasdaq denied our request for continued listing and notified us that unless werequested an appeal our common stock would be delisted.  We timely requested a hearing and on July 8,2010 we announced we received a letter from Nasdaq stating that the NasdaqHearings Panel (the “Panel”) granted our request for continued listing subjectto several conditions including, among other things, the occurrence of certainevents by August 15, 2010 and the Company’s ability to regain compliancewith all the requirements for continued listing on Nasdaq by October 18,2010.  We failed to comply with theserequirements by the relevant dates and received a notice on October 19,2010 that the Panel had determined to delist our common stock from The NASDAQStock Market and suspend trading of our common stock effective with the open oftrading on October 21, 2010. The delisting of our common stock from Nasdaqcould adversely affect the market liquidity of our common stock and cause themarket price of our common stock to decrease and could also adversely affectour ability to obtain financing for our continued operations and  result in the loss of confidence byinvestors, customers, suppliers, employees and adversely impact our business.In addition, although we are quoted on the OTCQB, the OTCQB is generallyconsidered to be a less liquid and efficient market, and our stock price, aswell as the liquidity of our common stock, may be adversely affected as aresult.

 

*Changein independent registered public accounting firm*

 

OnJune 10, 2010, we were orally notified by McGladrey &Pullen, LLP (“McGladrey & Pullen”), our independent registered publicaccounting firm, that it was resigning as our independent registered publicaccounting firm, effective immediately.  The termination of theauditor-client relationship was subsequently confirmed in writing. During thetwo most recent fiscal years ended December 31, 2009 and 2008, and throughthe date of its resignation, we did not have any disagreements withMcGladrey & Pullen on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedure, whichdisagreements, if not resolved to the satisfaction of McGladrey &Pullen, would have caused us to make reference to the subject matter of thedisagreement. On June 22, 2010, the Audit Committee of our Board ofDirectors engaged KPMG LLP (“KPMG”) to serve as our new independent registeredpublic accounting firm for the year ending December 31, 2010, and itsengagement commenced immediately.

 

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**General**

 

Weprovide end-to-end solutions for electronic medical record (“EMR”) and supplychain implementation and mobilization (“SCM”), with experience in over 2,200hospitals and businesses in North America. We assist our healthcare and commercialcustomers by implementing and optimizing EMR and SCM systems, offering mobility to caregivers andworkforces by making data accessible directly at the point of care or point ofactivity, and managingoperations with services to improve clinical and financial performance andsupply chain with services to drive greater efficiency.

 

We provide solutions to our customers by utilizing a combination ofproducts and services, including consulting, business software applications,mobile managed services, mobile devices, and wireless infrastructure. Oursolutions are designed to allow the real time usage of data throughout acustomer’s enterprise in order to enhance workflow, improve customer service,increase revenue and reduce costs. We sell wireless communication and computingdevices, including mobile workstations that connect to a customer’s wirelessnetwork so that information can be accessed from any location within theenterprise. We also implement customized and third-party software applicationswith a particular expertise in electronic medical records in the healthcareindustry and SAP® back-end systems in commercial enterprises. In addition, weoffer professional services that support and complement enterprise-widesoftware implementations and a customer’s wireless computing systems, includingconsulting, mobile managed services, training, engineering, technical supportand network monitoring.

 

We are continuing our efforts to transition our business to offerhigher margin consulting, other professional services, and softwareapplications. With our focus on selling services and software, we believe thatwe can provide more comprehensive enterprise mobility solutions to ourcustomers. These solutions involve:

 

·                  Consulting with ourcustomers to identify opportunities to use mobile technology in theirenterprise to improve operations and the quality of their customer service bymore efficiently managing people and assets.

 

·                  Providing our customers withongoing managed services that are designed to supplement their informationtechnology department, such as training, maintenance and repair, networkmonitoring including both on-site and remote, software application upgrades,network security and workflow consulting.

 

·                  Assessing our customer’s existingwireless infrastructure—the cables, routers and network adapters from which awireless network is constructed—and developing improved network designs toensure effective wireless connectivity and infrastructure systems integration.

 

·                  Developing and implementingcustom and industry specific software applications including healthcareclinical electronic medical records and enterprise-wide systems by usingexisting proprietary and third-party software.

 

·                  Delivering and installingwireless infrastructure and user devices, including mobile workstations.

 

We manage our business primarily by market verticals, driven by oursales organization. We have two operating segments consisting of our healthcareand commercial businesses. The healthcare segment is principally composed ofour activities in hospitals and other related healthcare facilities. Thecommercial segment focuses on all other vertical markets includingpharmaceutical, manufacturing, wholesale and retail distribution and serviceindustries.

 

In order to improve our operating efficiencies and gross margin, we aretransitioning from custom order processing for our mobile workstations to astandardized suite of products. In the first quarter of 2010, we startedpre-ordering our new standardized mobile workstations from a third-party vendorbased on our estimates of expected sales, thereby increasing the amount of ouravailable inventory on-hand. We started to receive inventory as the result ofthese pre-orders during the third quarter of 2010. If our estimates as to theamount of workstations to be sold or the timing of sales do not materiallycorrespond to actual sales, we will be required to hold workstations in ourinventory for periods longer than we expected.

 

We serve the healthcare and commercial industries,which are experiencing significant challenges, primarily due to the continuedweak macroeconomic conditions that have resulted in a decreased demand fortheir products and services. As a result, some of our customers may facebusiness and financial challenges for the remainder of 2010.  For example, some of our customers are facingconstraints on their information technology budgets and are seeking moreflexibility in the type of mobility solutions they implement and the timing oftheir purchases from us. It is unclear when the general economic climate willimprove and when our customers may benefit from improved conditions.

 

We conduct substantially all of our operations through our wholly-ownedsubsidiary, InfoLogix Systems Corporation. We own our patents and patentapplications through our wholly-owned subsidiaries OPT Acquisition, LLC,Embedded Technologies, LLC and InfoLogix—DDMS, Inc.

 

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**Going Concern**

 

Over the past several quarters, we have been transitioning fromfulfilling custom orders for our mobile workstations to introducing andlaunching our new ST7 product family, which is expected to reduce custom ordersand improve manufacturing economies, including transitioning to new suppliers.We have worked with our customers to launch the ST7 product family (includingmobile workstations and power systems) while maintaining customer order volumeof existing mobile workstation products. As reflected in our operating results in the second and third quartersof 2010, sales of mobile workstation products have continued, but order volumefor ST7 products has been increasing at a much slower pace than we anticipated.In addition, the current weak macroeconomic conditions have had a major impacton the industries we serve. During 2009 and continuing through the thirdquarter of 2010, we experienced reduced sales and compressed margins,particularly related to the sales of mobile workstations and relatedinfrastructure in the healthcare markets that we serve. We believe thisslowdown is primarily the result of adverse economic conditions affecting thehealthcare industry, including constrained budgets promulgated by difficultaccess to capital in community and other not-for-profit hospitals. We haveresponded to the challenging times by undertaking a series of cost reductioninitiatives, including the elimination of executive bonuses, reduction ofemployee salaries and reduction in the number of employees. Economic conditionsdid not improve in the first three quarters of 2010 and although we continue toreduce our expenses successfully, we expect 2010 to continue to be achallenging year.

 

Our condensed consolidated financial statements for the three and ninemonths ended September 30, 2010 have been prepared on a going concernbasis, which contemplates continuing operations, securing additional debt orequity financing, restructuring our existing debt, effecting one or morestrategic transactions, and realizing assets and liabilities in the ordinarycourse of business.  However, we haveincurred significant net losses from 2006 through the third quarter of 2010,including a net loss of $6,785 for the nine months ended September 30,2010.  Our losses are partly attributableto costs related to our debt and our debt restructuring, tightened credit termswith vendors which has impacted our purchasing power, and the difficulteconomic conditions under which we operate, and challenges related to ourtransition over the last several years from being primarily a seller ofinfrastructure and hardware to becoming a provider of comprehensive enterprisemobility solutions. During this transition period, we have hired experiencedmanagement and staff to execute our business plans and have made strategicacquisitions. We have also managed our liquidity through this transition,primarily by funding operations with indebtedness, which at September 30,2010 included $17,928 of senior debt at high interest rates and otherassociated costs, which has increased to $20,828 as of November 12, 2010.

 

As a result of our capital and debt structure and recurring losses, wehave substantial liquidity requirements related to the repayment of a sellernote that came due on September 30, 2010, our indebtedness to Hercules,and earn out payments for past acquisitions. We are in default under the sellernote and Hercules debt facility and do not currently expect to generatesufficient cash flow from operations to fund our working capital needs or thoseobligations. As a result, these factors raise substantial doubt as to ourability to continue as a going concern.

 

We have undertaken a series of actions to reduce costsand are actively pursuing various initiatives to continue as a going concernand provide for our future success. To facilitate this process, the Company’sBoard of Directors has established a special committee of our independentdirectors to assist in evaluating and recommending specific initiatives. Ourplan to improve our liquidity contemplates additional cost control measures andmay also include additional financing, further restructuring of our debt andeffecting one or more strategic transactions. Our ability to implement theseplans successfully is dependent on many circumstances outside of our directcontrol, including general economic conditions and the financial strength ofour customers.  We have increased ourborrowings under our revolving credit facility a number of times over the pastnine months, and any additional financing we are able to secure will likely besubject to a number of conditions and involve additional costs. In addition,our common stock was delisted from trading on The Nasdaq Stock Market as aresult of our failure to meet continued Nasdaq listing requirements.  Although our stock is quoted on theelectronic quotation service for securities traded over-the-counter, thedelisting could have an adverse affect on our ability to obtain financing.  As a result of this and given the currentnegative conditions in the economy generally and the credit markets inparticular, there is uncertainty as to whether we will be able to generatesufficient liquidity to meet our working capital needs, to repay our outstandingdebt and, to make our earn out payments, and to meet working capital needs. Ifwe are unable to improve our liquidity position, we may not be able to continueas a going concern.

 

**Characteristics of our net revenuesand expenses**

 

We generate our net revenues through the resale of wireless and mobilehardware and systems, including mobile workstations, handheld and wearablecomputers, peripherals, and related products under which the revenue isrecognized. Sales revenue on product is recognized when both the title and riskof loss transfer to the customer, generally upon shipment.

 

We also generate revenues from consulting and professional services oneither a fixed fee or time and expense basis. Net revenues from our consultingand professional services are primarily recognized on a time and expense basisat the time the service is delivered and the expenses are incurred. Netrevenues from the sale of our proprietary learning technologies and anyprofessional 

 

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consultingor engineering services provided on a fixed-fee basis are recognized accordingto a proportionate performance method of accounting and is recognized ratablyover the contract period based upon actual project hours as compared tobudgeted project hours. Payments received in advance of services performed arerecorded as deferred revenue. Certain contract payment terms may result incustomer billing occurring at a pace slower than revenue recognition. Theresulting revenue recognized in excess of amounts billed and project cost isincluded in unbilled revenue on our condensed consolidated balance sheet.

 

We also generate net revenues from the sale of warranties on wirelessand mobile hardware and systems, including mobile workstations, computers,peripherals, and related products.  Wesell original equipment manufacturers’ component warranties and warrantyprograms sponsored by other third parties, including extended warranties, andrecognize the revenue on a net basis upon execution of the warrantyagreement.  As we have been transitioningour business away from the sale of hardware and related warranties, we are notselling new extended warranty programs except for those serviced bythird-parties and we have taken steps to confirm with our customers thatthird-parties are the obligors under their warranties.

 

Cost of revenues consists of all expenses that are directlyattributable to the costs associated with the purchase, for resale, of wirelessand mobile hardware and systems, including computers, peripherals, and relatedproducts. Fluctuations in our gross margin may occur due to changes in ourability to obtain discounts on product sales or our ability to negotiate highermargins on sales contracts with large customers. Cost of sales also consists ofthe direct costs associated with those employees or sub-contractors thatperform our professional consulting services on behalf of our customers.

 

Sellingexpenses primarily consist of the salaries, benefits, travel and other costs ofour regional and national account sales representatives, sales management andbusiness development expenses. General and administrative expenses primarilyconsist of the costs attributable to the support of our operations, such as:costs related to salaries for management, administrative and human resourcespersonnel, information systems, expenses and office space costs, inside salesand customer support, warehousing, technical support, financial accounting,purchasing, insurance, recruiting fees, legal, accounting and otherprofessional services.

 

**CriticalAccounting Estimates and Policies**

 

Our condensed consolidated financial statements are prepared inconformity with accounting principles generally accepted in the United Statesof America (“GAAP”), which requires us to make estimates and assumptions thataffect the reported amounts of assets and liabilities at the date of thefinancial statements and the reported amounts of net revenues and expensesduring the reporting periods. Critical accounting policies are those thatrequire the application of management’s most difficult, subjective, or complexjudgments, often because of the need to make estimates about the effect of mattersthat are inherently uncertain and that may change in subsequent periods. Inpreparing the condensed consolidated financial statements, management has madeestimates and assumptions that affect the reported amounts of assets andliabilities at the date of the financial statements, and the reported amountsof net revenues and expenses during the reporting periods.  In preparing the consolidated financialstatements, management has utilized available information, including our pasthistory, industry standards and the current economic environment, among otherfactors, in forming its estimates and judgments, giving due consideration tomateriality. Actual results may differ from these estimates. In addition, othercompanies may utilize different estimates, which may impact the comparabilityof our results of operations to those of companies in similar businesses. Webelieve that of our significant accounting policies, the following may involvea higher degree of judgment and estimation.

 

*Revenue recognition*

 

Net revenues are generated through product sales, warranty andmaintenance agreements, professional consulting, programming and engineeringservices, long-term support services, and educational learning programs. Netrevenues from product sales are recognized when both the title and risk of losstransfer to the customer, generally upon shipment. Net revenue from the salesof warranties is recognized upon execution of the warranty agreement.  We do not bear associated warranty riskbecause it is contracted with third parties, the primary obligors, to fullyassume all risks and obligations.

 

Revenue from consulting and other professional services is recognizedon either a fee-for-service or fixed fee basis. Revenue from consulting andother professional services that is contracted as fee-for-service is recognizedin the period in which the services are performed. Direct costs for travel andaccommodations are reimbursable in accordance with the contract terms and arerecognized as revenue in the period the related expense is incurred.  Revenue from the sale of proprietary learningtechnologies and those consulting and other professional services provided on afixed-fee basis is recognized according to a proportionate performance methodof revenue recognition and is recognized over the contract period. Changes inthese assumptions, including estimates on fixed fee contracts, can materiallyaffect the amount of net revenue recognized in our net income from operations.Periodically, we recognize revenue and record unbilled revenue as an asset onour balance sheet to reflect services provided but not yet billed pursuant tocontract terms.

 

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We record amounts billed to our customers for shipping and handlingfees as revenue. All amounts billed in a sale transaction related to shippingand handling represent revenues earned for the goods provided and requires suchamounts are classified as revenue. Shipping and handling costs are recorded ingeneral and administrative expenses in the consolidated statement ofoperations.

 

*Inventory*

 

Inventory is stated at the lower of cost or market. Cost is determinedusing the first in, first out method.

 

We periodically review our inventories and make provisions as necessaryfor estimated obsolete and slow-moving goods. We mark down inventory in anamount equal to the difference between cost of inventory and the estimatedmarket value based on assumptions about future demands, selling prices andmarket conditions. The creation of such provisions results in a write-down ofinventory to net realizable value and a charge to cost of revenues.

 

*Goodwilland other intangible assets*

 

Goodwillis tested for impairment annually in December by comparing the fair valueof the recorded assets to their carrying amount. The carrying value of otherintangible assets is reviewed for possible impairment whenever events orchanges in circumstances indicate that their carrying value may not berecoverable.  If the carrying amount ofthe goodwill or other intangible assets exceeds its fair value, an impairmentloss is recognized. The evaluation of goodwill and other intangible assetsrequires the use of judgment and numerous subjective assumptions, which, ifactual experience varies, could result in material differences in therequirements for impairment charges.

 

*Stock based compensation*

 

We measure stock based compensation awards using a fair value methodand amortize the resulting expense on a straight line basis over the requisiteservice period of the award, generally the vesting period.

 

We estimate the grant date fair value of stock options using theBlack-Scholes option-pricing model which requires the input of highlysubjective assumptions. These assumptions include estimating the expected termof the award and the estimated volatility of our stock price over the expectedterm. Changes in these assumptions and in the estimated forfeitures of stockoption awards can materially affect the amount of stock based compensationrecognized in our consolidated statements of operations.

 

*Gain on fair value of derivativeliabilities*

 

Our derivativeliabilities are recorded at fair value, which is estimated using relevantmarket information and other assumptions. Fair value estimates involveuncertainties and matters of judgment regarding assumptions used. Changes inour assumptions or market conditions could significantly affect the estimatesand have a material impact on our financial position and results of operations.

 

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**Results of Operations (unaudited)**

 

Resultsof operations expressed as a percentage of net revenues were as follows:

 
| ** **                                      | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                      | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Net revenues                                    |       | 100.0                                                    | %          | 100.0                                                   | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                |       | 80.0                                                     | %          | 73.4                                                    | %          | 72.8 | % | 77.6 | % |
|                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Gross profit                                    |       | 20.0                                                     | %          | 26.6                                                    | %          | 27.2 | % | 22.4 | % |
|                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Selling, general and administrative expenses    |       | 49.1                                                     | %          | 29.2                                                    | %          | 41.5 | % | 33.5 | % |
| Gain on sale of intangible asset                |       | 0.0                                                      | %          | 0.0                                                     | %          | (4.4 | )% | 0.0 | % |
| Operating income (loss)                         |       | (29.1                                                    | )%         | (2.6                                                    | )%         | (9.9 | )% | (11.1 | )% |
|                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest expense                                |       | (10.2                                                    | )%         | (6.6                                                    | )%         | (8.3 | )% | (5.8 | )% |
| Interest income                                 |       | 0.0                                                      | %          | 0.0                                                     | %          | 0.0 | % | 0.0 | % |
| Loss on extinguishment of debt                  |       | 0.0                                                      | %          | 0.0                                                     | %          | 0.0 | % | (0.7 | )% |
| Fair value adjustment on derivative liabilities |       | 2.2                                                      | %          | 0.0                                                     | %          | 2.5 | % | 0.0 | % |
|                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Loss before income tax expense                  |       | (37.1                                                    | )%         | (9.2                                                    | )%         | (15.7 | )% | (17.6 | )% |
| Income tax expense                              |       | (0.7                                                     | )%         | (0.0                                                    | )%         | (0.4 | )% | (0.0 | )% |
|                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Net loss                                        |       | (37.8                                                    | )%         | (9.2                                                    | )%         | (16.1 | )% | (17.6 | )% |

 

***Three Months ended September 30, 2010 comparedwith the Three Months ended September 30, 2009***

 

**Net revenues**

 

Netrevenues for the three months ended September 30, 2010 and 2009 were asfollows:

 
| ** **            | ** **   | **Three Months Ended September 30,** | ** **   | **Amount of** | ** **   | **Percentage** | ** **   |
|-----------------------|--------------|----------------------------------------------------------|--------------|--------------------|--------------|----------------|--------------|
| ** **            | ** **   | **2010**                                                 | ** **   | **2009**           | ** **   | **Change**     | ** **   | **Change** | ** ** |
| *** ***          | *** *** | *** ***                                             | *** *** | *** ***       | *** *** | *** ***   | *** *** | *** *** | *** *** |
| Healthcare            |         |                                                     |         |               |         |           |         |   |   |
| Infrastructure        |         | $                                                        | 3,092        |               | $            | 6,403          |         | $ | (3,311 | ) | (52 | )% |
| Professional Services |         | 5,537                                                    |         | 5,525              |         | 12             |         | 0 | % |
| Managed Services      |         | 107                                                      |         | 931                |         | (824           | )            | (89 | )% |
| Total Healthcare      |         | 8,736                                                    |         | 12,859             |         | (4,123         | )            | (32 | )% |
|                  |         |                                                     |         |               |         |           |         |   |   |
| Commercial            |         |                                                     |         |               |         |           |         |   |   |
| Infrastructure        |         | 1,409                                                    |         | 7,325              |         | (5,916         | )            | (81 | )% |
| Professional Services |         | 1,622                                                    |         | 1,705              |         | (83            | )            | (5 | )% |
| Managed Services      |         | 234                                                      |         | 456                |         | (222           | )            | (49 | )% |
| Total Commercial      |         | 3,265                                                    |         | 9,486              |         | (6,221         | )            | (66 | )% |
|                  |         |                                                     |         |               |         |           |         |   |   |
| Total net revenues    |         | $                                                        | 12,001       |               | $            | 22,345         |         | $ | (10,344 | ) | (46 | )% |

 

Netrevenues were $12,001 for the three months ended September 30, 2010,compared to $22,345 for the three months ended September 30, 2009,representing a decrease of $10,344 or 46%. The decrease in our Healthcare segmentnet revenues was due to a decrease in sales of mobile workstations resultingfrom our transition to our new ST7 product family. Although we are beginning todeliver ST7 mobile workstations, sales have been increasing at a slower pacethan we anticipated. In addition, the current weak macro-economic conditionshave continued to adversely impact our customers’ order activities in the firstthree quarters of 2010, which is expected to continue through the end of2010.  The decrease in our Commercialsegment net revenues was due primarily to lower resales of infrastructure andhardware products as we continue to transition our business to offer highermargin consulting and other 

 

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professionalservices. The reimbursable expense revenue included in our professionalservices revenue totaled $663 and $813 for the three months ended September 30,2010 and 2009, respectively.

 

**Cost ofrevenues**

 

Costof revenues for the three months ended September 30, 2010 and 2009 was asfollows:

 
| ** **             | ** ** | **Three Months Ended September 30,** | ** ** | **Amount of** | ** ** | **Percentage** | ** ** |
|------------------------|------------|----------------------------------------------------------|------------|--------------------|------------|----------------|------------|
| ** **             | ** ** | **2010**                                                 | ** ** | **2009**           | ** ** | **Change**     | ** ** | **Change** | ** ** |
| ** **             | ** ** | ** **                                               | ** ** | ** **         | ** ** | ** **     | ** ** | ** ** | ** ** |
| Healthcare             |       |                                                     |       |               |       |           |       |   |   |
| Infrastructure         |       | $                                                        | 2,766      |               | $          | 4,653          |       | $ | (1,887 | ) | (41 | )% |
| Professional Services  |       | 4,117                                                    |       | 4,152              |       | (35            | )          | (1 | )% |
| Managed Services       |       | 11                                                       |       | (92                | )          | 103            |       | 112 | % |
| Total Healthcare       |       | 6,894                                                    |       | 8,713              |       | (1,819         | )          | (21 | )% |
|                   |       |                                                     |       |               |       |           |       |   |   |
| Commercial             |       |                                                     |       |               |       |           |       |   |   |
| Infrastructure         |       | 1,283                                                    |       | 6,437              |       | (5,154         | )          | (80 | )% |
| Professional Services  |       | 1,282                                                    |       | 1,283              |       | (1             | )          | (0 | )% |
| Managed Services       |       | 146                                                      |       | (34                | )          | 180            |       | (529 | )% |
| Total Commercial       |       | 2,711                                                    |       | 7,686              |       | (4,975         | )          | (65 | )% |
|                   |       |                                                     |       |               |       |           |       |   |   |
| Total cost of revenues |       | $                                                        | 9,605      |               | $          | 16,399         |       | $ | (6,794 | ) | (41 | )% |

 

Our cost of revenues was $9,605 for the three months ended September 30,2010, compared to $16,399 for the three months ended September 30, 2009, adecrease of $6,794 or 41%. The decrease in our Healthcare segment cost ofrevenues was a result of lower spending on infrastructure due to decreased salesof our mobile workstation products as we transition to our new suite of mobileworkstations and power systems, which was partially offset by increased costsfor our mobile workstation products we purchased in the first quarter of 2010from a former supplier which we then sold in the second and third quarters of2010. The decrease in our Commercial segment cost of sales was a result oflower resales of hardware and infrastructure as we transition our business tomore consulting and professional services, partially offset by costs associatedwith increasing our consulting staff to support an increased number of SCMengagements and to prepare for future growth as we continue to expand ourprofessional services business**.** Thereimbursable expenses included in our professional services cost of revenuetotaled $663 and $813 for the three months ended September 30, 2010 and2009, respectively.

 

**Grossprofit**

 

Grossprofit for the three months ended September 30, 2010 and 2009 was asfollows:

 

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| ** **            | ** ** | **Three Months Ended September 30,** | ** ** | **Amount of** | ** ** | **Percentage** | ** ** |
|-----------------------|------------|----------------------------------------------------------|------------|--------------------|------------|----------------|------------|
| ** **            | ** ** | **2010**                                                 | ** ** | **2009**           | ** ** | **Change**     | ** ** | **Change** | ** ** |
| ** **            | ** ** | ** **                                               | ** ** | ** **         | ** ** | ** **     | ** ** | ** ** | ** ** |
| Healthcare            |       |                                                     |       |               |       |           |       |   |   |
| Infrastructure        |       | $                                                        | 326        |               | $          | 1,750          |       | $ | (1,424 | ) | (81 | )% |
| Professional Services |       | 1,420                                                    |       | 1,373              |       | 47             |       | 3 | % |
| Managed Services      |       | 96                                                       |       | 1,023              |       | (927           | )          | (91 | )% |
| Total Healthcare      |       | 1,842                                                    |       | 4,146              |       | (2,304         | )          | (56 | )% |
|                  |       |                                                     |       |               |       |           |       |   |   |
| Commercial            |       |                                                     |       |               |       |           |       |   |   |
| Infrastructure        |       | 126                                                      |       | 888                |       | (762           | )          | (86 | )% |
| Professional Services |       | 340                                                      |       | 422                |       | (82            | )          | (19 | )% |
| Managed Services      |       | 88                                                       |       | 490                |       | (402           | )          | (82 | )% |
| Total Commercial      |       | 554                                                      |       | 1,800              |       | (1,246         | )          | (69 | )% |
|                  |       |                                                     |       |               |       |           |       |   |   |
| Total gross profit    |       | $                                                        | 2,396      |               | $          | 5,946          |       | $ | (3,550 | ) | (60 | )% |

 

Grossprofit percentage for the three months ended September 30, 2010 and 2009was as follows:

 
| ** **                    | ** ** | **Three Months Ended September 30,** | ** ** | **Amount of** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|--------------------|------------|
| ** **                    | ** ** | **2010**                                                 | ** ** | **2009**           | ** ** | **Change** | ** ** |
| ** **                    | ** ** | ** **                                               | ** ** | ** **         | ** ** | ** ** | ** ** |
| Healthcare                    |       |                                                     |       |               |       |   |   |
| Infrastructure                |       | 11                                                       | %          | 27                 | %          | (16 | )% |
| Professional Services         |       | 26                                                       | %          | 25                 | %          | 1 | % |
| Managed Services              |       | 90                                                       | %          | 110                | %          | (20 | )% |
|                          |       |                                                     |       |               |       |   |   |
| Commercial                    |       |                                                     |       |               |       |   |   |
| Infrastructure                |       | 9                                                        | %          | 12                 | %          | (3 | )% |
| Professional Services         |       | 21                                                       | %          | 25                 | %          | (4 | )% |
| Managed Services              |       | 38                                                       | %          | 107                | %          | (69 | )% |
|                          |       |                                                     |       |               |       |   |   |
| Total gross profit percentage |       | 20                                                       | %          | 27                 | %          | (7 | )% |

 

Ourgross profit was $2,396 for the three months ended September 30, 2010,compared to $5,946 for the three months ended September 30, 2009, adecrease of $3,550 or 60%, resulting in a gross margin of 20% for the threemonths ended September 30, 2010, a decrease from 27% for the three monthsended September 30, 2009. The decrease in our gross margin was the resultof continued downward pressure on our gross margin from the sale ofinfrastructure and third-party hardware, including, a 17% increase in the costof our mobile workstation products that were purchased from a former supplierin the first quarter of 2010 and sold during the second and third quarters of2010. In addition, the overall mix of our sales included more lower marginthird party hardware resales as a percentage of total revenue as compared tosales of new products to our primary customers and as a consequence, our totalgross profit margin was reduced. We continue to shift our business toward anoverall greater mix of solutions that includes consulting and otherprofessional****services. We continue to emphasizehigher margin consulting and professional services, which we expect couldbenefit our Healthcare segment as the industry has demonstrated a focus on EMRassessment and implementation projects and we expect our Commercial segmentcould benefit from customers evaluation and initiating SCM solutions.

 

**Selling,general and administrative expenses**

 

Ourselling, general and administrative expenses were $5,891 for the three monthsended September 30, 2010, compared with $6,534 for the three months ended September 30,2009, a decrease of $643, or 10%.  Selling expenses were $1,757 for thethree months ended September 30, 2010, compared with $2,699 for the threemonths ended September 30, 2009, a decrease of $942, or 35%.  The decrease in our selling expenses for thecomparable period was primarily attributable to lower commission on lowersales, as well as lower salary expense, benefits and recruiting costs resultingfrom staffing reductions and other cost control measures.  General andadministrative expenses were $3,474 for the three months ended September 30,2010, compared with $3,187 for the three months ended September 30, 2009,an increase of $287, or 9%.  The increase in our general andadministrative expenses 

 

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forthe comparable period was primarily attributable to an increase in salaryexpense, including consultants training expense, benefits and recruitingexpense, offset by decreases in outside professional fees.

 

Ourdepreciation and amortization expense, included with selling, general andadministrative expenses discussed above, decreased to $384 for the three monthsended September 30, 2010 from $466 for the three months ended September 30,2009, a decrease of $82 or 18%, as the result of fewer purchases of capitalizedassets required to run our business, such as laptop computers, servers andcommunication equipment.

 

Ourstock based compensation expense, included with selling, general andadministrative expenses discussed above, increased to $276  for the three months ended September 30,2010 from $182 for the three months ended September 30, 2009, an increaseof $94 or 52%. The increase is primarily the result of granting options in thefirst quarter of 2010.

 

**Interestexpense**

 

Ourinterest expense was $1,231 for the three months ended September 30, 2010,compared to $1,469 for the three months ended September 30, 2009, adecrease of $238 or 16%. The decrease in interest expense was primarily theresult of the conversion of $5,000 of Term Loan B principal into equity in August 2010which was offset by additional borrowings in February, April, and September 2010,and the default interest rate imposed in April 2010. We also hadadditional borrowings in October 2010 and as we continue to increase ourborrowing under our revolving credit facility with Hercules, we expect ourinterest expense will increase in future quarters. In addition, the delistingof our common stock in October 2010 could negatively impact our ability tosecure financing at a favorable interest rate. See “Liquidity and CapitalResources” below**.**

 

**Netloss**

 

Ournet loss was $4,533 for the three months ended September 30, 2010 comparedwith a net loss of $2,062 for the three months ended September 30, 2009.The increase in our net loss was primarily due to lower sales of infrastructureand third -party hardware at lower gross profit margins as we continue totransition to our new ST7 product family and away from third party hardwaresales to higher margin consulting and professional services in our role as acomprehensive solutions provider. We have maintained a consistent level ofprofessional services revenues at steady gross profit margins. We continued ourefforts to reduce our selling, general and administrative costs through avariety of cost-cutting measures. In the three months ended September 30,2010, our net loss included a gain of $276 for the fair value adjustment of ourderivative liabilities**.**

 

***Nine Months ended September 30, 2010 comparedwith the Nine Months ended September 30, 2009***

 

**Net revenues**

 

Netrevenues for the nine months ended September 30, 2010 and 2009 were asfollows:

 
| ** **            | ** **   | **Nine Months Ended September 30,** | ** **   | **Amount of** | ** **   | **Percentage** | ** **   |
|-----------------------|--------------|---------------------------------------------------------|--------------|--------------------|--------------|----------------|--------------|
| ** **            | ** **   | **2010**                                                | ** **   | **2009**           | ** **   | **Change**     | ** **   | **Change** | ** ** |
| *** ***          | *** *** | *** ***                                            | *** *** | *** ***       | *** *** | *** ***   | *** *** | *** *** | *** *** |
| Healthcare            |         |                                                    |         |               |         |           |         |   |   |
| Infrastructure        |         | $                                                       | 9,389        |               | $            | 22,638         |         | $ | (13,249 | ) | (59 | )% |
| Professional Services |         | 19,420                                                  |         | 14,325             |         | 5,095          |         | 36 | % |
| Managed Services      |         | 485                                                     |         | 1,454              |         | (969           | )            | (67 | )% |
| Total Healthcare      |         | 29,294                                                  |         | 38,417             |         | (9,123         | )            | (24 | )% |
|                  |         |                                                    |         |               |         |           |         |   |   |
| Commercial            |         |                                                    |         |               |         |           |         |   |   |
| Infrastructure        |         | 6,971                                                   |         | 21,540             |         | (14,569        | )            | (68 | )% |
| Professional Services |         | 5,144                                                   |         | 4,231              |         | 913            |         | 22 | % |
| Managed Services      |         | 828                                                     |         | 1,380              |         | (552           | )            | (40 | )% |
| Total Commercial      |         | 12,943                                                  |         | 27,151             |         | (14,208        | )            | (52 | )% |
|                  |         |                                                    |         |               |         |           |         |   |   |
| Total net revenues    |         | $                                                       | 42,237       |               | $            | 65,568         |         | $ | (23,331 | ) | (36 | )% |

 

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Netrevenues were $42,237 for the nine months ended September 30, 2010,compared to $65,568 for the nine months ended September 30, 2009,representing a decrease of $23,331 or 36%. The decrease in our Healthcaresegment net revenues was due to a decrease in sales of mobile workstationsresulting from our transition to our new ST 7 product family. Although we arebeginning to deliver ST 7 mobile workstations, sales have been increasing at aslower pace than we anticipated.  Inaddition, current weak macro-economic conditions have continued to adverselyimpact our customers’ order activities in the first three quarters of 2010,which we expect to continue through the end of 2010. This decrease waspartially offset by an increase in professional services net revenue resultingfrom increased demand for EMR implementation and SCM services.  The decrease in our Commercial segment netrevenues was due primarily to lower resales of infrastructure and hardwareproducts as we continue to transition our business to offer higher margin consultingand other professional services. The reimbursable expense revenue included inour professional services revenue totaled $2,271 and $1,859 for the nine monthsended September 30, 2010 and 2009, respectively.

 

**Cost ofrevenues**

 

Costof revenues for the nine months ended September 30, 2010 and 2009 was asfollows:

 
| ** **             | ** ** | **Nine Months Ended September 30,** | ** ** | **Amount of** | ** ** | **Percentage** | ** ** |
|------------------------|------------|---------------------------------------------------------|------------|--------------------|------------|----------------|------------|
| ** **             | ** ** | **2010**                                                | ** ** | **2009**           | ** ** | **Change**     | ** ** | **Change** | ** ** |
| ** **             | ** ** | ** **                                              | ** ** | ** **         | ** ** | ** **     | ** ** | ** ** | ** ** |
| Healthcare             |       |                                                    |       |               |       |           |       |   |   |
| Infrastructure         |       | $                                                       | 7,828      |               | $          | 16,991         |       | $ | (9,163 | ) | (54 | )% |
| Professional Services  |       | 12,810                                                  |       | 10,923             |       | 1,887          |       | 17 | % |
| Managed Services       |       | 56                                                      |       | (172               | )          | 228            |       | (133 | )% |
| Total Healthcare       |       | 20,694                                                  |       | 27,742             |       | (7,048         | )          | (25 | )% |
|                   |       |                                                    |       |               |       |           |       |   |   |
| Commercial             |       |                                                    |       |               |       |           |       |   |   |
| Infrastructure         |       | 5,605                                                   |       | 19,333             |       | (13,728        | )          | (71 | )% |
| Professional Services  |       | 4,027                                                   |       | 3,508              |       | 519            |       | 15 | % |
| Managed Services       |       | 405                                                     |       | 326                |       | 79             |       | 24 | % |
| Total Commercial       |       | 10,037                                                  |       | 23,167             |       | (13,130        | )          | (57 | )% |
|                   |       |                                                    |       |               |       |           |       |   |   |
| Total cost of revenues |       | $                                                       | 30,731     |               | $          | 50,909         |       | $ | (20,178 | ) | (40 | )% |

 

Our cost of revenues was $30,731 for the nine months ended September 30,2010, compared to $50,909 for the nine months ended September 30, 2009, adecrease of $20,178 or 40%. The decrease in our Healthcare segment cost ofrevenues was a result of lower spending on infrastructure due to decreasedsales of our mobile workstation products as we transition to our new suite ofmobile workstations and power systems, partially offset by a 17% increase inthe cost of our mobile workstation products that were purchased from a formersupplier in the first quarter of 2010 and sold during the second and thirdquarters of 2010. The decrease in our Commercial segment cost of sales was aresult of lower resales of hardware and infrastructure as we transition ourbusiness, which was partially offset by costs associated with increasing ourconsulting staff to support an increased number of SCM engagements and toprepare for future growth as we continue to expand our professional servicesbusiness**.** The reimbursable expenses included inour professional services cost of revenue totaled $2,271 and $1,859 for thenine months ended September 30, 2010 and 2009, respectively.

 

**Grossprofit**

 

Grossprofit for the nine months ended September 30, 2010 and 2009 was asfollows:

 

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| ** **            | ** ** | **Nine Months Ended September 30,** | ** ** | **Amount of** | ** ** | **Percentage** | ** ** |
|-----------------------|------------|---------------------------------------------------------|------------|--------------------|------------|----------------|------------|
| ** **            | ** ** | **2010**                                                | ** ** | **2009**           | ** ** | **Change**     | ** ** | **Change** | ** ** |
| ** **            | ** ** | ** **                                              | ** ** | ** **         | ** ** | ** **     | ** ** | ** ** | ** ** |
| Healthcare            |       |                                                    |       |               |       |           |       |   |   |
| Infrastructure        |       | $                                                       | 1,561      |               | $          | 5,647          |       | $ | (4,086 | ) | (72 | )% |
| Professional Services |       | 6,610                                                   |       | 3,402              |       | 3,208          |       | 94 | % |
| Managed Services      |       | 429                                                     |       | 1,626              |       | (1,197         | )          | (74 | )% |
| Total Healthcare      |       | 8,600                                                   |       | 10,675             |       | (2,075         | )          | (19 | )% |
|                  |       |                                                    |       |               |       |           |       |   |   |
| Commercial            |       |                                                    |       |               |       |           |       |   |   |
| Infrastructure        |       | 1,366                                                   |       | 2,207              |       | (841           | )          | (38 | )% |
| Professional Services |       | 1,117                                                   |       | 723                |       | 394            |       | 54 | % |
| Managed Services      |       | 423                                                     |       | 1,054              |       | (631           | )          | (60 | )% |
| Total Commercial      |       | 2,906                                                   |       | 3,984              |       | (1,078         | )          | (27 | )% |
|                  |       |                                                    |       |               |       |           |       |   |   |
| Total gross profit    |       | $                                                       | 11,506     |               | $          | 14,659         |       | $ | (3,153 | ) | (22 | )% |

 

Grossprofit percentage for the nine months ended September 30, 2010 and 2009was as follows:

 
| ** **                    | ** ** | **Nine Months Ended September 30,** | ** ** | **Amount of** | ** ** |
|-------------------------------|------------|---------------------------------------------------------|------------|--------------------|------------|
| ** **                    | ** ** | **2010**                                                | ** ** | **2009**           | ** ** | **Change** | ** ** |
| ** **                    | ** ** | ** **                                              | ** ** | ** **         | ** ** | ** ** | ** ** |
| Healthcare                    |       |                                                    |       |               |       |   |   |
| Infrastructure                |       | 17                                                      | %          | 25                 | %          | (8 | )% |
| Professional Services         |       | 34                                                      | %          | 24                 | %          | 10 | % |
| Managed Services              |       | 89                                                      | %          | 112                | %          | (23 | )% |
|                          |       |                                                    |       |               |       |   |   |
| Commercial                    |       |                                                    |       |               |       |   |   |
| Infrastructure                |       | 20                                                      | %          | 10                 | %          | 10 | % |
| Professional Services         |       | 22                                                      | %          | 17                 | %          | 5 | % |
| Managed Services              |       | 51                                                      | %          | 76                 | %          | (25 | )% |
|                          |       |                                                    |       |               |       |   |   |
| Total gross profit percentage |       | 27                                                      | %          | 22                 | %          | 5 | % |

 

Ourgross profit was $11,506 for the nine months ended September 30, 2010,compared to $14,659 for the nine months ended September 30, 2009, adecrease of $3,153 or 22%, resulting in a gross margin of 27% for the ninemonths ended September 30, 2010, up from 22% for the nine months ended September 30,2009. This increase was primarily the result of the decrease in sales of mobileworkstation products resulting form our transition to our new ST7 productfamily. We continue to emphasize higher margin consulting and professionalservices, which benefited our Healthcare segment as the industry demonstrated afocus on EMR assessment and implementation projects and our Commercial segmentbenefited from customers evaluating and initiating SCM solutions**.**We continue to experience downward pressure on our grossmargin from the sale of infrastructure and third-party hardware, including a17% increase in the cost of our mobile workstation products that were purchasedfrom a former supplier in the first quarter of 2010 and sold during the secondand third quarters of 2010. Consistent with our overall strategic plan, wecontinue to migrate the business toward an overall greater mix of solutionsthat include consulting and other professional****services.

 

**Selling,general and administrative expenses**

 

Ourselling, general and administrative expenses were $17,512 for the nine monthsended September 30, 2010, compared with $21,945 for the nine months ended September 30,2009, a decrease of $4,433, or 20%.  Selling expenses were $6,178 for thenine months ended September 30, 2010, compared with $8,352 for the ninemonths ended September 30, 2009, a decrease of $2,174, or 26%. Thedecrease in our selling expenses for the comparable period was primarilyattributable to lower commissions on lower sales, as well as lower salaryexpense, benefits and recruiting related costs resulting from staffingreductions and other cost control measures.  General and administrativeexpenses were $9,159 for the nine months ended September 30, 2010, comparedwith $11,465 for the nine months ended September 30, 2009, a decrease of$2,306, or 20%.  The decrease in our general and administrative 

 

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expensesfor the comparable period was primarily attributable to a reduction in salaryexpense, including consultants training expense, benefits and travel costs, andlower marketing expenses.

 

Ourdepreciation and amortization expense, included with selling, general andadministrative expenses discussed above, decreased to $1,258 for the ninemonths ended September 30, 2010 from $1,416 for the nine months ended September 30,2009, a decrease of $158 or 11%, as the result of fewer purchases ofcapitalized assets required to run our business, such as laptop computers,servers and communication equipment.

 

Ourstock based compensation expense, included with selling, general andadministrative expenses discussed above, increased to $917 for the nine monthsended September 30, 2010 from $712 for the nine months ended September 30,2009, an increase of $205 or 29%. The increase is primarily the result ofgranting options in the first quarter of 2010.

 

**Interestexpense**

 

Ourinterest expense was $3,494 for the nine months ended September 30, 2010,compared to $3,803 for the nine months ended September 30, 2009, adecrease of $309 or 8%. The decrease in interest expense is a result of therestructuring of our debt with Hercules in the fourth quarter of 2009 offset byadditional borrowings in February, April and September 2010, andthe default interest rate imposed in April 2010. We had additionalborrowings in October 2010 and as we continue to increase our borrowingunder our revolving credit facility with Hercules, we expect our interestexpense will increase in future quarters. In addition, the delisting of ourcommon stock in October 2010 could negatively impact our ability to securefinancing at a favorable interest rate. See “Liquidity and Capital Resources”below**.**

 

**Netloss**

 

Ournet loss was $6,785 for the nine months ended September 30, 2010 comparedwith a net loss of $11,513 for the nine months ended September 30, 2009, adecrease of $4,728 or 41%.The decrease in our net loss was primarily due to ourcontinued efforts to reduce our selling, general and administrative coststhrough a variety of cost-cutting measures and an increase in gross profit aswe continue to transition from infrastructure hardware sales to higher margin professionaland consulting services in our role as a comprehensive solutions provider.******In the nine months ended September 30,2010, our net loss included a gain on sale of patents of $1,863 and a gain of$1,040 for the fair value adjustment of our derivative liabilities. During thenine months ended September 30, 2010, our warrants were reclassified fromwarrant liability to equity upon meeting the criteria for equity classificationin accordance with GAAP. The charge to earnings was based upon the change infair value at the end of each reporting period or at the date the warrantsqualified for equity treatment offset by a change in assumptions that impactedthe warrant liability value at December 31, 2009 that was reflected in thefirst quarter of 2010.

 

**Liquidityand capital resources**

 

At September 30, 2010, we had cash and cash equivalents of $152,compared to $1,018 at December 31, 2009. Historically, we have funded ouroperating losses primarily through the private sale of equity securities andthrough current and long-term debt and working capital. At September 30,2010, our total liabilities were $34,676 and were comprised mostly of termdebt, an equipment loan, borrowings outstanding under our revolving line ofcredit, notes and earn out payments due to sellers related to prioracquisitions, and outstanding accounts payable. Net cash used in operatingactivities for the nine months ended September 30, 2010 was $6,629,related to interest payments on our borrowings and other operating expenses.Net cash provided by investing activities was $1,846 for the nine months ended September 30,2010, primarily from proceeds from the sale of a non-essential patent.****Net cash provided by financing activities was $3,917 forthe nine months ended September 30, 2010, primarily due to increasedborrowings under our Amended Loan Agreement with Hercules.

 

We have substantial liquidity needs that have not beenmet by our operating cash flow.  We havereceived additional capital from our lender on numerous occasions, most recentlyon September 13, October 1, October 8 and October 28;however there is no guarantee that Hercules will continue to provide usadditional capital on terms acceptable to us or at all. We have substantialliquidity requirements related to the repayment of our seller note, ourequipment loan, our term loans and our revolving line of credit under ourAmended Loan Agreement with Hercules that are currently due or become duewithin one year and earn out payments for past acquisitions. We do notcurrently expect to generate sufficient cash flow from operations to fund ourworking capital needs or those obligations. We have undertaken a series ofactions to reduce costs and have explored potential sources of financing andother strategic initiatives. On February 10, 2010, Hercules sent us aletter notifying us of an event of default because our borrowings under therevolving credit facility exceeded our borrowing base. In addition, under theterms of the Subordination Agreement by and among Hercules, HIA and us, ourdefault under the seller note issued to HIA which was due and payable on September 30,2010, has resulted in an additional event of default under the Amended LoanAgreement. Hercules has not chosen to accelerate our obligations under theAmended Loan Agreement, but has expressly not waived any events of default orany of its remedies under the Amended Loan

 

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Agreement. We do not have adequate liquidity to repayall outstanding amounts under the credit facility and payment accelerationwould have a material adverse effect on our liquidity, business, financialcondition and results of operations. Even without acceleration of ourobligations to Hercules and even with the restructuring of our debt withHercules on November 20, 2009, subsequent additional borrowings from Herculesin February, April, September and October 2010 and the sale of apatent in June 2010, we continue to believe that we need to restructureour debt, pursue additional debt and equity financing, complete one or morestrategic transactions, and continue further cost control actions to meet ourliquidity needs. Our continued operations are dependent on our ability toimplement those plans successfully which could be negatively impacted by ourrecent delisting from Nasdaq. If we fail to successfully implement these plans,we may not be able to continue as a going concern. For a discussion of ourplans with respect to these matters, see “Going Concern.”

 

*Senior indebtedness*

 

OnMay 1, 2008, we and our subsidiaries entered into a loan and securityagreement with Hercules (“Loan and Security Agreement”), which provided us witha revolving credit facility and a term loan facility. The Loan and SecurityAgreement was subsequently amended in November 2008 and May 2009, andwe entered into a forbearance agreement with respect to certain defaults underthe Loan and Security Agreement in July 2009, and we entered into fiveamendments to the forbearance agreement over the course of August throughOctober 2009. In connection with the Hercules Restructuring that closed onNovember 20, 2009, we entered into the Amended Loan Agreement withHercules, which amended and restated the Loan and Security Agreement. Thedescription of the Amended Loan Agreement below reflects the terms in placesince November 20, 2009, as amended on February 19, 2010 (to providethe Equipment Loan), April 6, 2010 (to issue Term Loan C), June 18,2010 (to facilitate sale of a patent) and October 28, 2010 (to issue TermLoan D).

 

Underthe Amended Loan Agreement, our indebtedness to Hercules consists of four termloans and an Equipment Loan aggregating approximately $10,311 and a revolvingcredit facility of $12,000, of which $10,517 was outstanding at November 1,2010. The revolving credit facility expires on May 1, 2011, but may beextended at our option for six months if there is no existing event of default.Any advances under the revolving credit facility bear interest initially at12.0% per annum until the term loans, as described below, are repaid in full,when the interest rate on outstanding advances will be prime plus 4%.Borrowings under the revolving credit facility are based on eligible accountsreceivable. On September 13, 2010, October 1, 2010, October 8,2010 and October 28, 2010, Hercules advanced us an additional $500, $500,$1,000 and $1,400, respectively, which were provided as extensions above oureligible borrowing base. Overadvances bear interest at 15% per annum and arepayable on demand.

 

Theterm loans are comprised of a $5,500 term loan due on November 1, 2013 (“TermLoan A”), $760 remaining as accrued interest and PIK interest on a convertibleterm loan due on November 1, 2014 (“Term Loan B”), a $1,350 convertibleterm loan due on April 1, 2013 (“Term Loan C”) and a $500 convertible termloan due on September 13, 2011 (“Term Loan D”). Principal amortization onTerm Loan A begins on December 1, 2010. Term Loan B may be converted intoshares of our common stock at a price of $1.8575 per share at Hercules’ option,or automatically if the 90-day value weighted adjusted trading price of ourcommon stock exceeds five times the conversion price. Term Loan B also has amandatory conversion feature and we have the right to pay a portion of theconversion amount in cash plus applicable fees, interest and other chargesinstead of shares of common stock under certain circumstances. If notconverted, the principal balance on Term Loan B is due November 2014. On August 13,2010, Hercules converted $5,000 of the aggregate principal amount of Term LoanB at the conversion price of $1.8575 per share, for an issuance of   2,691,790 shares of our common stock.Hercules continues to have the ability to convert the outstanding principalbalance into shares of our common stock. Term Loan C may be converted into sharesof our common stock at a price of $3.276 per share at Hercules’ option. If notconverted, the principal balance of Term Loan C is due April 2013.

 

TermLoan A bears interest at (i) 12% per annum for the first year,(ii) 18% per annum for the next year, and (iii) 15% thereafter. Allinterest on Term Loan A is payable in cash monthly commencing December 1,2009. Term Loan B bears interest at (i) 14.5% per annum for the firstyear, (ii) 20.5% per annum for the next year, and (iii) 17.5%thereafter. A portion (2.5%) of the interest rate on Term Loan B is to be “paidin kind” (“PIK”) compounded monthly. The balance of the interest on Term Loan Bis payable in cash monthly commencing December 1, 2009. Hercules also hasthe option, in its sole discretion, to require any and all interest on TermLoan B to be paid in cash, PIK or in shares of our common stock. The number ofshares into which accrued interest will be converted will be determined basedon 70% of the adjusted 60-day average trading price of our common stock on thedate of Hercules’ election to convert the interest into shares. In the eventTerm Loan A or Term Loan B is prepaid, a prepayment charge on the principalprepaid is 5% if prepaid during the first 12 months, 3% if prepaid during thenext 12 months and 1% thereafter will be due, provided that, if Term Loan A orTerm Loan B is prepaid during the first 12 months and there is then no event ofdefault, Hercules will waive the prepayment charge on both term loans. TermLoan C bears interest at a rate of 8% per annum and, at the discretion ofHercules, is payable either in cash or PIK.  Interest is payable monthlycommencing on May 1, 2010. We may prepay Term Loan C without incurring aprepayment penalty charge.

 

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OnFebruary 19, 2010, Hercules provided us with an Equipment Loan allowing usto request up to $3,000 in borrowings for use in purchasing equipment.  Wecould borrow in minimum increments of $250 under the Equipment Loan, subject tovalid, verified purchase orders acceptable to Hercules from suppliers approvedby Hercules in its sole discretion.  In connection with any advances, weare charged a fee of 3% of the purchase price identified in the relevantpurchase orders. All customer receipts related to sales of products financed bythe Equipment Loan are placed in a lockbox account under the exclusive controlof Hercules and customer receipts are applied first to payment of the EquipmentLoan fee, second, to the outstanding principal on the Equipment Loan and third,to all other obligations existing under the Equipment Loan. After suchapplication, the excess in the lockbox account will be returned to us, unlessan event of default exists or could reasonably be expected to exist, in whichcase, Hercules may apply the excess in the lockbox account to any obligationunder the Amended Loan Agreement. The Equipment Loan bears interest at a rateof 1.5% per month and Hercules’ commitment to make additional equipmentadvances terminated on June 30, 2010, which was extended from the originalcommitment termination date of April 30, 2010. At June 30, 2010, wehad an outstanding balance of $2,250 under this facility.

 

On April 6, 2010, we entered into AmendmentNo. 2 (“Amendment 2”) to the Amended Loan Agreement with Hercules.Pursuant to Amendment 2, Hercules funded Term Loan C in an original principalamount of $1,350. The proceeds of Term Loan C were used to repay outstandingover advances under the revolving credit facility. Interest on Term Loan Caccrues at a rate of 8% per annum and, at the discretion of Hercules, ispayable either in cash or in kind by adding the accrued interest to theprincipal of Term Loan C. All principal outstanding on Term Loan is due andpayable on April 1, 2013. Term Loan C may be converted into shares of ourcommon stock at a price of $3.276 per share at any time at Hercules’ option. Wemay prepay Term Loan C without incurring a prepayment penalty charge. We alsoentered into a registration rights agreement and subsequent letter agreement withHercules whereby we agreed to file by a shelf registration statement with theSEC covering the resale of the shares of common stock that may be issued toHercules upon the conversion of Term Loan C or in payment of default rateinterest with respect to the revolving credit facility, Term Loan A, Term B,Term Loan C and the Equipment Loan.  We haveagreed to use our best efforts to have the registration statement declaredeffective by the SEC no later than September 30, 2010, subject to a 60 dayextension in the event of SEC review.  Asof September 30, 2010, we have not filed the contemplated registrationstatement.

 

Amendment 2also amended the interest payment options under Term Loan B such that Herculesnow has the option, in its sole discretion, to require any and all interest onTerm Loan B to be paid in cash, in kind or in shares of our common stock. Thenumber of shares into which accrued interest will be converted will bedetermined based on 70% of the adjusted 60-day average trading price of ourcommon stock on the date of Hercules’ election to convert the interest intoshares.

 

Amendment2 also amended the default interest payment options under the Amended LoanAgreement. Whereas prior to Amendment 2, default rate interest was payable incash or in kind by adding the accrued interest to the outstanding principalamount, pursuant to Amendment 2, Hercules now has the option to elect to havedefault rate interest paid in cash, in kind or in shares of our common stock.All default rate interest paid in kind will be added to the outstandingprincipal amount on Term Loan B, notwithstanding on which loan the interest hasaccrued. If Hercules elects to have default rate interest paid in shares, thenumber of shares into which such accrued default rate interest will beconverted will be determined based on 70% of the adjusted 60-day average priceon the date of Hercules’ election to convert the interest into shares.

 

On October 28, 2010, we entered into Amendment No. 4(“Amendment 4”) to the Amended Loan Agreement with Hercules. Pursuant toAmendment 4, Hercules funded Term Loan D in an original principal amount of$500. The proceeds of Term Loan D were used to repay a portion of theoutstanding overadvances under the revolving credit facility. Interest on TermLoan D will accrue at a rate of 18% per annum, payable 10% in cash and 8% inPIK by adding such amount to the principal amount of Term Loan D. All principaloutstanding on Term Loan D will be due and payable on September 13, 2011.Term Loan D may be converted into shares of our common stock at a price of$3.30 at any time at Hercules’ option. We may prepay Term Loan D withoutincurring a repayment penalty charge. We also entered into a RegistrationRights Agreement with Hercules whereby we agreed to register the sharesunderlying Term Loan D and certain interest that may be paid in shares.

 

TheAmended Loan Agreement contains certain negative covenants and otherstipulations associated with the arrangement, including covenants that restrictour ability to incur indebtedness, make investments, make payments in respectof our capital stock, including dividends and repurchases of common stock, sellor license our assets, and engage in acquisitions without the priorsatisfaction of certain conditions. Additionally, the Amended Loan Agreementcontains the following financial covenants (i) minimum consolidatedadjusted EBITDA measured on a three month rolling basis as of the last day ofeach month of between $150 and $2,000, until December 31, 2011 andthereafter when $3,000 of consolidated adjusted EBITDA is required,(ii) maximum leverage ratio measured on a rolling twelve month basis as ofthe last day of each fiscal quarter commencing June 30, 2010 of 6.0 to 1.0decreasing to 1.5 to 1.0 by the quarter ending June 30, 2012,(iii) minimum consolidated fixed charge coverage ratio measured on arolling twelve month basis as of the last day of a fiscal quarter commencingJune 30, 2010 of 0.75 to 1.0 increasing to 2.0 to 1.0 by the quarterending June 30, 2012, and (iv) at least $1,000 in unrestricted cashat all times.  Failures to maintain the financial covenants, as well as 

 

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certainother events, are events of default under the Amended Loan Agreement. Upon anevent of default under the Amended Loan Agreement, Hercules may opt toaccelerate and demand payment of all or any part of our obligations.

 

Wewere assessed a transaction fee of $450 in connection with the HerculesRestructuring, which is payable in 12 equal monthly installments beginning inApril 2010. The outstanding balance is included in accrued expenses on theaccompanying balance sheet at September 30, 2010. Our obligations underthe Amended Loan Agreement are secured by all of our personal property,including all of our equity interests in our respective subsidiaries.

 

OnFebruary 10, 2010, Hercules sent us a letter notifying us of an event ofdefault because our borrowings under the revolving credit facility exceeded ourborrowing base as of February 5, 2010 and began charging us defaultinterest of an additional 3% to the applicable regular interest rate for theperiod starting February 5, 2010. Events of default are continuing anddefault rate interest will be payable monthly on the same date as regularinterest unless Hercules chooses to demand payment of default interest onanother date. Under the terms of our Amended Loan Agreement late fees are equalto 5% of the past due amount and default rate interest is equal to theapplicable regular interest rate plus 3%. Hercules may elect to have default rateinterest paid in cash, in kind or in shares of our common stock. All defaultrate interest paid in kind will be added to the outstanding principal amount onTerm Loan B, notwithstanding on which loan the interest has accrued. IfHercules elects to have default rate interest paid in shares, the number ofshares into which such accrued default rate interest will be converted will bedetermined based on the adjusted 60-day average trading price of our commonstock on the date of Hercules’ election to convert the interest into shares.

 

Herculeshas not chosen to accelerate our obligations under the Amended Loan Agreement,but has expressly not waived any events of default or any of its remedies underthe loan and security agreement. We do not have adequate liquidity to repay alloutstanding amounts under the credit facility and payment acceleration wouldhave a material adverse effect on our liquidity, business, financial conditionand results of operations.

 

As a result of the event of default and our noncompliance with theminimum cash and EBITDA requirement, total leverage ratio and fixed chargecoverage ratio required under the Amended Loan Agreement, we are prohibitedfrom satisfying our earn out obligations related to our acquisition of theassets of Healthcare Informatics Associates, Inc. (“HIA”) and Delta HealthSystems, Inc. We also have a seller note to HIA that was payable onSeptember 30, 2010. As of September 30, 2010, we were in defaultunder our indebtedness to Hercules and therefore were not permitted to repaythe seller note, and we are now in default under the seller note, however, as aresult of the subordination agreement by and among HIA, Hercules and us,, HIAdoes not have the ability to bring an enforcement action during the standstillperiod, which is 180 days from the date HIA gives Hercules notice ofdefault.  HIA, at its sole discretion,may charge us a default interest rate of an additional 2.5% until such timethat default is cured.  We are indiscussions with HIA about modifying the earn out payment and the seller note.

 

***Inventory***

 

During the third quarterof 2010 we began receiving pre-orders of mobile workstations and batteryinventory. Our inventory has consequently increased from $1,089 at December 31,2009 to $2,892 at September 30, 2010. The increase is attributable tominimum order requirements to receive pricing benefits and a slower thananticipated ramping up of sales of our new product line.

 

***Inflation***

 

Todate, the effects of inflation on our consolidated financial results have notbeen significant; however, we cannot be certain that inflation will not affectus materially in the future.

 

***Off Balance Sheet Arrangements***

 

Wedo not currently have any off-balance sheet arrangements.

 

***New Accounting Standards***

 

In July 2010, the FASBissued ASU 2010-20, which amends Accounting Standards Codification (ASC) 310 byrequiring more robust and disaggregated disclosures about the credit quality ofan entity’s financing receivables and its allowance for credit losses. Theobjective of enhancing these disclosures is to improve financial statementusers’ understanding of (a) the nature of an entity’s credit riskassociated with its financing receivables and (b) the entity’s assessmentof that risk in estimating its allowance for credit losses as well as changesin the allowance and the reasons for those changes. The guidance is effectivefor the first reporting period beginning after December 15, 2010. We donot expect that the adoption of these new disclosure requirements will have a materialimpact on our consolidated financial statements.

 

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InJanuary 2010, the FASB issued ASU No. 2010-06, *“*ImprovingDisclosures About Fair Value Measurements,” which added disclosurerequirements about an entity’s use of fair value measurements. Among theserequirements, entities will be required to provide enhanced disclosures abouttransfers into and out of the Level 1 (fair value determined based on quotedprices in active markets for identical assets and liabilities) and Level 2(fair value determined based on significant other observable inputs)classifications, provide separate disclosures about purchases, sales, issuancesand settlements relating to the tabular reconciliation of beginning and endingbalances of the Level 3 (fair value determined based on significantunobservable inputs) classification and provide greater disaggregation for eachclass of assets and liabilities that use fair value measurements. Except forthe detailed Level 3 roll-forward disclosures, the new standard was effectivefor us for interim and annual reporting periods beginning after December 31,2009. The adoption of this accounting standards amendment did not have amaterial impact on our consolidated financial statements. The requirement toprovide detailed disclosures about the purchases, sales, issuances andsettlements in the roll-forward activity for Level 3 fair value measurements iseffective for us for interim and annual reporting periods beginning after December 31,2010. We do not expect that the adoption of these new disclosure requirementswill have a material impact on our consolidated financial statements.

 

InOctober 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition(Topic 605) - Multiple-Deliverable Revenue Arrangements.” ASU No. 2009-13provides additional guidance on the accounting for revenue recognition formultiple-deliverable arrangements to enable vendors to account for products orservices (deliverables) separately rather than as a combined unit. Thisguidance establishes a selling price hierarchy for determining the sellingprice of a deliverable, which is based on: (a) vendor-specific objectiveevidence; (b) third-party evidence; or (c) estimates. This guidancealso eliminates the residual method of allocation and requires that arrangementconsideration be allocated at the inception of the arrangement to alldeliverables using the relative selling price method. In addition, thisguidance significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements. ASU No. 2009-13 is effectiveprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010 and early adoption ispermitted. A company may elect, but will not be required, to adopt theamendments in ASU No. 2009-13 retrospectively for all prior periods. We donot expect the provisions of ASU No. 2009-13 to have a material effect onour financial position, results of operations, or cash flow.

 

**Item 3.****                      ****Quantitative and Qualitative Disclosures About Market Risk**

 

Theprimary objective of our investment activities is to preserve principal. Ourfunds are currently held in checking accounts and money market funds which donot subject us to risk of a loss of principal due to changes in prevailinginterest rates and from time to time, in a portfolio of cash and cashequivalents that include investments in investment-grade securities, such ascommercial paper, money market funds, government debt securities andcertificates of deposit with maturities of less than nine months. Some of thesesecurities may be subject to market risk due to changes in prevailing interest rates,which may cause fluctuations in market value. We do not enter into derivativesor other financial instruments for trading or speculative purposes.

 

Twoof the main risks associated with these investments are interest rate risk andcredit risk.  Typically, when interest rates rise, there is acorresponding decline in the market value of debt securities. Fluctuations in interest rates would not have a material effect on ourfinancial statements because of the short-term nature of the securities inwhich we invest and our intention to hold the securities to maturity. Credit risk refers to the possibility that the issuer of the debt securitieswill not be able to make principal and interest payments.  We have limitedthe investments to investment grade or comparable securities and have notexperienced any losses on our investments to date due to credit risk.

 

The fair value of our cash and cash equivalents at September 30,2010, approximated its carrying value due to the short-term maturities of theseinvestments. The potential decrease in fair value resulting from a hypothetical10% increase in interest rates for our investment portfolio is not material.

 

The carrying value of our long-term debt at September 30, 2010approximated its fair value. Advances under our revolving credit facility bearinterest initially at 12% per annum until our term loans are repaid in full, atwhich time the interest rate on the outstanding advances will be prime plus4%.  Interest rates under our four termloans range between 8% and 23% over the next several years (including thedefault interest rate).  Because ourinterest rates are fixed, an increase in market rates of interest will notimpact our annual interest expense until the term loans are repaid.

 

The balance of our other long-term liabilities consists of two notes,bearing interest at fixed rates of 7.84% per annum and 9% per annum, issued inconnection with acquisitions that took place during 2007. A change in interestrates would not have any effect on our annual interest expense for this debt.

 

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**Item 4.        Controls and Procedures**

 

**a)****             ****Evaluationof disclosure controls**

 

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our reports filed under theSecurities Exchange Act of 1934, as amended (“Exchange Act”), is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms and that such information is accumulated and communicatedto our management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow for timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and management is required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

 

Asrequired by SEC Rule 13a-15(b) under the Exchange Act, we carried outan evaluation, under the supervision and with the participation of ourmanagement, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report. Based on theresults of the evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were noteffective.

 

**b)****             ****Changesin internal control over financial reporting**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting, as such term is defined in SEC Rule 13a-15(f) underthe Exchange Act. Our internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles. Our internal controlover financial reporting includes those policies and procedures that aredesigned to: (1) maintain records that in reasonable detail accurately andfairly reflect our transactions and dispositions of our assets;(2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that our receipts andexpenditures are being made only in accordance with authorizations of ourmanagement and our directors; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof our assets that could have a material effect on the financial statements.

 

Inconnection with its audit of our consolidated financial statements for theperiod ended December 31, 2009, our independent registered publicaccounting firm at such time, McGladrey & Pullen, LLP, identified amaterial weakness in internal control related to our accounting for theHercules Restructuring.  Specifically, our independent registered publicaccounting firm found that we failed to properly apply the Debt Topic of theFASB Accounting Standards Codification and failed to timely make certainmaterial adjustments required in connection with the Hercules Restructuring,including recording a $6,777 loss on debt extinguishment and a $4,294 increasein additional-paid-in-capital.

 

Wehave taken and continue to take appropriate and reasonable steps to make thenecessary improvements to remediate these deficiencies, including:

 

·                  continuing toeducate our management and finance personnel concerning accounting andreporting requirements;

·                  implementingpersonnel, policy and procedure changes as part of our on-going program tostrengthen the organization structure, financial reporting procedures and systemof internal control over financial reporting;

·                  continuing toutilize professional services firms to assist with accounting and financialreporting; and

·                  maintainingincreased management oversight of accounting and reporting functions in thefuture.

 

Additionally,we continue to improve and implement more rigorous period end reportingprocesses to include improved controls and procedures, resulting in frequentprocess refinement.  Our remediationefforts are continuing and we expect to make additional changes to our controlenvironment and accounting and reporting processes that we believe willstrengthen our internal control over financial reporting.  We havededicated considerable resources to the design, implementation, documentation,and testing of our internal controls and although we believe the steps taken todate have improved the effectiveness of our internal control over financialreporting, we have not completed all the corrective processes andprocedures.  Accordingly, we will continue to monitor theeffectiveness of our internal control over financial reporting and as required,perform additional procedures to ensure that our financial statements arefairly stated in all material respects. We do not expect that our disclosure controls and procedures or ourinternal control over financial reporting will prevent or detect allerrors.  A control system, no matter how well designed and operated,can provide only reasonable, not absolute, assurance that the control system’sobjectives will be met. The design of any system of controls is based, inpart, upon certain assumptions about the likelihood of future events and therecan be no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions.

 

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Exceptas set forth above, there was no change in our internal control over financialreporting that occurred during the period covered by this report that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II— OTHER INFORMATION**

 

**Item 1.        Legal Proceedings**

 

In the normal course of business, we have become andmight in the future become involved in legal actions relating to our business.In management’s opinion, the resolution of any such pending legal actions isnot expected to have a material adverse effect on our consolidated financialposition or results of operations.

 

**Item 1A.     Risk Factors**

 

Therisks and uncertainties described below are in addition to those included inour Annual Report on Form 10-K for the year ended December 31, 2009and our Quarterly Report on Form 10-Q for the quarterly periods ended  March 31, 2010 and June 30, 2010and are not the only risks we face. Additional risks and uncertainties notpresently known to us or that we currently deem immaterial may also affect ourbusiness and results of operations.

 

***Our stock was delisted from the Nasdaq CapitalMarket and now trades on the OTC bulletin board, which may adversely affectstockholders liquidity***

 

On October 21, 2010, our common stock becameeligible for trading under the symbol IFLG in the electronic quotation servicefor securities traded over-the-counter operated (“OTCQB”) by Pink OTC MarketsInc.  Prior to October 21, 2010, ourcommon stock had been listed on The Nasdaq Capital Market.  However, we were unable to continue to meetlisting requirements, including (a) maintaining a minimum of $2,500 instockholders’ equity, (b) having a minimum of $35,000 of market value oflisted securities, or (c) having net income from continuing operations ofat least $500 in the most recently completed fiscal year or in two of the threemost recently completed fiscal years, as required under Nasdaq listing rule 5550(b).Since receiving the initial letter from the Nasdaq Stock Market on August 19,2009 notifying us of our failure to comply with Nasdaq Listing Rule 5550(b),we have worked with Nasdaq to regain compliance with the listing rules. Since August 2009,we had intermittently regained compliance, however, on April 20, 2010,Nasdaq denied our request for continued listing and notified us that unless werequested an appeal our common stock would be delisted.  We timely requested a hearing and on July 8,2010 we announced we received a letter from Nasdaq stating that the NasdaqHearings Panel (the “Panel”) granted our request for continued listing subjectto several conditions including, among other things, the occurrence of certainevents by August 15, 2010 and the Company’s ability to regain compliancewith all the requirements for continued listing on Nasdaq by October 18,2010.  We failed to comply with theserequirements by the relevant dates and received a notice on October 19,2010 that the Panel had determined to delist our common stock from The NASDAQStock Market and suspend trading of our common stock effective with the open oftrading on October 21, 2010. The delisting of our common stock from Nasdaqcould adversely affect the market liquidity of our common stock and cause themarket price of our common stock to decrease and could also adversely affectour ability to obtain financing for our continued operations and result in theloss of confidence by investors, customers, suppliers, employees and adverselyimpact our business. In addition, although we are quoted on the OTCQB, theOTCQB is generally considered to be a less liquid and efficient market, and ourstock price, as well as the liquidity of our common stock, may be adverselyaffected as a result.

 

***Applicable SEC rules governing the trading of “penny stocks” maylimit the liquidity of our common stock which may affect its trading price.***

 

Our common stock may beconsidered a “penny stock” and be subject to SEC rules and regulationsthat impose limitations upon the manner in which our shares may be publiclytraded. These regulations require the delivery, before any transactioninvolving a penny stock, of a disclosure schedule explaining the penny stockmarket and the associated risks. Under these regulations, certain brokers whorecommend such securities to persons other than established customers orcertain accredited investors must make a special written suitability determinationregarding the purchaser and receive the purchaser’s written agreement to atransaction before a sale. These regulations could have the effect of limitingthe trading activity of our common stock and reducing the liquidity of aninvestment in our common stock. Therefore, our stockholders may find itdifficult to obtain accurate quotations of our common stock and/or to selltheir shares.

 

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***We will need additional financing to fund our operations and financeour growth; we may be unable to obtain financing on terms acceptable to us.***

 

We will be required to raiseadditional capital through either equity or debt financing to fund ouroperations, including our continued operating losses and general workingcapital needs, and to implement our current or future strategies. Factors thatcould increase our need to seek additional financing include decreased demandand market acceptance for our products and services and competitive pressuresresulting in lower pricing and new products and services offered by ourcompetitors. In addition, if our obligations under existing indebtedness areaccelerated or when our existing credit facilities expire, we would likely needto obtain replacement debt financing. The capital and credit markets in theUnited States continue to experience extreme volatility and disruptions, andthe current turmoil affecting the financial markets and the banking system, aswell as the possibility that financial institutions may consolidate or go outof business, have resulted in a tightening in the credit markets and a lowlevel of liquidity in many financial markets. These developments have madefinancing terms materially less attractive and, in some cases, made financingunavailable. As a result of these conditions and the delisting of our commonstock from The Nasdaq Stock Market in October 2010, we may be unable toobtain any financing, including both new and replacement financing, that wemight require to operate our business. In particular, in this environment, itmay be extremely difficult to obtain additional debt financing or to refinanceor replace our existing indebtedness.

 

There can be no assurancethat additional or replacement debt financing will be available to us oncommercially reasonable terms or at all. If we incur additional debt, ourinterest expense would increase. If we raise capital through the sale of equitysecurities, the percentage ownership of our existing stockholders would bediluted. Any new equity securities may have rights, preferences or privilegessenior to those of our common stock, including liquidation preferences,dividend rights, board representation, and blocking rights for certaintransactions and other matters. If we are unable to obtain additional orreplacement financing when we need it, our ability to fund our operations andmeet our plans for expansion would be materially adversely affected.

 

***We are currently in default under the terms of our amended and restatedloan and security agreement and there can be no assurance that we can cure thedefault.***

 

Our Amended Loan Agreementcontains restrictions and covenants and requires us to maintain specifiedfinancial ratios and tests. For example, the Amended Loan Agreement restrictsour ability, among other things, to incur additional indebtedness, to acquireother companies or the assets of other companies and to pay dividends withoutthe lender’s consent. If we fail to meet or satisfy any of the restrictions,covenants, financial ratios or financial tests, we would be in default underthe Amended Loan Agreement. The loans are secured by all of our assets. We arealso required by Hercules to maintain a minimum cash balance of $1,000. Anevent of default under the Amended Loan Agreement would give the lender theright to declare all amounts outstanding under the credit facility due andpayable and enforce its rights to foreclose on the collateral securing theloans.

 

On February 10, 2010, Herculessent us a letter notifying us of an event of default as of February 5,2010 and charging us a default interest rate of 3% in addition to theapplicable regular interest rate for the period starting February 5, 2010.  In addition, as a result of our failure topay the outstanding principal and interest on a promissory note issued to HIAon September 30, 2010, we are in default under this note, which is also anevent of default under the Amended Loan Agreement.  Events of default are continuing and defaultrate interest will be payable monthly on the same date as regular interestunless Hercules chooses to demand payment of default interest on another date.As of September 30, 2010, we were not in compliance with the borrowing baserequirement related to the revolving credit facility, the minimum cashrequirement of $1,000, and the minimum EBITDA requirement.  As a result ofthe above defaults, all balances outstanding under the Amended Loan Agreementat September 30, 2010 were classified as current in the consolidatedbalance sheet included in this Quarterly Report on Form 10-Q.  Hercules has not chosen to accelerate ourobligations under the Amended Loan Agreement, but has expressly not waived anyevents of default or any of its remedies. We do not have adequate liquidity to repay all outstanding amounts underthe credit facility and payment acceleration would have a material adverseeffect on our liquidity, business, financial condition and results ofoperations.

 

***We may engage in strategicdispositions of some or all of our assets or business that could adverselyimpact our business operations and stockholders.***

 

As part of our business strategy,we explore, from time-to-time, potential dispositions of certain or all of ourassets or business.  Such dispositionspresent numerous risks, including:

 

·                  impairment of our remaining business operations if only aportion of our assets or a segment of our business is sold;

·                  contingencies or conditions in the sale agreement regardingperformance that may reduce the sale price and/or increase potential liabilityof the Company and our stockholders;

·                  potential disputes with counterparties; and

·                  diversion of management resources from day-to-dayresponsibilities to managing the sale process.

 

In addition, if we announce astrategic disposition which subsequently fails to close, our continued businessoperations and stock price may be adversely affected.

 

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**Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds**

 

On August 13, 2010,Hercules converted $5,000 of the aggregate principal amount of our convertibleterm loan due on November 1, 2014 (“Term Loan B”) into shares of ourcommon stock at the conversion price of $1.8575 per share, for an issuanceof   2,691,790 shares of our commonstock. The common stock issued by us in this transaction was issued in aprivate transaction exempt from registration under the Securities Act of 1933,as amended, pursuant to Section 3(a)(9) and/or 4(2) thereof.This transaction did not involve the use of underwriters, and no commissionswere paid in connection therewith.

 

On September 10, 2010,we issued 7,257 common shares in a cashless exercise of a warrant for 12,000underlying shares. The common stock issued by us in this transaction was issuedin a private transaction exempt from registration under the Securities Act of1933, as amended, pursuant to Sections 3(a)9 and /or 4(2) thereof. Theshares were issued to an accredited investor. This transaction did not involvethe use of underwriters, and no commissions were paid in connection therewith.

 

**Item 3.        Defaults Upon Senior Securities**

 

On February 10, 2010, we received a notice fromHercules notifying us that as a result of our aggregate revolving loan advancesexceeding the maximum overadvance facility amount provided in Section 2.1(c) ofthe Amended Loan Agreement and our failure to repay the excess amount in accordancewith the terms of the Amended Loan Agreement, an event of default had occurredunder the Amended Loan Agreement as of February 5, 2010.  Events of default are continuing and as of September 30,2010, we were not in compliance with the borrowing base requirement related tothe revolving credit facility, the minimum cash and EBITDA requirement, TotalLeverage Ratio and Fixed Charge Coverage ratio. In addition, as of September 30, 2010, we are in default under apromissory note issued to HIA in connection with an acquisition in 2007, whichdefault is also an event of default under the Amended Loan Agreement and issubject to the terms of the Subordination Agreement by and among Hercules, HIAand us.  As of the November 12,2010, the amount of default on the HIA note, including interest is $4,580.

 

Formore information, see Part I, Item 1. Financial Statements, Notes to Condensed Consolidated FinancialStatements, Note G — Debt and Part I, Item 2.  “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — Liquidity and CapitalResources,” and Part II, Item 1A. Risk Factors — “*We are currently in default under the terms of our amended and restatedloan and security agreement and there can be no assurance that we can cure thedefault.*”

 

**Item 4.        Reserved**

 

**Item 5.        Other Information**

 

None.

 

**Item 6.        Exhibits**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|----------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.1                  |       | Amendment No. 4,  dated as of October 28, 2010, to the Amended and Restated Loan and  Security Agreement, dated as of November 20, 2009, as amended, by and  among InfoLogix, Inc., InfoLogix Systems Corporation, Embedded  Technologies, LLC, Opt Acquisition LLC and InfoLogix-DDMS, Inc., as  Borrowers and Hercules Technology Growth Capital, Inc., as Lender (filed  as Exhibit 4.1 to our Current Report on Form 8-K filed on  November 3, 2010 and incorporated herein by reference). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.1                 |       | Registration Rights  Agreement dated as of October 28, 2010 by and between  InfoLogix, Inc. and Hercules Technology Growth Capital, Inc. (filed  as Exhibit 10.1 to our Current Report on Form 8-K filed on  November 3, 2010 and incorporated herein by reference).                                                                                                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.2                 |       | Letter Agreement dated  November 3, 2010, by and between InfoLogix, Inc. and Futura  Services, Inc.*                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.1                 |       | Certification pursuant to  Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.*                                                                                                                                                                                                                                                                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.2                 |       | Certification  pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002.*                                                                                                                                                                                                                                                                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 32.1                 |       | Certification pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of                                                                                                                                                                                                                                                                                                                                                                                                                    |

 

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|   |   | 2002.+                                                                                                                               |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                 |
| 32.2   |   | Certification pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.+ |

 

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| (*) | Filed  herewith.     |
|-----|----------------------|
| (+) | Furnished  herewith. |

 

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**SIGNATURES**

 

Pursuantto the requirements of section 13 or 15(d) of the Securities Exchange Actof 1934, the Registrant has duly caused this report to be signed on its behalfby the undersigned; thereunto duly authorized, in Hatboro, Pennsylvania on November 15, 2010.

 
|     | INFOLOGIX, INC. |
|----------|----------------------|
|     |                 |   |
|     | By:                  | /s/  David T. Gulian |
|     |                 | David  T. Gulian |
| * * |                 | *President  and Chief Executive Officer* |
| * * | * *             | * * |
|     | By:                  | /s/  John A. Roberts |
|     |                 | John  A. Roberts |
| * * |                 | *Chief  Financial Officer and Principal Accounting Officer* |

 

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