-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GnADu821YBrznDJvVGb+6dQEJLYb/5JwwE/FFrZXPkJlGLu6ccxwnKCmsc+nWOLz c8knirtD+XtwbnFi7YN0vQ== 0000930413-06-005940.txt : 20060815 0000930413-06-005940.hdr.sgml : 20060815 20060815172416 ACCESSION NUMBER: 0000930413-06-005940 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060630 FILED AS OF DATE: 20060815 DATE AS OF CHANGE: 20060815 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INCENTRA SOLUTIONS, INC. CENTRAL INDEX KEY: 0001025707 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 860793960 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-32913 FILM NUMBER: 061036386 BUSINESS ADDRESS: STREET 1: 1140 PEARL STREET CITY: BOULDER STATE: CO ZIP: 80302 BUSINESS PHONE: 303-449-8279 MAIL ADDRESS: STREET 1: 1140 PEARL STREET CITY: BOULDER STATE: CO ZIP: 80302 FORMER COMPANY: FORMER CONFORMED NAME: FRONT PORCH DIGITAL INC DATE OF NAME CHANGE: 20000705 FORMER COMPANY: FORMER CONFORMED NAME: EMPIRE COMMUNICATIONS CORP DATE OF NAME CHANGE: 19980327 FORMER COMPANY: FORMER CONFORMED NAME: LITIGATION ECONOMICS INC DATE OF NAME CHANGE: 19961022 10QSB 1 c43894_10qsb.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form 10-QSB (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended June 30, 2006 [_] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______. Commission File Number 333-16031 INCENTRA SOLUTIONS, INC. ------------------------ (Exact name of small business issuer as specified in its charter) Nevada 86-0793960 ------ ---------- (State or other jurisdiction (I.R.S. Employer of (incorporation or organization) Identification No.) 1140 PEARL STREET BOULDER, COLORADO 80302 ----------------------- (Address of principal executive offices) (303) 449-8279 ------------- (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ ] No [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes [_] No [X] As of August 7, 2006, 13,285,713 shares of the issuer's common stock, $.001 par value per share, and 2,466,971 shares of the issuer's Series A preferred stock, $.001 par value per share, were outstanding. Transitional Small Business Disclosure Format (check one): Yes [_] No [X] PART I. FINANCIAL INFORMATION INCENTRA SOLUTIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED) JUNE 30, 2006 ---- ASSETS Current assets: Cash and cash equivalents $ 967,595 Accounts receivable, net of allowance for doubtful accounts of $224,496 9,038,079 Other current assets 743,582 Assets held for sale (Note 5) 19,770,920 ------------- Total current assets 30,520,176 Property and equipment, net 2,288,012 Capitalized software development costs, net 909,004 Intangible assets, net 624,000 Goodwill 14,698,106 Restricted cash 38,175 Other assets 510,492 ------------- TOTAL ASSETS $ 49,587,965 ============= LIABILITIES AND SHAREHOLDERS' DEFICIT Current liabilities: Current portion of notes payable, capital leases and other long term obligations $ 19,996,934 Accounts payable 10,269,472 Accrued expenses 3,883,704 Current portion of deferred revenue 775,024 Liabilities associated with assets held for sale (Note 5) 5,252,029 ------------- Total current liabilities 40,177,163 Notes payable, capital leases and other long term obligations, net of current portion 838,824 Deferred revenue, net of current portion 111,141 ------------- TOTAL LIABILITIES 41,127,128 ------------- Commitments and contingencies Series A convertible preferred stock, $.001 par value, $31,500,000 liquidation preference, 2,500,000 shares authorized, 2,466,971 shares issued and outstanding 25,927,117 ------------- Shareholders' deficit: Preferred stock, nonvoting, $.001 par value, 2,500,000 shares authorized, none issued or outstanding Common stock, $.001 par value, 200,000,000 shares authorized, 14,421,293 shares outstanding at June 30, 2006 14,421 Additional paid-in capital 122,738,844 Accumulated other comprehensive gain 210,164 Accumulated deficit (140,429,709) ------------- TOTAL SHAREHOLDERS' DEFICIT (17,466,280) ------------- TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 49,587,965 ============= See accompanying notes to unaudited condensed consolidated financial statements. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS (UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 2006 2005 2006 2005 ---------------------------- ---------------------------- Revenues: Products $14,739,546 $ 10,422,023 $ 20,579,015 $ 11,524,000 Services 3,362,707 3,120,682 5,882,577 5,198,340 ----------- ------------ ------------ ------------ TOTAL REVENUE 18,102,253 13,542,705 26,461,592 16,722,340 ----------- ------------ ------------ ------------ Cost of revenue: Products 12,433,923 8,923,683 17,089,836 9,694,174 Services 2,262,237 2,005,189 4,204,612 3,400,662 ----------- ------------ ------------ ------------ Total cost of revenue 14,696,160 10,928,872 21,294,448 13,094,836 ----------- ------------ ------------ ------------ GROSS MARGIN 3,406,093 2,613,833 5,167,144 3,627,504 Selling, general and administrative 5,480,587 3,709,220 9,398,833 6,087,945 Stock-based compensation expense 468,452 60,792 835,332 168,861 Depreciation and amortization 134,774 286,638 268,119 582,573 ----------- ------------ ------------ ------------ 6,083,813 4,056,650 10,502,284 6,839,379 ----------- ------------ ------------ ------------ OPERATING LOSS FROM CONTINUING OPERATIONS (2,677,720) (1,442,817) (5,335,140) (3,211,875) ----------- ------------ ------------ ------------ Other income (expense): Interest income 205 3,516 339 25,947 Interest expense (1,045,115) (610,000) (1,668,674) (1,171,310) Loss on early extinguishment of debt - - (1,232,174) - Other income (expense) 23,828 (34,843) 33,669 319,897 Foreign currency transaction gain 18,239 1,424 17,551 1,397 ----------- ------------ ------------ ------------ (1,002,843) (639,903) (2,849,289) (824,069) ----------- ------------ ------------ ------------ LOSS FROM CONTINUING OPERATIONS (3,680,563) (2,082,720) (8,184,429) (4,035,944) INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF INCOME TAXES (Note 5) (465,805) (273,406) 399,053 (668,749) ----------- ------------ ------------ ------------ NET LOSS (4,146,368) (2,356,126) (7,785,376) (4,704,693) Accretion of redeemable preferred stock to redemption amount (654,392) (654,392) (1,308,784) (1,308,784) ----------- ------------ ------------ ------------ NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $(4,800,760) $ (3,010,518) $ (9,094,160) $ (6,013,477) =========== ============ ============ ============ COMPREHENSIVE NET LOSS Net loss $(4,146,368) $ (2,356,126) $ (7,785,376) $ (4,704,693) Foreign currency translation adjustments 305,377 (76,717) 313,399 $ (153,950) ----------- ------------ ------------ ------------ $(3,840,991) $ (2,432,843) $ (7,471,977) $ (4,858,643) =========== ============ ============ ============ Weighted average number of common shares outstanding - basic and diluted 14,239,362 12,703,068 13,780,565 11,901,066 =========== ============ ============ ============ Basic and diluted net loss per share applicable to common shareholders: Loss from continuing operations $ (0.31) $ (0.22) $ (0.69) $ (0.45) Income (loss) from discontinued operations (0.03) (0.02) 0.03 (0.06) ----------- ------------ ------------ ------------ Net loss per share--basic and diluted $ (0.34) $ (0.24) $ (0.66) $ (0.51) =========== ============ ============ ============
See accompanying notes to unaudited condensed consolidated financial statements. INCENTRA SOLUTIONS AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT AND COMPREHENSIVE GAIN (LOSS) SIX MONTHS ENDED JUNE 30, 2006 (UNAUDITED)
ACCUMULATED COMMON STOCK OTHER --------------------- ADDITIONAL COMPREHENSIVE ACCUMULATED SHARES AMOUNT PAID-IN CAPITAL GAIN (LOSS) DEFICIT TOTAL ---------- -------- --------------- ------------- -------------- -------------- BALANCES, JANUARY 1, 2006 13,326,810 $ 13,327 $ 119,517,168 $ (103,235) $ (132,644,333) $ (13,217,073) Common stock issued in acquisition of Network Systems Technologies, Inc. (Note 4) 1,034,483 1,034 1,303,449 1,304,483 Amortization of employee stock-based compensation expense 884,665 884,665 Accretion of FPDI mandatorily redeemable preferred stock to redemption amount (1,308,784) (1,308,784) Warrants issued to Laurus related to 2006 financings (Notes 7(B) and 7(C)) 1,707,052 1,707,052 Common stock issued to investment advisor 60,000 60 80,340 80,400 Warrants issued related to Convertible Notes (Note 7(E)) 554,954 554,954 Components of comprehensive loss: Net loss (7,785,376) (7,785,376) Change in foreign currency translation adjustments 313,399 313,399 -------------- Total comprehensive loss (7,471,977) -------------------------------------------------------------------------------------------- BALANCES, JUNE 30, 2006 14,421,293 $ 14,421 $ 122,738,844 $ 210,164 $ (140,429,709) $ (17,466,280) =========== ======== ============= ========== =============== ==============
See accompanying notes to unaudited consolidated financial statements. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30, 2006 2005 ---- ---- Cash flows from operating activities: Net loss $ (7,785,376) $ (4,704,693) Adjustments to reconcile net loss to net cash used in continuing operating activities: (Income) loss from discontinued operations, net of income taxes (399,053) 668,749 Depreciation 728,067 736,519 Amortization of intangible assets and software development costs 320,270 661,862 Amortization of non-cash loan discount 0 12,735 Stock-based compensation 835,332 168,851 Non-cash interest expense 768,214 959,402 Non-cash loss on early extinguishment of debt 749,674 Bad debt expense 12,204 20,787 Loss on disposal of assets 45,773 Gain on revaluation of of derivative warrant liability (390,280) Changes in operating assets and liabilities, net of business acquisitions: Accounts and other receivables 1,086,160 337,574 Other current assets 140,220 90,440 Other assets (40,544) 55,496 Accounts payable (75,945) 40,903 Accrued liabilities 458,152 (396,693) Deferred revenue 54,913 (102,545) Other liabilities 182,227 (68,932) ------------ ------------ Net cash used in continuing operations (2,965,485) (1,864,052) Net cash provided by discontinued operations 977,892 745,451 ------------ ------------ Net cash used in operating activities (1,987,593) (1,118,601) ------------ ------------ Cash flows from investing activities: Purchases of property and equipment (838,930) (409,929) Capitalized software development costs (307,419) (309,504) Proceeds from sale of property and equipment 750 Cash acquired in STAR acquisition 1,597,498 Cash acquired in PWI acquisition 74,297 Cash paid in acquisition of NST (Note 4) (5,192,858) Net change in restricted cash 42,781 (366) ------------ ------------ Net cash (used in) provided by continuing operations (6,296,426) 952,746 Net cash used in discontinued operations (616,613) (526,314) ------------ ------------ Net cash (used in) provided by investing activities (6,913,039) 426,432 ------------ ------------ Cash flows from financing activities: Proceeds from line of credit, net 3,895,096 131,452 Proceeds form acquisition term notes 3,250,000 Proceeds from convertible notes 2,410,000 Proceeds from lease line of credit, net 56,180 (12,424) Payments on capital leases, notes payable and other long-term liabilities (186,333) (354,315) ------------ ------------ Net cash provided by (used in) continuing operations 9,424,943 (235,287) Net cash provided by (used in) discontinued operations ------------ ------------ Net cash provided by (used in) financing activities 9,424,943 (235,287) Effect of exchange rate changes on cash and cash equivalents (related to discontinued operations) 291,364 (82,417) Net increase (decrease) in cash and cash equivalents from continuing operations 163,032 (1,146,593) Net increase in cash and cash equivalents from discontinued operations 652,643 136,720 ------------ ------------ Net increase (decrease) in cash and cash equivalents 815,675 (1,009,873) ------------ ------------ Cash and cash equivalents at beginning of period: Continuing operations 804,563 2,469,881 Discontinued operations 304,079 598,576 ------- ------- Total 1,108,642 3,068,457 Cash and cash equivalents at end of period: Continuing operations 967,595 1,323,288 Discontinued operations 956,722 735,296 ------------ ------------ Total $ 1,924,317 $ 2,058,584 ============ ============ Supplemental disclosures of cash flow information: Cash paid during the period for interest $ 900,121 $ 185,961 Supplemental disclosures of non-cash investing and financing activities: Net liabilities acquired in Incentra of CA acquisition, excluding cash 620,178 Net assets acquired in PWI acquisition, excluding cash 269,306 Net liabilities acquired in NST acquisition, excluding cash (Note 4) 958,490 Purchases of property and equipment included in accounts payable 220,414 Conversion of notes payable and accrued interest in exchange for common stock 400,000 Reclassification of derivative liability to equity 1,910,254
See accompanying notes to unaudited condensed consolidated financial statements. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS UNAUDITED (1) ORGANIZATION Incentra Solutions, Inc. (which is referred to herein together with its subsidiaries as "we", "us" or "our"), formerly Front Porch Digital, Inc. ("FPDI"), was organized and incorporated in the state of Nevada. On October 25, 2004, we changed our name from Front Porch Digital, Inc. to Incentra Solutions, Inc., and our common stock now trades on the Over-the-Counter Bulletin Board under the trading symbol "ICNS". We have completed four acquisitions: On August 18, 2004, we acquired ManagedStorage International, Inc., a Delaware corporation incorporated in March 2000 ("MSI"); on February 18, 2005, we acquired Incentra of CA, formerly known as STAR Solutions of Delaware, Inc., a privately-held Delaware corporation ("Incentra of CA "); on March 30, 2005, we acquired PWI Technologies, Inc., a privately-held Washington corporation ("PWI"); and on April 13, 2006, we acquired Network Systems Technologies, Inc, a private-held Illinois corporation ("NST"). The MSI acquisition was accounted for as a reverse merger, and therefore, MSI was deemed to be the acquirer for accounting purposes. Accordingly, the consolidated financial statements presented herein include the results of operations of MSI for all periods presented and include the results of operations of the acquired companies from the dates of the acquisitions forward. On July 31, 2006, we completed the sale of the assets of FPDI. The sale included all of the outstanding capital stock of our wholly-owned subsidiary in France, Front Porch Digital International, SAS. FPDI provides archive solutions to broadcasters and media companies. The sales price was approximately $33 million in cash and we have the right to receive up to an additional $5 million in cash pursuant to the terms of an earn-out based on a percentage of gross revenues received by Front Porch from certain software sales through December 31, 2008. Management believes the sale of the FPDI business will allow us to focus on our core business as represented by Incentra of CA, MSI, PWI, and NST. Proceeds from the sale of FPDI were used to repay most of our long-term debt (see Note 10(B)) and management plans to use the remainder for investment in our other businesses, potential future acquisitions, and to generally strengthen our balance sheet. We provide complete solutions for an enterprise's data protection needs. We supply a broad range of storage products and storage management services to enterprises and information technology service providers worldwide. We market to service providers and enterprise clients under the trade names MSI, Incentra of CA, PWI and NST. MSI provides outsourced storage solutions, including engineering, hardware and software procurement and remote storage operations services. Incentra of CA, PWI and NST are leading systems integrators that provide Information Technology ("IT") products, professional services and outsourcing solutions to enterprise customers located primarily in the central and western United States. Our customers are located in North America, Europe, Asia and the Pacific Rim. BASIS OF PRESENTATION The unaudited condensed consolidated financial statements as of June 30, 2006 and for the three and six months ended June 30, 2006 and 2005 include Incentra Solutions, Inc. and its wholly-owned subsidiaries, MSI, which is based INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED in Colorado, and MSI's wholly-owned subsidiaries, ManagedStorage UK, Inc. and Seabrook Technologies, Inc.; Incentra of CA, which is based in San Diego, California; PWI, which is based in Kirkland, Washington; and NST, which is based in Lombard, Illinois, from the date of acquisition through June 30, 2006. As a result of the asset sale (as discussed in Note 5), the operations of FPDI are presented retroactively for 2005 as discontinued operations. Substantially all of its operating assets, including certain liabilities associated with these assets, are presented as held for sale as of June 30, 2006 and are classified as current since the proceeds were realized in cash in July 2006. ManagedStorage UK, Inc. and Seabrook Technologies, Inc. did not have any significant operating activities during the quarter ended June 30, 2006 and the six months then ended. All significant intercompany accounts and transactions have been eliminated in consolidation. The accompanying unaudited condensed consolidated financial statements have been prepared by us in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such regulations. The unaudited condensed consolidated financial statements reflect all adjustments and disclosures that are, in the opinion of management, necessary for a fair presentation. Except as described above, all such adjustments are of a normal recurring nature. For further information, refer to the consolidated financial statements and footnotes included in our Annual Report on Form 10-KSB for the year ended December 31, 2005 filed with the SEC on April 4, 2006. GOING CONCERN MATTERS AND RESOLUTION Our unaudited condensed consolidated financial statements as of June 30, 2006 and for the quarter and six months then ended have been prepared on a going concern basis, which contemplates the realization of assets and settlements of liabilities and commitments in the normal course of business. Our audited consolidated financial statements for the year ended December 31, 2005 were also prepared on a going concern basis. In our Annual Report on Form 10-KSB for the year ended December 31, 2005, the Report of our Independent Registered Public Accounting Firm includes an explanatory paragraph that describes substantial doubt about our ability to continue as a going concern as a result of nearly all of our long term debt being callable due to a dispute with the former principal stockholder of Incentra of CA. On July 28, 2006, we entered into a Letter Agreement, as amended on July 31, 2006, with the former principal stockholder of Incentra of CA, pursuant to which we settled all claims and disputes with the former principal stockholder that arose from our claimed adjustment of the purchase price paid in connection with our acquisition of Incentra of CA in February 2005. Pursuant to the Letter Agreement, as amended, we agreed to pay the former principal stockholder $2,380,000, of which $505,000 was paid upon execution of the Letter Agreement and $1,875,000 was paid on August 2, 2006. As part of the settlement, the former principal stockholder returned to us all of the 1,135,580 shares of our common stock issued to him in the acquisition and cancelled the $2.5 million promissory note issued to him in February 2005. Upon full performance of each party's obligations, the parties will seek a dismissal of the action filed by the former principal stockholder. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED In addition, repayments of indebtedness amounting to $14,589,662 owed to Laurus Master Fund, Ltd. ("Laurus") were made on July 31, 2006. Included in this payment were all amounts previously in default. Following the sale in July 2006 of our FPDI operations and finalization of a negotiated agreement with the creditor as discussed above, sufficient funds were available to fully pay off all of the callable indebtedness. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES IMPAIRMENT OF LONG-LIVED ASSETS In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", we review the carrying value of long-lived assets, including property and equipment and amortizable intangible assets, to determine whether there are any indications of impairment. Impairment of long-lived assets is assessed by a comparison of the carrying amount of an asset to expected future cash flows to be generated by the asset. If the assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. At June 30, 2006, we believe that there are no indicators that an impairment of any long-lived assets has occurred. GOODWILL Goodwill represents the excess of the purchase price over the net of the fair value of the identifiable tangible and intangible assets acquired and the fair value of liabilities assumed in acquisitions. SFAS No. 142, "Goodwill and Other Intangible Assets", (SFAS 142) requires the testing of goodwill and indefinite-lived intangible assets for impairment at least annually. We test goodwill for impairment in the fourth quarter of each year or during interim periods if factors indicating impairment concerns arise. REVENUE RECOGNITION Revenue is recognized when all of the following criteria are met: persuasive evidence of an agreement exists, delivery has occurred or services have been rendered, the sales price is fixed or determinable, and collectibility is reasonably assured. We license software under license agreements and provide professional services, including training, installation, consulting and maintenance. License fee revenues are recognized when a license agreement has been signed, the software product has been shipped, the fees are fixed and determinable, collection is reasonably assured, and no significant vendor obligations remain. We allocate revenue to each component of a contract based on objective evidence of its fair value, as established by management. Because licensing of software is generally not dependent on the professional services portion of the contract, software revenue is generally recognized upon delivery, unless a contract exists with the customer requiring customer acceptance. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED Fees for first call maintenance agreements are recognized ratably over the terms of the agreements. Maintenance is generally billed in advance, resulting in deferred revenue. We also provide software-related professional services. Services are generally provided on a time-and-materials basis and revenue is recognized as the services are provided. Revenues from storage services are recognized at the time the services are provided and are billed on a monthly basis. Fees received for up-front implementation services are deferred and recognized over the term of the arrangement. Deferred revenue is recorded for billings sent to or paid by customers for whom we have not yet performed the related services. Revenues from product sales, including the resale of third-party maintenance contracts, are recognized when shipped. Consulting revenues are recognized when the services are performed. SOFTWARE DEVELOPMENT COSTS We account for costs related to software developed for internal use and marketed for external use in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed". Our GridWorks software product is used internally for providing services to our customers and is also marketed separately as a stand-alone product. As required by SFAS No. 86, we capitalize costs in developing software products upon determination that technological feasibility has been established for the product, if that product is to be sold, leased or otherwise marketed. Costs incurred prior to the establishment of technological feasibility are charged to research and development expense. When the product or enhancement is available for general release to customers, capitalization is ceased, and previously capitalized costs are amortized based on current and future revenue for the product, but with an annual amortization amount at least equal to the straight-line amortization over an estimated useful life of three years. For the three and six-month periods ended June 30, 2006, capitalized software development costs, which related primarily to enhancements to our GridWorks software solution, totaled $146,221 and $307,419, respectively. These costs are amortized on a straight-line basis over the estimated life of the enhancements, typically three years. For the three and six-month periods ended June 30, 2006, $131,704 and $256,717, respectively, of amortization costs were charged to expense. As of June 30, 2006, the unamortized portion of software development costs was $909,004. For the three and six-month periods ended June 30, 2005, capitalized software development costs totaled $138,218 and $309,504, respectively. For the three and six-month periods ended June 30, 2005, $130,449 and $248,182, respectively, of amortization costs were charged to expense. FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS The balance sheet accounts of our international subsidiary (Front Porch Digital International, SAS) (included in assets and liabilities held for sale) were translated using the exchange rate in effect at the balance sheet date, and the results of these operations (included in gain (loss) on discontinued operations) were translated at the average exchange rates during the period. At June 30, 2006, we reported a cumulative translation gain of INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED $210,164 as a component of accumulated other comprehensive gain (loss). We were also subject to foreign exchange transaction exposure when our subsidiary transacts business in a currency other than its own functional currency. The effects of exchange rate fluctuations in remeasuring foreign currency transactions for the three-month periods ended June 30, 2006 and 2005 were gains of $18,239 and $1,424, respectively. The effects of exchange rate fluctuations in remeasuring foreign currency transactions for the six-month periods ended June 30, 2006 and 2005 were gains of $17,551 and $1,397, respectively. ACCOUNTING FOR OBLIGATIONS AND INSTRUMENTS POTENTIALLY SETTLED IN OUR COMMON STOCK We account for obligations and instruments potentially to be settled in our stock in accordance with Emerging Issues Task Force ("EITF") No. 00-19, "Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled In a Company's Own Stock" ("EITF No. 00-19"). This issue addresses the initial balance sheet classification and measurement of contracts that are indexed to, and potentially settled in, our own stock. Under EITF No. 00-19 contracts are initially classified as equity or as either assets or liabilities, depending on the situation. All contracts are initially measured at fair value and subsequently accounted for based on the then current classification. Contracts initially classified as equity do not recognize subsequent changes in fair value as long as the contracts continue to be classified as equity. For contracts classified as assets or liabilities, we report changes in fair value in earnings and disclose these changes in the financial statements as long as the contracts remain classified as assets or liabilities. If contracts classified as assets or liabilities are ultimately settled in shares, any previously reported gains or losses on those contracts continue to be included in earnings. The classification of a contract is reassessed at each balance sheet date. PER SHARE DATA On April 12, 2005, our Board of Directors (the "Board") and the holders of the required number of shares of our capital stock approved an amendment to our Articles of Incorporation to effect a one-for-ten reverse stock split effective June 9, 2005. All references to shares, options, and warrants in our financial statements for the three and six-month periods ended June 30, 2006 and in prior periods have been adjusted to reflect the post-reverse split amounts. We report our earnings (loss) per share in accordance with SFAS No. 128, "Accounting for Earnings Per Share". Basic loss per share is calculated using the net loss allocable to common shareholders divided by the weighted average common shares outstanding during the period. In accordance with accounting requirements for reverse mergers and stock splits, the historical loss per share amounts have been retroactively restated to reflect our capital structure. Due to our net losses for the periods presented, shares from the assumed conversion of outstanding warrants, options, convertible preferred stock and convertible debt have been omitted from the computations of diluted loss per share for the three and six-month periods ended June 30, 2006 and 2005 because the effect would be antidilutive. An aggregate of 14.7 million and 10.3 million shares of common stock issuable upon the conversion of outstanding convertible preferred stock, the exercise of outstanding options and warrants, and restricted stock have been omitted from the computations of basic and diluted loss per share at June 30, INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED 2006 and 2005, respectively and for the three and six-month periods then ended, because the effect would be antidilutive. STOCK-BASED COMPENSATION On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123 (revised 2004), "Share-Based Payment" (SFAS 123R). SFAS 123R supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees", and amends SFAS No. 95, "Statement of Cash Flows". Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values at the date of grant. Pro forma disclosure is no longer an alternative. On January 1, 2006 (the first day of our 2006 fiscal year), we adopted SFAS 123R using the modified prospective method as permitted under SFAS 123R. Under this transition method, compensation cost recognized in 2006 includes: (a) compensation cost for all share-based payments granted prior to but not yet vested as of December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. In accordance with the modified prospective method of adoption, our results of operations and financial position for prior periods have not been restated. We use the Black-Scholes option pricing model to calculate the grant-date fair value of an award. The fair value of options granted in 2006 and 2005 were calculated using the following estimated weighted average assumptions: 2006 2005 ---- ---- Stock options granted 1,254,611 175,000 Weighted-average exercise price $ 1.29 $ 0.21 Weighted-average grant date fair value $ 1.10 $ 1.43 Assumptions: Expected volatility 112% 111% Expected term (in years) 6 Years 3 Years Risk-free interest rate 4.79% 3.64% All of our employee options vest over three years, which is considered to be the requisite service period. We use the graded vesting attribution method to recognize expense for all options granted prior to the adoption of SFAS 123R. Upon adoption of SFAS 123R on January 1, 2006, we switched to the straight-line attribution method to recognize expense for options granted after December 31, 2005. The expense associated with the unvested portion of the pre-adoption grants will continue to be expensed using the graded vesting attribution method. The amount of stock-based compensation recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term "forfeitures" is distinct from "cancellations" or "expirations" and represents only the unvested portion of the surrendered option. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED We currently expect, based on an analysis of historical forfeitures that approximately 90% of our options will actually vest, and therefore have applied a forfeiture rate of 3.5% per year to all unvested options as of June 30, 2006. This analysis will be re-evaluated periodically and the forfeiture rate will be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will only be for those shares that vest. Expected volatilities are based on the historical volatility of the price of our common stock. The expected term of options is derived based on the sum of the vesting term plus the original option term, divided by two. The adoption of SFAS 123R on January 1, 2006 had the following impact on the first six months of 2006 results: net loss before deemed dividends and accretion on preferred stock increased by $0.8 million and net loss per weighted average common share outstanding--basic and diluted increased by $.06 per share. The following table details the effect on net loss before accretion on preferred stock and net loss per weighted average common share outstanding had stock-based compensation been recorded for the first three and six-months of 2005, respectively, based on the fair-value method under SFAS 123, "Accounting for Stock-Based Compensation". The reported and pro forma net loss before accretion on preferred stock and net loss per weighted average common share for the second quarter of 2006 and year-to-date for 2006 are the same since stock-based compensation expense was calculated under the provisions of SFAS 123R. All amounts except per share amounts in 000's:
Three Months Six Months Ended June 30, Ended June 30, 2005 2005 ---- ---- Loss from continuing operations before accretion on preferred stock, as reported $ (2,083) $ (4,036) Add stock-based compensation expense included in reported net loss 61 169 Deduct total stock-based employee compensation expense determined under the fair-value based method for all awards (634) (1,091) --------- --------- Pro forma loss from continuing operations before accretion on preferred stock (2,656) (4,958) Loss from discontinued operations, net of income taxes (273) (669) --------- --------- Pro forma net loss, before accretion on preferred stock $ (2,929) $ (5,627) ========= ========= Net loss per weighted average common share outstanding-- Basic and diluted--pro forma $ (0.28) $ (0.58) ========= ========= Net loss per weighted average common share outstanding- Basic and diluted-as reported $ (0.24) $ (0.51) ========= =========
Summaries of option activity under the plans as of June 30, 2006, changes during the six months then ended, and status of non-vested options are presented below: INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED
Weighted Weighted Average Average Number of Exercise Contractual Options Price Life ------- ----- ---- Balance January 1, 2006 2,217,016 $ 2.92 8.50 Granted 1,254,611 1.29 10.00 Exercised - - - Forfeited (106,862) 5.09 8.70 ---------- ------- ------- Balance at June 30, 2006 3,364,765 $ 2.25 9.05 ========== ======= ======= Vested balance at June 30, 2006 901,095 $ 3.27 7.59 ========== ======= ======= Weighted Average Grant Date Fair Value ---------- Non-vested options January 1, 2006 1,379,524 $ 2.42 $ 0.52 Granted 1,254,611 1.29 1.10 Vested (79,303) 1.96 1.38 Forfeited (91,162) 2.23 1.16 ---------- ------- ------- Non-vested options at June 30, 2006 2,463,670 $ 1.87 $ 0.94 ========== ======= =======
As of June 30, 2006, there was $3.0 million of total unrecognized compensation expense related to the non-vested, share-based compensation arrangements granted under the plans. That cost is expected to be recognized over a weighted-average period of 1.92 years. The total fair value of shares vested during the six-month period ended June 30, 2006 was approximately $86,000. The intrinsic value of vested options is not material at June 30, 2006. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. We have recorded transactions that include the issuance of options and warrants to purchase shares of our preferred and common stock. The accounting for such securities is based upon fair values of our equity securities and other valuation criteria that were determined by our Board and us. We believe these estimates of fair value are reasonable. Other significant estimates made by us include those related to fair values of acquired intangible assets, and the establishment of an allowance for estimates of uncollectible accounts receivable. (3) CONCENTRATIONS OF CREDIT RISK We sell our products and services throughout the United States, Europe, Asia and the Pacific Rim. We perform periodic credit evaluations of our customers' financial condition and generally do not require collateral. Accounts receivable are reported at their outstanding unpaid principal balances reduced INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED by an allowance for doubtful accounts. We estimate doubtful accounts based on historical bad debts, factors related to a specific customer's ability to pay and current economic trends. We write off accounts receivable against the allowance when a balance is determined to be uncollectible. Credit losses have been within management's expectations. For the six-month period ended June 30, 2006, no one customer accounted for greater than 10% of total revenues from continuing operations nor did any single customer account for over 10% of accounts receivable at June 30, 2006. For the six-month period ended June 30, 2005, no one customer accounted for greater than 10% of revenue from continuing operations. (4) ACQUISITION OF NST On April 13, 2006 (the "NST Closing Date"), we acquired all of the outstanding capital stock of NST, pursuant to a Stock Purchase Agreement, dated as of the NST Closing Date (the "NST Stock Purchase Agreement"). The consideration paid for NST was approximately $8.2 million, which consisted of $5.5 million in cash, the issuance of 1,034,483 shares of our common stock valued at $1,304,483 (based on an average of the closing prices of our common stock during the seven-day periods before and after the acquisition date) and the issuance of a two-year unsecured promissory note in the amount of $1.5 million (the "NST Note"). In addition, the NST Stock Purchase Agreement contains an earn-out provision pursuant to which Transitional Management Consultants, Inc. ("TMC"), a newly-formed corporation owned by the former NST shareholder, may receive additional unregistered shares of our common stock based upon certain levels of EBITDA (as defined in the NST Stock Purchase Agreement) achieved by NST during the twenty-four month period ending March 31, 2008. The maximum number of shares issuable under the earn-out is 1,120,690 shares (subject to customary adjustments for stock splits, stock dividends and similar transactions) if NST's EBITDA is $4 million or greater during such period and provided certain other conditions are met. In addition, TMC's right to receive the earn-out described above is subject to the continued performance of consulting services by the former shareholder through TMC to us through March 31, 2008, with certain exceptions as defined in the NST Stock Purchase Agreement. If the services terminate prior to such date, TMC may under certain circumstances receive a pro-rated portion of the earn-out amount. The cash required for the acquisition was provided by additional borrowings on our existing line of credit and two newly-issued term notes from Laurus Master Fund, Ltd. (Note 7(C)). The NST Note accrues interest at an annual rate of one-half percent (1/2%). The NST Note has been discounted by $109,300 to reflect a fair value rate of interest of 8.75%. We are required to make eight equal payments of principal and interest in the amount of $190,190, the first payment of which was paid on July 15, 2006, and the seven remaining payments being due on the first day of September, December, March and June during the period beginning on September 1, 2006 and ending on March 1, 2008. The NST Note further provides that all unpaid principal and accrued interest shall become immediately due and payable upon the occurrence of an event of default (as defined in the NST Note). Such events of default include, among others, the occurrence either of the following events: (i) our failure to make payment when due, subject to a five (5) day notice and cure period or (ii) our failure to observe, keep or comply with any provision or requirement contained in the NST Stock Purchase Agreement. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED Concurrently with the consummation of the acquisition, we granted certain registration rights to the former owner and TMC with respect to the shares of our common stock issued in the acquisition and the shares issuable under the earn-out provision contained in the NST Stock Purchase Agreement. Pursuant to the registration rights agreements, at any time after April 13, 2008, the holders have a demand registration right to require us to register under the Securities Act such shares of our common stock issued in the acquisition. The agreements also provide that, after April 13, 2008, the holders shall have 'piggy-back' registration rights with respect to such shares. We also entered into a lock-up agreement with the former shareholder. Under such agreement, the former shareholder agreed not to sell or transfer the shares he received pursuant to the NST Stock Purchase Agreement until after April 13, 2008, with certain exceptions, as defined in the NST Stock Purchase Agreement. In connection with the consummation of the acquisition, we entered into a consulting and subcontractor agreement (the "Consulting Agreement") with TMC under which TMC will provide consulting services to us relating to the business of NST and will receive a monthly fee of $24,251. The agreement has a two-year term and provides that TMC may terminate the agreement for any reason upon thirty (30) days prior written notice and that we may terminate the agreement, for cause (as defined in the Consulting Agreement), at any time upon written notice to TMC. In addition, TMC has the right to earn an annual cash bonus based upon certain levels of EBITDA (as defined in the Consulting Agreement) achieved by NST during the twelve (12) months ended March 31, 2007 and 2008. The maximum annual bonus amount is equal to $150,000 plus twenty-five percent (25%) of the amount by which EBITDA exceeds $2 million during the relevant annual period. TMC's right to receive the earn-out described above is subject to the continued performance of consulting services by TMC to us through end of each such period, with certain exceptions. In connection with our acquisition of NST, we paid investment banking fees to a third party of $475,000. Legal fees and other costs of approximately $100,000 were also paid in connection with the acquisition. The following represents the preliminary purchase price allocation at the date of the NST acquisition: Cash and cash equivalents $ 885,555 Other current assets 3,339,493 Property and equipment 136,036 Goodwill 8,840,336 Current liabilities (4,434,019) ----------- Total purchase price $ 8,767,401 =========== The purchase price is not considered final as of the date of this report as we, along with our independent valuation advisors, are still reviewing all of the underlying assumptions and calculations used in the allocation. However, we believe the final purchase price allocation will not be materially different than presented herein. The following unaudited pro forma financial information presents our combined results of operations as if the acquisition of NST had occurred as of the beginning of each of the periods presented below. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated results of operations that would have been reported by us had the acquisition been completed as of the beginning of the periods presented, and should not be taken as representative of our future consolidated results of INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED operations or financial condition. Unaudited pro forma results were as follows for the three and six-month periods ended June 30, 2006 and 2005:
Three Months Ended June 30 Six Months Ended June 30 2006 2005 2006 2005 ---- ---- ---- ---- Revenues $ 18,102,253 $ 21,441,705 $ 32,316,592 $ 30,597,340 Loss from continuing operations (1) (3,680,563) (1,811,043) (8,288,236) (3,509,286) Income (loss) from discontinued operations (1) (465,805) (273,406) 399,054 (668,749) Net loss applicable to common shareholders (4,800,760) (2,738,841) (9,197,965) (5,486,819) Net earnings (loss) per share - basic and diluted, pro forma: From continuing operations $ (0.31) $ (0.27) $ (0.67) $ (0.38) From discontinued operations (0.03) (0.02) 0.03 (0.06) ------------ ------------ ------------ ------------ Total net loss per share-basic and diluted, pro forma $ (0.34) $ (0.29) $ (0.64) $ (0.44) ============ ============ ============ ============
(1) In July 2006, we sold substantially all of the assets of FPDI, including certain liabilities associated with those assets as described in Note 5. (5) ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS As of June 30, 2006, we were in active negotiations related to the sale of FPDI and we met the criteria defined in SFAS No. 144 requiring the classification of FPDI as held for sale. Accordingly, the assets and liabilities of FPDI are segregated from our continuing business and classified as held for sale as of June 30, 2006. Similarly, FPDI's operations are classified as discontinued in the related statements of operations and cash flows. On July 31, 2006, we completed the sale of substantially all of the assets of FPDI, including our wholly-owned subsidiary, Front Porch International, SAS. See note 10(A) to these unaudited condensed consolidated financial statements. The operating results from discontinued operations were as follows for the periods presented below: INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED
Three Months Ended June 30 Six Months Ended June 30 2006 2005 2006 2005 ---- ---- ---- ---- Revenues $ 3,886,017 $ 4,056,527 $ 8,435,848 $ 6,884,056 Cost of revenues 1,705,400 1,576,553 2,900,167 2,474,572 --------- --------- --------- --------- Gross profit 2,180,617 2,479,974 5,535,681 4,409,484 Operating expenses 2,421,249 2,230,760 4,743,586 4,331,831 --------- --------- --------- --------- Operating income (loss) (240,632) 249,214 792,095 77,653 Other income (expense) 9,242 36,380 (64,287) 130,598 ----- ------ ------- ------- Income (loss) before income taxes (231,390) 285,594 727,808 208,251 Income tax expense (234,415) (559,000) (328,755) (877,000) -------- -------- -------- -------- Income (loss) $ (465,805) $ (273,406) $ 399,053 $ (668,749) =========== =========== =========== =========== The components of assets held for sale and liabilities associated with assets held for sale are as follows: June 30, 2006 ---- Cash and cash equivalents $ 956,722 Accounts receivable, net of allowance for doubtful accounts doubtful accounts of $10,967 3,135,723 Unbilled revenue 1,899,377 Other current assets 412,903 Property and equipment, net 378,212 Capitalized software development costs, net 1,495,149 Intangible assets, net 11,464,564 Other noncurrent assets 28,270 -------------- Assets held for sale $ 19,770,920 ============== Accounts payable 1,463,310 Accrued expenses 2,161,582 Deferred revenue 1,627,137 -------------- Liabilities associated with assets held for sale $ 5,252,029 ==============
(6) PROPERTY AND EQUIPMENT Property and equipment consisted of the following as of June 30, 2006: Computer equipment $ 5,282,850 Software 1,797,531 Leasehold improvements 116,540 Office furniture and equipment 129,591 ------------ 7,326,512 Less accumulated depreciation (5,038,500) ------------ $ 2,288,012 ============ Depreciation expense from continuing operations for the three and six-month periods ended June 30, 2006 was $345,825 and $728,067, respectively and for the three and six-month periods ended June 30, 2005 was $367,681 and $736,519, respectively. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED Included in property and equipment was equipment under capital leases with a cost of $2,020,283 and accumulated depreciation of $707,489 at June 30, 2006. (7) NOTES PAYABLE, CAPITAL LEASES, AND OTHER LONG-TERM OBLIGATIONS The following is a summary of our long-term debt as of June 30, 2006: Senior secured convertible note (A) $ 2,480,939 Line of credit (B) 8,811,735 Acquisition term notes (C) 2,818,642 STAR note (D) 2,106,281 Convertible notes (E) 1,947,538 NST note (F) 1,404,365 Capital leases (G) 830,235 Other obligations 436,023 ----------- 20,835,758 Less current portion (19,996,934) ---------- Long term portion $ 838,824 =========== (A) SENIOR SECURED CONVERTIBLE NOTE On May 13, 2004, we consummated a private placement pursuant to which we issued a secured convertible term note due May 13, 2007 (the "Maturity Date") in the principal amount of $5,000,000 (the "Laurus Note"), and we issued a common stock purchase warrant entitling the holder to purchase through May 13, 2011 up to 443,500 shares of common stock (the "Laurus Warrant") at $4.80 per share, subject to standard antidilution adjustments. The principal and unpaid interest on the Laurus Note were convertible into shares of our common stock at a price of $3.00 per share. All outstanding principal and accrued interest were paid in full on July 31, 2006 as described in Note 10(B) to these unaudited condensed consolidated financial statements. In connection with the issuance of the Laurus Note, we recorded the fair value of the Laurus Warrant as a debt discount in the amount of approximately $1.8 million based upon the Black-Scholes option-pricing model, resulting in an imputed interest rate of 37%. This discount is being amortized to earnings as additional interest expense over the term of the Laurus Note. (B) LINE OF CREDIT In June 2005, we entered into a Security Agreement with Laurus pursuant to which Laurus provided us a $9 million revolving, convertible credit facility (the "2005 Facility"). The term of the 2005 Facility was three years. In connection with the 2005 Facility, we executed in favor of Laurus a $9 million Secured Revolving Note (the "Revolver Note"). In connection with the financing, we issued to Laurus a warrant that entitles Laurus to purchase, at any time through June 30, 2012, up to 400,000 INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED shares of our common stock at a price of $2.63 per share, subject to adjustment for standard antidilution provisions (the "2005 Warrant"). The value of the warrant was determined, using the Black-Scholes model, to be approximately $600,000 and was recorded as a debt discount. All borrowings under the 2005 facility were repaid in full on February 6, 2006 on which we incurred a loss on early extinguishment of debt of approximately $1.2 million. The loss included the write-off of the balance of the debt discount and the deferred financing costs. In addition, $375,000 was paid to Laurus as an early termination fee for the 2005 Facility and $107,500 (recorded as expense) was applied towards costs of the 2006 Facility. On February 6, 2006, we entered into a New Security Agreement with Laurus pursuant to which Laurus agreed to provide us with a non-convertible revolving credit facility of up to $10 million (the "2006 Facility"). The term of the 2006 Facility was three years and borrowings under the 2006 Facility accrue interest on the unpaid principal and interest at a rate per annum equal to the prime rate plus 1%, subject to a floor of 7%. All outstanding principal amounts were due and payable on February 6, 2009. On July 31, 2006, all outstanding principal and accrued interest under the 2006 Facility were repaid, as more fully described in Note 10(B) to these unaudited condensed consolidated financial statements. In connection with the 2006 Facility, we issued to Laurus an option to purchase 1,071,428 shares of common stock at a price of $.001 per share. The option expires on February 26, 2026. Pursuant to the 2006 Facility, Laurus may not sell any shares of our common stock it receives through the exercise of the option (the "Option Shares") prior to January 31, 2007 and subject to certain volume limitations. Based upon the Black-Scholes model, we determined the value of the option to be approximately $1.2 million and recorded a debt discount of the same amount which is being amortized over the term of the 2006 Facility. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED (C) ACQUISITION TERM NOTES On March 31, 2006, we consummated a private placement with Laurus pursuant to which we issued to Laurus a secured term note due May 31, 2009 in the principal amount of $1,750,000 (the "2006 Term Note") and a secured convertible term note due May 31, 2009 in the principal amount of $1,500,000 (the "2006 Convertible Note"). In connection with the issuance of the 2006 Term Note and the 2006 Convertible Note, we issued to Laurus a common stock purchase warrant (the "2006 Warrant") to purchase 417,857 shares of common stock at $0.001 per share, subject to certain standard antidilution adjustments, at any time after March 31, 2007 and on or prior to March 31, 2026. Based upon the Black-Scholes model, we determined the value of the 2006 Warrant to be approximately $476,000 and recorded a debt discount of the same amount to be amortized over the term of the notes beginning in April 2006. The 2006 Term Note, 2006 Convertible Note and the 2006 Warrant were sold to Laurus for a purchase price of $3,250,000 and were funded on April 13, 2006 in connection with the acquisition of NST. All outstanding principal and interest on the 2006 Term Note was repaid on July 31, 2006 as more fully described in Note 10(B) to these unaudited condensed consolidated financial statements. The 2006 Convertible Note provides for monthly payments of interest at a rate per annum equal to the prime rate plus 2%, subject to a floor of 9%. The 2006 Convertible Note also provides for monthly amortization of principal, commencing on August 1, 2006, at the rate of $46,875 per month. The principal and unpaid interest on the 2006 Convertible Note are convertible into shares of our common stock at a fixed conversion price of $1.40 per share, subject to certain standard antidilution adjustments. The conversion price exceeded the market price of our common stock on the date the 2006 Convertible Note was issued. All of our indebtedness to Laurus is accompanied by substantially similar agreements governing registration rights, standard events of default provisions, typical remedies available to Laurus in the event of default, restrictions on the payment of dividends and other provisions standard in these types of arrangements. (D) STAR NOTE As part of the acquisition of Incentra of CA in February 2005, we issued an unsecured convertible promissory note for $2,500,000 to the selling stockholder of Incentra of CA (the "STAR Note") that was payable in ten installments and was to mature on August 1, 2007. The STAR Note provided that all unpaid principal and accrued interest shall, at the option of the holder and without notice, become immediately due and payable upon the occurrence of an event of default. On August 1, 2005, we elected not to make a scheduled payment due under the STAR Note after we identified significant required post-closing adjustments to the purchase price for the assets of STAR and, consequently, the principal amount of the STAR Note. Our failure to make the scheduled payment and any subsequent payments constituted an event of default. Accordingly, as of June 30, 2006, we classified the entire principal amount to current liabilities based on the default. We accrued interest at the 12% default rate since August 11, 2005. The event of default on the STAR Note created an event of default of certain provisions of the Laurus Note, and as a result, all amounts due under the Laurus Note, the 2006 Term Note, and the 2006 Convertible Note have also been classified with current liabilities at June 30, 2006. On July 28, 2006, and as amended on July 31, 2006, we entered into a settlement agreement with the holder of the STAR Note, which, among other provisions, included our payment of INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED $2,380,000 to the noteholder as payment in full of all amounts due under the STAR Note. (E) CONVERTIBLE NOTES On May 19, 2006 and May 26, 2006, we entered into a Note Purchase Agreement (the "Purchase Agreement") with twelve "accredited investors" (the "Purchasers"), pursuant to which we issued and sold unsecured convertible term notes (the "Convertible Notes") in the aggregate principal amount of $1,060,000 in connection with the offering by our company of up to $4,000,000 aggregate principal amount of such Convertible Notes. The Convertible Notes are convertible, at the option of the Purchasers, into shares of our common stock at a conversion price of $1.40 per share (as adjusted for stock splits, stock dividends and the like, the "Conversion Price"). The Conversion Price exceeded the market price of our common stock on the date the Convertible Notes were issued. We also issued to the Purchasers five-year warrants (the "Warrants") to purchase an aggregate of 251,048 shares of our Common Stock, at an exercise price $1.40 per share (as adjusted for stock splits, stock dividends and the like, the "Exercise Price"). Of the $1,060,000 aggregate principal amount purchased by investors in this offering, $775,000 aggregate principal amount was purchased by certain officers and directors of our company. The remaining $285,000 aggregate principal amount of the Convertible Notes was purchased by certain employees or consultants of our company. On June 26, 2006 and June 30, 2006, we consummated second and third closings (collectively, the "Additional Closings") under which we issued and sold to the Purchasers Convertible Notes in the aggregate principal amount of $1,350,000 and Warrants to purchase 320,421 shares of our common stock also at an exercise price of $1.40 per share. The Conversion Price exceeded the market price of our common stock on the date the Convertible Notes were issued. The sale of the Convertible Notes were made to three institutional investors pursuant to a Note Purchase Agreement (the "Second Purchase Agreement") dated as of June 6, 2006. As a result of the Additional Closings, aggregate proceeds received from the offering to date total $2,410,000. Based upon the Black-Sholes model, we determined the value of all Warrants issued in connection with the Purchase Agreement and the Second Purchase Agreement to be $555,000, to be amortized over the term of the Convertible Notes beginning in May 2006. Both purchase agreements contain standard events of default provisions. Absent earlier redemption by our company, or conversion by the Purchaser, the Convertible Notes issued in May 2006 mature on May 19, 2007 and the Convertible Notes issued in June 2006 mature on June 6, 2007. Interest accrues on the unpaid principal and interest on the Convertible Notes at a rate of 12% per annum (subject to certain adjustments). Any outstanding principal amount together with any accrued and unpaid interest, along with any amounts due to Purchasers under the Convertible Notes, is due and payable on the respective maturity dates. Subject to a prepayment penalty payable to the Purchaser (ranging from 11% to zero depending on the month during the term in which such prepayment is made), we may prepay the Convertible Notes issued in May 2006 at any time by paying to the Purchaser all sums due and payable under the Convertible Notes, the Purchase Agreement and any Related Agreement. Convertible Notes issued pursuant to the Additional Closings may be prepaid without penalty at any time prior to the maturity date. INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED Each Purchaser may convert any portion or all of the issued and outstanding principal amount and/or accrued interest and fees due and payable under such Convertible Note into fully paid and nonassessable shares of our Common Stock at the Conversion Price. Subject to the payment of the prepayment penalty referenced above (if applicable), we also have the right to convert any amounts due to a Purchaser under the Convertible Notes, Purchase Agreement or any Related Agreement into fully paid and nonassessable shares of our common stock at the Conversion Price. The Convertible Notes issued in the Additional Closings contain a provision that gives us the right to convert all or any portion of the then unpaid and accrued interest on such Convertible Notes into shares of our common stock at the then-effective conversion price of such Convertible Notes, if the average closing price of our common stock on the applicable market for the five (5) consecutive trading days immediately preceding the date of conversion is greater than or equal to one hundred twenty-five percent (125%) of the conversion price; provided there is an effective registration statement covering the resale of the shares issuable upon conversion of such Convertible Notes. Pursuant to the terms of a Registration Rights Agreement between the Purchasers and our company (the "Registration Rights Agreement") for the Convertible Notes issued in May 2006, upon the request of fifty-one percent of the Purchasers, and as soon as practicable, we are obligated to file a "resale" registration to register the resale of shares of our Common Stock (the "Registrable Securities") issuable (i) upon conversion of the Convertible Notes or (ii) upon exercise of the Warrant (with certain exceptions). If, at any time after May 19, 2007, we decide to register any of our equity securities or other securities convertible into equity securities, we must notify each Purchaser and include any Registrable Securities as such Purchaser may request, in such registration statement. Registration rights for the Convertible Notes issued in the Additional Closings (the "Second Registration Rights Agreement") require us to register by September 26, 2006 for resale under the Securities Act the shares of our common stock issuable to them upon conversion of the Convertible Notes or upon exercise of the Warrants. The Convertible Notes and Warrants executed in connection with the Additional Closings include a weighted-average anti-dilution provision and a limitation on the number shares for which the Convertible Note and Warrant may be converted or exercised. Pursuant to such limitation, a holder may not convert its Convertible Note nor exercise its Warrant if, as a result of such conversion or exercise, the number of shares of our common stock such holder would beneficially own exceeds the difference between (i) 9.99% of the then-issued and outstanding shares of our common stock and (ii) the number of shares of our common stock beneficially owned by such holder and/or such holder's affiliates (as defined under Rule 144 of the Securities Act of 1933, as amended (the "SECURITIES ACT")), except upon (i) sixty-one (61) days' prior notice from such holder to us or (ii) upon the occurrence and continuance of an event of default under the Purchase Agreement. Unlike the Convertible Notes issued in May 2006, the Convertible Notes issued in the Additional Closings do not permit us to redeem the Convertible Notes in cash upon five (5) days notice. (F) NST Note Pursuant to the NST Stock Purchase Agreement discussed in Note 4, we issued an unsecured convertible promissory note for $1,500,000 to the selling stockholder of NST (the "NST Note") which is payable in eight installments and matures on March 1, 2008. The NST Note provides that all unpaid principal and accrued interest shall, at the option of the holder and without notice, become INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED immediately due and payable upon the occurrence of an event of default (as defined in the NST Note). Such events of default include, among others, (i) our failure to make a payment when due, subject to a five (5) days notice and cure period or (ii) our failure to observe, keep or comply with any provision or requirement in contained in the NST Stock Purchase Agreement. (G) CAPITAL LEASES In November 20, 2003, we entered into a capital lease line of credit agreement (the "Lease Line") for $1,500,000 with a third-party lender. Subsequent to November 2003, we entered into two amendments to the Lease Line which has enabled us to draw an additional $1.5 million in total on the line for purchases through August 31, 2006. The amendments also grant to us a call option to purchase equipment from the lessor. The terms of the agreement are for lease terms of 12-15 months with interest rates ranging from 14.964% to 15%. The unpaid balance on the Lease Line at June 30, 2006 was $830,235. (8) SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK We have designated 2.5 million authorized shares of preferred stock as Series A Preferred shares and issued 2,466,971 of such shares in connection with an acquisition in 2004. Warrants are outstanding for the purchase of 26,075 Series A Preferred shares at a purchase price of $10.35 per share and 6,954 Series A Preferred shares at a purchase price of $6.02 per share. The Series A Preferred shares are convertible at any time upon written notice to us into shares of common stock on a two-for-one basis. So long as at least 500,000 originally issued shares of Series A Preferred are outstanding, the holders of Series A Preferred shares have the right to appoint three directors to our Board of Directors. As a result, our Board of Directors has been expanded to seven members to accommodate these three directors. On or after August 16, 2008, the holders of at least 80% of the Series A Preferred shares may elect to have us redeem the Series A Preferred for a price equal to the greater of (i) the original issue price of $12.60 per share ($31.5 million in the aggregate) plus accrued dividends, to the extent dividends are declared by us, or (ii) the fair market value of the number of shares of common stock into which such shares of Series A Preferred are convertible. Other material terms of the Series A Preferred shares include a preference upon liquidation or dissolution of our company, weighted-average anti-dilution protection and pre-emptive rights with respect to subsequent issuances of securities by us (subject to certain exceptions). (9) 2006 STOCK OPTION PLAN On May 4, 2006, our board of directors approved and adopted the Incentra Solutions, Inc. 2006 Stock Option Plan (the "Plan"), which provides for the granting of options to key employees, officers and certain individuals to purchase shares of our common stock. We currently have reserved 1,750,000 shares of common stock for issuance under the Plan. The Plan has a term of ten years and provides for the grant of "incentive stock options" within the meaning INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) UNAUDITED of Section 422 of the Internal Revenue Code of 1986, as amended and nonstatutory stock options. Options granted under the plan may not have a term of more than a ten-year period (five years in the case of incentive stock options granted to employees who hold more than ten percent (10%) of the voting power of the Company's common stock). Subject to the terms of any award agreement, options generally terminate three months after the termination of employment, except in the case of termination for cause or upon death or disability. On July 7, 2006, we filed a registration statement on Form S-8 to register under the Securities Act of 1933, the resale of the shares of our common stock issuable upon exercise of the options granted pursuant to the Plan. (10) SUBSEQUENT EVENTS (A) SALE OF FRONT PORCH DIGITAL, INC. On July 31, 2006, we sold substantially all of the assets of our wholly-owned subsidiary, Front Porch Digital, Inc., a Delaware corporation ("Front Porch"), to FPD Acquisition Corporation, a newly-formed Delaware corporation ("FPD"), and 1706045 Ontario Limited, an Ontario corporation ("Ontario" and collectively with FPD, the "Buyers"), each owned by Genuity Capital Management Services, Inc., pursuant to the terms of the Purchase Agreement (the "Purchase Agreement"), dated as of July 31, 2006, among our company, MSI and the Buyers. The material assets owned and operated by Front Porch, all of which were transferred to the Buyers in the sale, included, without limitation, all of the outstanding capital stock of Front Porch International SAS, its wholly-owned French subsidiary, its DIVArchive and Bitscream software and all intellectual property rights associated with that software and all tangible personal property, contracts, account receivables relating to Front Porch's business. The purchase price was $33,000,000 plus an amount by which the net working capital amount (defined as current assets minus current liabilities) of Front Porch on the closing date exceeded a targeted amount of $660,000, or less an amount by which $660,000 exceeded such net working capital amount. Of such purchase price, $30,500,000 was received in cash at the closing and $2,500,000 was placed in escrow to secure payment of indemnification claims the Buyers may have against us following the closing. Following the closing, the parties will reconcile the net working capital amount of Front Porch as of the closing date. In addition to the purchase price payable at the closing, we may receive up to $5,000,000 pursuant to an earn-out provision. Under the terms of the earn-out, we are entitled to receive an amount equal to five percent (5%) of Front Porch's gross software sales, net of customer discounts, for each of the years ending December 31, 2006, 2007 and 2008, not to exceed $5,000,000 in the aggregate. An estimated gain of approximately $17.6 million was realized on the sale after expenses and fees of approximately $2.4 million and subject to finalization of post-closing adjustments. (B) REPAYMENT OF LONG-TERM DEBT TO LAURUS On July 31, 2006, we used $14.6 million of the proceeds from the sale of the assets of Front Porch to repay in full all outstanding principal amounts, accrued interest and any applicable prepayment penalties related to the Laurus Note, the 2006 Facility and the 2006 Term Note. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION RECENT DEVELOPMENTS In July 2006, we sold substantially all of the assets of our Front Porch division ("Front Porch"), through which we previously provided complete digital archive solutions to broadcasters and media companies. The sale price was approximately $33 million and we have the right to receive up to an additional $5 million pursuant to the terms of an earn-out based on a percentage of gross revenues received by Front Porch from certain software sales through December 31, 2008. A portion of the proceeds of the sale were used to repay approximately $14.5 million of our outstanding secured debt to Laurus Master Fund, Ltd ("Laurus"). Management believes the sale of the Front Porch business will allow us to focus on our core business as represented by Incentra of CA, MSI, PWI, and NST. Proceeds from the sale of FPDI were used to repay most of our long-term debt, and management plans to use the remainder for investment in our other businesses, potential future acquisitions, and to generally strengthen our balance sheet. GENERAL When used in this discussion, the word "believes", "anticipates", "expects" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Our business and results of operations are affected by a wide variety of factors that could materially and adversely affect us and our actual results, including, but not limited to: (1) the availability of additional funds to enable us to successfully pursue our business plan; (2) the uncertainties related to the effectiveness of our technologies and the development of the our products and services; (3) our ability to maintain, attract and integrate management personnel; (4) our ability to complete the development and continued enhancement of our products in a timely manner; (5) our ability to effectively market and sell our products and services to current and new customers; (6) our ability to negotiate and maintain suitable strategic partnerships, vendor relationships and corporate relationships; (7) the intensity of competition; and (8) general economic conditions. As a result of these and other factors, we may experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect our business, financial condition, operating results and stock price. Any forward-looking statements herein speak only as of the date hereof. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Incentra Solutions, Inc. is a leading provider of complete solutions for the data protection needs of an enterprise. We supply a broad range of storage products and storage management services to enterprises and information technology service providers worldwide. We market our products and services to service providers and enterprise clients under the trade names Incentra Solutions of Colorado ("Colorado"), ManagedStorage International ("MSI"), Incentra Solutions of California ("Incentra of CA"), PWI Technologies ("PWI") and Network Technology Systems ("NST"). We formerly sold unique software and professional solutions for digital archive to management and media companies under the name Front Porch Digital ("Front Porch"). As noted above, Front Porch's assets were sold in July 2006. Through MSI, we deliver comprehensive storage services, including remote monitoring/management services, maintenance support services (first call) for third-party hardware and software maintenance, professional services, third-party hardware/software procurement and resale and financing solutions. MSI provides data protection solutions and services that ensure that its customers' data is backed-up and recoverable and meets internal data retention compliance policies. MSI's remote monitoring and management services are delivered from its Storage Network Operations Center ("NOC") in Broomfield, Colorado, which monitors and manages a wide spectrum of diverse storage infrastructures on a 24x7 basis throughout the United States, the United Kingdom, the Netherlands, Bermuda and Japan. MSI delivers these services worldwide using its proprietary GridWorks Operations Support System, which enables automated remote monitoring and management of complete storage infrastructures and back-up applications. MSI provides outsourcing solutions for customer data protection needs under long-term contracts. Customers pay on a monthly basis for storage services based on the number of assets managed and/or the volume of storage assets utilized. We believe customers benefit from improved operating effectiveness with reduced operating costs and reductions in capital expenditures. Through Incentra of CA and PWI, we deliver complete IT solutions, including professional services, third-party hardware/software procurement and resale, financing solutions, maintenance support services (first call) for third-party hardware and software maintenance and managed storage solutions. Solutions are sold primarily to enterprise customers in the financial services, government, hospitality, retail, security, healthcare and manufacturing sectors. Incentra of CA and PWI primarily service customers in the western United States. Through NST (which we acquired in April 2006), we provide storage, networking and security solutions, as well as professional services, to over 300 existing customers in the financial services, healthcare, education, non-profit and manufacturing verticals in the Chicago, Illinois area and central state region of the U.S. NST's customer base will provide an immediate market for our other products, such as First Call and Enhanced First Call support services and our GridWorks remote monitoring and management system in an area of the U.S. market not previously available to us with our direct sales force. The following discussion and analysis of financial condition and results of operations is based upon our historical consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For the three and six month-periods ended June 30, 2006, revenues from continuing operations totaled $18.1 million and $26.5 million, respectively, as compared to $13.5 million and $16.7 million, respectively, for the comparable periods in the prior year. The rate of increase for revenues from continuing operations for the three-month period ended June 30, 2006 was approximately 34% and 58% for the six-month period when compared to the same period for 2005. The increase in revenue from continuing operations from the prior year quarter was a result of the acquisition of NST in April 2006. The increase in revenues from continuing operations for the six-month period in 2006 was the result of the acquisitions of NST in April 2006, the inclusion of the results of Incentra of CA and PWI for the full six-month period as compared to from the dates of acquisition for the prior year, and increased sales of hardware as part of complete archive solutions. We continue to invest in hardware and the development of our software and in the data storage and infrastructure areas. During the three and six-month periods ended June 30, 2006, we invested $0.1 million and $0.3 million, respectively, in software development and $0.3 million and $0.8 million, respectively, for data storage infrastructure. During the three months ended June 30, 2006, our operating loss from continuing operations increased by approximately $1.3 million to $2.7 million as compared to a loss of $1.4 million for the comparable prior-year period. This increase in our loss from continuing operations was due to the adoption of SFAS 123R accounting for additional non-cash compensation expense of $0.5 million, decreased contribution from PWI, MSI and Incentra of CA and an increase in sales-related headcount in the various regions.. For the six months ended June 30, 2006, the operating loss from continuing operations increased by approximately $2.1 million to $5.3 million as compared to a loss of $3.2 million for the comparable prior-year period. This increase in our loss from continuing operations was due to the adoption of SFAS 123R accounting for additional non cash compensation expense of $0.8 million, decreased contribution from PWI, MSI and Incentra of CA and an increase in sales related headcount in the various regions. During the three months ended June 30, 2006, our results from continuing operations on an EBITDA(1) basis include the add back of $468,000 of non-cash compensation expense following the adoption of SFAS 123R effective January 1, 2006. For the six month period ended June 30, 2006, EBITDA results include the add back of the $1.2 million loss on the early extinguishment of debt related to our 2005 secured credit facility from Laurus and $0.8 million of non-cash compensation expense as compared to an add back of $0.2 million for non-cash compensation expense for the comparable period in the prior year. - ------------- (1) EBITDA is defined as earnings before interest, taxes, depreciation and amortization and cumulative effect of changes in accounting principles. Although EBITDA is not a measure of performance or liquidity calculated in accordance with generally accepted accounting principles (GAAP), we believe the use of the non-GAAP financial measure EBITDA enhances an overall understanding of our past financial performance and is a widely used measure of operating performance in practice. In addition, we believe the use of EBITDA provides useful information to the investor because EBITDA excludes significant non-cash interest and amortization charges related to our past financings that, when excluded, we believe produces more meaningful operating information. EBITDA also excludes depreciation and amortization expenses, which are significant when compared to such levels prior to the acquisition of MSI. However, investors should not consider this measure in isolation or as a substitute for net income, operating income, cash flows from operating activities or any other measure for determining our operating performance or liquidity that are calculated in accordance with GAAP, and this measure may not necessarily be comparable to similarly titled measures employed by other companies. A reconciliation of EBITDA to the most comparable GAAP financial measure net loss before deemed dividends and accretion on preferred stock is set forth below. EBITDA Reconciliation All amounts in (000's)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 2006 2005 2006 2005 ---- ---- ---- ---- Loss from continuing operations before accretion on preferred stock $ (3,681) $(2,083) $(8,184) $(4,036) Depreciation and amortization 556 669 1,048 1,398 Interest (cash portion) 574 171 901 186 Interest (non-cash portion) 471 439 768 959 -------- ------- ------- ------- EBITDA from continuing operations $ (2,080) $ (804) $(5,467) $(1,493) -------- ------- ------- ------- Loss on early extinguishment of debt - - 1,232 - Non-cash stock based compensation 468 108 835 169 Referral fees - 29 - 72 -------- ------- ------- ------- EBITDA from continuing operations, as adjusted $ (1,612) $ (667) $(3,400) $(1,252) ======== ======= ======= =======
We continue to expand our product and service offerings in an effort to position our company as a provider of a wide range of services and products and to further solidify our leading market position. We also continue to increase the number of products we have available for resale to our customers both directly and through existing channel partners. We introduced the sales of managed services along with our sales of storage products and professional services directly to enterprise customers. We also believe we can increase our sales of managed services by introducing these services to the customers of our acquired businesses. We believe our professional services business will be enhanced as we leverage our engineering resources across our entire customer base. RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2006 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2005 Our unaudited condensed consolidated financial statements as of June 30, 2006 and for the three and six-month periods then ended have been prepared on a going concern basis, which contemplates the realization of assets and settlements of liabilities and commitments in the normal course of business. Our audited consolidated financial statements for the year ended December 31, 2005 were also prepared on a going concern basis. In our Annual Report on Form 10-KSB for the year ended December 31, 2005, the Report of our Independent Registered Public Accounting Firm includes an explanatory paragraph that describes substantial doubt about our ability to continue as a going concern as a result of the possibility that substantially all of our long term debt may be accelerated due to a dispute with a creditor. The nature and subsequent resolution of the dispute is discussed in Notes 1, 7(D) and 10(B) to our unaudited condensed consolidated financial statements. REVENUE. Total revenue from continuing operations for the three months ended June 30, 2006 increased $4.6 million, or 34%, to $18.1 million as compared to total revenue of $13.5 million for the three months ended June 30, 2005. This increase was attributable to additional revenues of $8.7 million resulting from the inclusion of NST for the period, offset by a reduction in sales from MSI, Incentra of CA and PWI of 4.1 million. Revenue from the sale of our products increased to $14.7 million compared to revenue of approximately $10.4 million for the comparable prior year period. Revenue from the delivery of our services increased $0.3 million to $3.4 million compared to $3.1 million for the comparable prior year period. On a pro forma basis, assuming that the acquisition of NST occurred on January 1, 2005, revenue for the three months ended June 30, 2006 decreased $3.3 million, or 16%, from $21.4 million to $18.1 million due primarily to lower sales of third-party product sales for Incentra of CA and PWI of $3.9 million, and slightly lower service revenues for MSI of $0.3 million. For the quarter ended June 30, 2006, a portion of our revenues was derived from the European and Asian geographic markets. During that period, aggregate revenues from customers located in Europe and Asia amounted to $0.7 million, or 4% of total revenue, while revenues from customers located in North America totaled $17.4 million, or 96% of total revenue. For the quarter ended June 30, 2005, revenues from customers located in Europe and Asia amounted to $0.5 million, or 4% of total revenue, while revenues from customers located in North America totaled $13.0 million, or 96% of total revenue. GROSS MARGIN. Total gross margin from continuing operations for the three months ended June 30, 2006 increased $0.8 million to $3.4 million, or 19% of total revenue, as compared to gross margin of $2.6 million, or 19% of total revenue, for the comparable prior year period. The increase in total gross margin is due to the inclusion of NST in the 2006 period of $1.7 million offset by the lower margins from PWI and Incentra of CA and lower contribution from a managed service customer. Product gross margin for the three months ended June 30, 2006 totaled $2.3 million, or 16% of product revenue. Service gross margin for the three months ended June 30, 2006 totaled $1.1 million, or 33% of service revenue. On a pro forma basis, assuming acquisition of NST had occurred as of April 1, 2006 and 2005, gross margin for the three months ended June 30, 2006 decreased $0.9 million due to the lower sales experienced by PWI and Incentra of CA and lower contribution from a managed service customer. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative ("SG&A") expenses from continuing operations for the three months ended June 30, 2006 increased by approximately $1.8 million to $5.5 million from $3.7 million for the comparable prior year period. SG&A expenses included $3.9 million in salaries and related benefits for employees not directly related to the production of revenue, $0.6 million in general office expenses, $0.4 million in professional fees, $0.3 million for travel-related costs, and $0.3 million in facilities costs. SG&A expenses of $3.7 million for the comparable prior year period included $2.6 million in salaries and related benefits for employees not directly related to the production of revenue, $0.4 million in general office expenses, $0.2 million in travel related costs, $0.3 million in professional fees and $0.2 million of facilities costs. The increase for the three months ended June 30, 2006 was due to an additional $1.2 million of SG&A expenses relating to NST as a result of the inclusion of those operations for the entire quarter in 2006, and an increase of $0.5 million in salaries related to an increase in employee headcount. Also included in the 2006 increase in SG&A expenses was an increase of $0.4 million related to the adoption of SFAS 123R and the recording of additional non-cash compensation expense. On a pro forma basis, SG&A expenses for the three months ended June 30, 2006 increased $0.6 million, primarily due to the increase of non-cash compensation expense related to the adoption of SFAS 123R and an increase in employee headcount. DEPRECIATION AND AMORTIZATION. Amortization expense consists of amortization of intellectual property, capitalized software development costs and other intangible assets. Depreciation expense consists of depreciation of furniture, equipment, software and improvements. Depreciation and amortization expense was approximately $0.6 million for the three months ended June 30, 2006 and $0.7 million for the same period in 2005, of which approximately $0.4 million and $0.3 million was included in cost of revenue for the three-month periods ending June 30, 2006 and 2005, respectively. OPERATING LOSS FROM CONTINUING OPERATIONS. During the three months ended June 30, 2006, we incurred a loss from continuing operations of $2.7 million as compared to a loss from operations of $1.4 million for the three months ended June 30, 2005. This increase in our loss from continuing operations was due to the adoption of SFAS 123R accounting for additional non-cash compensation expense of $0.4 million, decreased contribution from PWI, MSI and Incentra of CA and an increase in sales related headcount in the various regions. INTEREST EXPENSE. Interest expense was $1.0 million for the three months ended June 30, 2006 compared to $0.6 million for the three months ended June 30, 2005 due to a significant increase on borrowings primarily related to acquisitions. OTHER INCOME AND EXPENSE. Other income was approximately $24,000 for the three months ended June 30, 2006 as compared to other expense of approximately $35,000 for the three months ended June 30, 2005. None of the components of the change was significant. FOREIGN CURRENCY GAIN. As discussed above, we conduct business in various countries outside the United States in which the functional currency of the country is not the U.S. dollar. We are subject to foreign exchange transaction exposure because we provide for intercompany funding between the U.S. and international operations, when we transact business in a currency other than our own functional currency. The effects of exchange rate fluctuations in remeasuring foreign currency transactions for the three months ended June 30, 2006 and 2005 were minimal for each period. LOSS FROM DISCONTINUED OPERATIONS. During the three months ended June 30, 2006 the loss from discontinued operations was $0.5 million as compared to a loss from discontinued operations for the three months ended June 30, 2005 of $0.3 million. NET LOSS APPLICABLE TO COMMON SHAREHOLDERS. During the three months ended June 30 2006, we incurred a net loss applicable to common shareholders of $4.8 million as compared to a net loss applicable to common shareholders of $3.0 million for the three months ended June 30, 2005. The increase in the net loss for the three months ended June 30, 2006 was primarily due to an increase in operating expenses explained earlier in addition to increased interest expense. RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2005 REVENUE. Total revenue from continuing operations for the six months ended June 30, 2006 increased $9.8 million, or 58%, to $26.5 million as compared to total revenue of $16.7 million for the six months ended June 30, 2005. This increase was attributable to the additional revenues of $8.7 million resulting from the inclusion of NST for the 2006 period and $1.7 million for the inclusion of PWI (which was acquired on March 31, 2005) for 2006, offset by a reduction in sales from MSI of $0.3 million. Revenue from the sale of our products increased to $20.6 million compared to revenue of approximately $11.5 million for the comparable prior year period. Revenue from the delivery of our services increased $0.7 million to $5.9 million compared to $5.2 million for the comparable prior year period. On a pro forma basis assuming that the acquisition of NST occurred on January 1, 2005, revenue from continuing operations for the six months ended June 30, 2006 increased $1.7 million, or 6%, to $32.3 million due to increased sales by PWI and NST of $2.4 million offset by lightly lower service revenues for MSI and Incentra of CA of $0.7 million. For the six months ended June 30, 2006, a portion of our revenues was derived from the European and Asian geographic markets. During that period, aggregate revenues from customers located in Europe or Asia amounted to $1.3 million, or 5% of total revenue, while revenues from customers located in North America totaled $25.2 million, or 95% of total revenue. For the six months ended June 30, 2005, revenues from customers located in Europe and Asia amounted to $1.1 million, or 6% of total revenue, while revenues from customers located in North America totaled $15.6 million, or 94% of total revenue. GROSS MARGIN. Total gross margin from continuing operations for the six months ended June 30, 2006 increased $1.6 million to $5.2 million, or 20% of total revenue, as compared to gross margin of $3.6 million, or 22% of total revenue, for the comparable prior year period. The increase in total gross margin is due to the inclusion of NST in the period for 2006 of $1.7 million and $0.6 million in additional margin from PWI in 2006 offset by the lower margins from managed service customers of $0.8 million due to renegotiation of long term contracts. Product gross margin for the six months ended June 30, 2006 totaled $3.5 million, or 17% of product revenue. Service gross margin for the six months ended June 30, 2006 totaled $1.7 million, or 29% of service revenue. On a pro forma basis, assuming acquisition of NST had occurred as of January 1, 2005, gross margin for the six months ended June 30, 2006 decreased $0.2 million due to the lost contribution from a managed service customer, offset by increases in margin from PWI and NST. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses from continuing operations for the six months ended June 30, 2006 increased by $3.3 million to $9.4 million from $6.1 million for the comparable prior year period. SG&A expenses included $6.7 million in salaries and related benefits for employees not directly related to the production of revenue, $1.0 million in general office expenses, $0.7 million in professional fees, $0.4 million for travel-related costs, and $0.5 million in facilities costs. SG&A expenses of $6.1 million for the comparable prior year period included $3.9 million in salaries and related benefits for employees not directly related to the production of revenue, $0.8 million in general office expenses, $0.3 million in travel related costs, $0.7 million in professional fees and $0.4 million of facilities costs. The increase for the six months ended June 30, 2006 was primarily due to an additional $1.2 million of SG&A expenses relating to NST as a result of the inclusion of those operations for the second quarter in 2006, an increase of $1.2 million in salaries related to an increase in employee headcount in other units. On a pro forma basis, SG&A expenses for the six months ended June 30, 2006 increased $3.0 million, due to the increase of non-cash compensation expense related to the adoption of SFAS 123R and an increase in employee headcount. DEPRECIATION AND AMORTIZATION. Amortization expense consists of amortization of intellectual property, capitalized software development costs and other intangible assets. Depreciation expense consists of depreciation of furniture, equipment, software and improvements. Depreciation and amortization expense was approximately $1.0 million and $1.4 million for each of the six-month periods ended June 30, 2006 and 2005, respectively, of which approximately $0.7 million and $0.8 million, respectively was included in cost of revenue for the six-month periods ending June 30, 2006 and 2005. OPERATING LOSS FROM CONTINUING OPERATIONS. During the six months ended June 30, 2006, we incurred a loss from continuing operations of $5.3 million as compared to a loss from operations of $3.2 million for the six months ended June 30, 2005. This increase in our loss from continuing operations was due to the adoption of SFAS 123R accounting for additional non-cash compensation expense of $0.7 million, decreased contribution from PWI, MSI and Incentra of CA and an increase in sales-related headcount in the various regions. INTEREST EXPENSE. Interest expense was $1.7 million for the six months ended June 30, 2006 compared to $1.2 million for the six months ended June 30, 2005. This increase is due to the additional debt incurred since July 2005. LOSS ON EARLY EXTINGUISHMENT OF DEBT. The refinancing of our 2005 credit facility with Laurus in the first quarter of 2006 was accounted for as an early extinguishment of debt. A loss of $1.2 million was recorded, which included $375,000 for an early termination fee and $107,500 in costs associated with the refinancing. No similar refinancing occurred in 2005. OTHER INCOME AND EXPENSE. Other income was approximately $34,000 for the six months ended June 30, 2006 as compared to other income of approximately $320,000 for the six months ended June 30, 2005. Other income for 2005 included $0.3 million of income resulting from the reassessment of the value of contracts recorded under EITF 00-19 for outstanding warrants and $0.1 million of investment income from leased equipment to customers and gains from sales of fixed assets. FOREIGN CURRENCY GAIN. As discussed above, we conduct business in various countries outside the United States in which the functional currency of the country is not the U. S. dollar. We are subject to foreign exchange transaction exposure because we provide for intercompany funding between the U.S. and international operations, when we transact business in a currency other than our own functional currency. The effects of exchange rate fluctuations in remeasuring foreign currency transactions for the six months ended June, 2006 and 2005 were minimal for each period. INCOME OR LOSS FROM DISCONTINUED OPERATIONS. During the six months ended June 30, 2006 income from discontinued operations was $0.4 million as compared to a loss from discontinued operations for the six months ended June 30, 2005 of $0.7 million. The difference in earnings was primarily due to increased income tax expense in 2005 recorded on the income generated by our Front Porch division in France. NET LOSS APPLICABLE TO COMMON SHAREHOLDERS. During the six months ended June 30, 2006, we incurred a net loss applicable to common shareholders of $9.1 million as compared to a net loss applicable to common shareholders of $6.0 million for the six months ended June 30, 2005. The increase in net loss for the six months ended June 30, 2006 was primarily due to an increase in interest expense, a loss on early extinguishment of debt, as well as increased operating expenses as explained above. LIQUIDITY AND CAPITAL RESOURCES At June 30, 2006, we had $1.0 million of cash and cash equivalents. Issuance of convertible debt and equity securities has been a principal source of liquidity for us. On May 13, 2004, we consummated a private placement pursuant to which we issued to Laurus Master Fund Ltd ("Laurus") a secured convertible term note due May 13, 2007 in the principal amount of $5.0 million (the "2004 Note"), and a common stock purchase warrant entitling the noteholder to purchase 443,500 shares of our common stock. On June 30, 2005, we entered into a Security Agreement with Laurus pursuant to which Laurus provided us a $9 million revolving, convertible credit facility. The outstanding principal amount under this facility was paid off on February 6, 2006 in connection with our execution of a new security agreement with Laurus pursuant to which Laurus provided us a non-convertible revolving credit facility of up to $10 million (the "2006 Facility"). The term of the 2006 Facility is three years and borrowings under the 2006 Facility accrue interest on the unpaid principal and interest at a rate per annum equal to the "prime rate" published in The Wall Street Journal from time to time, plus 1%, subject to a floor of seven percent (7%). In connection with the 2006 Facility, we executed in favor of Laurus a secured non-convertible revolving note in the principal amount of $10 million (the "2006 Revolver Note"). Interest on borrowings under the 2006 Revolver Note is payable monthly on the first day of each month during the term of the 2006 Revolver Note, commencing on March 1, 2006. All outstanding principal amounts are due and payable on February 6, 2009. The minimum amount available to us until April 30, 2006 was $6.5 million. Thereafter, the maximum principal amount outstanding under the 2006 Revolver Note cannot exceed 90% of the combined eligible accounts receivable of our company and all our U.S. subsidiaries. On March 31, 2006, we consummated a private placement pursuant to which we issued a secured convertible term note due May 31, 2009 in the principal amount of $1,500,000 (the "2006 Convertible Note") and a secured term note due May 31, 2009 in the principal amount of $1,750,000 (the "2006 Term Note"). In connection with the issuance of the 2006 Term Note and 2006 Convertible Note, we issued a common stock purchase warrant entitling Laurus to purchase 417,857 shares of common stock at $0.001 per share. Funding of $3.25 million under the 2006 Term note and the 2006 Convertible Note was completed on April 13, 2006 and was used to fund part of the cash portion of the purchase price of our acquisition of NST. On May 19, 2006 and May 26, 2006, we entered into a Note Purchase Agreement (the "Purchase Agreement") with twelve "accredited investors" (the "Purchasers"), pursuant to which we issued and sold unsecured convertible term notes (the "Convertible Notes") in the aggregate principal amount of $1,060,000 in connection with the offering by our company of up to $4,000,000 aggregate principal amount of such Convertible Notes. The Convertible Notes are convertible, at the option of the Purchasers, into shares our common stock (the "Common Stock"), par value $0.001 per share at a conversion price of $1.40 per share (as adjusted for stock splits, stock dividends and the like, the "Conversion Price"). On June 26, 2006 and June 30, 2006, we consummated a second and third closing (collectively, the "Additional Closings") under our offering (the "Offering") of up to $4,000,000 in aggregate principal amount of unsecured, Convertible Notes. At the Additional Closings, we issued and sold to the Purchasers Convertible Notes in the aggregate principal amount of $1,350,000 and Warrants to purchase 320,421 shares of our common stock at an exercise price of $1.40 per share. The sale of the Convertible Notes were made to three institutional investors pursuant to a Note Purchase Agreement (the "Second Purchase Agreement") dated as of June 6, 2006. As a result of the Additional Closings, aggregate proceeds received from the Offering to date total $2,410,000. On July 31, 2006, we completed the sale of substantially all of the assets of FPDI. Proceeds from the sale amounted to $33 million in cash with a potential earn out of an additional $5 million. We received $30.5 million in cash at closing, which is net of an escrow of $2.5 million that will be released after a year if certain conditions are met. With the proceeds, we immediately paid off the remaining principal balance ($2.7 million) and accrued interest of the 2004 Note. In addition, we repaid the principal balance ($1,750,000) of the 2006 Term Note plus accrued interest and the full amount outstanding of the 2006 Facility ($9.2 million) plus accrued interest. The pay off of these notes also included prepayment penalties amounting to approximately $0.8 million. On July 27, 2006 we reached an agreement as amended on July 31, 2006, with the former owner of Incentra of CA to settle the arbitration award, whereby, we agreed to pay $2,380,000, of which $505,000 was paid on execution of the agreement and $1,875,000 was paid on August 2, 2006. As part of the settlement, the former owner returned to us all of the 1,135,580 shares of our common stock and cancelled the $2.5 million promissory note issued to him in February 2005. As of June 30, 2006, we had current assets of $30.5 million. These assets were primarily derived from our operations in 2006 and from our acquisition of NST and include assets from discontinued operation of $19.8 million. Long-term assets of $19.1 million consisted of $0.6 million of intangible assets resulting from the acquisitions of MSI, Incentra of CA and PWI, $14.7 million of goodwill resulting from the acquisitions of Incentra of CA, PWI and NST, $2.3 million of property and equipment, $0.9 million of software development costs and $0.5 million of other assets. Current liabilities of $40.2 million at June 30, 2006 consisted of $10.3 million of accounts payable; $5.2 million of liabilities related to assets held for sale; $0.8 million of deferred revenue, which consisted of billings in excess of revenue recognized, deposits and progress payments received on engagements currently in progress; $3.9 million of accrued expenses; and $20.0 million of the current portion of notes payable, other long term obligations, and capital leases. Of this total, $14.9 million was paid off on July 31, 2006. Our working capital deficit was $9.7 million as of June 30, 2006 and includes the effect of including $14.5 million in assets net of liabilities of discontinued operations. Included in the deficit is the balance on the 2006 Facility of $8.8 million, net of debt discount of $1.1 million. The outstanding principal amount of the 2006 facility was paid in full on July 31, 2006. Also included in the deficit was $2.1 million (net of discount) due to the former owner of Incentra of CA and $2.5 million (net of discount) on the Laurus Note. Both amounts were in default at June 30, 2006 and therefore classified as current liabilities. Both amounts were paid off in full in July 2006. See Note 10(B) to the unaudited condensed consolidated financial statements. We used net cash of $3.0 million in operating activities of our continuing operations during the six months ended June 30, 2006, primarily as a result of the net loss incurred during the period. We used net cash of $6.3 million in investing activities in continuing operations during the six months ended June 30, 2006, of which $1.1 million was used primarily to purchase or develop computer software and equipment and $5.2 million was used to purchase NST. Financing activities provided net cash of $9.4 million during the six months ended June 30, 2006 primarily from new financings with Laurus and from issuing the Convertible Notes. Discontinued operations generated cash of $0.3 million during the six-month period ending June 30, 2006. We are still in the early stages of executing our business strategy, have completed four significant acquisitions and expect to begin numerous new acquisition engagements during the next 12 months. Although we did complete the successful sale of our broadcast division which provided a significant amount of working capital and we are experiencing success in the deployment of our marketing strategy for the sale and delivery of our software solutions, continuation of this success is contingent upon several factors, including the availability of cash resources, the prices of our products and services relative to those of our competitors, and general economic and business conditions, among others. Our management believes our cash and cash equivalents and borrowings available from the 2006 Facility, proceeds from the issuance of unsecured, convertible notes to accredited investors and the proceeds from the sale of FPDI unit will provide us with sufficient capital resources to fund our operations, debt service requirements, and working capital needs for the next 12 months. There can be no assurances that we will be able to obtain additional funding when needed, or that such funding, if available, will be obtainable on terms acceptable to us. In the event that our operations do not generate sufficient cash flow, or we cannot obtain additional funds if and when needed, we may be forced to curtail or cease our activities, which would likely result in the loss to investors of all or a substantial portion of their investment. Our actual financial results may differ materially from our stated plan of operations. Factors that may cause a change from our plan of operations to vary, include, without limitation, decisions of our management and board of directors not to pursue our stated plan of operations based on its reassessment of the plan and general economic conditions. Additionally, there can be no assurance that our business will generate cash flows at or above current levels. Accordingly, we may choose to defer capital expenditures and extend vendor payments for additional cash flow flexibility. We expect capital expenditures to be approximately $2.0 million and capitalized software development costs to be approximately $1.0 million during the 12-month period ended June 30, 2007. It is expected that our principal uses of cash will be for working capital, to finance capital expenditures and for other general corporate purposes, including financing the expansion of the business and implementation of our sales and marketing strategy. The amount of spending in each respective area is dependent upon the total capital available to us. ITEM 3. CONTROLS AND PROCEDURES DISCLOSURE CONTROLS AND PROCEDURES. Our management, with the participation of our chief executive officer and chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, our chief executive officer and chief financial officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that it files or submits under the Exchange Act. INTERNAL CONTROL OVER FINANCIAL REPORTING. Except for the matter discussed below, there have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the second quarter of 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During the second quarter of 2006, the Audit Committee of our Board of Directors directed us to create a formal review process covering acquisition accounting and to include a Statement of Changes in Shareholders' Deficit and Comprehensive Gain or Loss for the current year with future filings on Form 10-QSB. These measures were implemented in April 2006. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS STAR NOTE DEFAULT As previously reported in our Current Report on Form 8-K, dated July 28, 2006, we settled all claims and disputes with Alfred Curmi relating to our claimed adjustments of the purchase price paid in connection with our acquisition of STAR Solutions of Delaware, Inc. (now known as Incentra of CA, Inc.) in February 2005. ITEM 6. EXHIBITS. The exhibits required by this item are listed on the Exhibit Index attached hereto. SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: August 14, 2006 INCENTRA SOLUTIONS, INC. By: /s/ Thomas P. Sweeney III ------------------------- Thomas P. Sweeney III Chief Executive Officer (principal executive officer) By: /s/ Paul McKnight ------------------------- Paul McKnight Chief Financial Officer (principal financial and accounting officer) EXHIBIT INDEX Exhibit No. Exhibit Description - ------- ------------------- 31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. EX-31.1 2 c43894_ex31-1.txt EXHIBIT 31.1 CERTIFICATION Pursuant to 18 U.S.C. 1350 (Section 302 of the Sarbanes-Oxley Act of 2002) I, Thomas P. Sweeney III, Chief Executive Officer of Incentra Solutions, Inc., certify that: 1) I have reviewed this Quarterly Report on Form 10-QSB of Incentra Solutions, Inc; 2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 14, 2006 By: /s/ Thomas P. Sweeney III ------------------------- Thomas P. Sweeney III Chief Executive Officer EX-31.2 3 c43894_ex31-2.txt EXHIBIT 31.2 CERTIFICATION Pursuant to 18 U.S.C. 1350 (Section 302 of the Sarbanes-Oxley Act of 2002) I, Paul McKnight, Chief Financial Officer of Incentra Solutions, Inc., certify that: 1) I have reviewed this Quarterly Report on Form 10-QSB of Incentra Solutions, Inc; 2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which re reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 14, 2006 By: /s/ Paul McKnight ------------------ Paul McKnight Chief Financial Officer EX-32.1 4 c43894_ex32-1.txt EXHIBIT 32.1 CERTIFICATION Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) In connection with the Quarterly Report on Form 10-QSB of Incentra Solutions, Inc. (the "Company") for the period ended June 30, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Thomas P. Sweeney III, as Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: August 14, 2006 By: /s/ Thomas P. Sweeney III ------------------------- Thomas P. Sweeney III Chief Executive Officer - -------------------------------------------------------------------------------- This certification accompanies each Report pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss.18 of the Securities Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 5 c43894_ex32-2.txt EXHIBIT 32.2 CERTIFICATION Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) In connection with the Quarterly Report on Form 10-QSB of Incentra Solutions, Inc. (the "Company") for the period ended June 30, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Paul McKnight, as Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: August 14, 2006 By: /s/ Paul McKnight ----------------- Paul McKnight Chief Financial Officer - -------------------------------------------------------------------------------- This certification accompanies each Report pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss.18 of the Securities Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----