10QSB 1 sevi1130200510qsb.htm SEVI NOV 30, 2005 10QSB SEVI Nov 30, 2005 10QSB
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-QSB
QUARTERLY REPORT

x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended November 30, 2005
 o Transition Report pursuant to 13 or 15(d) of the Securities Exchange Act of 1934


Commission File Number 000-31090
 
SYSTEMS EVOLUTION INC.
(Exact name of Small Business Issuer as specified in its charter)


 Idaho
82-0291029
(State or other jurisdiction of
incorporation or organization)
(IRS Employer Identification No.)



10777 Westheimer Road, Suite 810
Houston, Texas 77042
(Address of principal executive offices)


713-979-1600
Issuer's telephone number

 
None
(Former name, former address and former fiscal year, if changed since last report)


Check whether the issuer (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities and 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.

(1) x Yes o No

(2) x Yes o No

The number of shares of issuer's Common Stock outstanding as of January 17, 2006:
106,258,626 shares












SYSTEMS EVOLUTION INC.
INDEX
QUARTERLY REPORT ON FORM 10-QSB
FOR QUARTERLY PERIOD ENDED November 30, 2005
 

PART I. FINANCIAL INFORMATION
 

PART II. OTHER INFORMATION
  ITEM 6 - Exhibits      

SIGNATURES




PART I. FINANCIAL INFORMATION

ITEM 1 - Unaudited Consolidated Financial Statements

SYSTEMS EVOLUTION, INC.
November 30, 2005
(Unaudited)

 
 ASSETS        
         
 Current Assets        
 Cash
   $ 7,755  
 Accounts receivable, net of allowance for doubtful accounts of $23,341
     493,286  
 Unbilled revenue
     318,706  
 Prepaid expenses and other current assets
     37,947  
 Total Current Assets
     857,694  
         
 Deferred financing cost, net of $2,384,729 accumulated amortizaton     3,247,535  
 Other assets     10,639  
 Furniture and equipment, net of accumulated depreciation of $162,936     112,638  
 Goodwill     1,231,648  
 Intangibles, net of $919,115 amortization and $91,150 impairment     1,302,246  
 TOTAL ASSETS
   $ 6,762,400  
         
 LIABILITIES AND STOCKHOLDERS' EQUITY        
         
 Current Liabilities        
 Accounts payable
   $ 500,428  
 Accrued expenses
     452,321  
 Unearned service revenues
     3,198  
 Notes payable
     79,193  
 Total Current Liabilities
     1,035,140  
         
 Deferred rents     19,222  
 Convertible note, net     1,236,974  
 Long-term debt - related parties     131,509  
 Total Liabilities
     2,422,845  
         
 STOCKHOLDERS' EQUITY        
Common stock, no par value, 750,000,000 shares authorized, 106,258,626 shares issued and outstanding
     16,202,520  
Accumulated deficit
     (11,862,965 )
Total Stockholders' Equity
     4,339,555  
         
 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY   $ 6,762,400  

 



SYSTEMS EVOLUTION, INC.
Three Months Ended November 30, 2005 and 2004

 
Three Months 
Six Months
Ending November 30,
    
2005
    
2004
    
2005
    
2004
  
 
                          
Revenues
  
$
1,049,601
  
$
839,047
  
$
2,404,989
  
$
1,083,503
  
                           
Cost of Goods Sold
    
419,630
    
106,035
    
917,870
    
117,862
  
 
                      
Gross Profit
    
629,971
    
733,012
    
1,487,119
    
965,641
  
                           
Operating Expenses:
                          
    Payroll and related costs
    
890,449
    
1,161,312
    
1,900,275
    
1,465,177
  
    General, administrative, and selling
    
320,602
    
353,034
    
479,659
    
2,003,170
  
    Depreciation & amortization
    
194,997
    
223,009
    
389,993
    
251,159
  
                           
Operating loss
    
(776,077
)
  
(1,004,343
)
  
(1,282,808
)
  
(2,753,865
)
 
                      
Interest expense
    
(890,511
)
  
(610,622
)
  
(1,779,150
)
  
(628,064
)
Other Income
    
13,201
   
-
    
15,931
   
-
  
Other costs
    
(5,546
)
  
-
   
(8,773
)
  
-
 
 
                      
Net loss
  
$
(1,658,933
)
$
(1,614,965
)
$
(3,054,800
)
$
(3,381,929
)
 
                      
Basic and diluted loss per share
  
$
(0.02
)
$
(0.02
)
$
(0.03
)
$
(0.05
)
 
                      
Basic and diluted weighted average shares outstanding
    
101,015,247
    
67,239,771
    
93,593,484
    
65,888,643
  





SYSTEMS EVOLUTION, INC.
For the Three Months Ended November 30, 2005 and 2004
 
 
     
2005 
    
2004 
  
 CASH FLOWS FROM OPERATING ACTIVITIES    
 
    
 
  
 Net loss    $ (3,054,800 )  $ (3,381,929 )
 Adjustments to reconcile net loss to net cash used in operating activities:              
     Depreciation and amortization     389,993     823,129  
     Amortization of discount on notes payable     586,868     -  
     Amortization of deferred financing costs     989,313     -  
     Shares issued for services     292,058     162,050  
     Stock options and warrant expense     -     1,536,486  
     Bad debt expense     -     10,006  
     Gain on sale of fixed assets     -     1,392  
     Changes in:              
         Accounts receivable     (173,674 )   (12,600 )
         Prepaid expenses and other assets     33,633     (69,501 )
         Unbilled revenue     157,835     -  
         Other assets     (1,668 )   (3,040 )
         Accounts payable     224,726     261,661  
         Unearned service revenue     (12,311 )   -  
         Accrued expenses     229,376     (111,711 )
 NET CASH USED IN OPERATING ACTIVITIES     (338,651 )   (784,057 )
               
 CASH FLOWS FROM INVESTING ACTIVITIES              
     Purchase of CMS     -     (10,000 )
     Purchase of Duration Software     -     (450,000 )
     Purchase of equipment     (2,500 )   (29,5446 )
 NET CASH USED IN INVESTING ACTIVITIES     (2,500 )   (489,546 )
               
 CASH FLOWS FROM FINANCING ACTIVITIES              
     Proceeds from notes payable and long-term debt     25,714     82,527  
     Payments notes payable and long-term debt     (10,000 )   (419,240 )
     Proceeds from convertible note     250,000     1,825,000  
     Deferred rent     17,132     -  
     Deferred financing cost     -     (286,616 )
     Common stock issued for cash     -     127,091  
 NET CASH PROVIDED BY FINANCING ACTIVITIES     282,846     1,328,762  
               
 NET CHANGE IN CASH    $ (58,305 )  $ 55,159  
               
     Cash, beginning of period     66,060     19,522  
     Cash, end of period    $ 7,755    $ 74,681  
               
 SUPPLEMENTAL CASH FLOW INFORMATION:              
     Interest paid     -     3,287  
     Taxes paid     -     4,465  
               
 NON-CASH INVESTING AND FINANCING ACTIVITIES:              
     Common stock issued for acquisition of CMS     -     104,000  
     Common stock issued for acquisition of Duration     -     2,250,000  
     Common stock issued for acquisition of Next Hire     -     40,000  
     Common stock issued for computer equipment     -     52,070  
     Common stock issued for debt     175,400     -  
     Discount of notes payable
     250,000     -  
 
 




SYSTEMS EVOLUTION INC.
November 30, 2005
(UNAUDITED)

NOTE 1 - BASIS OF PRESENTATION
 
The accompanying unaudited interim financial statements of Systems Evolution Inc. ("SEVI") have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission ("SEC"), and should be read in conjunction with the audited financial statements and notes thereto contained in the SEVI's Annual Report filed with the SEC on Form 10-KSB. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosure contained in the audited financial statements for fiscal 2005 as reported in the 10-KSB have been omitted.

Impairment of Long-Lived Assets - SEVI reviews the carrying value of its long-lived assets annually or whenever events or changes in circumstances indicate that the historical cost-carrying value of an asset may no longer be appropriate. SEVI assesses recoverability of the carrying value of the asset by estimating the future net cash flows expected to result from the asset, including eventual disposition. If the future net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset’s carrying value and fair value.

NOTE 2 - STOCK BASED COMPENSATION

SEVI accounts for stock-based compensation under the intrinsic value method. Under this method, SEVI recognizes no compensation expense for stock options granted when the number of underlying shares is known and exercise price of the option is greater than or equal to the fair market value of the stock on the date of grant. The following table illustrates the effect on net loss and net loss per share if SEVI had applied the fair value provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for the three months ended November 30, 2005 and 2004:
 
 

 
 
  
Three Months Ending
November 30,
  
     
2005
    
2004
  
               
 Net loss as reported    $ (1,658,933 )  $ (1,619,817 )
 Add: Intrinsic value expense recorded     -     148,936  
 Deduct: Total stock - based employee compensation expense determined under fair value based method     -     (312,010 )
 Pro forma net loss    $ (1,658,933 )  $ (1,782,891 )
               
 Basic and diluted net loss per common share:              
 As reported    $ (0.02 )  $ (0.02 )
 Pro forma    $ (0.02 )  $ (0.03 )
 

The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: (1) 1.5% risk-free interest rate, (2) expected option life is the actual remaining life of the options as of each year end, (3) expected volatility is from 181% to 781% and (4) zero expected dividends.




NOTE 3 - CONVERTIBLE NOTES

During 2005, SEVI issued a total of $3,075,000 in convertible promissory notes pursuant to a private placement. Promissory notes for $1,825,000 are convertible at the holder’s option into SEVI common stock at $0.05 per share, accrue interest at 8% per annum, and have 36,500,000 warrants attached to them. During the second quarter of 2006 SEVI issued an additional $250,000 in convertible promissory notes pursuant to a private placement. Additionally, $150,000 of the promissory notes were converted into 3,000,000 shares of SEVI common stock during the second quarter of 2005. Interest on these notes is payable semi-annually, and the notes mature on August 31, 2007. The warrants were denominated as Series A, B, C, and D warrants. The following table summarizes each series.

Series
Number of shares
Exercise Price
Expiration
A
9,125,000
$0.06
90 days from registration of underlying common shares
B
9,125,000
$0.07
180 days from registration of underlying common shares
C
9,125,000
$0.08
270 days from registration of underlying common shares
D
9,125,000
$0.15
August 31, 2009
 
36,500,000
    

Promissory notes for $1,500,000 are convertible at the holders’ option into SEVI common stock at the lesser of 50% of the average of the three lowest trading prices 20 days prior to one day before the holder sends the conversion notice to SEVI or $0.13 per share, accrue interest at 8% per annum, and have 4,500,000 warrants attached to them. The exercise price of the warrants is $0.08 per share. Accrued interest and principal are due at maturity. $500,000 matures on December 30, 2006, $500,000 matures on January 14, 2007, $250,000 matures on April 28, 2007, and $250,000 matures on November 14, 2007. The warrants are exercisable for 5 years.

The notes have been discounted for the relative fair value of the warrants, the offering costs and beneficial conversion feature. As of November 30, 2005, the stock has not been issued to the investors. All discounts will be amortized over the life of the notes. The relative fair values were calculated using the Black-Scholes model. Variables used in the Black-Scholes model include (1) 2.0% risk-free interest rate, (2) expected volatility between 166% and 227% and (3) zero expected dividends.

A summary of the convertible notes at November 30, 2005 is as follows:
      
Gross proceeds from notes
  
$
3,325,000
  
Less: Relative value of warrants
    
(1,797,468
)
Less: Beneficial conversion feature
    
(1,386,118
)
Less: Retirement of debt for stock
    
(150,000
)
Add: Amortization of discounts
    
1,245,560
  
Carrying value of note on November 30, 2005
  
$
1,236,974
  


NOTE 4 - COMMON STOCK

During the three months ending August 31, 2005, SEVI issued the following shares:
 
 ·
In July 2005, SEVI issued 6,369,189 shares per a board resolution to offer restricted SEVI shares in exchange for all vested options in a one for one exchange (one vested option for one restricted SEVI share) as of May 31, 2005 and still employed by the company as of June 30th, 2005. SEVI received a signed agreement from all option holders in order to receive the Share Grant that stipulates that the Holder agrees to give up all un-vested options; these agreements amended all employment contracts then in force as of May 31, 2005.
 ·
In July 2005, SEVI issued 300,000 shares to directors of the company as of December 2004.
 
During the three months ending November 30, 2005, SEVI issued the following shares:

 ·
  In September 2005, SEVI issued 3,120,000 shares in exchange for the conversion of a $150,000 convertible promissory note held by Platinum Partners Value Arbitrage Fund LP and the associated accrued interest valued at $6,000.
 ·
  In November 2005, SEVI issued 1,340,000 in exchange for interest accrued on the convertible notes issued September 2004. The shares were valued at $0.01 per share.
 ·
  In November 2005, SEVI issued 4,000,000 shares in exchange for an executed release from an employment contract with an officer of the company. The shares were valued at $0.01 per share.
 ·
  In November 2005, SEVI issued 4,500,000 shares, per board resolution, to individuals taking on new management positions with the company. The shares were valued at $0.01 per share.
 ·
  In November 2005, SEVI issued 4,165,512 shares, per board resolution, to individuals for services. The shares were valued at $0.01 per share.
 
 
Note 5 - Segment Information

Reportable segments are based on internal organizational structure and are comprised of the Business & Technology division (“B&T”) or the Next Hire Consultants (“NHC”) division. The B&T division provides high-end, value-added software development services and the NHC division provides contract staff and permanent placement services.

Segment financial information is summarized as follows:

   
B&T 
    
NHC
    
Corporate and other
    
Total
  
Three Months ending
November 30, 2005
Revenue
    $
888,095
    $
161,235
    $
271
  
$
1,049,601
  
Depreciation and amortization
    
4,950
    
-
    
190,047
    
194,997
  
Interest expense
    
631
    
-
    
889,880
    
890,511
  
Net income (loss)
    
(244,022
)
  
(25,130
)
  
(1,389,781
)
  
(1,658,933
)
Total assets
    
1,264,165
    
38,081
    
5,460,154
    
6,762,400
  
Expenditures for long-lived assets
    
-
   
-
   
-
    
-
  
                           
Three Months ending
November 30, 2004
Revenue
    $
732,169
    $
99,832
    $
7,046
    $
839,047
  
Depreciation and amortization
    
3,865
    
-
    
219,144
    
223,009
  
Interest expense
    
1771
    
940
    
607,911
    
610,622
  
Net income (loss)
    
(404,828
)
  
(24,730
)
  
(1,185,407
)
  
(1,614,965
)
Expenditures for long-lived assets
    
29,546
    
-
    
-
    
29,546
  




FORWARD LOOKING STATEMENTS

This quarterly report contains forward-looking statements that involve risks and uncertainties. We use words such as anticipate, believe, plan, expect, future, intend and similar expressions to identify such forward-looking statements. You should not place too much reliance on these forward-looking statements. Our actual results are likely to differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described in this section.

The Company, previously known as Wallace Resources Inc., was organized in the State of Idaho on August 26, 1968. Systems Evolution Inc., our Texas operating company was acquired by the Company on September 9, 2003, and after the acquisition, the Company's current directors and management took control of the Company. We generate revenue from professional services performed for our end-user customers and the end-user customers of our software partners.
        
Revenue is derived primarily from professional services provided on a time and materials basis, with the remaining revenue provided from fixed fee engagements. For time and material contracts, revenue is recognized and billed by multiplying the number of hours expended by our professionals in the performance of the contract by the established billing rates. For fixed fee projects, revenue is generally recognized using the proportionate performance method. Provisions for estimated losses on uncompleted contracts are made on a contract-by-contract basis and are recognized in the period in which such losses are determined. Billings in excess of costs plus earnings are classified as deferred revenues. On many projects we are also reimbursed for out-of-pocket expenses such as airfare, lodging and meals. These reimbursements are included as a component of revenue.

Our revenue and operating results are subject to substantial variations based on our customers' expenditures and the frequency with which we are chosen to perform services for our customers. Revenue from any given customer will vary from period to period.
 
Our gross margins are affected by trends in the utilization rate of our professionals (defined as the percentage of our professionals' time billed to customers, divided by the total available hours in the respective period), the salaries we pay our consulting professionals, and the average rate we receive from our customers. If a project ends earlier than scheduled or we retain professionals in advance of receiving project assignments, our utilization rate will decline and adversely affect our gross margins.

Recent Developments

In October 2005, SEVI entered into a teaming agreement with The Project Group Inc. (“TPG”), a company currently in Chapter 11 Bankruptcy and publicly traded on the Pink Sheets with the symbol PJTGQ. TPG is an integrator of Microsoft Project software and a Microsoft Gold Partner. This teaming agreement provides SEVI and TPG the ability to increase market penetration by cross marketing our services (software development) to TPG clients and TPG’s services (Microsoft Project implementation) to our clients, increase operating efficiencies by integrating our physical Houston offices, and gain Microsoft Gold Partner status (achieved October 2005).

Furthermore, on October 4, 2005, SEVI and TPG entered into a non-binding term sheet that provides a plan of reorganization of TPG in bankruptcy court and the corporate integration of the two companies after TPG emerges from bankruptcy. “The entire transaction and relevant terms are subject to approval by the respective Board of Directors of SEVI and TPG, our respective shareholders as required, by the SEVI convertible note holders as required, by the creditors of TPG, and the Bankruptcy Court.”

SEVI discontinued the $1,500,000 factoring facility with Allied Capital Partners, LP on the anniversary of the facility as provided in the original agreement with no costs associated with its discontinuance. SEVI signed a term sheet with a lender to provide a $500,000 “Accounts Receivable Factoring Line of Credit” with a maximum of 75% of the current accounts receivable with an immediate advance of $50,000. Since SEVI has not been able to amend the security agreement with previous Convertible Note holders to provide the lender with the first lien on accounts receivable in a timely fashion, SEVI has entered into a payment plan to re-pay the advance to the lender within 30 days.
 
Results of Operations for the three month period ending November 30, 2005

Total gross revenue increased from $839,047 for the three month period ended November 30, 2004 to $1,049,601 for the three month period ended November 30, 2005, an increase of 25%. The increase in revenue resulted from increased sales in the B&T division along with increase placement fees generated in the NHC division.

Net loss from operations increased from $1,614,965 for the three month period ended November 30, 2004 to $1,658,933 for the three month period ended November 30, 2005. The increase in the loss is attributable services paid by stock within the period.
 
Operating Expenses

Payroll and related costs make up the majority of our cost of revenue. Total payroll and related costs decreased from $1,161,312 for the three month period ended November 30, 2004 to $890,449 for the three month period ended November 30, 2005, a decrease of 23%. This decrease is attributed to reduction in operations related staff.

General and administrative expenses consist of salaries and benefits for sales, executive and administrative employees, training, marketing activities, investor relations, recruiting, non-reimbursable travel costs and expenses and miscellaneous expenses. General and administrative expenses decreased from $353,034 for three month period ended November 30, 2004 to $320,034 for the three month period ended November 30, 2005. This decrease is related to retaining a small administrative management team and little ongoing professional services.

Liquidity and Capital Resources

Net cash used by operating activities was $338,651 for the three month period ended November 30, 2005 compared to $784,057 used by operating activities for the three month period ended November 30, 2004.

Net cash provided by financing activities was $282,846 for the three month period ended November 30, 2005 compared to $1,328,762 for three month period ended November 30, 2004.

On August 31, 2004, the Company executed a Purchase Agreement with certain institutional and accredited investors under which the Company agreed to sell and the purchasers agreed to purchase convertible promissory notes due August 31, 2007 (the "Notes") in the aggregate principal amount of up to $2,500,000 bearing interest at the rate of 8% per annum and convertible into shares of our Common Stock at a conversion price of $0.05 per share. On September 9, 2004, the Company completed the sale of an aggregate of $1,825,000 in Notes and accompanying Warrants under the Purchase Agreement which resulted in net proceeds to the Company of $1,542,417. The Notes are initially convertible into 36,500,000 shares of Common Stock, and an additional 36,500,000 shares of Common Stock are reserved for issuance upon exercise of the Warrants issued to the note holders.

On December 30, 2004, we executed a securities purchase agreement with certain institutional and accredited investors for the sale of 8% Callable Secured Promissory Notes and accompanying Warrants. Under this agreement, on December 30, 2004, we completed the sale of an aggregate of $500,000 of these Notes, which resulted in net proceeds to SEVI of $408,148; on January 14, 2005, completed the sale of an additional $500,000 of these Notes, with net proceeds to SEVI of $497,500; on April 29, 2005 completed the sale of an additional $250,000 principal amount of these notes with net proceeds to SEVI of $230,000; and on November 14, 2005 completed the sale of an additional $250,000 principal amount of these notes with net proceeds to SEVI of $250,000.

The Company estimates that our requirements for additional capital over the next 12 months will be in the range of $1,354,604 or four times our net cash used in operating activities. There can be no assurance we will be able to raise this additional required capital on satisfactory terms, or at all. In the event we are unable to obtain such additional capital or to obtain it on acceptable terms or in sufficient amounts, the impact thereof would have a material adverse effect on our business, operating results, financial condition and may affect our ability to carry on as a Company.

Critical Accounting Policies

Consulting revenues are comprised of revenue from professional services fees recognized primarily on a time and materials basis as performed. For fixed fee engagements, revenue is recognized using the proportionate performance method (based on the ratio of hours expended to total estimated hours). Provisions for estimated losses on uncompleted contracts are made on a contract-by-contract basis and are recognized in the period in which such losses are determined. Billings in excess of costs plus earnings are classified as deferred revenues. Our normal payment terms are net 30 days. We record an expense for the expected losses on uncollectible accounts receivable each period based on known facts and circumstances for the respective period.

Deferred Financing Costs

Deferred financing costs relate to the cost incurred in the arrangement of Systems Evolution Inc.'s debt agreement and are being amortized using the straight-line method over the terms of the related debt.
 

Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer, has evaluated the effectiveness of the Company's 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, the Company's Chief Executive Officer has concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.

Internal Control Over Financial Reporting. There have not been any changes in the Company's 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 fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II - OTHER INFORMATION
 
ITEM 6 - Exhibits and Report on Form 8-K

(a) Exhibits.

Ex
31  Certification of Chief Executive Officer and Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


Ex
32 Certification of Chief Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.



SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the Company caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Systems Evolution Inc.

Dated: January 17, 2006

/s/ Robert C. Rhodes
Robert C. Rhodes
Chief Executive Officer


/s/ Robert C. Rhodes
Robert C. Rhodes
Chief Financial Officer