10QSB 1 form10qsb.txt FORM 10-QSB - QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-QSB [x] QUARTERLY REPORT UNDER SECTION 13 0R 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended February 28, 2002 OR [ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANCE ACT OF 1934 For the transition period from _____________ to ________________ Commission File Number 0-22969 Paladyne Corp. (Name of Small Business Issuer in its charter) Delaware 59-3562953 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1650A Gum Branch Road, Jacksonville, NC 28540 (Address of Principal Executive Offices) 910-478-0097 (Issuer's Telephone Number) N/A (Former name, former address and former fiscal year, if changed since last report) Checked 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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. Class Outstanding as of April 4, 2002 Common Stock, $.001 PAR VALUE 16,709,351 Transitional Small Business Disclosure Format (check one): Yes No X --- --- 1 TABLE OF CONTENTS Page ---- PART I. CONSOLIDATED FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements 3 Condensed Consolidated Balance Sheets - February 28, 2002 and August 31, 2001 4 Condensed Consolidated Statements of Operations - three months ended February 28, 2002 and February 28, 2001 5 Condensed Consolidated Statements of Operations - six months ended February 28, 2002 and February 28, 2001 6 Condensed Consolidated Statements of Cash Flows - six months ended February 28, 2002 and February 28, 2001 7 Notes to Condensed Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds 17 Item 6. Exhibits and Reports on Form 8-K 17 SIGNATURES 17 2 PART I. ITEM 1. FINANCIAL STATEMENTS The following unaudited Condensed Consolidated Financial Statements for the three months and six months ended February 28, 2002 and February 28, 2001 have been prepared by Paladyne Corp., a Delaware corporation. 3 PALADYNE CORP. CONDENSED CONSOLIDATED BALANCE SHEETS FEBRUARY 28, 2002 AUGUST 31, 2001 (UNAUDITED) --------------- ----------- ASSETS Current Assets: Cash and cash equivalents $ 176,128 $ 158,225 Accounts receivable, net of allowance for doubtful accounts of $164,000 and $607,999, respectively 1,900,072 1,414,473 Prepaid expenses and other current assets 49,041 113,960 ----------- ----------- Total Current Assets 2,125,241 1,686,658 Property and equipment, net of accumulated depreciation of $1,270,747 and $783,449 2,252,945 2,429,736 Other assets 18,311 28,685 ----------- ----------- $ 4,396,497 $ 4,145,079 =========== =========== LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable and accrued expenses $ 2,831,381 $ 2,500,585 Notes payable 2,903,513 2,663,752 Accrued preferred stock dividends Series A 170,000 149,600 Current portion of capital lease obligations 816,528 816,649 ----------- ----------- Total current liabilities 6,721,422 6,130,586 Notes payable 2,446,487 2,986,248 Capital lease obligations 337,727 634,230 ----------- ----------- Total liabilities 9,505,636 9,751,064 COMMITMENTS AND CONTINGENCIES DEFICIENCY IN STOCKHOLDERS' EQUITY Preferred stock; Series A 137 137 Series C 930 - Common stock 16,709 16,709 Additional paid-in capital 14,260,548 12,869,647 Accumulated deficit (19,387,463) (18,492,478) ----------- ----------- Total deficiency in stockholders' equity (5,109,139) (5,605,985) ----------- ----------- $ 4,396,497 $ 4,145,079 =========== =========== See accompanying notes to condensed consolidated unaudited financial statements 4 PALADYNE CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED FEBRUARY 28, 2002 2001 (UNAUDITED) (UNAUDITED) ----------- ----------- Total Revenues $ 2,523,723 $ 897,082 Cost of Revenues 1,368,102 472,809 ----------- ----------- Gross Profit 1,155,621 424,273 Selling, general and administrative expenses 1,112,968 485,704 Depreciation and amortization 234,852 130,357 ----------- ----------- Loss from operations (192,199) (191,788) Other income (expense): Interest expense (149,828) (57,721) ----------- ----------- Loss from continuing operations, before income taxes and discontinued operations (342,027) (249,261) Income tax benefits - - ----------- ----------- Loss from continuing operations, before discontinued operations (342,027) (249,261) Loss from discontinued operations - (697,392) ----------- ----------- Loss (342,027) (946,653) Cumulative Convertible Preferred Stock Dividend Requirement (10,200) (10,200) ----------- ----------- Loss attributable to common stockholders $ (352,227) $ (956,853) =========== =========== Weighted average common shares outstanding: Basic 16,709,351 8,459,351 Diluted 16,709,351 8,459,351 Earnings (loss) per share: Basic $ (.02) $ (.11) Diluted $ (.02) $ (.11) See accompanying notes to condensed consolidated financial statements 5 PALADYNE CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED FEBRUARY 28, 2002 2001 (UNAUDITED) (UNAUDITED) ----------- ----------- Total Revenues $ 4,963,999 $ 897,082 Cost of Revenues 2,684,896 472,809 ----------- ----------- Gross Profit 2,279,103 424,273 Selling, general and administrative expenses 2,363,797 485,704 Depreciation and amortization 487,298 130,357 ----------- ----------- Loss from operations (571,992) (191,788) Other income (expense): Interest expense (322,994) (57,473) ----------- ----------- Loss from continuing operations, before income taxes and discontinued operations (894,986) (249,261) Income tax benefits - - ----------- ----------- Loss from continuing operations, before discontinued operations (894,986) (249,261) Loss from discontinued operations - (1,107,157) ----------- ----------- Loss (894,986) (1,356,418) Cumulative Convertible Preferred Stock Dividend Requirement (20,400) (20,400) ----------- ----------- Net loss attributable to common stockholders ($915,386) ($1,376,818) =========== =========== Weighted average common shares outstanding: Basic 16,709,351 8,458,956 Diluted 16,709,351 8,458,956 Earnings (loss) per share: Basic $ (.05) $ (.16) Diluted $ (.05) $ (.16) See accompanying notes to condensed consolidated financial statements 6 PALADYNE CORP. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED FEBRUARY 28, 2002 2001 (UNAUDITED) (UNAUDITED) ----------- ----------- Cash flows used in operating activities $ (477,172) $ (165,641) Cash flows used in investing activities (300,133) (380,833) Cash flows provided by financing activities 795,208 309,321 ----------- ----------- Net increase (decrease) in cash and cash equivalents 17,903 (237,153) Cash and cash equivalents at beginning of period 158,225 635,612 ------------ ------------ Cash and cash equivalents at end of period $ 176,128 $ 398,459 =========== =========== Supplemental Cash Flow Information: Cash paid for interest $ 322,994 $ 57,473 Non cash investing and financing activities: Accrual of preferred stock dividend 20,400 20,400 Preferred shares issued in exchange for debt 300,000 See accompanying notes to condensed consolidated financial statements 7 PALADYNE CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS UNAUDITED NOTE 1. BASIS OF PRESENTATION The consolidated financial information included herein contains the information for Paladyne Corp. and its wholly owned subsidiary. All significant inter-company transactions and balances have been eliminated. The consolidated financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that, in the opinion of management, are necessary for a fair statement of results for this interim period. The accompanying financial statements include estimated amounts and disclosures based on management's assumptions about future events. Actual results may differ from those estimates. The results of operations and cash flows for the interim periods are not necessarily indicative of the results to be expected for the full year. The condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements included in the Company's Form 10-KSB for the fiscal year ended August 31, 2001 as filed with the Securities and Exchange Commission. The Company's consolidated financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. As with any new venture, concerns must be considered in light of the normal problems, expenses and complications encountered by entrance into established markets and the competitive environment in which the Company operates. The consolidated financial statements do not include, nor does management feel it necessary, any adjustments to reflect any possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern NOTE 2. BUSINESS COMBINATION On February 1, 2001, Paladyne Corp. ("Paladyne") through a wholly-owned subsidiary ecom Acquisition Corp. ("Acquisition Sub"), merged (the "Merger") with e-commerce support centers, inc., a North Carolina corporation ("ecom"), pursuant to an Agreement and Plan of Merger, dated as of December 21, 2000, as amended (collectively, the "Merger Agreement") in a transaction accounted for using the purchase method of accounting. Upon the Merger, ecom became a wholly owned subsidiary of Paladyne. ecom is a provider of Customer Relationship Management (CRM) solutions and customer contact center services as an outsourcing option to companies from its contact center in Jacksonville, NC. The merger consideration (the "Merger Consideration") to the ecom shareholders consisted of shares of newly created Series B Convertible Preferred Stock, $.001 par value (the "Series B Preferred Stock"), Anti-Dilution Warrants and Performance Warrants (as discussed below) and the right to receive additional shares of Paladyne Common Stock in conjunction with future placements by Paladyne. Terrence J. Leifheit, the principal shareholder of ecom, and another ecom shareholder, delivered into escrow securities representing approximately 25% of the aggregate Merger Consideration as security for indemnification claims Paladyne may have under the Merger Agreement. 8 NOTE 2-BUSINESS COMBINATION (continued) --------------------------------------- Upon the Merger, Paladyne issued 4,100,000 shares of Series B Preferred Stock. Each share of Series B Preferred Stock voted on a two-for-one basis with the Common Stock on all matters, but with a separate vote on matters directly affecting such Series, mandatorily converts into two shares of Paladyne Common Stock immediately following stockholder approval of an increase in the number of authorized shares of Common Stock, will receive any dividends declared on an as-converted basis with the Common Stock and will have a liquidation preference of $5.00 per share. The stockholder approval was obtained at a July 10, 2001 stockholders meeting, accordingly, the shares are deemed converted as of that date. To protect against dilution to the former ecom shareholders upon exercise of outstanding pre-Merger Paladyne options and warrants (the "Present Options/Warrants"), Paladyne granted to them Anti-Dilution Warrants to purchase 4,000,000 shares of Paladyne Common Stock at an exercise price of $1.146 per share (subject to adjustment), vesting as to 0.6 of a share of Common Stock for each share of Common Stock issued upon the exercise of Present Options/Warrants, and expiring 30 days after the later of (i) termination or exercise of all Present Options/Warrants or (ii) notice from Paladyne as to the aggregate number of Present Options/Warrants that were exercised. Approximately 258,000 of these Anti-Dilution Warrants have now expired unexercised as a result of the expiration of approximately 430,000 of the Present Options/Warrants. To give the former ecom shareholders the opportunity to participate more directly in the future performance of Paladyne resulting from the acquired ecom business, Paladyne granted to them Performance Warrants to purchase 500,000 shares of Paladyne Common Stock at an exercise price of $1.146 per share (subject to adjustment), exercisable for five years and vesting in 100,000 share tranches for each $20 million of net revenue increases, above $50 million annually, achieved in either year or both of the two (2) year periods ending January 31, 2002 and 2003. For the purpose of these awards, the measurement will be on a trailing 12-month basis, and with an acceptable gross margin (20% or greater) for each tranche to qualify. In addition, ending upon the earlier to occur of December 20, 2002 or Paladyne's completion of $6,500,000 in cash from sales of Common Stock or Common Stock equivalents (the "New Securities"), ecom shareholders will receive, one share (the "Deferred Shares") of Common Stock for each $1.00 in gross proceeds received upon the sale of New Securities or issuable upon conversion, exercise or exchange of New Securities. ecom shareholders waived their rights under this provision for the private placement of Series C Preferred Stock. The Merger Agreement provided that Paladyne would grant options, at market value, to ecom employees for the purchase of an aggregate of 500,000 shares of Paladyne Common Stock under its 1999 Stock Option Plan. The Compensation Committee of the Board of Directors was authorized to grant such options upon receipt from former ecom management of a proposal of the ecom employees to whom the options should be granted. Immediately prior to the Merger, ecom purchased from Gibralter Publishing, Inc., a North Carolina corporation, all of the tangible and intangible assets used in ecom's call center operations, subject to related liabilities, pursuant to an Option Agreement. Prior to the Merger, Gibralter had been operating the call center on behalf of ecom. The purchase price for these assets was $5 million which is payable by ecom pursuant to two amended promissory notes issued to Gibralter and guaranteed by Paladyne, one note for $1,500,000, repayable in two installments of $750,000, the first being due after completion of a $3,000,000 equity or convertible debt offering and the remaining payment due no sooner than six months after the first payment and after three consecutive months of positive cash flow from operations. The second note for $3,500,000 is repayable in equal quarterly principal and interest payments of $377,000 beginning in April 2002 and continuing through January 2005. Both notes bear interest at 10% per annum and are secured by the purchased assets. A portion of these assets used by ecom in its contact center operations consists of equipment that is leased by Gibraltar pursuant to various equipment leases. Pending the receipt by Gibralter of lessor consents to the assignments of these leases to ecom, and in accordance with an Equipment Use Agreement entered into by Gibralter and ecom, Gibralter has granted to ecom the right to possess and use the equipment and ecom has agreed to assume and pay to the lessors the payments to be made by Gibralter pursuant to the leases. 9 The total purchase price and carrying value of the net assets acquired and liabilities assumed of ecom were as follows: Debts assumed $ 5,000,000 Other liabilities assumed 2,375,579 Costs of acquisition 467,000 Preferred stock issued 5,765,000 Less: assets acquired (4,234,636) ----------- Excess of purchase price over fair value of assets acquired $ 9,372,943 =========== The 4,100,000 shares of Series B Preferred Stock issued in the Merger was valued based upon the underlying 8,200,000 shares of Common Stock at a price of $.7031 (the average the Company's common stock price five days prior to February 1, 2001) for a total consideration of $5,765,000. The Company has recorded the carryover basis of the net assets acquired, which did not differ materially from their fair value. The results of operations subsequent to the date of acquisition are included in the Company's consolidated statement of operations. Impairment Charge ----------------- During the year ended August 31, 2001, the Company recorded a charge of $ 9,008,713 for goodwill impairment related to its ecom subsidiary. Subsequent to its acquisition in February 2001, the ecom subsidiary experienced significant changes in market conditions. This change caused the subsidiary not to reach the sales levels the Company originally anticipated at the time of the acquisition. In addition, the Company's acquisition and related business plan contemplated the private placement of the Company's equity in order to develop the subsidiary. Due to adverse capital market conditions, the Company was unable to raise a significant amount of equity financing. Separately, during the year ended August 31, 2001, the Company ceased the development of the Company's data integration and data quality software and recorded a charge of $338,037 for impairment of capitalized software related to this discontinued operations. Due to the significance of the changes discussed above, management performed an evaluation of the recoverability of all of the assets of ecom, as described in Statement of Financial Accounting Standards No. 121, "Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of". Management concluded from the results of this evaluation that a significant impairment charge was required because estimated fair value was less than the carrying value of the assets. Considerable management judgment is necessary to estimate fair value. Accordingly, actual results could vary significantly from managements' estimates. Based upon the evaluation, the Company recognized an asset impairment loss of $9,346,750 or $ .71 per share during the year ended August 31, 2001. The following unaudited pro forma information presents the condensed consolidated statement of operations of the Company as if the acquisition had taken place on September 1, 1999. e-com had a December 31 year end and therefore, e-com's results for the three and six months ended December 31, 2000 have been consolidated with Paladyne's results for the three and six months ended February 28, 2001. e-com's results for the three and six months ended March 31, 2000 have been consolidated with Paladyne's results for the three and six months ended February 29, 2000. For the three months ended For the six months ended February 28, February 28, 2002 2001 2001 2000 ---- ---- ---- ---- Actual Pro Forma Revenues $ 2,523,723 $ 2,121,055 $ 4,963,999 $ 4,733,619 Net loss attributable to common stockholders $ (352,227) $(1,392,276) $ (915,386) $(2,799,814) 10 Weighted average common shares outstanding: Basic and diluted 16,709,351 8,459,351 16,709,351 8,458,956 Earnings (loss) per share: Basic and diluted $ (.02) $ (.16) $ (.05) $ (.33) These unaudited pro forma results have been prepared for comparative purposes only and include certain adjustments, such as additional amortization expense as a result of the goodwill and increased interest expense on acquisition related debt. They do not purport to be indicative of the results of operations that actually would have resulted on the date indicated, or which may result in the future. NOTE 3. SERIES A DIVIDEND The holders of the Company's Series A cumulative convertible preferred stock are entitled to receive, out of the net profits of the Company, annual dividends at the rate of $.2975 per share. If the net profits of the Company are not sufficient to pay the preferred dividend, then any unpaid portion of the dividend will be included in accrued expenses. The Company had accrued cumulative preferred stock dividends of $170,000 as of February 28, 2002. NOTE 4. STOCKHOLDERS' DEFICIT The Series A Preferred Stock issued in the 1998 acquisition of WG Controls, a former subsidiary, provides for annual dividends of $0.2975 per share or $40,800 per year. If the Company's profits are insufficient to pay such dividends, they will be cumulative and accrued for payment when Company profits are adequate to fund payment. The conversion provision of the Series A Preferred Stock calls for each of the 137,143 preferred shares to be converted into .67361 shares of the Company's Common Stock, or an aggregate of 92,381 shares of Common Stock when the Company's Common Stock achieves an average closing price of $5.25 per share for a consecutive 60-day trading period. The Series A Preferred Stock has the same voting rights as the Common Stock and have preference to the Common Stock in the event of any liquidation, dissolution or winding up of the Company, whether voluntary of involuntary. On February 1, 2001, the Board of Directors authorized the issuance of 4,100,000 shares of newly created Series B Convertible Preferred Stock in connection with the Merger of ecom. These shares were converted to 8,200,000 shares of the Company's Common Stock on July 10, 2001. On September 24, 2001, the Board of Directors authorized a private placement of up to 600,000 units priced at $5.00 per unit, with a unit consisting of three shares of the Company's Series C 8% Cumulative Convertible Preferred Stock. Each Series C Preferred share is convertible into 10 shares of the Company's Common Stock at $3.00 per share. Net proceeds from this private placement as of February 28, 2002 $1,412,230, which is net of offering expenses of $136,920 and includes the exchange of $300,000 in debt for this Series C Preferred Stock. This resulted in the issuance of 930,000 shares of Series C Preferred Stock. NOTE 5. INCOME TAXES The Company has adopted Financial Accounting Standard Number 109(SFAS 109) which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statement or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Temporary differences between taxable income reported for financial reporting purposes and income tax purposes are insignificant. For income tax reporting purposes, the Company's aggregate unused net operating losses approximate $13,520,000, which expire through 2020. The deferred tax asset related to the carryforward is approximately $4,400,000. The Company has provided a valuation reserve against the full amount of the net operating loss benefit, since in the opinion of management based upon the earnings history of the Company, it is more likely than not that the benefits will be realized. Significant changes in ownership may limit the Company's future use of its existing net operating losses. 11 NOTE 6. CONTINGENCY A former Company employee filed a complaint against the Company alleging that the Company owes the plaintiff additional compensation. The Company believes that it has meritorious defenses to the plaintiff's claims and intends to vigorously defend itself against the plaintiff's claims. The Company is also subject to other legal proceedings and claims that arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur, the Company believes that the final disposition of such matters will not have a material adverse effect on its financial position, results of operations or liquidity. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Since the February merger with e-commerce support centers, inc. ("ecom"), Paladyne Corp. (the "Company") has provided CRM-based customer and tech support, and outbound telemarketing for business-to-business and business-to-customer needs, see Note 2 to the notes to the financial statements. The Company's consolidated financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. As with any new venture, concerns must be considered in light of the normal problems, expenses and complications encountered by entrance into established markets and the competitive environment in which the Company operates. The consolidated financial statements do not include, nor does management feel it necessary, any adjustments to reflect any possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern. The Company's independent accountant's report contained a going concern qualification for the year ended August 31, 2001. The Company maintains substantial business relationships with Gibralter Publishing, Inc. ("Gibralter"), from which it has acquired or leased a substantial portion of the ecom assets in exchange for the installment notes, see note 2 to the condensed consolidated financial statements. Gibralter continues to be the Company's principal customer, accounting for approximately 50% of the revenues for the six month period and three month period ended February 28, 2002. During the three months ended February 28, 2002, the Company has continued to reduce or eliminate non-critical expenses and operations. Certain personnel continue to defer all or a portion of their compensation. RESULTS OF OPERATIONS The following table sets forth the percentage relationship to the total revenues of principal items contained in the Company's Condensed Consolidated Statements of Operations for the three and six months ended February 28, 2002 and 2001, respectively. The percentages discussed throughout this analysis are stated on an approximate basis. Three months Ended Six months Ended February 28, February 28, 2002 2001 2002 2001 ------------------ ---------------- (UNAUDITED) (UNAUDITED) Total revenues 100% 100% 100% 100% Cost of revenues 54% 53% 54% 53% ---- ---- ---- ---- Gross profit 46% 47% 46% 47% Operating expenses 53% 69% 57% 69% ---- ---- ---- ---- Operating loss (7%) (22%) (11%) (22%) Interest expense (6%) (6%) (6%) (6%) Loss from discontinued operations (77%) (123%) ---- ---- ---- ---- Net loss (13%) (105%) (17%) (151%) ---- ---- ---- ---- ---- ---- ---- ---- 13 COMPARISON OF THE SIX MONTHS ENDED FEBRUARY 28, 2002 TO THE SIX MONTHS ENDED FEBRUARY 28, 2001 ---------------------------------------------------------------------------- Revenues for the six months ended February 28, 2002 and 2001 were $4,963,999 and $897,082, respectively; this represents a 450% increase in sales. This is due to the February 28. 2001 period containing only one month's revenue. All of these revenues were derived entirely from the Company's CRM-based customer and tech support, and outbound telemarketing for business-to-business to business-to- customer operations. These operations began with the purchase of ecom on February 1, 2001 as discussed in Note 2 to the condensed financial statements. Other revenue for the six months ended February 28, 2001 were attributable entirely to the discontinued operations relating to the contract software and service center operations and have accordingly been combined into the loss from discontinued operations. Cost of revenues of $2,684,896 and $472,809, respectively for the six months ended February 28, 2002 and 2001 were 54% and 53% of revenue for the periods. The increase in cost of sales of $2,212,087 from the six months ended February 28, 2001 to February 28, 2002 is due to the 2001 period reflecting only one month of activity. Gross profit was $2,279,103 and $424,273, respectively for the six months ended February 28, 2002 and 2001 were 46% and 47% of revenue for the periods. The increase in gross profit of $1,854,830 from the six months ended February 28, 2001 to February 28, 2002 is due to the 2001 period reflecting only one month of activity. Operating expenses of $2,851,095 and $616,061, respectively for the six months ended February 28, 2002 and 2001 were 57% and 69% of revenue for the periods. The decline as a percentage of revenue from 69% to 57% is due significant cost cutting actions taken during the last nine months and the decrease in depreciation and amortization expenses as a result of the write off of goodwill due to its impaired value. This reduction in depreciation and amortization expenses totaled approximately $294,000 or 6% of revenue for the six months ended February 28, 2002. The increase in operating expenses of $2,235,034 from the six months ended February 28, 2001 to February 28, 2002 is due to the 2001 period reflecting only one month of activity. Interest expense, as percentage of revenue, remained unchanged at 6% during the six months ended February 28, 2001 as compared to the six months ended February 29, 2002. The increase from $57,473 to $322,944 is attributable to the six months of activity in 2002 as compared to the one period month shown in 2001. COMPARISON OF THE THREE MONTHS ENDED FEBRUARY 28, 2002 TO THE THREE MONTHS ENDED FEBRUARY 28, 2001 -------------------------------------------------------------------------------- Revenues for the three months ended February 28, 2002 and 2001 were $2,523,723 and $897,082, respectively; this represents a 180% increase in sales. This is due to the February 28. 2001 period containing only one month's revenue. All of these revenues were derived entirely from the Company's CRM-based customer and tech support, and outbound telemarketing for business-to-business to business-to-customer operations. These operations began with the purchase of ecom on February 1, 2001 as discussed in Note 2 to the condensed financial statements. Other revenue for the six months ended February 28, 2001 were attributable entirely to the discontinued operations relating to the contract software and service center operations and have accordingly been combined into the loss from discontinued operations. Cost of revenues of $1,368,102 and $472,809, respectively for the six months ended February 28, 2002 and 2001 were 54% and 53% of revenue for the periods. The increase in cost of sales of $895,293 from the three months ended February 28, 2001 to February 28, 2002 is due to the 2001 period reflecting only one month of activity. Gross profit was $1,155,621 and $424,273, respectively for the three months ended February 28, 2002 and 2001 and was 46% and 47% of revenue for the periods. The increase in gross profit of $731,348 from the three months ended February 28, 2001 to February 28, 2002 is due to the 2001 period reflecting only one month of activity. Operating expenses, including depreciation and amortization, have decreased as percentage of revenue from 69% for the three months ended February 28, 2001 to 53% for the six months ended February 28, 2002. The decline as a percentage of revenue from 69% to 57% is due significant cost cutting actions taken during the last nine months and the decrease in depreciation and amortization expenses as a result of the write off of goodwill due to its impaired value. This reduction in 14 depreciation and amortization expenses totaled approximately $147,000 or 6% of revenue for the six months ended February 28, 2002. The increase in operating expenses of $731,759 from the three months ended February 28, 2001 to February 28, 2002 is due to the 2001 period reflecting only one month of activity. Interest expense, as a percentage of revenue, remained unchanged at 6% during the three months ended February 28, 2001 as compared to the three months ended February 28, 2002. The increase from $57,473 to $149,828 is attributable to the three months of activity in 2002 as compared to the one period month shown in 2001. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company's principal cash requirements are for operating expenses, including employee costs, funding of accounts receivable, capital expenditures and funding of the operations. The Company's primary sources of cash had been from private placements of the Company's preferred or common stock and a bank line of credit. The Company has continued to aggressively seek additional financing or additional equity infusion to fund the acquisition and growth of ecom. A private placement of the Company's Series C Preferred Stock was offered through February 28, 2002. At February 28, 2002 $1,549,150 has been raised (this includes the $300,000 issued in exchange for debt). The Company has completed most of its cost cutting moves including closing the Florida and Virginia offices and certain employee reductions. Conventional bank financing has not been expanded but with successful completion of the private placement we intend to aggressively pursue increases in our bank financing. The existing line of credit of $350,000 is past due and in default. The Company plans to repay this borrowing with proceeds from the private placement or an alternate borrowing source. The Company must obtain additional capital, primarily to enable payment of the merger related costs from the February 2001 merger with ecom and to enable the execution of the ecom business plan. These merger costs, additional borrowing related to the merger, and the loss of the Company's traditional revenue sources (discontinued operations) have strained liquidity significantly Cash used in operating activities was $477,172 for the six months ended February 28, 2002. This cash decrease is primarily the result of increased operating losses, caused by the loss of the Company's traditional revenue source and revenue levels that are at less than a breakeven volume. Increasing revenues or further cost cutting will be required in the future. The Company invested $303,266 in computers and leasehold improvements during this period. The Company met its cash requirements during the six months ended February 28, 2002 through the receipt of $1,249,150 (net of exchange for debt and before payment of private placement expenses) from the sale of the Series C Preferred Stock in a private placement. While the Company has raised capital to meet its working capital requirements in the past, additional financing is required, in order to meet current and projected cash flow deficits from operations. The Company is seeking financing in the form of equity and debt. There are no assurances the Company will be successful in raising the funds required and any equity raised would be substantially dilutive to existing shareholders. In prior periods, significant shareholders have loaned money to or guaranteed indebtedness of the Company to satisfy certain obligations. No assurance can be given that such shareholders would guarantee any further indebtedness or seek to withdraw their existing guarantees. As the Company continues to expand, the Company will incur additional costs for personnel. In order for the Company to attract and retain quality personnel, management anticipates it will continue to offer competitive salaries, issue common stock to consultants and employees, and grant Company stock options to current and future employees. The Company's independent certified public accountants have stated in their report included in the Company's August 31, 2001 Form 10-KSB, that the Company is experiencing difficulty in generating sufficient cash flow to meet it obligations and sustain its operations. These factors among others may raise substantial doubt about the Company's ability to continue as a going concern. INFLATION --------- In the opinion of management, inflation has not had a material effect on the operations of the Company. 15 RISK FACTORS AND CAUTIONARY STATEMENTS -------------------------------------- Forward-looking statements in this report are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. The Company wishes to advise readers that actual results may differ substantially from such forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those expressed in or implied by the statements, including, but not limited to, the following: the ability of the Company to provide for its debt obligations and to provide for working capital needs from operating revenue, and other risks detailed in the Company's periodic report filings with the Securities and Exchange Commission. 16 PART II ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (a) None (b) None (c) Sale of Securities During the fiscal quarter ended February 28, 2002, the Company sold 298,000 shares of its Series C Preferred Stock in a placement claimed to be exempt from the registration provisions of the Securities Act by reason of Section 4(2) thereof. The purchasers entered into Subscription Agreements containing customary representations and warranties regarding their knowledge of the Company and their understanding of the exemption from registration. The purchasers either paid cash or exchanged existing outstanding indebtedness for their shares. The Company received $436,116, net of commissions of $59,784 to Attkinson Carter & Co., the placement agent. The Series C Preferred Stock is convertible into shares of Common Stock, see Note 4 to the financial statements in this report. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits (b) Reports on Form 8-K 1. None SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PALADYNE CORP. Date: April 5, 2002 By /s/ Terrance Leifheit --------------------- Terrance Leifheit President Date: April 5, 2002 By /s/ Clifford Clark --------------------- Clifford Clark Chief Financial Officer 17