S-1/A 1 ds1a.htm S-1/A AMENDMENT #6 S-1/A Amendment #6
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As filed with the Securities and Exchange Commission on July 22, 2011

Registration No. 333-164568

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

AMENDMENT No. 6 to

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

GLASSHOUSE TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   7373   04-3561337
(State or Other Jurisdiction of
Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
 

(I.R.S. Employer

Identification Number)

200 Crossing Boulevard

Framingham, Massachusetts 01702

(508) 879-5729

(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices)

Mark A. Shirman

Chairman of the Board of Directors, President and Chief Executive Officer

200 Crossing Boulevard

Framingham, Massachusetts 01702

(508) 879-5729

(Name, address, including zip code and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Marc F. Dupré

Keith J. Scherer

Gunderson Dettmer Stough

Villeneuve Franklin & Hachigian, LLP

850 Winter Street

Waltham, Massachusetts 02451

Telephone: (781) 890-8800

Telecopy: (781) 622-1622

 

Keith F. Higgins

Ropes & Gray LLP

Prudential Tower

800 Boylston Street

Boston, Massachusetts 02199

Telephone: (617) 951-7000

Telecopy: (617) 951-7050

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Larger accelerated filer  ¨

   

Accelerated filer  ¨

Non-accelerated filer  x

 

(Do not check if a smaller reporting company)

 

Smaller reporting company  ¨

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated July 22, 2011.

LOGO

                     Shares

Common Stock

 

 

This is an initial public offering of shares of common stock of GlassHouse Technologies, Inc. All of the             shares of common stock are being sold by the company.

Prior to this offering, there has been no public market for the common stock. It is currently estimated that the initial public offering price per share will be between $             and $            . We have applied to have our common stock listed on the Nasdaq Global Market under the symbol “GLAS”.

 

 

Please see the section titled “Risk Factors” beginning on page 11 to read about factors you should consider before buying shares of the common stock.

 

 

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discount

   $                    $                

Proceeds, before expenses, to GlassHouse

   $                    $                

To the extent that the underwriters sell more than              shares of common stock, the underwriters have the option to purchase up to an additional              shares from GlassHouse at the initial public offering price less the underwriting discount.

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2011.

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

Prospectus dated                     , 2011.

 

Stifel Nicolaus Weisel   William Blair & Company

Oppenheimer & Co.

Needham & Company, LLC


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LOGO

 


Table of Contents

TABLE OF CONTENTS

Prospectus

 

     Page  

Prospectus Summary

     1   

The Offering

     6   

Summary Historical and Unaudited Pro Forma Consolidated Financial and Other Data

     8   

Risk Factors

     11   

Special Note Regarding Forward-Looking Statements

     26   

Industry and Market Data

     27   

Use of Proceeds

     28   

Dividend Policy

     29   

Capitalization

     30   

Dilution

     32   

Selected Consolidated Financial Data

     34   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     36   

Business

     77   

Management

     91   

Transactions with Related Persons, Promoters and Certain Control Persons

     111   

Principal Stockholders

     114   

Description of Capital Stock

     117   

Shares Eligible for Future Sale

     120   

Underwriting

     122   

Legal Matters

     126   

Experts

     126   

Where You Can Find More Information

     127   

Index to Financial Statements

     F-1   

 

 

Through and including                     , 2011 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This obligation is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

 

We have not authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses we have prepared. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the common stock offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.


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PROSPECTUS SUMMARY

This summary highlights the most important features of this offering and the information contained elsewhere in this prospectus. This summary is not complete and does not contain all of the information that you should consider before investing in our common stock. We have experienced recurring operating losses in the past and may continue to do so, and our auditors have raised substantial doubt about our ability to continue as a going concern through December 31, 2011. You should read the entire prospectus carefully, especially the risks of investing in our common stock discussed under the heading “Risk Factors” and our consolidated financial statements and related notes included in this prospectus.

Summary

We are a global provider of information technology (IT) consulting, implementation and managed services focused in the data center. We believe that cloud computing, virtualization, the increasing demand for data storage, backup and disaster recovery, and a growing number of government and industry regulations, among other things, are driving a major shift in data center architecture and IT infrastructure. In addition, the increasing demand for energy and computing power in outdated data centers, ongoing data growth and constrained data center budgets are creating a demand for services to help companies adopt, integrate and manage new technologies and capabilities. Our vendor independent services help our clients address inefficiencies in their data center environment and help them fill the gap between their current capabilities and those needed to support these new and emerging data center architectures and technologies.

We deliver IT services through Transom, our unique business model consisting of software tools, methodologies and subject matter expertise, each developed over the course of thousands of client engagements. Transom standardizes our global offerings into high quality services we can deliver in a consistent manner to our clients.

Our clients include approximately half of the Fortune 100 companies. We have clients across many industries, including financial services and insurance, energy, healthcare and medical, travel and entertainment and government agencies, primarily in North America, Europe and the Middle East. Our clients use our services to reduce costs, minimize risk and improve control and visibility in their data centers.

Our Services

We offer our clients a number of services aimed at improving the performance of their data centers. A data center is the physical environment that houses IT infrastructure, which typically consists of storage, server and networking hardware and software that supports business functions, such as accounting and payroll, marketing and sales, and customer service. Initiatives like cloud computing cross several areas of IT infrastructure and our services help clients design, plan, execute and manage the new technology in their data centers.

Strategic Consulting Services

Our strategic consulting services typically consist of customized, industry-specific consulting engagements through which we help our clients develop strategies, architectures and business cases to optimize their IT infrastructure. During these engagements, our consultants work with our client’s in-house IT team to understand the current state and the desired future state of their IT environment and design solutions to meet the client’s objectives.

Implementation Services

Our implementation services help clients with the technical deployment, modernization and integration of complex technologies in their data centers. Our services help clients integrate new technologies into their existing IT environments and create a more efficient IT infrastructure that fully leverages assets, reduces costs and meets or exceeds target service levels.

Managed Services

Our managed services provide operational management of various aspects of a client’s IT infrastructure, including storage, backup, databases, virtual server environments and facets of IT security. Governed by a set

 

 

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of service level agreements, we assume all operational responsibilities on behalf of our clients for day-to-day tasks for these areas of IT infrastructure. We also provide visibility into clients’ IT infrastructure through reporting and monitoring services, delivered through a software-as-a-service tool suite, and customer support services that include global remote technical support, field services and logistics through our 24 hour, seven days a week, 365 days a year service operations center.

Market Overview

Our data center consulting, implementation and managed services target a number of large and growing segments of the market.

 

   

Cloud Computing: Cloud computing is Internet-based computing in which hardware, software and information are provided to the customer as an on-demand service. Cloud infrastructure is the servers, network security and storage that enable cloud computing solutions. According to Gartner Inc. (Gartner), cloud systems infrastructure services are expected to grow at a 47.8% CAGR from $2.8 billion in 2010 to $19.6 billion in 2015.1 We believe that the expected growth in cloud services reflects a shift in business computing that will result in clients utilizing our services as they seek to leverage this new technology.

   

Virtualization: Virtualization is the creation of a virtual (rather than physical) version of something, such as an operating system, a server, a storage device or network resources, resulting in higher utilization of actual physical hardware. According to Gartner, spending on x86 server (the industry’s most commonly deployed server) and desktop virtualization software technologies is forecast to grow at a 25.7% CAGR through 2014, reaching $6.3 billion.2 We believe that this growth in the virtualization software market will result in increased spending for our services as clients seek external expertise and support to integrate new technology and migrate to virtualized data center environments.

   

Data Storage/Backup & Recovery: According to Gartner, the data storage services market, which includes consulting and managed services as well as data storage capacity services for backup and recovery operations, is expected to grow at a 4.0% CAGR from $14.7 billion in 2009 to $18.3 billion by 2014.3 Although we do not currently provide data storage capacity as part of our service offerings, we believe the growth in the overall data storage services market will lead to increased demand for our consulting, implementation and managed services offerings.

   

Data Center Consolidations/Migrations: Consolidations and migrations involve the creation of a new architecture for IT hardware and software, relocation of data and the hardware that holds it, technology upgrades and changes to IT management processes. In a recent Enterprise Strategy Group survey, respondents ranked consolidating their data centers in the top quartile of their initiatives over the next 12-18 months.4 We believe that the focus on consolidation will lead to increased demand for our services as we help clients plan and execute these projects.

   

IT Security: The IT security services market is expected to increase at a CAGR of 8.2% from $27.8 billion in 2009 to $41.4 billion in 2014, according to Gartner.5 We believe that this growth will result in increased demand for our IT security services, as we help clients plan and execute projects to improve their IT security.

 

1. Gartner Inc: Forecast: Public Cloud Services, Worldwide and Regions, Industry Sectors, 2010-2015, 2011 Update. By Ben Pring, Robert H. Brown, Lydia Leong, Fabrizio Biscotti, Laurie F. Wurster, Jeffrey Roster, Susan Cournoyer, Andrew Frank, Michele C. Caminos and Venecia K. Liu. 29 June 2011. The Gartner Reports described herein (the Gartner Reports) represent data, research, opinions or viewpoints published, as part of a syndicated subscription service available only to clients, by Gartner, and are not representations of fact. We have been advised by Gartner that each Gartner Report speaks as of its original publication date (and not as of the date of this prospectus) and the opinions expressed in the Gartner Reports are subject to change without notice. Please see the section titled “Industry and Market Data” for more information about the industry and market data and other statistical information used by us throughout this prospectus.
2. Gartner Inc: Market Trends: x86 Virtualization Market Driven by Management and Desktop Needs. By Alan Dayley. 17 September 2010.
3. Gartner Inc: Forecast: Storage Professional Services, Worldwide, 2009-2014. By Adam W. Couture, Rob Addy, Yuko Adachi and Freddie Ng. 4 January 2011.
4. Enterprise Strategy Group, 2011 IT Spending Intentions Survey. January 2011
5. Gartner Inc: Forecast: Security Services Markets Worldwide, 2009-2014. By Ruggero Contu, Andrew Walls, Casper Carsten, Jason Harris and Kelly Kavanagh. September 2010.

 

 

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Disaster Recovery: The disaster recovery market crosses several domains, including storage, backup, virtualization and IT security. We believe that as other market areas experience growth, the need for updated disaster recovery plans, processes and technical implementation will increase, resulting in additional demand for our services.

The convergence of new technologies and increased demands on IT infrastructure is creating significant challenges for IT executives. In order to remain competitive on a cost and time-to-market basis, IT executives must ensure that they are adapting to new paradigms of efficiency, speed and application delivery. We believe that IT executives recognize that their in-house teams are more focused on managing day-to-day operations and will therefore increasingly turn to third-party consulting firms to help identify and incorporate new and emerging technologies in order to:

 

   

Capitalize on Cloud Computing and Virtualization Technologies: To improve efficiency and agility, as well as to manage costs, IT executives are looking to optimize existing assets while leveraging new technologies such as cloud computing and virtualization to gain higher efficiency from their IT environments. We believe these initiatives have inherent challenges and are leading enterprises to augment their internal IT teams with third-party consulting and managed services to ensure best practices are implemented and service levels are met.

   

Manage Risk Efficiently and Cost Effectively: IT executives must address both external and internal threats in order to manage risk. External threats include catastrophic weather events and terrorist attacks that are beyond an IT executive’s control, but still must be addressed through contingency plans. External threats also include computer and network viruses and attacks from hackers. Internal risks are associated with complex, multi-vendor IT environments. As new and emerging technologies are introduced into the data center, there is an increasing risk of improperly integrating these technologies into an overall IT infrastructure.

   

Minimize Costs Within Constrained IT Budgets: Business and technology leaders are expected to address an increasing scope and complexity of IT challenges with fewer resources and usually under substantial time pressures, and we believe that IT executives will seek third-party assistance to reduce operational expenses and understand asset utilization and total cost of ownership, in an effort to justify current spending and future investments.

We believe our services provide compelling benefits to our clients, including:

 

   

access to leading-edge data center infrastructure strategies and practices;

   

demonstrable return on investment in IT infrastructure;

   

minimized project execution risk;

   

decreased risk of data loss; and

   

enhanced visibility into the IT environment.

Our Growth Strategy

Our objective is to enhance our industry position, while continuing to grow our revenues and profitability. Our strategy to achieve these objectives includes the following:

 

   

Deepen and Expand Relationships with Our Current Client Base: We have historically generated a significant amount of our revenues from new projects with existing clients. As clients adopt cloud computing and other new technologies, we expect to continue to sell services to meet their evolving needs.

   

Engage New Clients with Our Direct Sales Force: Our direct sales team pursues a target prospect list of Fortune 2500 companies to establish new client relationships. We also participate in industry events and direct marketing activities to increase broad awareness of our services to prospective clients. We have an inside sales function in the United States and the United Kingdom to pursue and develop these prospects into new clients.

 

 

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Leverage Our Strategic Partners: Our indirect sales channel relationships with strategic partners such as Dell, IBM, Cisco, Bull, Citrix, Cable&Wireless Worldwide and HP provide us with access to additional enterprise clients to whom we can ultimately cross-sell a broad range of consulting, implementation and managed services. We plan to continue expanding our strategic partnerships while deepening our relationships with existing partners.

   

Broaden Our Managed Services Offerings: We provide operational management in several areas of our clients’ IT infrastructure as well as monitoring and reporting services, and customer support services. We intend to expand our managed services offerings to provide additional services within our targeted domain areas.

   

Acquire Complementary Businesses and Technology: We believe that in many cases, the best approach to meeting client demand and adding new skills and services to our service offerings is to acquire complementary resources and expertise. We evaluate all potential acquisitions using our Transom business model as a filter. We assess potential acquisition targets for software tools, methodologies and domain expertise with the potential to be complementary to our existing business.

Clients

We have developed relationships with a large number of Fortune 1000 companies, including approximately half of the Fortune 100 companies, as well as many smaller organizations and government agencies. We market and provide our services primarily to companies in North America, Europe and the Middle East. We believe that our regular, direct interaction with our clients, the breadth of our client relationships and our reputation among these clients as an independent advisor differentiate us from our competitors.

For 2010, and the three months ended March 31 2011, we had no direct client or indirect channel relationships that represented 10% or more of our total revenues.

As of March 31, 2011, we had 533 employees, including approximately 41 direct sales people. Our sales effort is further bolstered by our strategic relationships with technology companies such as Dell Products L.P. (Dell), International Business Machines Corp. (IBM), Cisco Systems, Inc. (Cisco), Bull SAS (Bull), Hewlett-Packard Company (HP), Cable&Wireless Worldwide (C&WW) and Citrix Systems, Inc. (Citrix).

Our revenues consist of services and product revenues. Our focus is on growing our services revenues. Our services revenues have grown from $35.2 million in 2006 to $94.9 million in 2010, reflecting a total compounded annual growth rate of 28%, including acquisitions. Our services revenues have grown from $21.3 million for the three months ended March 31, 2010 to $26.5 million for the three months ended March 31, 2011. For 2006, 2007, 2008, 2009, 2010 and the three months ended March 31, 2010 and 2011 we had net losses to common stockholders of $(13.1) million, $(18.2) million, $(28.1) million, $(12.8) million, $(25.9) million, $(10.2) million and $(6.6) million, respectively. At March 31, 2011, we had an accumulated deficit of $(151.8) million.

Recent Developments

We issued Dell Products L.P. (Dell) a convertible promissory note that is currently outstanding and under which we will owe Dell approximately $38.5 million in total payments at maturity, of which $1.4 million has been paid as of the date of this filing. Dell has extended the maturity date on the note through September 16, 2011. We paid Dell $350,000 upon execution of definitive documentation formalizing the extension and paid an additional $1.3 million on July 21, 2011. Interest accrues at a simple annual rate of 22.5% effective June 13, 2011. We have agreed to repay the note in full upon the consummation of this offering and to provide Dell with certain rights of refusal in the event we receive an acquisition proposal prior to payment in full of the note.

In July 2011, we sold shares of our Series F Preferred Stock, along with warrants to purchase our common stock, to Citrix Systems, Inc. and Greenspring Associates with net proceeds of approximately $5.0 million and $1.0 million respectively.

 

 

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Risks That We Face

You should carefully consider the risks described under the section titled “Risk Factors” and elsewhere in this prospectus, including the risks associated with our ability to continue as a going concern. These risks could materially and adversely impact our business, financial condition, operating results and cash flow, which could cause the trading price of our common stock to decline and could result in a partial or total loss of your investment.

Our Corporate Information

We were incorporated in Delaware in 2001. Our principal executive offices are located at 200 Crossing Boulevard, Framingham, Massachusetts 01702 and our telephone number is (508) 879-5729. Our Web site address is www.glasshouse.com. The information on, or that can be accessed through, our Web site is not part of this prospectus.

TransomSM is our service mark.

 

 

 

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THE OFFERING

 

Total common stock offered by us

             shares

Option to purchase additional shares offered to underwriters by us

             shares

Total common stock to be outstanding after this offering

             shares

Use of proceeds

We expect to use the net proceeds of this offering for working capital, repayment of our outstanding loan from Dell, and general corporate purposes, and we intend to use a portion of the net proceeds to repay, from time to time, acquisition-related loans. Please see the section titled “Use of Proceeds.”

Risk factors

You should read the “Risk Factors” section of this prospectus for a discussion of factors that you should consider carefully before deciding to invest in shares of our common stock.

Proposed Nasdaq Global Market symbol

GLAS

The number of shares of our common stock to be outstanding after the offering is based on 69,448,838 shares of common stock issued and outstanding as of March 31, 2011, including the assumed conversion of 52,429,679 shares of preferred stock issued and outstanding on March 31, 2011 into 52,429,678 shares of common stock in connection with the closing of this offering. Except where stated otherwise herein, the number of shares of common stock to be outstanding after this offering does not take into account:

 

   

11,536,551 shares of our common stock issuable upon exercise of options outstanding as of March 31, 2011 at a weighted average exercise price of $1.02 per share;

   

2,427,697 shares of our common stock reserved as of March 31, 2011 for future issuance under our stock-based compensation plans;

   

7,042,256 shares of our common stock issuable upon the exercise of outstanding warrants at a weighted average exercise price of $2.62 per share;

   

up to 653,748 unvested restricted shares of our common stock issued or issuable in conjunction with our acquisitions;

   

shares of our common stock issuable to Dell upon the exercise by Dell of a warrant to purchase shares of our common stock or preferred stock which is exercisable in connection with a qualifying financing or sale of our company and which expires upon the consummation of a qualified public offering;

   

shares of our common stock representing 5% of our fully diluted common stock issuable to Dell upon exercise of an option to purchase such shares as early as ten months after a qualified public offering;

   

up to 1,565,108 shares of our common stock issuable upon the assumed closing of the acquisition of an IT services company based in the Netherlands. See the section titled “Business—Our Growth Strategy”;

   

shares issuable upon conversion of the unsecured promissory notes issued in June and October 2010 and warrants issued or issuable in connection therewith; and

   

shares of our common stock issuable to Dell upon the exercise by Dell of a warrant to purchase shares of our common stock which becomes exercisable upon completion of this offering.

Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Borrowings” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Warrants and Other Equity Rights Issued in Conjunction with Borrowings” for more information regarding the convertible note, option and warrant issued to Dell and the unsecured promissory notes and warrants issued in 2010.

 

 

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Unless otherwise indicated, the information we present in this prospectus assumes and reflects the following:

 

   

the automatic conversion of all outstanding shares of our preferred stock into shares of common stock upon the closing of this offering;

   

the filing of our amended and restated certificate of incorporation and the adoption of our amended and restated bylaws to be effective upon the closing of this offering;

   

no exercise by the underwriters of their option to purchase additional shares; and

   

a 1-for-             reverse split of our common stock to be effected prior to this offering.

 

 

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SUMMARY HISTORICAL AND UNAUDITED PRO FORMA

CONSOLIDATED FINANCIAL AND OTHER DATA

The tables below summarize our consolidated financial data. The following summary financial data should be read together with our consolidated financial statements and related notes, “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

    Year Ended December 31,     Three Months Ended
March
31,
 
      2008         2009         2010         2010         2011 (1)    
    (in thousands, except per share data)  

Consolidated Statements of Operations Data:

         

Revenues

  $ 85,058      $ 89,545      $ 98,938      $ 22,941      $ 29,826   

Cost of revenues

    65,346        63,934        76,872        18,865        22,386   
                                       

Gross profit

    19,712        25,611        22,066        4,076        7,440   

Research and development expenses

    1,050        667        1,214        257        286   

Selling and marketing expenses

    19,056        15,299        18,940        4,984        4,811   

General and administrative expenses

    15,419        9,951        14,398        3,584        3,906   

Amortization of intangible assets

    2,771        2,535        2,853        733        727   
                                       

Loss from operations

    (18,584     (2,841     (15,339     (5,482     (2,290

Interest and other income (expense), net

    (4,481     (4,473     (5,028     (3,408     (3,014
                                       

Loss before income taxes

    (23,065     (7,314     (20,367     (8,890     (5,304

Provision for (benefit from) income taxes

    240        78        232        (12     56   
                                       

Net loss

    (23,305     (7,392     (20,599     (8,878     (5,360
                                       

Dividends and accretion on preferred stock

    (4,821     (5,360     (5,325     (1,315     (1,229
                                       

Net loss to common stockholders

  $ (28,126   $ (12,752   $ (25,924   $ (10,193   $ (6,589
                                       

Net loss per share, basic and diluted

  $ (2.13   $ (0.95   $ (1.59   $ (0.63   $ (0.40
                                       

Other unaudited financial data: EBITDA(2)

  $ (16,395   $ 1,580      $ (10,777   $ (5,108   $ (1,502
                                       

 

 

(1) On January 1, 2011, we adopted Accounting Standards Update No. 2009-13, “Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). Our adoption of ASU 2009-13 had a material impact on our results for the three months ended March 31, 2011. The following table presents our results for the three months ended March 31, 2011 as reported and as if we did not adopt ASU 2009-13. This information is presented to allow comparability between our results for the three months ended March 31, 2010 and 2011.

 

     Three Months Ended March 31, 2011  
     As Reported with
Adoption of ASU2009-13
    As Reported without
Adoption of ASU2009-13
 
     (in thousands, except per share data)  

Service revenues

   $ 26,451      $ 26,390   

Product revenues

     3,375        1,398   
                

Total revenues

     29,826        27,788   

Cost of services revenues

     20,004        19,911   

Cost of product revenues

     2,382        815   
                

Total cost of revenues

     22,386        20,726   

Gross profit

     7,440        7,052   

Operating loss

     (2,290     (2,668

Net loss to common shareholder

   $ (6,589   $ (6,967
                

Basic and diluted net loss to common shareholder

   $ (0.40   $ (0.42
                

EBITDA (2)

   $ (1,502   $ (1,880
                

 

 

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     As of March 31, 2011
     Actual     Pro-forma
As Adjusted (3)

Consolidated Balance Sheet Data:

    

Cash and cash equivalents

   $ 6,632     

Total assets

     95,584     

Total long term debt, including current portion

     51,747     

Redeemable convertible preferred stock warrant liability

     3,170     

Total redeemable convertible preferred stock

     106,787     

Total stockholders’ deficit

     (123,176  

 

(2) EBITDA represents net loss before deductions for interest expense, income taxes, depreciation and amortization of tangible and intangible assets, and adjustments for non-cash changes in fair value of warrant liability. EBITDA is a supplemental financial measure, which is not based on United States generally accepted accounting principles (GAAP), used by management and industry analysts to evaluate operations.
(3) The Unaudited Pro Forma As Adjusted column in the balance sheet data table above reflects the automatic conversion of all outstanding shares of our preferred stock into an aggregate of 52,429,678 shares of common stock upon completion of this offering and our sale of              shares of common stock in this offering, at an assumed initial public offering price of $             per share (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting estimated underwriting discounts and commissions and offering expenses payable by us.

The following is a reconciliation of net loss to EBITDA (in thousands, unaudited):

 

     Year Ended December 31,     Three Months Ended
March 31,
 
     2008     2009     2010         2010             2011             2011      
                             As  Reported
with
Adoption  of
ASU2009-13
    As  Reported
without
Adoption  of
ASU2009-13
 

EBITDA Calculation:

            

Net loss

   $ (23,305   $ (7,392   $ (20,599   $ (8,878   $ (5,360   $ (5,738

Depreciation

     495        669        823        198        208        208   

Interest expense

     4,693        5,509        8,068        2,686        3,058        3,058   

Warrant revaluation

     (1,607     (102     (2,536     65        (319     (319

Derivative revaluation

     —          —          (99     —          (5     (5

Taxes

     240        78        232        (12     56        56   

Amortization of intangible assets (including amounts in cost of revenues)

     3,089        2,818        3,334        833        860        860   
                                                

EBITDA

   $ (16,395   $ 1,580      $ (10,777   $ (5,108   $ (1,502   $ (1,880
                                                

In addition to providing financial measurements based on GAAP, we present EBITDA as an additional historical financial metric that is not prepared in accordance with GAAP (non-GAAP). We believe that the inclusion of this non-GAAP financial measure, together with our GAAP financial measures, helps investors to gain a meaningful understanding of our past performance and future results. This approach is consistent with how management measures and forecasts our performance, especially when comparing such results to previous periods or forecasts. Our management uses this non-GAAP measure, in addition to GAAP financial measures, as the basis for measuring our core operating performance and comparing such performance to that of prior periods and to the performance of our competitors. This non-GAAP measure is also used by management in its financial, operational and strategic decision-making and in developing incentive compensation plans.

We consider EBITDA to be an important indicator of our operational strength and performance of our core business and a valuable measure of our historical operating trends.

 

 

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There are limitations associated with reliance on EBITDA because it is specific to our operations and financial performance, which makes comparisons with other companies’ financial results imprecise. It does not include interest expense, which is a necessary and ongoing part of our cost structure resulting from debt incurred to acquire businesses and expand operations. EBITDA also excludes depreciation, amortization and derivative revaluation expenses and gains and losses on non-cash changes in fair value of warrant liabilities. The exclusion of these items, in light of their recurring nature, is a material limitation of EBITDA. To manage these limitations, we have policies and procedures in place to identify expenses that qualify as interest, taxes, depreciation and amortization to approve and segregate these expenses from other expenses to ensure that our EBITDA is consistently reflected from period to period.

EBITDA excludes some items that affect net loss and may vary among companies. The EBITDA we present may not be comparable to similarly titled measures of other companies. EBITDA does not give effect to the cash that we must use to service our debt or pay income taxes and thus does not reflect the funds generated from operations or actually available for capital investments. By providing both GAAP and non-GAAP financial measures, we believe that investors are able to compare our GAAP results to those of other companies while also gaining a better understanding of our operating performance as evaluated by management.

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. Before investing in our common stock, you should carefully consider each of the following risk factors and all of the other information set forth in this prospectus (including our financial statements and the related notes appearing at the end of this prospectus). If any of the events contemplated by the following discussion of risks should occur, our business, financial condition, results of operations and future prospects would likely be materially and adversely affected. As a result, the market price of our common stock could decline, and you could lose all or part of your investment.

Risks Related to Our Business and Industry

Our auditors have expressed substantial doubt as to whether we can continue as a going concern.

The audit report covering our December 31, 2010 consolidated financial statements contains an explanatory paragraph that states that our need to raise additional capital to meet our debt obligations coming due in 2011, recurring losses from operations, limited cash resources and approximately $35 million of debt obligations coming due in 2011 raise substantial doubt about our ability to continue as a going concern through December 31, 2011. Our financial statements do not include any adjustments to the value of our assets or the classification of our liabilities that might result if we would be unable to continue as a going concern through December 31, 2011. We have incurred annual operating losses since inception and have not achieved profitable operations.

We believe that the successful completion of this offering will eliminate this doubt and enable us to continue as a going concern; however, if we are unable to raise sufficient capital in this offering, we will need to obtain alternative financing or significantly modify our operational plans for us to continue as a going concern. Further, even if we successfully complete and receive the net proceeds from this offering, it is possible that our independent registered public accounting firm may conclude that there is substantial doubt regarding our ability to continue as a going concern in future periods. See also our consolidated financial statements and related notes, including Note 1.

We have a history of losses and we may not achieve or sustain profitability in the future.

We have not yet achieved profitability for any fiscal year. We had a net loss to common shareholders of $(6.6) million for the three months ended March 31, 2011 and as of March 31, 2011 our accumulated deficit was $(151.8) million. We expect to continue to incur losses, and we may not become profitable in the foreseeable future, if ever. We expect to make significant expenditures to further develop our business. In addition, as a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. We will have to generate and sustain increased revenues to achieve profitability. Our revenue growth trends in prior periods may not be sustainable, and we may not generate sufficient revenues to achieve or maintain profitability. We may incur significant losses in the future for a number of reasons, including those discussed in other risk factors and factors that we cannot foresee.

We operate in a rapidly evolving industry, which makes our future operating results difficult to predict.

Since the founding of our company in May 2001, we have operated in an industry characterized by rapid technological innovation, changing client needs, evolving industry standards and frequent introductions of new products and services. Our success depends on our ability to implement data center strategic consulting, implementation and managed services that anticipate and respond to rapid and continuing changes in technology, industry developments and client needs. As we encounter new client requirements and increasing competitive pressures, we will likely be required to modify, enhance, reposition or introduce new solutions and service offerings. We may not be successful in doing so in a timely, cost-effective and appropriately responsive manner, or at all. All of these factors make it difficult to predict our future operating results, which may impair our ability to manage our business and our investors’ ability to assess our prospects.

We may experience quarterly fluctuations in our operating results due to a number of factors, which makes our future results difficult to predict and could cause our operating results to fall below expectations or our guidance.

Our operating results may fluctuate due to a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. If our revenues or operating results fall below the

 

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expectations of investors or securities analysts, or below any guidance we may provide to the market, the price of our common stock could decline substantially.

In addition to other risk factors listed in this “Risk Factors” section, factors that may affect our quarterly operating results include:

 

   

fluctuations in demand for our data center strategic consulting, implementation and managed services;

   

fluctuations in sales cycles and prices for our services and solutions;

   

reductions in clients’ budgets for IT purchases and delays in their purchasing cycles;

   

the timing of recognizing revenues in any given quarter as a result of revenue recognition rules;

   

our ability to develop, introduce and provide new services and solutions that meet client requirements in a timely manner;

   

our ability to hire additional technical and sales personnel and the length of time required for any such additional personnel to generate significant revenues;

   

any significant changes in the competitive dynamics of our markets, including new entrants or substantial discounting of services or solutions;

   

our ability to control costs, including our operating expenses; and

   

general economic conditions in our domestic and international markets.

The amount of our outstanding debt may prevent us from taking actions we would otherwise consider in our best interest.

We had approximately $58.1 million in outstanding principal, accrued interest and final balloon payments under existing debt obligations as of March 31, 2011. Of this amount, approximately $41.6 million represented convertible debt and accrued interest. In the event any convertible debt is converted into shares of our common stock following this offering, the holders of shares of our common stock, including investors purchasing shares of our common stock in this offering, will incur immediate and substantial dilution as of the date of the debt conversion.

We issued Dell a convertible promissory note that is currently outstanding and under which we will owe Dell approximately $38.5 million in total payments at maturity, of which $1.4 million has been paid on or before the date of this filing. Dell has extended the maturity date on the note through September 16, 2011. We paid Dell $350,000 upon execution of definitive documentation formalizing the extension and paid an additional $1.3 million on July 21, 2011. Interest accrues at a simple annual rate of 22.5% effective June 13, 2011. We have agreed to repay the note in full upon the consummation of this offering and to provide Dell with certain rights of refusal in the event we receive an acquisition proposal prior to payment in full of the note.

Debt that remains outstanding following this offering and the limitations contained in the loan agreements governing the terms of such debt (the Loan Agreements) could have material consequences on our business, including:

 

   

it may be difficult to generate sufficient capital to satisfy our obligations under the Loan Agreements;

   

the amounts outstanding under the Loan Agreements may make it more difficult to obtain other debt financing in the future;

   

the debt obligations represented by the Loan Agreements could make us more vulnerable to general adverse economic and industry conditions; and

   

we could be at a competitive disadvantage to competitors with less debt.

We have in the past had to cure our failure to meet financial covenants under certain of our debt obligations by raising additional equity. We can provide no assurance that we will not have to raise additional equity in the future for such purpose or that we will be able to raise such equity at all.

Our failure to promptly satisfy our obligations under the Loan Agreements may limit our ability to implement our business plan which may have an immediate, severe and adverse impact on our business, results of operations, financial condition and liquidity. In the event that we cannot satisfy our obligations under the Loan Agreements, we would be forced to drastically curtail operations, dispose of assets or cease operations altogether. Non-compliance with covenants in the Loan Agreements has caused and may again cause default and cross default under the Loan Agreements. In the future, we may not be able to receive waivers or make payments to remedy the non-compliance, which may limit our ability to implement our business plan. Please see the sections titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Borrowings” and “Management’s

 

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Discussion and Analysis of Financial Condition and Results of Operations—Warrants and Other Equity Rights Issued in Conjunction with Borrowings” for more information regarding our outstanding debt and equity rights granted to our lenders in connection with the incurrence of such debt.

Our business could be materially and adversely affected as a result of the risks associated with our acquisitions.

As part of our business strategy, we have acquired and will continue seeking to acquire businesses that provide us with additional intellectual property, client relationships, geographic coverage and domain expertise. We can provide no assurances that we will be able to find and identify desirable acquisition targets in the future or that we will be successful in entering into a definitive agreement with any one target. In addition, even if we reach a definitive agreement with a target with respect to an acquisition, there can be no assurance that we will consummate such acquisition.

Our acquisitions have been and will be accompanied by risks commonly encountered in the acquisition of a business, which include, among other risks:

 

   

the effect of the acquisition on our financial and strategic position and reputation;

   

the failure of an acquisition to result in expected benefits, which may include benefits relating to enhanced revenues, technology, human resources, cost savings, operating efficiencies and other synergies;

   

the difficulty and cost of integrating the acquired businesses, including costs and delays in implementing common systems and procedures, costs and delays caused by communication difficulties and costs and delays caused by integration of target company financials;

   

the assumption of liabilities of the acquired business, including litigation-related liabilities;

   

the potential impairment of acquired assets, including goodwill;

   

the reduction of our cash available for operations and other uses, the increase in amortization expenses related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt;

   

the lack of experience in new markets, products or technologies or the initial dependence on unfamiliar distribution partners;

   

the diversion of our management’s attention from other business concerns;

   

the impairment of relationships with clients or suppliers of the acquired business or our existing clients;

   

the potential loss of key employees of the acquired company; and

   

the potential incompatibility of business cultures.

If one or more of the above risks is realized, our business, results of operations or financial condition could be materially adversely affected. To the extent that we issue shares of our common stock or other rights to purchase our common stock or other equity securities in connection with any future acquisition, existing stockholders may experience dilution and our earnings per share may decrease.

In addition to the risks commonly encountered in the acquisition of a business, we may also experience risks relating to the challenges and costs of closing an acquisition transaction. These risks may be exacerbated as a result of managing multiple acquisitions at the same time.

We rely on indirect sales channels to refer clients to us and disruptions to, or our failure to establish new and maintain existing relationships with companies in, our indirect sales channels would harm our business.

Our future success is dependent upon establishing and maintaining successful relationships in our indirect sales channels, which are new channels derived from our existing strategic relationships. A significant portion of our revenues is generated by sales through our indirect sales channels and we expect indirect sales to continue to make up a significant portion of our total revenues in the future. For the three months ended March 31, 2011, approximately 28% of our revenues were generated by sales through our indirect sales channels. Accordingly, our revenues depend in large part on the referral and effective sales and lead generation activities of these indirect sales channels.

Establishing and maintaining our indirect sales channels and providing training in our service offerings and solutions to companies in our indirect sales channels requires significant time and resources. In order to develop and expand our indirect sales channels, we must continue to scale and improve our processes and procedures that support these channels, including investment in systems and training. Those processes and procedures may become

 

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increasingly complex and difficult to manage as we grow our organization. Our indirect sales channels contracts do not typically prohibit the offering of products or services that compete with ours. Our competitors may provide incentives to companies in our indirect sales channels that favor our competitors’ services and solutions or that prevent or reduce sales of our services and solutions. Companies in our indirect sales channels may choose not to offer our services and solutions exclusively or at all. Establishing relationships with companies in our indirect sales channels that have a history of selling our competitors’ services and solutions may also prove to be difficult. In addition, some companies in our indirect sales channels are also competitors. Our failure to establish and maintain successful relationships within our indirect sales channels would seriously harm our business and operating results.

We depend on a limited number of clients for a substantial portion of our revenues in any fiscal period and the loss of, or a significant shortfall in demand from, these clients could significantly harm our results of operations.

During any given fiscal period, a relatively small number of clients typically accounts for a significant percentage of our revenues. For example, for the three months ended March 31, 2011, revenues generated by sales to our top 20 clients accounted for approximately 43% of our total revenues and sales to one company in our indirect sales channels accounted for approximately 5% of our total revenues. In the past, the clients that comprised our top 20 clients have continually changed and we also have experienced significant fluctuations in individual clients’ usage of our services. In addition, our operating costs are relatively fixed in the near term. As a consequence, we may not be able to adjust our expenses in the short term to address the unanticipated loss of a large client during any particular period. As such, we may experience significant, unanticipated fluctuations in our operating results which may cause us to not meet our expectations or those of stock market analysts, which could cause our stock price to decline.

Our clients have unexpectedly terminated and in the future could unexpectedly terminate their contracts for our services.

Some of our client contracts have been, and in the future could be, cancelled by the client with limited advance notice and without significant monetary penalty. In the three months ended March 31, 2011, and in 2010, 2009, and 2008, we had one, seven, twelve and nine customers respectively, cancel contracts before the term of the contracts had expired representing approximately $497,000, $682,400, $314,000 and $2.7 million, respectively, of future revenues. A client’s unexpected termination of a contract for our services could result in a loss of expected revenues and additional expenses for staff that were allocated to that client’s project. We could be required to maintain underutilized employees who were assigned to the terminated contract, thereby reducing the overall utilization rate of our professionals. The unexpected cancellation or significant reduction in the scope of any of our large projects, or client termination of one or more recurring revenues contracts, could have a material adverse effect on our overall profitability, business, financial condition and results of operations.

Our financial results would suffer if the market for IT services and solutions does not continue to grow.

Our services and solutions are designed to address the growing markets for (i) data center strategic consulting services (including migrations, consolidations and disaster recovery), (ii) implementation services (including storage and data protection services and the implementation of virtualization solutions) and (iii) managed services (including operational support and client support). These markets are still evolving. A reduction in the demand for our services and solutions could be caused by, among other things, lack of client acceptance, weakening economic conditions, competing technologies and services or reductions in corporate spending. Our future financial results would suffer if the market for our IT services and solutions does not continue to grow.

Our financial results may be adversely impacted if we are unable to maintain favorable pricing and utilization rates and control our costs.

Our profitability is primarily based on three factors:

 

   

the prices for our services;

   

the utilization rate of our IT professionals; and

   

our costs.

 

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Our gross profit margin, and therefore our profitability, is dependent on the rates we are able to recover for our services. If we are not able to maintain favorable pricing for our services, our gross profit margin and profitability may suffer. The rates we are able to recover for our services are affected by a number of factors, including:

 

   

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

   

our competitors’ pricing policies;

   

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

   

the use by our competitors and our clients of offshore resources to provide lower-cost services;

   

the necessity of using subcontractors to the extent we are unable to hire service professionals when, and as needed, and at commercially reasonable rates; and

   

general economic conditions, including the level of corporate spending for our services.

If we are not able to maintain an appropriate utilization rate for our professionals, our profit margin and profitability may suffer. Our utilization rates are affected by a number of factors, including:

 

   

our ability to transition professionals from completed projects to new assignments and to hire and assimilate new employees;

   

our ability to forecast demand for our services and thereby maintain an appropriate level of headcount in each of our geographies and workforces;

   

our ability to manage attrition; and

   

our need to devote time and resources to training, professional development and other non-chargeable activities.

We expect our costs to increase as a public company, based in part on an increase in legal, accounting and other expenses that we have not incurred as a private company. In addition, we expect our costs to increase as we expand our sales and marketing activities. These increased costs, considered independently or in the context of any failure to maintain our pricing and utilization rates with respect to the services we provide, could have a material adverse effect on our overall profitability, business, financial condition and results of operations.

We may lose money if we do not accurately estimate costs of fixed-price engagements.

Most of our projects are based on fixed-price, fixed-time contracts, rather than contracts in which payment to us is determined on a time and materials basis. Our pricing on these projects is highly dependent on our internal forecasts and predictions about the projects and the marketplace, which might be based on limited data and could be inaccurate. There is a risk that we will underprice our contracts or fail to estimate accurately the costs of performing the work. Our failure to estimate accurately the resources and schedule required for a project, or our failure to complete our contractual obligations in a manner consistent with the project plan upon which our fixed-price, fixed-time contract was based, could make these projects less profitable or unprofitable and could have a material adverse effect on our overall profitability, business, financial condition and results of operations. We are increasingly entering into contracts for large projects that magnify this risk.

If we are unable to further penetrate our existing markets, our business prospects may be limited.

We expect that our future success will depend, in part, upon our ability to further penetrate the existing markets for data center strategic consulting, implementation and managed services. To date, we have penetrated these markets in varying degrees. Part of our strategy for expanding our share of each market involves “cross-selling” our services in one market to our existing clients and partners in a different market. Our sales strategies may not be effective in further penetrating our existing markets and such failure could limit our business prospects and results of operations.

 

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Our international sales and operations subject us to additional risks that may adversely affect our operating results.

For the three months ended March 31, 2010 and 2011, approximately 64% and 65% of our revenues were generated by our subsidiaries located outside the United States. We have facilities and sales personnel located in the United Kingdom (U.K.), Switzerland, Israel, Turkey, Germany and Australia. We expect to continue to add personnel in additional countries. Our international operations subject us to a variety of risks, including:

 

   

the difficulty of managing and staffing international offices and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;

   

the management of our relationships with channel partners outside the United States, whose sales and lead generation activities are very important to our international operations;

   

difficulties in enforcing contracts and longer payment cycles, especially in emerging markets;

   

tariffs and trade barriers and other regulatory or contractual limitations on our ability to sell or develop our products in certain foreign markets;

   

increased exposure to foreign currency exchange rate risk;

   

reduced protection for intellectual property rights in some countries; and

   

political and economic instability.

As we continue to expand our business internationally, our success will depend, in part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our failure to manage any of these risks successfully could harm our international operations, reduce our international sales and negatively impact our results of operations.

If we are unable to manage our growth effectively, our revenues and profits could be adversely affected.

We have expanded our operations significantly over the past several years, increasing our total number of employees from approximately 459 at March 31, 2008 to 533 at March 31, 2011, and acquiring eleven companies in diverse geographic areas over that same time period. In addition, we have entered into a non-binding letter of intent to acquire an IT services company based in the Netherlands. We anticipate that further significant increases in employee headcount and geographic expansion will be required as we continue to grow our business. Our future operating results depend to a large extent on our ability to manage this expansion and growth successfully. Sustaining our growth will place significant demands on our management as well as on our administrative, operational and financial resources. For us to continue to manage our growth, we must continue to improve our operational, financial and management information systems and expand, motivate and manage our workforce as well as successfully integrate our acquisitions. If we are unable to manage our growth successfully without compromising our quality of service and our profit margins, or if new systems that we implement to assist in managing our growth do not produce the expected benefits, our revenues and profits could be adversely affected. Risks that we face in undertaking future expansion include:

 

   

training new personnel to become productive and generate revenues;

   

controlling expenses and investments in anticipation of expanded operations;

   

implementing and enhancing our administrative infrastructure, systems and processes;

   

addressing new markets; and

   

expanding international operations.

A failure to manage our growth effectively could materially adversely affect our ability to market and sell our services and solutions.

We may not be able to respond to rapid technological changes with new solutions and service offerings, which could have a material adverse effect on our sales and profitability.

The markets for our services and solutions are characterized by rapid technological changes, evolving client needs, frequent new service, software and product introductions and changing industry standards. The introduction of services and solutions by competitors embodying new technologies and the emergence of new industry standards could make our existing and future services and solutions obsolete and unmarketable. As a result, we may not be able to accurately predict the lifecycle of our services and solutions, and our offerings may become obsolete before we receive the amount of revenues that we anticipate from them. If any of the foregoing events occurs, our ability to retain or increase our position in the relevant markets could be adversely affected.

 

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To be successful, we need to develop and introduce new services and solutions on a timely and cost-effective basis that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of our clients. We may experience difficulties that could delay or prevent the successful development, introduction and marketing of services and solutions that respond to technological changes or evolving industry standards, or fail to develop services and solutions that adequately meet the requirements of the marketplace or achieve market acceptance. Our failure to develop and market such services and solutions on a timely basis, or at all, could have a material adverse effect on our sales and profitability.

We partner with third parties on certain complex engagements in which our performance depends upon, and may be adversely impacted by, the performance of such third parties.

Our partners frequently engage us to perform discrete IT infrastructure services within the context of broader, sophisticated projects. If our partners fail to perform their portions of the projects in a timely or satisfactory manner, the relevant client may elect to terminate the project. A termination of this type would result in our recognition of lower-than-expected future revenues, but would not impact revenues recognized to date. Additionally, we may realize lower profits if we incur additional costs due to delays or because we must assign additional personnel to complete the project and are unable to charge these additional costs to our partner. Furthermore, our relationships with our clients and our reputation generally may suffer as a result of our partners’ unsatisfactory performance.

If we do not attract and retain qualified professional staff, we may be unable to adequately perform our client projects and could be limited in accepting new client engagements.

Our business is labor intensive and our success depends on our ability to attract, retain, train and motivate highly skilled employees, including employees that become part of our organization in connection with our acquisitions. The increase in demand for data center strategic consulting, implementation and managed services has further increased the need for employees with specialized skills or significant experience in these areas. We may not be successful in attracting and retaining enough employees to achieve our desired expansion or staffing plans. Furthermore, the industry turnover rates for these types of employees are high and we may not be successful in retaining, training or motivating our employees. Any inability to attract, retain, train and motivate employees could impair our ability to adequately manage and complete existing projects and to accept new client engagements. Such inability may also force us to increase our hiring of independent contractors, which may increase our costs and reduce our profitability on client engagements. We must also devote substantial managerial and financial resources to monitoring and managing our workforce. Our future success will depend on our ability to manage the levels and related costs of our workforce.

If we fail to meet our service level obligations under our service level agreements, we would be subject to penalties and could lose clients.

We have service level agreements with many of our clients under which we guarantee specified levels of service availability. These arrangements involve the risk that we may not have adequately estimated the level of service we will in fact be able to provide. If we fail to meet our service level obligations under these agreements, we would be subject to penalties, which could result in higher than expected costs, decreased revenues and decreased gross and operating margins. We could also lose clients by failing to meet our service level obligations under these agreements and our reputation generally may suffer as a result.

If we fail to offer high quality client support and services, our business would suffer.

Once our solutions and methodologies are deployed within our clients’ IT infrastructure environments, our clients rely on our support services to resolve any related issues. A high level of client support and service is important for the successful marketing and sale of our services and solutions. High quality client support and service will be of increasing importance. If we do not help our clients quickly resolve post-deployment issues and provide effective ongoing support, our ability to sell our solutions and methodologies to existing clients would suffer and our reputation with potential clients would be harmed. As we expand our sales, we will be required to hire and train additional support personnel. In addition, as we expand our operations internationally, our support organization will face additional challenges, including those associated with delivering support, training and documentation in languages other than English. If we fail to maintain high quality client support or grow our support organization to match any future sales growth, our business will suffer.

 

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Our executive officers and senior management are important to our client relationships and the loss of one or more senior managers could have a negative impact on our business.

We believe that our success depends in part on the continued contributions of our president and chief executive officer, Mark Shirman, and other executive officers and members of our senior management. We rely on our executive officers and senior management to generate business and execute our strategies successfully. In addition, the relationships and reputation that members of our management team have established and maintain with our clients contribute to our ability to operate a robust business. The loss of Mr. Shirman or any other executive officer or member of senior management could impair our ability to identify and secure new clients, new engagements from existing clients and otherwise manage our business.

Economic conditions, including prolonged economic downturns, could materially harm our business.

Negative trends in the general economy could cause a decrease in corporate spending on IT services and solutions in general and negatively affect the rate of growth of our business. Any reduction in corporate confidence or corporate spending in general may adversely affect demand for our services and solutions.

We face intense competition that could prevent us from increasing our revenues or could reduce our gross profit margin.

The data center strategic consulting, implementation and managed services markets are competitive, and, due in part to the forecasted growth rates in each market, we expect competition in all markets to intensify in the future. Other companies may introduce new services and solutions in the same markets we have entered or intend to enter. This competition could result in increased pricing pressure, reduced gross profit margins, increased sales and marketing expenses and stagnant or reduced market share.

Many of our current or potential competitors have longer operating histories, greater name recognition, larger client bases and significantly greater financial, technical, sales, marketing and other resources than we have. In addition, our competitors may be able to bundle services that we do not offer together with other products or services at a combined price that is more attractive than the prices we charge for our services alone. As competitive services are introduced or new competitors enter our markets, we expect increased pricing pressure, which could have a negative impact on our revenues and on the gross margins for our services and solutions.

As our markets continue to develop and expand, we expect increased competition from both established and emerging companies, including offshore companies that benefit from lower labor costs. We also expect that some of our competitors may make acquisitions or enter into partnerships or other strategic relationships with one another in order to offer more comprehensive product and service offerings than they are able to offer individually. We believe these types of transactions will continue to occur in the future as companies attempt to strengthen or maintain their market positions in an evolving industry. The companies resulting from these transactions could significantly change the competitive landscape and adversely affect our ability to compete effectively and maintain indirect sales channels.

Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate significantly.

The timing of our revenues is difficult to predict. Our sales efforts involve educating our clients about the use and benefit of our services and solutions, including their technical capabilities and potential cost savings to an organization. Clients typically undertake a significant evaluation process that has in the past resulted in a lengthy sales cycle, which typically lasts several months, and may last a year or longer. We spend substantial time, effort and money on our sales efforts without any assurance that our efforts will produce any sales. In addition, client purchases of our services and solutions are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. If sales expected from a specific client for a particular quarter are not realized in that quarter or at all, our results could fall short of public expectations and our business, operating results and financial condition could be materially adversely affected.

If we are unable to expand our sales capabilities, we may not be able to generate increased revenues.

We must expand our sales force to generate increased revenues from clients. As of March 31, 2011 we had a team of 41 dedicated sales professionals. Our services and solutions require a sophisticated sales effort targeted at the

 

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senior management of our prospective clients. New hires require training and will take time to achieve full productivity. We cannot be certain that new hires will become as productive as necessary or that we will be able to hire enough qualified individuals in the future. Failure to hire qualified sales personnel will preclude us from expanding our business and growing our revenues.

Our services and solutions involve storing and replicating mission-critical data for our clients and are highly technical in nature. If client data is lost or corrupted, our reputation and business could be harmed.

Our data center strategic consulting and implementation services involve storing and replicating mission-critical data for our clients within their data centers. The process of storing and replicating that data within their data centers is highly technical and complex. If any data is lost or corrupted in connection with the use of our services and solutions, our reputation could be seriously harmed and market acceptance of our solutions and services could suffer. In addition, our solutions have contained, and may in the future contain, undetected errors, defects or security vulnerabilities. Some errors in our solutions may only be discovered after a solution has been in use by clients. Any errors, defects or security vulnerabilities discovered in our solutions after commercial release could result in loss of revenues, loss of clients, increased service and warranty cost and diversion of attention of our management and technical personnel, any of which could significantly harm our business. In addition, we could face claims for product liability, tort or breach of warranty. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our service offerings.

Failures or interruptions of our services could materially harm our revenues, impair our ability to conduct our operations and damage relationships with our clients.

Our success depends in part on our ability to provide reliable data center strategic consulting, implementation and managed services to our clients. Our network operations are currently located in Cary, North Carolina, Marlborough, Massachusetts and London, England and are susceptible to damage or interruption from human error, fire, flood, power loss, telecommunications failure, terrorist attacks and similar events. We could also experience failures or interruptions of our systems and services, or other problems in connection with our operations, as a result of:

 

   

damage to or failure of our computer software or hardware or our connections;

   

errors in the processing of data by our system;

   

computer viruses or software defects;

   

physical or electronic break-ins, sabotage, intentional acts of vandalism and similar events;

   

increased capacity demands or changes in systems requirements of our clients; and

   

errors by our employees or third-party service providers.

In addition, our business interruption insurance may be insufficient to compensate us for losses that may occur. Any interruptions in our systems or services could damage our reputation and substantially harm our business and results of operations.

We may need additional capital in the future and it may not be available on acceptable terms.

We have historically relied on outside financing and cash flow from operations to fund our operations, capital expenditures and expansion. However, we may require additional capital in the future to fund our operations and acquisitions, finance investments in equipment or personnel, or respond to competitive pressures. We cannot assure you that additional financing will be available on terms acceptable to us. In addition, the terms of available financing may place limits on our financial and operational flexibility. If we are unable to obtain sufficient capital in the future, we may not be able to continue to meet client demand for service quality, availability and competitive pricing. We also may be forced to reduce our operations or may not be able to expand or acquire complementary businesses or be able to develop new services or otherwise respond to changing business conditions or competitive pressures.

Present economic conditions and the recent economic downturn have made the business climate more volatile and more costly. If economic conditions deteriorate further, or do not improve, it may make any necessary debt or equity financing more difficult or costly to obtain, and more dilutive to our stockholders. While we believe we have adequate capital resources and cash flows from operations to meet current working capital and capital expenditure requirements, a further economic downturn or significant increase in our expenses could require additional financing on less than attractive rates or on terms that are excessively dilutive to existing stockholders. Failure to

 

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secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our stock price and our future operating results.

We have a large amount of goodwill as a result of our acquisitions. Our earnings will be harmed if we suffer an impairment of our goodwill.

As of March 31, 2011, we had goodwill of approximately $22.2 million. Goodwill represents the excess of the amount we paid in our various acquisitions over the fair value of their net assets at the date of the acquisition. We do not amortize acquired goodwill but instead we test it for impairment on an annual basis based upon a fair value approach. Testing for impairment of goodwill involves an estimation of the fair value of our net assets and involves a high degree of judgment and subjectivity. If we have an impairment to our goodwill, the amount of any impairment could be significant and could have a material adverse effect on our reported financial results for the period in which the charge is taken and could result in a decrease in the market price of our common stock.

We will incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Global Market, have imposed various new requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these new compliance initiatives. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time consuming and costly. We expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to incur substantial costs to maintain the same or similar coverage. We estimate that the increase in these costs will total approximately $750,000 to $1.5 million on an annual basis. Our future financial statements will reflect the impact of these expenses, whereas our historical annual financial statements do not reflect these expenses.

We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws.

The U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. As a global services company, we conduct business in North America, Europe and the Middle East, including with governments and government agencies in these regions. Prior to the completion of this offering, we will adopt policies and procedures designed to enforce compliance with these regulations. However, we cannot assure you that we will not be subject to liability under anti-bribery laws for acts committed by our employees or agents. Violations of these laws, or allegations of such violations, could lead to civil and criminal penalties or other sanctions that could have a material adverse effect on our overall profitability, business, financial condition and results of operations.

If we fail to establish and maintain proper and effective internal control over financial reporting, our operating results and our ability to operate our business could be harmed.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. In particular, we will be required to perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report, commencing in our annual report on Form 10-K for the year ending December 31, 2012, on the effectiveness of our internal controls over financial reporting. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 of the Sarbanes-Oxley Act will require that we incur substantial accounting expenses and expend significant management efforts. We currently do not have an internal audit group, and we will need to hire additional accounting and financial staff. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner or if we or our independent registered public accounting firm identify deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the Nasdaq Global Market, the Securities and Exchange Commission or

 

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other regulatory authorities, which would require additional financial and management resources. We expect the one-time costs of meeting the legal and regulatory requirements of Section 404 of the Sarbanes-Oxley Act to reach $750,000 and the ongoing annual costs of maintaining such requirements to be approximately $500,000.

Our investment portfolio may become impaired by further deterioration of the capital markets.

Our investments are intended to preserve principal while providing liquidity adequate to meet projected cash requirements. Risks of principal loss are intended to be minimized through investing primarily in money market funds, but these investments are not, in every case, guaranteed or fully insured. In light of recent changes in the credit market, some high quality short-term investment securities, similar to the types of securities that we invest in, have suffered investment losses. From time to time, we may suffer losses on our investments, which could have a material adverse impact on our operations.

The recent disruptions in the credit and financial markets have negatively affected investments generally, including money market funds. The recent global economic crisis may have a negative impact on the market values of the investments in our investment portfolio. We cannot predict future market conditions or market liquidity and there can be no assurance that the markets for these securities will not deteriorate or that the institutions that these investments are with will be able to meet their debt obligations at the time we may need to liquidate such investments or until such time as the investments mature.

Our methodologies and software solutions may infringe the intellectual property rights of third parties and may create liability for us as well as harm our reputation and client relationships.

The methodologies and software solutions we offer to clients may infringe upon the intellectual property rights of third parties and result in legal claims against our clients and us. These claims may damage our reputation, adversely impact our client relationships and create liability for us. Moreover, we generally agree in our client contracts to indemnify clients for expenses or liabilities they incur as a result of third party intellectual property infringement claims associated with our services and the resolution of these claims, irrespective of whether a court determines that our methodologies and software solutions infringed another party’s intellectual property rights, may be time-consuming, disruptive to our business and extraordinarily costly. Finally, in connection with an intellectual property infringement dispute, we may be required to cease using or developing certain intellectual property that we offer to our clients. These circumstances could adversely affect our ability to generate revenues as well as require us to incur significant expenses to develop alternative or modified services for our clients.

If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.

Our success depends to a significant degree upon the protection of our proprietary technology rights, particularly the proprietary tools associated with our Transom business model. We rely on trade secret, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which offer only limited protection. The steps we have taken to protect our intellectual property may not prevent misappropriation of our proprietary rights or the reverse engineering of our solutions. Additionally, our business often involves the development of services and solutions for specific client engagements. While we generally retain ownership of these service methodologies and solutions, issues relating to the ownership of and rights to intellectual property developed in client engagements can be complicated and there can be no assurance that disputes will not arise that affect our ability to continue to engage in the commercial use of such intellectual property. Legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in other countries are uncertain and may afford little or no effective protection of our services, software, methodology and other proprietary rights. Consequently, we may be unable to prevent our services, software, methodologies and other proprietary rights from being exploited abroad and efforts to prevent such exploitation could be costly. Policing the unauthorized use of our services, software, methodologies and other proprietary rights is expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of management resources, either of which could harm our business. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property. Additionally, we occasionally license certain of our intellectual property to partners and customers, which have the effect of diluting the proprietary nature of our intellectual property. Please see the section titled “Business–Sales and Marketing” for additional information regarding our strategic relationships.

 

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Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to developing and protecting their technology or intellectual property rights than we do. In addition, our attempts to protect our proprietary technology and intellectual property rights may be further limited due to the fact that our employees are attractive to other market participants and may leave our company with significant knowledge of our proprietary information. Consequently, others may develop services and methodologies that are similar or superior to our services and methodologies or design around our intellectual property.

Our use of open source software could impose limitations on our ability to commercialize our solutions.

We incorporate open source software into certain of our solutions. Although we monitor our use of open source closely, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. In such event, we could be required to seek licenses from third parties in order to continue offering our products, to re-engineer our products or to discontinue the sale of our products in the event re-engineering cannot be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition.

Risks Related to this Offering and Ownership of Our Common Stock

Our existing stockholders will have the ability to control the outcome of matters submitted for stockholder approval and may have interests that differ from those of our other stockholders.

After this offering, our existing stockholders, which will include certain executive officers, key employees and directors and their affiliates, will beneficially own approximately     % of our outstanding common stock (approximately     % if the underwriters’ option to purchase additional shares is exercised in full) and will have the ability to control all matters requiring stockholder approval, including the election of directors. As a result, our existing stockholders would have the power to prevent a change of control in our company. The interests of our existing stockholders may differ from the interests of our stockholders who purchased their shares of our common stock in this offering, and this concentration of voting power may have the effect of delaying or impeding actions that could be beneficial to you, including actions that may be supported by our board of directors. As part of the purchase agreement we executed with Dell (the Dell Purchase Agreement), we granted Dell an option to purchase 5% of our common stock calculated on a fully-diluted basis (the Dell Option) which may be exercised by Dell as soon as ten months following this offering, if the offering satisfies the contractual definition of a qualified public offering. We also issued Dell a warrant (the Dell Warrant) to purchase shares of our common stock or preferred stock which is exercisable in connection with a qualifying financing or a sale of our company and which expires upon the consummation of a qualified public offering. If Dell exercises its rights under the Dell Option and/or Dell Warrant, voting power will be further concentrated among existing stockholders. Further, Dell, Cisco and Citrix have rights of first refusal with respect to certain issuances of our new securities and notice and information rights with respect to a proposed sale of our company. Please see the section titled “Principal Stockholders” for additional information regarding the ownership of our outstanding stock by our executive officers, directors and their affiliates and the sections titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Borrowings” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Warrants and Other Equity Rights Issued in Conjunction with Borrowings” for additional information related to the Dell Purchase Agreement, Dell Option and Dell Warrant.

An active trading market for our common stock may not develop.

Prior to this offering, there has been no public market for our common stock. Although we anticipate that our common stock will be approved for listing on the Nasdaq Global Market, an active trading market for our shares may never develop or be sustained following this offering. If the market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that is attractive to you or at all. In addition, an inactive market may impair our ability to raise capital by selling shares and may impair our ability to acquire other companies or technologies by using our shares as consideration, which, in turn, could materially adversely affect our business.

The price of our common stock may be volatile and fluctuate substantially, which could result in substantial losses for investors purchasing shares in this offering.

The initial public offering price for the shares of our common stock sold in this offering will be determined by negotiation between the representatives of the underwriters and us. This price may not reflect the market price of

 

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our common stock following this offering. In addition, the market price of our common stock is likely to be highly volatile and may fluctuate substantially due to the following factors (in addition to the other risk factors described in this section):

 

   

actual or anticipated fluctuations in our results of operations;

   

variance in our financial performance from the expectations of equity research analysts;

   

conditions and trends in the markets we serve;

   

announcements of significant new services or solutions by us or our competitors;

   

additions or changes to key personnel;

   

the commencement or outcome of litigation;

   

changes in market valuation or earnings of our competitors;

   

the trading volume of our common stock;

   

future sale of our equity securities;

   

changes in the estimation of the future size and growth rate of our markets;

   

legislation or regulatory policies, practices or actions; and

   

general economic conditions.

In addition, the stock markets in general have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the particular companies affected. These broad market and industry factors may materially harm the market price of our common stock irrespective of our operating performance. As a result of these factors, you might be unable to resell your shares at or above the initial public offering price after this offering. In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against the affected company. This type of litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

We currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

Following the completion of this offering, we do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend on results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant. Accordingly, if you purchase shares in this offering, realization of a gain on your investment will depend on the appreciation of the price of our common stock, which may never occur. Investors seeking cash dividends in the foreseeable future should not purchase our common stock. Please see the section titled “Dividend Policy” for additional information.

Upon expiration of lock-up agreements between the underwriters and our officers, directors and holders of substantially all of our common stock, a substantial number of shares of our common stock could be sold into the public market shortly after this offering, which could depress our stock price.

Our officers, directors and the holders of substantially all of our common stock and securities convertible into our common stock will enter into lock-up agreements with our underwriters which prohibit the disposal or pledge of, or the hedging against, any of their common stock or securities convertible into or exchangeable for shares of common stock for a period through the date 180 days after the date of this prospectus, subject to limited extension in certain circumstances. The market price of our common stock could decline as a result of sales by our existing stockholders in the market after this offering and after the expiration of the lock-up period, or the perception that these sales could occur. Once a trading market develops for our common stock, and after the lock-up period expires, many of our stockholders will have an opportunity to sell their stock for the first time. These factors could also make it difficult for us to raise additional capital by selling stock. Please see the section titled “Shares Eligible for Future Sale” for additional information regarding these factors.

As a new investor, you will incur immediate and substantial dilution as a result of this offering.

The initial public offering price of our common stock will be substantially higher than the pro forma as adjusted net tangible book value per share of our outstanding common stock. Accordingly, if you purchase shares of our common stock at the assumed initial public offering price (the midpoint of the range set forth on the cover page of

 

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this prospectus), you will incur immediate and substantial dilution of $             per share. If the holders of outstanding options or warrants exercise those options or warrants, you will suffer further dilution. Please see the section titled “Dilution” for additional information.

Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment.

Our management will have broad discretion to use the net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. They might not apply the net proceeds of this offering in ways that increase the value of your investment. We expect to use the net proceeds from this offering principally to repay our outstanding loan from Dell, for general corporate purposes, including working capital, capital expenditures, acquisitions and further development of our services and solutions, and for other debt repayment from time to time. We have not allocated these net proceeds for any specific purposes. Our management might not be able to yield any return on the investment and use of these net proceeds. You will not have the opportunity to influence our decisions on how to use the proceeds.

Anti-takeover provisions in our certificate of incorporation and bylaws and in Delaware law could prevent or delay a change in control of our company.

We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. For more information, please see the section titled “Description of Capital Stock—Anti-Takeover Effects of Our Certificate of Incorporation, Bylaws and Delaware Law.” In addition, our amended and restated certificate of incorporation and bylaws may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable. Our amended and restated certificate of incorporation and bylaws, which will be in effect as of the closing of this offering:

 

   

authorize the issuance of “blank check” preferred stock that could be issued by our board of directors to thwart a takeover attempt;

   

do not provide for cumulative voting in the election of directors, which would allow holders of less than a majority of the stock to elect some directors;

   

establish a classified board of directors, as a result of which the successors to the directors whose terms have expired will be elected to serve from the time of election and qualification until the third annual meeting following their election;

   

require that directors only be removed from office for cause;

   

provide that vacancies on the board of directors, including newly-created directorships, may be filled only by a majority vote of directors then in office;

   

limit who may call special meetings of stockholders;

   

prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders; and

   

establish advance notice requirements for nominating candidates for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.

For information regarding these and other provisions, please see the section titled “Description of Capital Stock.”

We have contractual obligations that could prevent or delay a change in control of our company.

In November 2008, we entered into a securities purchase agreement with Dell and Cisco and an amendment to the Dell Purchase Agreement which together contain provisions requiring us to notify Cisco and Dell in the event that we receive a bona fide proposal for a merger, sale of substantially all of our assets, sale or redemption of our shares or similar transaction that results in a change of control of our company. In December 2010, we entered into a similar agreement with Citrix Systems Inc. (Citrix). For a period of ten days following receipt of our notification, each of Citrix, Cisco and Dell has the right to submit a proposal to acquire us or to enter into a similar change of control transaction and, if requested, we are required to provide them with information regarding the proposed change of control transaction. Until the expiration of the ten day period, we are required to refrain from entering into any action or arrangement which would limit or restrict our ability to provide information to, negotiate with, receive, accept or approve a proposal from, or otherwise complete an acquisition or change of control transaction

 

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with Citrix, Cisco or Dell. In addition, in connection with our extension to September 16, 2011 of the convertible promissory note issued to Dell, we granted and will grant a right of first refusal and a right of last refusal for any potential acquisition. By limiting our ability to negotiate and complete transactions with potential acquirers or purchasers other than Citrix, Cisco or Dell, these restrictions may discourage, delay or prevent a change in control. In addition, most of our debt obligations include repayment or default provisions that are triggered upon a change of control, which could prevent or delay a change in control of our company.

If securities or industry analysts do not publish research or reports or publish unfavorable research or reports about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us, our business, our market or our competitors. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our stock could be negatively impacted. In the event we obtain securities or industry analyst coverage, if one or more of the analysts who covers us downgrades our stock, our stock price would likely decline. If one or more of these analysts ceases to cover us or fails to regularly publish reports on us, interest in our stock could decrease, which could cause our stock price or trading volume to decline.

Completion of this offering may limit our ability to use our net operating loss carryforwards.

As of March 31, 2011, we had substantial federal and state net operating loss carryforwards along with certain foreign net operating loss carryforwards. Under the provisions of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership may limit the amount of our net operating loss carryforwards that can be utilized annually in the future to offset taxable income. We believe that, as a result of this offering, it is possible that a change in our ownership might be deemed to have occurred. If such a change in our ownership occurs, our ability to use our net operating loss carryforwards in any fiscal year will be significantly limited under these provisions.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements. All statements other than statements of historical fact contained in this prospectus, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

In some cases, we identify forward-looking statements by terms such as “may,” “will,” “likely,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “would,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. The forward-looking statements in this prospectus are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this prospectus and are subject to a number of risks, uncertainties and assumptions described in the “Risk Factors” section and elsewhere in this prospectus. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not occur and actual results could differ materially from those projected in our forward-looking statements. We undertake no obligation, and specifically decline any obligation, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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INDUSTRY AND MARKET DATA

The industry and market data and other statistical information used throughout this prospectus are based on independent industry publications. While we believe that each of these publications is reliable, we have not independently verified market data and other statistical information from third-party sources. Some data are also based on our good faith estimates, which are derived from our review of internal surveys, as well as independent industry publications, government publications, reports by market research firms or other published independent sources. None of the independent industry publications referred to in this prospectus were prepared on our behalf or at our expense. Some of the independent industry publications referred to in this prospectus are copyrighted and, in such circumstances, we have obtained permission from the copyright owners to refer to such information in this prospectus.

In particular, the reports (the Gartner Reports) issued by Gartner Inc. (Gartner) described in this prospectus represent data, research, opinions or viewpoints published, as part of a syndicated subscription service available only to clients, by Gartner, and are not representations of fact. We have been advised by Gartner that each Gartner Report speaks as of its original publication date (and not as of the date of this prospectus) and the opinions expressed in the Gartner Reports are subject to change without notice.

The discussion above does not, in any manner, disclaim our responsibilities with respect to the disclosures contained in this prospectus.

Please see the footnotes in the Prospectus Summary and in the section titled “Business” for a reference to the sources for the industry and market data and other statistical information used throughout this prospectus.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us of the sale of the common stock that we are offering will be approximately $             million, assuming an initial public offering price of $             per share, which is the midpoint of the range listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses that we must pay. A $1.00 increase or decrease in the assumed initial public offering price of $             per share would increase or decrease the net proceeds to us from this offering by approximately $             million, assuming the number of shares offered by us, as set forth on the cover page of the prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

We intend to use these net proceeds for working capital and other general corporate purposes, including the expansion of our current business through acquisitions of complementary or strategic businesses, products or technologies, the enhancement of our existing services and solutions and the hiring of additional personnel to increase our development, sales and marketing activities. The amount and timing of the use of the net proceeds for the enumerated purposes will depend on market conditions and opportunities. We also intend to use approximately $37.1 million of the net proceeds from this offering to repay our loan from Dell along with additional accrued interest and extension fees. A description of the Dell loan is included in Note 9 to our Consolidated Financial Statements. The Dell loan has the following terms:

 

• Principal at June 30, 2011:

  

$35.1 million (due in full September 2011).

• Interest Rate:

  

10% per annum March 2008 – February 2011; 18% per annum March 2011 – June 2011 (no payments until maturity); 22.5% per annum June 2011 – maturity; $7.8 million accrued interest converted into principal per the terms of the extension dated March 2011; $1.5 million accrued interest and $0.7 million fees converted into principal per the terms of the extension dated June 2011.

• Maturity Date:

  

June 2011.

We issued Dell a convertible promissory note that is currently outstanding and under which we will owe Dell approximately $38.5 million in total payments at maturity, of which $1.4 million has been paid on or before the date of this filing. Dell has extended the maturity date on the note through September 16, 2011. We paid Dell $350,000 upon execution of definitive documentation formalizing the extension and paid an additional $1.3 million on July 21, 2011. Interest accrues at a simple annual rate of 22.5% effective June 13, 2011. We have agreed to repay the note in full upon the consummation of this offering and to provide Dell with certain rights of refusal in the event we receive an acquisition proposal prior to payment in full of the note.

The amount and timing of our debt repayment will depend on numerous factors, including the cash used or generated in our operations and the cash on hand or used for acquisitions. As a result, except as described above, we cannot estimate the amount of the net proceeds that will be used for debt repayment and we have not otherwise allocated any minimum portion or specific amount of the proceeds to possible debt repayment.

As discussed below in the section titled “Business—Our Growth Strategy,” we have entered into a non-binding letter of intent to acquire an IT services company based in the Netherlands. If we complete the transaction according to the terms contained in the letter of intent, we would use approximately $10.2 million of the net proceeds of this offering to pay the cash portion of the consideration for the acquisition.

Pending use of proceeds from this offering, we intend to invest the proceeds in a variety of capital preservation investments, including short and medium-term, investment-grade, interest-bearing instruments.

 

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DIVIDEND POLICY

We have never declared or paid any cash dividends on capital stock. We currently intend to retain all available funds and any future earnings for use in financing the growth of our business and do not anticipate paying any cash dividends after the offering and for the foreseeable future. Any future determination relating to dividend policy will be made at the discretion of our board of directors, subject to compliance with certain covenants under our loans, which restrict or limit our ability to declare or pay dividends, and will depend on our future earnings, financial condition, results of operations, capital requirements, general business conditions, future prospects, applicable Delaware law, which provides that dividends are only payable out of surplus or current net profits, and other factors that our board of directors may deem relevant.

 

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CAPITALIZATION

The table below sets forth the following information:

 

   

our actual capitalization, including our debt and preferred and common stock warrant liability, as of March 31, 2011;

   

our pro forma capitalization after giving effect to the conversion, upon completion of this offering, of all outstanding shares of preferred stock into common stock and all outstanding warrants to purchase preferred stock into warrants to purchase common stock; and

   

our pro forma capitalization as adjusted to reflect the receipt of the estimated net proceeds from our sale of              shares of common stock in this offering, after deducting the underwriting discounts and commissions and estimated offering expenses, the filing of an amended and restated certificate of incorporation after the closing of this offering.

 

     As of March 31, 2011  
     Actual     Pro Forma     Pro Forma
As Adjusted
 
    

(in thousands, except share and par

value data)

 

Preferred and common stock warrant liability

   $ 3,170      $ 2,043      $                

Long-term debt, including current portion

     51,254        51,254     

Due to employees and shareholders

     493        493     

Series A Preferred Stock, $0.001 par value, 3,360,000 shares authorized, 3,360,000 shares issued and outstanding actual; 3,360,000 shares authorized, no shares outstanding pro forma and pro forma as adjusted

     2,676        —       

Series B Preferred Stock, $0.001 par value, 10,658,017 shares authorized, 10,642,815 shares issued and outstanding actual; 10,658,017 shares authorized, no shares outstanding pro forma and pro forma as adjusted

     11,973        —       

Series C Preferred Stock, $0.001 par value; 8,717,647 shares authorized, 8,364,707 shares issued and outstanding actual; 8,717,647 shares authorized, no shares outstanding pro forma and pro forma as adjusted

     10,337        —       

Series D Preferred Stock, $0.001 par value; 17,511,727 shares authorized, 15,918,949 shares issued and outstanding actual; 17,511,727 shares authorized, no shares outstanding pro forma and pro forma as adjusted

     51,503        —       

Series E Preferred Stock, $0.001 par value, 4,805,815 shares authorized, 4,493,245 shares issued and outstanding actual; 4,805,815 shares authorized, no shares outstanding pro forma and pro forma as adjusted

     14,133        —       

Series F Preferred Stock, $0.001 par value, 33,591,913 shares authorized, 5,441,176 shares issued and outstanding actual; 33,591,913 shares authorized, no shares outstanding pro forma and pro forma as adjusted

     16,165        —       
                        

Total redeemable convertible preferred stock

     106,787        —       

Stockholders’ (deficit) equity:

      

Series 1 Convertible Preferred Stock, $0.001 par value, 6,000,000 shares authorized, 4,208,787 shares issued; 6,000,000 shares authorized, no shares outstanding pro forma and pro forma as adjusted

     347        —       

Common stock, $0.001 par value, 125,500,000 shares authorized, 17,019,160 shares issued; 125,500,000 shares authorized, 69,448,838 issued pro forma and [                ] shares outstanding pro forma as adjusted.

     17        69     

Additional paid-in capital

     25,085        133,294     

Contingent shares issuable

     313        313     

Accumulated other comprehensive income

     2,898        2,898     

Accumulated deficit

     (151,836     (151,836  
                        

Total stockholders’ (deficit) equity

     (123,176     (15,262  
                        

Total capitalization

   $ 38,528      $ 38,528      $     
                        

 

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This table excludes, as of March 31, 2011, the following:

 

   

11,536,551 shares of our common stock issuable upon exercise of stock options outstanding at a weighted average exercise price of $1.02 per share;

   

2,427,697 shares of our common stock available for future issuance under our stock-based compensation plans;

   

7,042,256 shares of our common stock issuable upon the exercise of outstanding warrants at a weighted average exercise price of $2.62 per share;

   

up to 653,748 unvested restricted shares of common stock issued or issuable in conjunction with our acquisitions;

   

shares of our common stock issuable to Dell upon the exercise by Dell of a warrant to purchase shares of our common stock or preferred stock which is exercisable in connection with a qualifying financing or sale of our company and which expires upon the consummation of a qualified public offering;

   

shares of our common stock representing 5% of our fully diluted common stock issuable to Dell upon exercise of an option to purchase such shares as early as ten months after a qualified public offering;

   

up to 1,565,108 million shares of common stock issuable upon the assumed closing of the acquisition of the IT services company based in the Netherlands. See the section titled “Business—Our Growth Strategy”;

   

shares issuable upon conversion of the unsecured promissory notes issued in June and October 2010 and warrants issued or issuable in connection therewith; and

   

shares of our common stock issuable to Dell upon the exercise by Dell of a warrant to purchase shares of our common stock which becomes exercisable upon completion of this offering.

Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Borrowings” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Warrants and Other Equity Rights Issued in Conjunction with Borrowings” for more information regarding the convertible note, option and warrant issued to Dell and the unsecured promissory notes and warrants issued in 2010.

Please see “Management—Employee Benefit Plans,” and Note 12 to our consolidated financial statements for a description of our equity plans.

 

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DILUTION

Our pro forma net tangible book value as of March 31, 2011 was approximately $(48.8) million, or approximately $(0.71) per share. Pro forma net tangible book value per share represents the amount of total tangible assets minus our total liabilities, divided by 69,448,838 shares of common stock outstanding, after giving effect to the conversion, upon completion of this offering, of all outstanding preferred stock into common stock and all outstanding warrants to purchase preferred stock into warrants to purchase common stock.

Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the net tangible book value per share of common stock immediately after completion of this offering. After giving effect to our sale of              shares of common stock in this offering at an assumed initial public offering price of $             per share, and after deducting the underwriting discounts and commissions and estimated offering expenses, the pro forma net tangible book value as of March 31, 2011 would have been approximately $             million or approximately $             per share. This represents an immediate increase in net tangible book value of $             per share to existing stockholders and an immediate dilution in net tangible book value of $             per share to purchasers of common stock in the offering, as illustrated in the following table:

 

Assumed initial public offering price per share

      $                

Pro forma net tangible book value per share before this offering

   $                   

Increase per share attributable to new investors

   $        
           

Pro forma net tangible book value per share after this offering

      $     
           

Dilution per share to new investors

      $     
           

If the underwriters exercise their option to purchase additional shares of our common stock in full in this offering, the pro forma net tangible book value per share after the offering would be approximately $             per share, the increase in pro forma net tangible book value per share to existing stockholders would be approximately $             per share and the dilution to new investors purchasing shares in this offering would be approximately $             per share.

The table below presents on a pro forma basis as of March 31, 2011, after giving effect to the conversion of all outstanding shares of preferred stock into common stock upon completion of this offering and all outstanding warrants to purchase preferred stock into warrants to purchase common stock the differences between the existing stockholders and the purchasers of shares in the offering with respect to the number of shares purchased from us, the total consideration paid and the average price paid per share:

 

     Shares Purchased     Total Consideration     Average Price
Per Share
 
     Number      Percent     Amount      Percent    

Existing stockholders

     69,448,838                $ 96,310,205              %   $ 1.39   

New stockholders

            

Totals

                    100.0 %  

The table above does not include shares issuable to Dell Products L.P. (Dell) upon the exercise by Dell of a warrant to purchase shares of our common stock or preferred stock (the Dell Warrant) which is exercisable in connection with a qualifying financing or sale of our company and which expires upon the consummation of a qualified public offering. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Borrowings” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Warrants and Other Equity Rights Issued in Conjunction with Borrowings” for more information regarding the Dell Warrant.

As of March 31, 2011, there were options outstanding to purchase a total of 11,536,551 shares of our common stock at a weighted average exercise price of $1.02 per share. In addition, as of March 31, 2011, there were warrants outstanding to purchase 2,464,129 shares of common stock at a weighted average exercise price of $2.86 per share, and warrants outstanding to purchase 4,578,127 shares of preferred stock at a weighted average exercise price of

 

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$2.49 per share which will convert into the right to purchase 4,578,127 shares of common stock upon the completion of the offering. The number of shares subject to outstanding warrants and the average warrant exercise price do not include the Dell Warrant. To the extent outstanding options or warrants are exercised, there will be further dilution to new investors. For a description of our equity plans, please see Note 12 of the notes to our consolidated financial statements.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following consolidated statements of operations data for 2008, 2009 and 2010, and the consolidated balance sheet data as of December 31, 2009 and 2010 have been derived from our audited consolidated financial statements and related notes included elsewhere in this prospectus. The consolidated statements of operations data for the years 2006 and 2007, and the consolidated balance sheet data as of December 31, 2006, 2007 and 2008 have been derived from our audited consolidated financial statements and related notes not included in this prospectus. The consolidated statements of operations data for the three months ended March 31, 2010 and 2011 and the consolidated balance sheet data as of March 31, 2010 and 2011 have been derived from our unaudited financial statements and related notes which are included elsewhere in this prospectus. In the opinion of management, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited financial statements and include all adjustments necessary for the fair presentation of our financial position and results of operations for these periods. The following selected financial data should be read together with our financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

    Year Ended December 31,     Three Months Ended
March 31,
 
    2006     2007     2008 (1)     2009     2010         2010             2011 (2)      
                                  (unaudited)     (unaudited)  

Consolidated Statements of Operations Data:

             

Revenues

  $ 37,808      $ 61,241      $ 85,058      $ 89,545      $ 98,938      $ 22,941      $ 29,826   

Cost of revenues

    29,279        45,140        65,346        63,934        76,872        18,865        22,386   
                                                       

Gross profit

    8,529        16,101        19,712        25,611        22,066        4,076        7,440   

Research and development expenses

    —          146        1,050        667        1,214        257        286   

Selling and marketing expenses

    10,906        15,313        19,056        15,299        18,940        4,984        4,811   

General and administrative expenses

    7,058        9,421        15,419        9,951        14,398        3,584        3,906   

Amortization of intangible assets

    1,165        2,260        2,771        2,535        2,853        733        727   
                                                       

Loss from operations

    (10,600     (11,039     (18,584     (2,841     (15,339     (5,482     (2,290

Interest and other income (expense), net

    393        (3,298     (4,481     (4,473     (5,028     (3,408     (3,014
                                                       

Loss before income taxes and cumulative effect of change in accounting principle

    (10,207     (14,337     (23,065     (7,314     (20,367     (8,890     (5,304

Provision (benefit) for income taxes

    —          (485     240        78        232        (12     56   
                                                       

Loss before cumulative effect of change in accounting principle

    (10,207     (13,852     (23,305     (7,392     (20,599     (8,878     (5,360

Cumulative effect of change in accounting principle

    558        —          —          —          —          —          —     
                                                       

Net loss

    (9,649     (13,852     (23,305     (7,392     (20,599     (8,878     (5,360
                                                       

Dividends and accretion on preferred stock

    (3,482     (4,310     (4,821     (5,360     (5,325     (1,315     (1,229
                                                       

Net loss to common stockholders

  $ (13,131   $ (18,162   $ (28,126   $ (12,752   $ (25,924   $ (10,193   $ (6,589
                                                       

Net loss per share to common stockholders

  $ (2.21   $ (1.79   $ (2.13   $ (0.95   $ (1.59   $ (0.63   $ (0.40
                                                       

Weighted average number of shares outstanding (basic and diluted)

    5,955        10,160        13,193        13,399        16,282        16,211        16,466   
                                                       

Consolidated Balance Sheet Data:

             

Cash and cash equivalents

  $ 3,735      $ 5,948      $ 12,509      $ 7,587      $ 11,860      $ 7,469      $ 6,632   

Total assets

    18,072        69,492        79,330        86,199        98,735        87,928        95,584   

Total long term debt, including current portion

    5,695        19,305        37,168        36,297        46,343        40,201        51,747   

Redeemable convertible preferred stock warrant liability

    993        4,483        3,706        3,558        1,446        4,224        3,170   

Total redeemable convertible preferred stock

    54,680        74,617        89,087        94,493        105,559        95,808        106,787   

Total stockholders’ deficit

    (54,523     (62,511     (88,765     (95,987     (118,290     (104,756     (123,176

 

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(1) Operating results in 2008 reflect the full effect of significant business acquisitions completed in 2007. See note 6 to the accompanying consolidated financial statements.
(2) On January 1, 2011, we adopted Accounting Standards Update No. 2009-13, “Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). Our adoption of ASU 2009-13 had a material impact on our results for the three months ended March 31, 2011. The following table presents our results for the three months ended March 31, 2011 as reported and as if we did not adopt ASU 2009-13. This information is presented to allow comparability between our results for the three months ended March 31, 2010 and 2011.

 

     Three Months Ended March 31, 2011  
     As Reported with
Adoption of ASU2009-13
    As Reported without
Adoption of ASU2009-13
 
     (in thousands, except per share data)  

Service revenues

   $ 26,451      $ 26,390   

Product revenues

     3,375        1,398   
                

Total revenues

     29,826        27,788   

Cost of services revenues

     20,004        19,911   

Cost of product revenues

     2,382        815   
                

Total cost of revenues

     22,386        20,726   

Gross profit

     7,440        7,052   

Operating loss

     (2,290     (2,668

Net loss to common shareholder

   $ (6,589   $ (6,967
                

Basic and diluted net loss to common shareholder

   $ (0.40   $ (0.42
                

EBITDA

   $ (1,502   $ (1,880
                

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors. We discuss factors that we believe could cause or contribute to these differences below and elsewhere in this prospectus, including those set forth under “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Overview

We are a global provider of information technology (IT) consulting, implementation and managed services focused in the data center. We believe cloud computing, virtualization, the increasing demand for data storage, backup and disaster recovery, and a growing number of government and industry regulations, among other things, are driving a major shift in data center architecture and IT infrastructure. In addition, the increasing demand for energy and computing power in outdated data centers, ongoing data growth and constrained data center budgets are creating a demand for services to help companies adopt, integrate and manage new technologies and capabilities. Our vendor independent services help our clients address inefficiencies in their data center environment and help them fill the gap between their current capabilities and those needed to support these new and emerging data center architectures and technologies.

We deliver IT services through Transom, our unique business model consisting of software tools, methodologies and subject matter expertise, each developed over the course of thousands of client engagements. Transom standardizes our global offerings into high quality services we can deliver in a consistent manner to our clients.

Founded in 2001, we initially focused on storage and data protection consulting services. In response to client demand, we expanded our breadth of services to include managed services and added expertise and services in cloud computing, virtualization, disaster recovery and security. From our inception through 2005, we made six acquisitions. These acquisitions accelerated our expansion into international markets, our development of proprietary tools and our entrance into managed services.

In 2007, 2008 and 2009 we grew our revenues, capabilities, service offerings and international presence through additional strategic acquisitions and partnerships. These acquisitions added data center consolidation and migration expertise, virtualization technology skills and expanded our managed services capabilities. Both acquisitions and partnerships have expanded our market opportunities in existing and new geographies, including our presence in Europe and the United States, as well as facilitated expansion into Israel and Turkey to serve the Middle East markets.

We have identified several key trends in our business that have contributed to the growth potential in our revenues and margins:

 

   

expansion of our managed services offerings;

   

further integration of our tools and intellectual property (IP) into our service offerings;

   

expanding the size and scope of our projects;

   

expansion of services provided in our global accounts; and

   

increased volume of opportunities from indirect sales channels.

By expanding our managed services offerings, we are able to sell a broader range of managed services into new and existing customer accounts. The growth in managed services allows us to realize the investments made in people, process and intellectual property. We anticipate growth in this recurring revenue model as we develop additional service offerings and look to acquire businesses that bring more intellectual property as well as a new geographical market into our portfolio.

Our services are scalable and cost efficient because of our IP. Over the past three years, we have focused on internally cultivating and acquiring software tools and proprietary methodologies to enhance our services. Our tools and methodologies are an intrinsic part of our service offerings and provide our customers with predictability and visibility into their IT environments through reports and monitoring, self-service portals and modeling capabilities. We gain efficiency and cost savings by deploying tools and processes that decrease the need for our consultants to spend extra man-hours creating and delivering reports and models. We will continue to grow our breadth of software tools and proprietary methodologies through focused research and development, by encouraging and

 

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supporting our consultants in pursuing new ideas and through future acquisitions. We look to acquire companies that already have IP that is complementary to our services and our customers’ needs.

The leverage we get with our IP is a significant differentiator in the market. Our IP not only drives revenue growth, but also enables standardization of delivery and efficiency. In general, our IP falls into two categories. The first category is comprised of the pre-sales tools and methodologies that allow the end customer to understand the benefits of our services and the second category includes the tools and methodologies that are used in the implementation of those services. As a result, partners and customers are increasingly finding that the value of our IP is maximized when used in conjunction with our services.

Since 2007, we have focused on optimizing our go-to-market strategies by installing a new inside sales team in the U.S. and the U.K. to support lead generation, increasing sales training globally for our direct sales team and growing our indirect channels with strategic relationships. By working with companies such as Dell, Cisco, IBM, HP, Cable & Wireless Worldwide, Citrix and Bull, we reach new customers who have not had prior experience with our Company and expand our reach into new geographies. These partners not only leverage our IP, but also sell our services as part of their own services portfolio, thereby bringing our tools, methodologies and consultants into their customer accounts. We anticipate establishing more indirect sales relationships with other technology vendors over the next few years.

We have focused on taking new services to market. New services are developed both internally, through our customer experiences and identification of market opportunities, as well as through our acquisitions, which have also expanded our geographical reach. Over the past three years, we have expanded our managed services offerings to include database, virtual server and security services, and we have grown our consulting service offerings to include cloud computing virtualization (server and desktop), security and archiving. In addition, we have extended our ability to service customers globally by adding offices in Israel, Turkey, Australia, Switzerland and Germany. These efforts have allowed us to sell more services into our existing customer base, which deepens those customer relationships and also optimizes our cost of sales with those accounts. We anticipate continuing to expand our service offerings into new and growing service areas, such as cloud computing and virtualization, as well as continuing to expand into new geographical markets through acquisition.

Our efforts to continue to increase our revenues and margins present significant operational and financial challenges. In order to meet these challenges we are focused on the following initiatives:

 

   

Finding and training qualified staff. We believe the rising demand for cloud computing and virtualization technologies offers significant opportunities for growth. In order for us to meet these demands, we must attract and retain qualified personnel that can deliver against these opportunities. Over the past few quarters, we have optimized our recruiting function by expanding our in-house team and engaging with outsourcing firms. We have done this on a global basis and we believe the success of this initiative will enable us to continue to attract the talent necessary to meet our staffing requirements.

 

   

Maintaining a collaborative corporate culture. We have worked diligently to create and foster a customer centric and innovative corporate culture. We believe these traits differentiate us from our peers. It is critical to our future success for us to preserve and enhance a high level of quality and collaboration amongst our employee base. To meet these challenges, we are focused on adhering to a strict set of performance metrics, processes and methodologies for our personnel. In addition, we intend to continue to leverage our intranet collaboration engine to assist in the process of consistent messaging for both sales and delivery.

 

   

Managing larger and oftentimes more complex projects. Many of our projects are fixed fee in nature. In order to ensure we continue to meet and exceed our financial goals, we plan to maintain a disciplined approach to project management and, where applicable, leverage our intellectual property. As we expand the size and scope of our projects, we believe the combination of these efforts will increase the quality of our projects and reduce our delivery risk. In addition, we are currently adding more oversight processes to our projects and rolling out new computer systems to track these projects with a higher degree of accuracy.

 

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Over the past few years, we have placed an increased emphasis on improving our gross margins in order to enhance profitability. Meeting this challenge has required significant investment in our Transom business model and supporting software tools, which we are now beginning to fully leverage. We intend to continue to increase our gross margins by focusing on the following initiatives:

 

   

Selling and delivering larger projects which will enhance the efficiency and utility of our personnel and reduce the amount of time in between projects;

 

   

Leveraging our in-house methodologies and processes in order to ensure our staff is operating at the highest levels of productivity and deployed in the most cost-effective manner;

 

   

Continuing to deemphasize the product portion of our business in Switzerland and Israel; and

 

   

Increasing the sales of fixed fee engagements in the Middle East in order to improve time and material residencies.

Impact of foreign currency translation on reported results and use of the constant currency method

We have significant operations outside of the U.S. and generate revenues and incur expenses in currencies other than the U.S. dollar. During 2009, the exchange rates between our foreign subsidiaries’ functional currencies and the U.S. dollar fluctuated significantly and had a significant impact on our consolidated financial results reported in U.S. dollars. For purposes of comparability with 2008 results, we have included a Constant Currency Method analysis in which we have translated the results of operations for 2009 at the same exchange rates used to translate the reported operating results for 2008 (i.e., the average exchange rates for 2008). We have included this analysis and related commentary because we believe that it provides a more meaningful analysis of our underlying business trends during periods of significant exchange rate fluctuations. However, the Constant Currency Method is not meant to replace or supersede the comparison of our operating results translated using actual exchange rates in accordance with U.S. GAAP. The table below sets forth the reconciliation of our reported results of operations and the results of operations calculated using the Constant Currency Method for 2009 (in thousands):

 

     Year Ended December 31, 2009  
     As Reported     Constant Currency     Impact of Currency  

Revenues

      

Services

   $ 87,489      $ 93,766      $ 6,277   

Product

     2,056        2,269        213   
                        

Total Revenue

   $ 89,545      $ 96,035      $ 6,490   
                        

Gross profit

      

Services

     24,823        26,614        1,791   

Product

     788        897        109   
                        

Total gross profit

   $ 25,611      $ 27,511      $ 1,900   
                        

Operating expenses:

      

Research and development expenses

     667        863        196   

Selling and marketing expenses

     15,299        17,510        2,211   

General and administrative expenses

     9,951        10,473        522   

Amortization of intangible assets

     2,535        2,728        193   
                        

Total operating expenses

   $ 28,452      $ 31,574      $ 3,122   
                        

Interest expense

   $ (5,509   $ (5,528   $ (19
                        

Other income (expense), net

   $ 1,036      $ 1,133      $ 97   
                        

Provision for income taxes

   $ 78      $ 78      $ —     
                        

The impact of foreign currency translation did not have a significant impact on other periods presented.

 

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Impact of new accounting standards

On January 1, 2011, we adopted Accounting Standards Codification (“ASC”) 605-25—Revenue Recognition—Multiple Element arrangements (“ASC 605-25”). Prior to our adoption of ASC 605-25, we recognized multiple element revenue arrangements as one unit of accounting over the longest service period. The multiple element revenue arrangements that will be impacted by our adoption of ASC 605-25 are our arrangements where we sell third party products with our managed services. Under ASC 605-25, we recognize the different elements of the multiple element arrangement as separate units of accounting based on their relative fair values. This will result in our recognition of revenue, and related costs, related to third party products as product revenue and cost upon the products being functional in the customers’ environment, while the services component of the multiple element arrangements will continue to be recognized as services revenue and related cost during the period in which the service is delivered. Under ASC 605-25, we will continue to recognize revenue from multiple element arrangements from periods prior to January 1, 2011 as services revenue and cost through the applicable service period.

As a result of our adoption of ASC 605-25 and ASU 2009-13, we expect our third party product revenue to increase and our managed service revenue to decrease over time as the deferred revenue related to third party products is recognized and not replaced. The following table details the impact our adoption of ASC 605-25 and ASU 2009-13 had on our results for the three months ended March 31, 2011.

 

     Three Months Ended March 31, 2011  
     As Reported with
Adoption of ASU2009-13
    As Reported without
Adoption of ASU2009-13
 
     (in thousands, except per share data)  

Service revenues

   $ 26,451      $ 26,390   

Product revenues

     3,375        1,398   
                

Total revenues

     29,826        27,788   

Cost of services revenues

     20,004        19,911   

Cost of product revenues

     2,382        815   
                

Total cost of revenues

     22,386        20,726   

Gross profit

     7,440        7,052   

Operating loss

     (2,290     (2,668

Net loss to common shareholder

   $ (6,589   $ (6,967
                

Basic and diluted net loss to common shareholder

   $ (0.40   $ (0.42
                

Results of Operations

Revenues

 

    Year Ended December 31,     Year Ended December 31,     Three Months Ended March 31,  
    2008     2009     %
Change
    2009     2010     %
Change
      2010         2011       %
  Change  
 
    (dollars in thousands)  

Revenues

                 

Services

  $ 82,998      $ 87,489        5   $ 87,489      $ 94,919        8   $ 21,256      $ 26,451        24

Product

    2,060        2,056        —          2,056        4,019        95     1,685        3,375        100
                                                                       

Total revenues

  $ 85,058      $ 89,545        5   $ 89,545      $ 98,938        10   $ 22,941      $ 29,826        30
                                                                       

Our revenues consist of services and product revenues. Services revenues consist of consulting services and managed services. Managed services consist of infrastructure operations services (IOS) and multi-element contracts. Consulting services typically have a delivery cycle of less than a year and managed services typically have a delivery cycle of one to three years. Consulting services contracts can be fixed fee or time and materials-based and managed services contracts are fixed fee. We sell consulting services and managed services in all of the geographies in which we operate. Multi-element contracts contain the resale of third-party software and/or hardware with consulting services, IOS services or both. The consulting services included in the multi-element arrangements can

 

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be fixed fee or time and material. Our Israeli, Turkish, German and Swiss subsidiaries sell multi-element service contracts in the geographies in which they operate. Only our Swiss subsidiary sells maintenance contracts on our software in the geographies in which it operates. Product revenues consist of the sale of perpetual license of our intellectual property (IP) and our own software products, and the resale of third party software and/or hardware. We have licensed our IP in the U.S. and where our U.K. subsidiary operates. Our Israeli, Turkish, German and Swiss subsidiaries resell third party software and/or hardware. We are primarily focused on generating services revenues.

Most of our growth in revenues has been in relation to growth in demand for our services and the ability to provide a broader array of services to our existing customer base. We periodically raise our billing rates to our customers, depending upon geography and timing. These increases are generally small and are generally in line with increases in our cost of labor.

Vendor independence is one of our key business differentiators. After we make an acquisition, part of our integration plan is to transition product sales resulting from the resale of third party equipment and/or software out to a partner. Product sales resulting from the resale of third party equipment in 2008, 2009, and 2010 were a result of revenues generated from our Israeli and Swiss subsidiaries. After becoming part of our organization in March 2007, our Israeli subsidiary has seen an increase in services work performed without a product component.

Service revenues increased by $5.2 million or 24% to $26.5 million for the three months ended March 31, 2011 from $21.3 million for the same period in 2010. Consulting services revenues increased by $1.6 million or 14% to $13.0 million for the three months ended March 31, 2011 from $11.4 million for the same period in 2010 and managed services revenues increased by $3.6 million or 37% to $13.5 million for the three months ended March 31, 2011 from $9.8 million for the same period in 2010. The increase in our consulting services revenue for the three months ended March 31, 2011 as compared to the same period in 2010 is the result of an increase in our consulting revenue in our UK subsidiary. The increase in our managed services revenue is the result of our accelerated recognition of $845,000 of deferred revenue related to the early termination of a contract and organic growth of our managed service offerings. In the three months ended March 31, 2011 we had no one customer who represented greater than 10% of our total revenue.

Service revenues increased by $7.4 million or 8% to $94.9 million for 2010 from $87.5 million for 2009. Consulting services revenues increased by $15.6 million or 45% to $50.1 million for 2010 from $34.5 million in 2009 and managed services revenues decreased by $8.1 million or 15% to $44.8 million for 2010 from $53.0 million for 2009. The increase in our consulting services revenue for 2010 as compared to 2009 is the result of a $13.1 million of increased consulting service revenue from our US, UK and Middle East companies combined with a $2.4 million increase resulting from the full year impact in 2010 of our fourth quarter 2009 Swiss acquisition. The decrease in our managed services revenue is the result of a decrease in managed service revenue from our US, UK and Middle East companies partially offset with a $7.3 million increase resulting from the full year impact in 2010 of our fourth quarter 2009 Swiss acquisition. Approximately $15.5 million of the decrease in our managed services in 2010 as compared to 2009 resulted from the loss of two customers who were acquired.

Services revenues increased by $4.5 million or 5% to $87.5 million for 2009 from $83.0 million for 2008. Consulting services revenues decreased by $2.5 million or 7% to $34.5 million for 2009 from $37.0 million for 2008 and managed services revenues increased $7.0 million or 15% to $53.0 million for 2009 from $46.0 million for 2008. In the fourth quarter of 2009, we recognized approximately $1.4 million of deferred managed services revenue related to the early termination of one of our managed services customers. The decrease in our consulting services revenue for 2009 as compared to 2008 is a result of a lower spend by our existing and new customers as a result of general economic conditions in 2009. We believe that our customers delayed certain projects due to the general economic conditions and uncertainties in 2009. The increase in our managed services revenue for 2009 as compared to 2008 is a result of increased IOS revenue sold into our existing customer base, the attainment of new customers and $1.4 million of accelerated recognition of previously deferred revenue resulting from a customer cancellation, which is not expected to recur. Our managed services revenue is less impacted by general economic conditions because its subscription based model results in customers signing longer term contracts for recurring services. In 2009, we had one client that represented 17% of our total revenues. Our 2009 acquisitions did not have a significant impact on our services revenues. Using the Constant Currency Method, services revenues increased by $10.8 million or 13% to $93.8 million for 2009 from $83.0 million for 2008. Consulting services revenues increased by $1.2 million or 3% to $38.2 million for 2009 from $37.0 million for 2008 and managed services revenues increased $9.6 million or 21% to $55.6 million for 2009 from $46.0 million for 2008.

 

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Product revenue increased by $1.7 million or 100% to $3.4 million for the three months ended March 31, 2011 from $1.7 for the same period in 2010. The increase in product revenue is principally the result of our adoption of ASC 605-25.

Product revenue increased by $2.0 million or 95% to $4.0 million for 2010 from $2.1 million for 2009. Of this increase, $3.3 million relates to the full year impact of our fourth quarter 2009 Swiss acquisition. Excluding the impact of our fourth quarter 2009 Swiss acquisition, product revenue would have decreased by $1.3 million.

Product revenues remained essentially unchanged at $2.1 million for 2009 from $2.1 million for 2008. We did not have product sales in the U.S. In 2009, we started transitioning our Israeli and Turkish entities away from product sales. Using the Constant Currency Method, product revenues increased by $200,000 or 10% to $2.3 million for 2009 from $2.1 million for 2008.

Cost of Revenues and Gross Profit

Cost of revenues includes all costs related to the delivery of our services and consists primarily of salaries and benefits of our consultants, billable and non-billable travel and entertainment, third party contractors, third party products and services and facility related expenses. Our managed services business is performed onsite and offsite, but using client-owned assets. Our investments in this area are primarily staff, our software tools and basic monitoring equipment.

 

     Year Ended
December 31,
    Year Ended
December 31,
    Three Months Ended March
31,
 
     2008     2009     %
Change
    2009     2010     %
Change
    2010     2011     %
Change
 
     (dollars in thousands)  

Gross profit

                  

Services

   $ 19,283      $ 24,823        29   $ 24,823      $ 21,125        (15 )%    $ 3,589      $ 6,447        80

Product

     429        788        84     788        941        19     487        993        104
                                                                        

Total gross profit

   $ 19,712      $ 25,611        30   $ 25,611        22,066        (14 )%    $ 4,076      $ 7,440        83
                                                                        

Gross margin

                  

Services

     23     28       28     22       17     24  

Product

     21     38       38     23       29     29  
                                                      

Total gross margin

     23     29       29     22       18     25  
                                                      

Total gross margin increased 7 points to 25% for three months ended March 31, 2011 from 18% for the same period in 2010. Services gross margin increased 7 points to 24% for the three months ended March 31, 2011 from 17% for the same period in 2010. The increase in services gross margin is the result of an increased managed service revenue which allows us to spread our fixed delivery cost structure over a larger revenue base, the accelerated recognition of $845,000 of deferred revenue related to the early termination of a contract, and the reduced impact of low margin contracts acquired with our 2009 fourth quarter acquisition.

Total gross margin decreased 7 points to 22% for 2010 from 29% for 2009. Services gross margin decreased 6 points to 22% for 2010 from 28% for 2009. The decrease in services gross margin is a result of decreased managed services revenues which reduces our ability to spread our fixed costs over a larger revenue base.

Total gross margin increased 6 points to 29% for 2009 from 23% for 2008. Services gross margin increased 5 points to 28% for 2009 from 23% in 2008. The increase in our service gross margins in 2009 as compared to 2008 is a result of (i) our increased utilization rates in 2009; (ii) increased managed service revenues and (iii) the consolidation of our two service operation centers into one in the U.S. The increased managed services revenues allows us to spread our fixed delivery cost structure over a larger revenue base. The change in the exchange rates for 2009 from 2008 did not have a material impact on our 2009 gross profit.

 

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Operating Expenses

 

    Year Ended
December 31,
    Year Ended
December 31,
    Three Months Ended
March 31,
 
    2008     2009     %
Change
    2009     2010     %
Change
    2010     2011     %
Change
 
    (dollars in thousands)  

Operating expenses:

                 

Research and development expenses

  $ 1,050      $ 667        (36 )%    $ 667      $ 1,214        82   $ 257      $ 286        11

Selling and marketing expenses

    19,056        15,299        (20 )%      15,299        18,940        24     4,984        4,811        (3 )% 

General and administrative expenses

    15,419        9,951        (35 )%      9,951        14,398        45     3,584        3,906        9

Amortization of intangible assets

    2,771        2,535        (9 )%      2,535        2,853        13     733        727        (1 )% 
                                                                       

Total operating expenses

  $ 38,296      $ 28,452        (26 )%    $ 28,452      $ 37,405        31   $ 9,558      $ 9,730        2
                                                                       

Research and Development

Research and development expenses are attributable to our 2007 acquisition of Integrity Systems Ltd., the newly formed research and development group in our U.K. subsidiary in 2008 and the acquisition of our Switzerland subsidiary in late 2009. The research and development efforts relate to the integration of newly acquired tools into our standard services offerings and continued development of the software and proprietary methodologies used in the delivery of our consulting and managed services. These expenses consist primarily of salaries and benefits of our development personnel, third party consultants and third party software and equipment costs.

Research and development expenses increased $29,000 or 11% to $286,000 for the three months ended March 31, 2011 from $257,000 for the same period in 2010 and remained flat as a percentage of revenue at approximately 1%. The increase was predominately related to an increase in subcontractor expense. We expect research and development costs to increase in absolute dollars, but decrease as a percentage of revenue.

Research and development expenses increased $547,000 or 82% to $1.2 million for 2010 from $667,000 for 2009 and remained flat as a percentage of revenue at approximately 1%. Of this increase, $505,000 relates to the full year impact of our fourth quarter 2009 Swiss acquisition. The increase in research and development not including our fourth quarter 2009 Swiss acquisition consists of a $97,000 increase in salaries, bonuses, benefits and stock based compensation expenses and a $14,000 increase in miscellaneous expenses partially offset by a $38,000 decrease in subcontractor expenses, a $23,000 decrease in IT expenses and a $21,000 decrease in travel and entertainment expenses.

Research and development expenses decreased $383,000 or 36% to $667,000 for 2009 from $1.1 million for 2008 and remained flat as a percentages of revenues at approximately 1%. This decrease is due to the consolidation of our research and development functions resulting from the completion of the initial integration and upgrade of acquired tools and IP. The decrease consists of a $184,000 decrease in salaries, bonuses, benefits and stock-based compensation expenses, a $117,000 decrease in subcontractors expenses, a $51,000 decrease in facilities expenses, a $15,000 decrease in travel and entertainment expenses and a $16,000 decrease in miscellaneous expenses. Using the Constant Currency Method, research and development expenses decreased $187,000 or 17% to $863,000 for 2009 from $1.1 million for 2008.

Sales and Marketing

Sales and marketing expenses consist primarily of salaries with related benefits, commissions and marketing expenses such as advertising, product literature and trade show costs.

Sales and marketing consist of three key components:

 

   

Direct Sales—regionally based sales representatives who call primarily on named accounts in their region;

   

Indirect Sales—sales representatives who focus on creating channel relationships in specific geographies and domain competencies; and

   

Marketing—personnel who manage lead generation, collateral material development, and press and analyst relations.

 

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Sales commissions are paid regardless of whether the opportunity is closed directly or through a channel partner. As our offerings have become more robust and project sizes have grown, sales representatives have become more productive with respect to the revenues they can produce.

Sales and marketing expenses decreased $172,000 or 3% to $4.8 million for the three months ended March 31, 2011 from $5.0 million for the same period in 2010 and decreased as a percentage of revenue to 16% for the three months ended March 31, 2011 from 22% for the same period in 2010. The decrease in sales and marketing expenses consists of a $471,000 decrease in salaries, bonuses, benefits and stock-based compensation expenses, a $69,000 decrease in marketing events and collateral expenses, a $52,000 decrease in travel and entertainment expenses and a $33,000 decrease in miscellaneous expenses partially offset by a $400,000 increase in commission expenses and a $51,000 increase in recruiting costs. We expect sales and marketing expenses to increase in absolute dollar value, but decrease as a percentage of revenue.

Sales and marketing expenses increased $3.6 million or 24% to $18.9 million for 2010 from $15.3 million for 2009 and increased as a percentage of revenue to 19% for 2010 from 17% in 2009. Of this increase, $2.1 million relates to the full year impact of our fourth quarter 2009 Swiss acquisition. The increase in sales and marketing expenses not including our fourth quarter 2009 Swiss acquisition consists of a $1.1 million increase in salaries, bonuses, benefits and stock-based compensation expenses, a $667,000 increase in commission expense, a $291,000 decrease in third party reimbursement of sales expense, a $224,000 increase in marketing events and collateral expenses, partially offset by a $459,000 decrease in outside consultants, a $53,000 decrease in travel and entertainment expenses and a $415,000 decrease in miscellaneous expenses. The 2010 increase in salaries, bonuses, benefits and stock-based compensation expenses represents our investment in direct sales, partner sales and sales support functions.

Sales and marketing expenses decreased $3.8 million or 20% to $15.3 million for 2009 from $19.1 million for 2008 and decreased as a percentage of revenues to 17% for 2009 from 22% in 2008. This decrease consists of a $2.0 million decrease in salaries, bonuses, and benefits, a $853,000 decrease in stock-based compensation expenses, a $482,000 decrease in commission expenses, a $374,000 decrease in marketing events and collateral expenses, a $315,000 decrease in travel and entertainment expenses, $205,000 decrease in recruiting expenses and a $203,000 decrease in facility charges offset by a $702,000 increase in miscellaneous expenses. Using the Constant Currency Method, sales and marketing expenses decreased $1.6 million or 8% to $17.5 million for 2009 from $19.1 million for 2008. The change in marketing expenses in 2009 as compared to the same period in 2008 is attributed to a restructuring of the sales teams. Due to our acquisitions made in 2007 and 2008, we had an ‘overlay’ of sales management responsible for training and supporting our sales force in the new services and capabilities of our acquisitions. As our sales teams’ understanding of the services improved and their reliance on the overlay sales managers decreased, the overlay roles were eliminated, thus reducing the number of senior managers across the sales teams.

General and Administrative

General and administrative expenses include the costs of financial, human resources, IT and administrative personnel, professional services and corporate overhead.

General and administrative expenses increased $321,000 or 9% to $3.9 million for the three months ended March 31, 2011 from $3.6 million for the same period in 2010 and decreased as a percentage of revenue to 13% for the three months ended March 31, 2011 from 16% for the same period in 2010. The increase in general and administrative expenses consists of a $244,000 increase in salaries, bonuses, benefits and stock-based compensation expenses, a $143,000 increase in facilities a $76,000 increase in recruiting expenses, a $55,000 increase in travel and entertainment, a $23,000 increase in miscellaneous expenses partially offset by a $174,000 decrease in outside consultants and legal expenses. We expect general and administrative expenses to increase in absolute dollar value, but decrease as a percentage of revenue.

General and administrative expenses increased $4.5 million or 45% to $14.4 million for 2010 from $10.0 million for 2009 and increased as a percentage of revenue to 15% for 2010 from 11% in 2009. Of this increase, $2.0 million relates to the full year impact of our fourth quarter Swiss acquisition. The increase in general and administrative expenses not including our fourth quarter 2009 acquisition consists of a $974,000 million increase in salaries, bonuses, benefits and stock-based compensation expenses, a $243,000 increase in miscellaneous expenses, a

 

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$613,000 increase in outside consultants, a $167,000 increase in IT expenses, a $118,000 increase in recruiting costs, a $84,000 increase in facilities expenses and a $72,000 increase in travel and entertainment expenses, partially offset by a $18,000 decrease in depreciation expense.

General and administrative expenses decreased $5.5 million or 35% to $9.9 million for 2009 from $15.4 million for 2008 and decreased as a percentage of revenues to 11% for 2009 from 18% for 2008. The decrease reflects the write-off of $4.0 million of deferred initial public offering costs in 2008, a $1.3 million decrease in salaries, bonuses and benefits expenses, a $756,000 decrease in stock-based compensation expenses, a $140,000 decrease in travel and entertainment expenses, a $101,000 decrease in recruiting expenses, a $33,000 decrease in IT expenses offset by a $242,000 increase in facility expenses, a $48,000 increase in outside accounting and legal costs, a $145,000 increase in depreciation expense and a $435,000 decrease in miscellaneous expenses. Using the Constant Currency Method, general and administrative expenses decreased $4.9 million or 32% to $10.5 million for 2009 from $15.4 million for 2008.

Amortization

We have purchased intangible assets as part of our acquisitions. We have amortized these intangible assets over the estimated useful life of each such asset.

Amortization expense decreased $7,000 or 1% to $727,000 for the three months ended March 31, 2011 from $833,000 for the same period in 2010. The decrease is due to exchange rate fluctuations.

Amortization expense increased $318,000 or 13% to $2.9 million for 2010 from $2.5 million for 2009, reflecting the full year impact of our 2009 acquisitions.

Amortization expense decreased $236,000 or 9% to $2.5 million for 2009 from $2.8 million for 2008, reflecting the impact of the fully amortized intangible assets. The change in exchange rates for 2009 from 2008 did not have a material impact on our 2009 amortization expense.

Interest Expense

Interest expense increased $373,000 or 14% to $3.1 million for the three months ended March 31, 2011 from $2.7 million for the three months ended March 31, 2010.

Interest expense increased $2.6 million or 47% to $8.1 million for 2010 from $5.5 million in 2009. This increase is the result of interest on new debt of $1.1 million, additional debt discount and cost of debt items amortized through interest expense , debt extinguishment costs, and debt modification expense.

Interest expense increased $816,000 or 17% to $5.5 million for 2009 from $4.7 million for 2008. The increase was due to the full period impact of 2008 and 2009 debt refinancings. The change in exchange rates in 2009 from 2008 did not have a material impact on our 2009 interest expense.

Other Income (Expense), Net

Other income (expense), net consists of the impact of foreign currency exchange gains/losses, the net impact of changes in fair value of the preferred stock warrant liability, interest income and the receipts for services that are not considered to be our core business.

Other income (expense) increased $766,000 to income of $44,000 for the three months ended March 31, 2011 from an expense of $722,000 for the three months ended March 31, 2010. The increase is primarily due to an $110,000 foreign currency exchange gain for the three months ended March 31, 2011 compared to a $783,000 foreign currency exchange loss for the three months ended March 31, 2010.

Other income (expense) increased $2.0 million to $3.0 million for 2010 from $1.0 million for 2009. The increase is due to a $2.6 million increase in the fair value of the preferred stock warrant expense compared to the $18,000 gain in 2009. This was partially offset by a $621,000 loss in the foreign currency exchange loss in 2010 compared to a $386,000 gain in 2009.

Other income (expense), net increased $825,000 to $1.0 million for 2009 from $212,000 in 2008. The increase was due to a $101,000 gain on the change in the fair value of the preferred stock warrants in 2009 compared to a $1.6 million gain in 2008 and a $1.9 million decrease in other income offset by a $386,000 foreign currency exchange gain in 2009 as compared to a $2.5 million loss in 2008.

 

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Provision (Benefit) for Income Taxes

We have incurred losses since inception and therefore do not pay significant income taxes, except in certain foreign jurisdictions where we are profitable. We have net operating loss carryforwards that may be available to offset future taxable income. We have applied a full valuation allowance against the benefits of a majority of our deferred tax assets.

Our income tax expense (benefit) includes current income taxes in jurisdictions where we are profitable, non-cash deferred tax expense from amortization of goodwill for tax but not book purposes and the impact of other book-tax differences.

Income tax provision increased $68,000 to an expense of $56,000 for the three months ended March 31, 2011 from a $12,000 benefit for the three months ended March 31, 2010. We do not record a tax benefit for the majority of our net losses because of the uncertainty regarding our ability to utilize those losses to offset future taxable income. The tax expense of $56,000 is primarily due to an increase in deferred tax expense of $59,500 from goodwill amortization deductible for tax but not book purposes and a decrease in deferred tax expense of $52,000 from other timing differences against existing deferred tax liabilities. Current tax expense for the three months ended March 31, 2011 is $49,000. At March 31, 2011, accrued interest and penalties on a gross basis, of which $225 is included in current tax expense above, were $32,275.

Income tax provision increased $154,000 to an expense of $232,000 for the year ended December 31, 2010 from a $78,000 expense for the year ended December 31, 2009. We do not record a tax benefit for the majority of our net losses because of the uncertainty regarding our ability to utilize those losses to offset future taxable income. The tax expense of $232,000 is primarily due to an increase in deferred tax expense of $250,000 from goodwill amortization deductible for tax but not book purposes and a decrease in deferred tax expense of $50,000 from other timing differences against existing deferred tax liabilities. Current tax expense for the year ended December 31, 2010 is $283,378. At December 31, 2010, accrued interest and penalties on a gross basis, which are included in current tax expense above, were $32,050.

Income tax provision decreased $162,000 to a $78,000 expense in 2009 from a $240,000 expense for 2008. We do not record a tax benefit for the majority of our net losses because of the uncertainty regarding our ability to utilize those losses to offset future taxable income. The tax expense of $78,000 is primarily due to deferred tax expense of (i) $211,000 from goodwill amortization deductible for tax but not book purposes and (ii) $133,000 from an increase in net deferred tax assets from the offsetting net operating losses and other timing differences against existing deferred tax liabilities.

 

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Unaudited Quarterly Results of Operations

 

    Quarter Ended in 2009     Quarter Ended in 2010     Quarter Ended in 2011  
    March 31     June 30     September 30     December 31     March 31     June 30     September 30     December 31,     March 31, (1)  
                            (in thousands, except per share data)  

Consolidated Statements of Operations Data:

                 

Revenues

  $ 22,156      $ 21,649      $ 21,867      $ 23,873      $ 22,941      $ 25,402      $ 24,445      $ 26,150      $ 29,826   

Cost of revenues

    16,470        16,037        15,436        15,991        18,865        19,700        18,700        19,607        22,386   
                                                                       

Gross profit

    5,686        5,612        6,431        7,882        4,076        5,702        5,745        6,543        7,440   

Research and development expenses

    132        118        199        218        257        256        377        324        286   

Selling and marketing expenses

    3,437        3,317        3,484        5,061        4,984        4,500        4,266        5,190        4,811   

General and administrative expenses

    2,226        2,164        2,709        2,852        3,584        3,681        3,406        3,727        3,906   

Amortization of intangible assets

    602        608        634        691        733        696        701       
723
  
    727   
                                                                       

Loss from operations

    (711     (595     (595     (940     (5,482     (3,431     (3,005     (3,421     (2,290

Interest and other income (expense), net

    (1,852     655        (1,612     (1,664     (3,408     (204     (426     (990     (3,014
                                                                       

Loss before income taxes

    (2,563     60        (2,207     (2,604     (8,890     (3,635     (3,431     (4,411     (5,304

Provision for (benefit from) income taxes

    (228     102        135        69        (12     64        51        129        56   
                                                                       

Net loss

    (2,335     (42     (2,342     (2,673     (8,878     (3,699     (3,482     (4,540     (5,360
                                                                       

Dividends and accretion on preferred stock

    (1,321     (1,335     (1,350     (1,354     (1,315     (1,328     (1,341     (1,341     (1,229
                                                                       

Net loss to common stockholders

  $ (3,656   $ (1,377   $ (3,692   $ (4,027   $ (10,193   $ (5,027   $ (4,823   $ (5,881   $ (6,589
                                                                       

Net loss per share, basic and diluted

  $ (0.28   $ (0.10   $ (0.28   $ (0.28   $ (0.63   $ (0.31   $ (0.29   $ (0.36   $ (0.40
                                                                       

Other unaudited financial data: EBITDA (2)

  $ (308   $ 1,932      $ 117      $ (161   $ (5,108   $ (2,407   $ (740     (2,522   $ (1,502
                                                                       

Weighted average shares outstanding

    13,044        13,174        13,225        14,159        16,211        16,270        16,303        16,347        16,466   
                                                                       

Consolidated Statements of Operations Data:

                 

Revenues

    100.0     100.0     100.0     100.0     100.0     100.0     100.0     100.0     100.0

Cost of revenues

    74.3     74.1     70.6     67.0     82.2     77.6     76.5    
75.0

    75.1
                                                                       

Gross profit

    25.7     25.9     29.4     33.0     17.8     22.4     23.5    
25.0

    24.9

Research and development expenses

    0.6     0.5     0.9     0.9     1.1     1.0     1.5     1.2     1.0

Selling and marketing expenses

    15.5     15.3     15.9     21.2     21.7     17.7     17.5     19.8     16.1

General and administrative expenses

    10.0     10.0     12.4     11.9     15.6     14.5     13.9    
14.3

    13.1

Amortization of intangible assets

    2.7     2.8     2.9     2.9     3.2     2.7     2.9     2.8     2.4
                                                                       

Loss from operations

    -3.2     -2.7     -2.7     -3.9     (23.9 )%      (13.5 )%      (12.3 )%      (13.1 )%      (7.7 )% 

Interest and other income (expense), net

    -8.4     3.0     -7.4     -7.0     (14.9 )%      (0.8 )%      (1.7 )%      (3.8 )%      (10.1 )% 
                                                                       

Income/(loss) before income taxes

    -11.6     0.3     -10.1     -10.9     (38.8 )%      (14.3 )%      (14.0 )%      (16.9 )%      (17.8 )% 

Provision (benefit) for income taxes

    -1.0     0.5     0.6     0.3     (0.1 )%      0.3     0.2     0.5     0.2
                                                                       

Net loss

    -10.6     -0.2     -10.7     -11.2     (38.7 )%      (14.6 )%      (14.2 )%      (17.4 )%      (18.0 )% 
                                                                       

 

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(1) On January 1, 2011, we adopted Accounting Standards Update No. 2009-13, “Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). Our adoption of ASU 2009-13 had a material impact on our results for the three months ended March 31, 2011 as reported and as if we did not adopt ASU 2009-13. This information is presented to allow comparability between our results for the three months ended March 31, 2010 and 2011.

 

     Three Months Ended March 31, 2011  
     As Reported with
Adoption of ASU2009-13
    As Reported without
Adoption of ASU2009-13
 
     (in thousands, except per share data)  

Service revenues

   $ 26,451      $ 26,390   

Product revenues

     3,375        1,398   
                

Total revenues

     29,826        27,788   

Cost of services revenues

     20,004        19,911   

Cost of product revenues

     2,382        815   
                

Total cost of revenues

     22,386        20,726   

Gross profit

     7,440        7,052   

Operating loss

     (2,290     (2,668

Net loss to common shareholder

   $ (6,589   $ (6,967
                

EBITDA

   $ (1,502   $ (1,880
                

Basic and diluted net loss to common shareholder

   $ (0.40   $ (0.42
                
(2) EBITDA represents net loss before deductions for interest expense, income taxes, depreciation and amortization of tangible and intangible assets and adjustments for non-cash changes in fair value of warrant liability. EBITDA is a supplemental financial measure, which is not based on United States generally accepted accounting principles (GAAP), used by management and industry analysts to evaluate operations.

The following is a reconciliation of net income (loss) to EBITDA:

 

    Quarter Ended in 2009     Quarter Ended in 2010     Quarter Ended in 2011  
    March 31     June 30     September 30     December 31     March 31     June 30     September 30     December 31,     March 31,     2011  
                                                    As Reported
with
Adoption of
ASU2009-13
    As  Reported
without
Adoption of
ASU2009-13
 
    (in thousands, except per share data)  

EBITDA Calculation:

                   

Net loss

  $ (2,335   $ (42   $ (2,342   $ (2,673   $ (8,878   $ (3,699   $ (3,482   $ (4,540   $ (5,360   $ (5,738

Depreciation

    141        150        156        222        198        197        214        214        208        208   

Interest expense

    1,258        1,450        1,334        1,467        2,686        1,487        1,764        2,131        3,058        3,058   

Warrant revaluation

    190        (402     129        (19     65        (1,428     (65     (1,108     (319     (319

Derivative revaluation

    —          —          —          —          —          153        (50     (202     (5     (5

Taxes

    (228     102        135        69        (12     64        51        129        56        56   

Amortization of intangible assets (including amounts in cost of revenues)

    666        674        705        773        833        819        828        854        860        860   
                                                                               

EBITDA

  $ (308   $ 1,932      $ 117      $ (161   $ (5,108   $ (2,407   $ (740   $ (2,522   $ (1,502   $ (1,880
                                                                               

In addition to providing financial measurements based on GAAP, we present additional historical financial metrics that are not prepared in accordance with GAAP (non-GAAP). Legislative and regulatory changes discourage the use of and emphasis on non-GAAP financial metrics and require companies to explain why non-GAAP financial metrics are relevant to management and investors. We believe that the inclusion of these non-GAAP financial measures, together with our GAAP financial measures, helps investors to gain a meaningful understanding of our past performance and future results. This approach is consistent with how management measures and forecasts our performance, especially when comparing such results to previous periods or forecasts. Our management uses these non-GAAP measures, in addition to GAAP financial measures, as the basis for measuring our core operating performance and comparing such performance to that of prior periods and to the performance of our competitors. These measures are also used by management in its financial, operational and strategic decision-making and in developing incentive compensation plans.

 

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Our non-GAAP financial measures consist of EBITDA. We define EBITDA as net income, before interest expense, income taxes, depreciation and amortization of tangible and intangible assets, and adjustments for non-cash changes in fair value of our warrant and derivative liabilities. We consider EBITDA to be an important indicator of our operational strength and performance of our core business and a valuable measure of our historical operating trends.

There are limitations associated with reliance on these non-GAAP financial metrics because they are specific to our operations and financial performance, which makes comparisons with other companies’ financial results imprecise. We recognize that the non-GAAP measure EBITDA does have certain limitations. It does not include interest expense, which is a necessary and ongoing part of our cost structure resulting from debt incurred to expand operations. EBITDA also excludes depreciation, amortization expense, and adjustments for non-cash changes in fair value of our warrant and derivative liabilities. The exclusion of these items, in light of their recurring nature, is a material limitation of EBITDA. To manage these limitations, we have policies and procedures in place to identify expenses that qualify as interest, taxes, depreciation and amortization to approve and segregate these expenses from other expenses to ensure that our EBITDA is consistently reflected from period to period.

EBITDA excludes some items that affect net income (loss) and may vary among companies. The EBITDA we present may not be comparable to similarly titled measures of other companies. EBITDA does not give effect to the cash that we must use to service our debt or pay income taxes and thus does not reflect the funds generated from operations or actually available for capital investments. By providing both GAAP and non-GAAP financial measures, we believe that investors are able to compare our GAAP results to those of other companies while also gaining an understanding of our operating performance as evaluated by management.

Liquidity and Capital Resources

Overview

Since our inception in 2001, we have primarily funded our operations through the issuance of an aggregate of $82 million in preferred stock and $68 million in borrowings under our loan and security agreements described below.

We used these proceeds to fund our operations, invest in property and equipment and acquire other companies. We issued Dell a convertible promissory note that is currently outstanding and under which we will owe Dell approximately $38.5 million in total payments at maturity, of which $1.4 million has been paid as of the date of this filing. Dell has extended the maturity date on the note through September 16, 2011. We paid Dell $350,000 upon execution of definitive documentation formalizing the extension and paid an additional $1.3 million on July 21, 2011. Interest accrues at a simple annual rate of 22.5%, effective June 13, 2011. We have agreed to repay the note in full upon the consummation of this offering and to provide Dell with certain rights of refusal in the event we receive an acquisition proposal prior to payment in full of the note. We believe that our existing cash and cash equivalents of $6.6 million as of March 31, 2011, combined with the $6.0 million raised from the sale of our Series F preferred stock in July 2011, and any cash generated from operations will not be sufficient to pay off this note. We intend to use part of the proceeds from this offering to pay off the note in full. In the event that we do not complete this offering by the extension date and that Dell does not elect to convert or further extend the maturity of the Dell Note, and without the benefit of any additional debt or equity funding, we believe we have sufficient cash to operate through December 31, 2011.

In order to meet our debt obligations and to fund operations through June 2012, we anticipate needing to raise approximately $50.0 million in additional funding in addition to our $6.6 million of cash on hand at March 31, 2011 and $6.0 million of cash raised through our sale of preferred stock in July 2011. Specifically, we anticipate that we will need $38.5 million to repay the Dell Note and all related accrued interest, $16.9 million to service other debt obligations through June 30, 2012, and $5.4 million to fund working capital needs. Of this need, we anticipate being able to fund $1.5 million through cash generated from operations. In the event that we raise less than $50.0 million, we would not be able meet these cash needs. In this case, we would need to take certain actions to ensure that we had sufficient cashflows to operate our business. These actions would include:

 

   

Renegotiate our note with Dell and other creditors. We have historically been able to work with our creditors to restructure our debt obligations. These restructurings have taken the form of extended maturity dates, interest only repayment periods and deferred payment periods. Depending on the amount of the net proceeds raised in this offering and our success in taking the other steps outlined below, this could include one or all of our creditors. Of all of our available options to finance our continuing obligations and operations, this is the most critical and would have the greatest impact on our ability to meet our cashflow requirements.

 

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Curtail both our organic growth and acquisitions. Our use of cash is partially driven by our organic growth and acquisitions. In order to reduce our cash needs, we would reduce and eliminate these growth strategies in the near term. This could hurt our ability to attract potential investors and cause us to lose market share, which could decrease our ability to raise capital and generate cashflow from operations.

 

   

Restructure our operations. Our current operations and staffing structure includes costs and cash needs to meet both growth and service development. These costs and cash usages could be reduced in the form of a reduction in our work force. Although this would increase our cash usage in the near term due to severance costs, it would ultimately reduce cash usage over the long-term. Any action to reduce our investment in growth and service offerings would have an adverse impact on us. This could hurt our ability to attract potential investors and cause us to lose market share, which could decrease our ability to raise capital and generate cashflow from operations.

 

   

Divest of certain subsidiaries. Our divesting of some or all of our foreign operations would allow us to raise capital in the short term. The time frame and ultimate success of such an action is unknown and not predictable. Again, this action could hurt our ability to attract potential investors and cause us to lose market share, which could decrease our ability to raise capital and generate cashflow from operations.

 

   

Actively market the Company for sale. If we are unsuccessful in our other actions, we would ultimately attempt to sell the Company.

Apart from our debt obligations, our future working capital and financing requirements will depend on many factors, including the rate of our revenue growth, our ability to integrate acquisitions and our expansion of sales and marketing and product development activities. To the extent that our cash and cash equivalents, cash flow from operating activities and net proceeds of this offering are insufficient to fund our future activities, we may need to raise additional funds through bank credit arrangements or public or private equity or debt financings. We may also need to raise additional funds in the event we decide to complete one or more acquisitions of companies, technologies or products. In the event additional financing is required, we may not be able to obtain financing on terms acceptable to us or at all. Further, limitations on our ability to incur additional debt under our loan obligations with certain debt and equity holders may limit our ability to obtain additional financing. Specifically, our lenders and equity holders have the contractual ability to prevent us from incurring additional indebtedness, including subordinated indebtedness, as well as from raising equity, completing acquisitions or consummating other material events.

Our plans of operations, even if successful, may not result in cash flow sufficient to finance and expand our business. Consequently, our limited cash resources, obligations coming due in 2011 and recurring losses raise substantial doubt about our ability to continue as a going concern through December 31, 2011. Realization of assets is dependent upon our continued operations, which in turn is dependent upon management’s plans to meet our financing requirements and the success of our future operations. Our ability to continue as a going concern is dependent on improving our profitability and cash flow and securing additional financing. While we believe in the viability of our strategy to increase revenues and profitability and in our ability to raise additional funds, and believe that the actions presently being taken provide the opportunity for us to continue as a going concern, there can be no assurances to that effect.

Apart from the maturity of the Dell Note, our future working capital and financing requirements will depend on many factors, including the rate of our revenue growth, our ability to integrate acquisitions and our expansion of sales and marketing and product development activities. To the extent that our cash and cash equivalents, cash flow from operating activities and net proceeds of this offering are insufficient to fund our future activities, we may need to raise additional funds through bank credit arrangements or public or private equity or debt financings. We may also need to raise additional funds in the event we decide to complete one or more acquisitions of companies, technologies or products. In the event additional financing is required, we may not be able to obtain financing on terms acceptable to us or at all. Further, limitations on our ability to incur additional debt under our loan obligations with certain debt and equity holders may limit our ability to obtain additional financing. Specifically, our lenders and equity holders have the contractual ability to prevent us from incurring additional indebtedness, including subordinated indebtedness.

Our plans of operations, even if successful, may not result in cash flow sufficient to finance and expand our business. Consequently, our limited cash resources, obligations coming due in 2011 and recurring losses raise substantial doubt about our ability to continue as a going concern through December 31, 2011. Realization of assets

 

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is dependent upon our continued operations, which in turn is dependent upon management’s plans to meet our financing requirements and the success of our future operations. Our ability to continue as a going concern is dependent on improving our profitability and cash flow and securing additional financing. While we believe in the viability of our strategy to increase revenues and profitability and in our ability to raise additional funds, and believe that the actions presently being taken provide the opportunity for us to continue as a going concern, there can be no assurances to that effect.

We expect to pay off all short term obligations with proceeds from this offering, leaving only the Wellington Note, due in March 2012. Cash generated from the recent Citrix investment along with cash generated from operations should be enough to fund our anticipated costs at our current growth rates. We also anticipate either refinancing the Wellington Note or working with Wellington who has shown a willingness to extend the March 2012 maturity date.

Cash Flows

The following table summarizes our cash flows for the years ended December 31, 2008, 2009 and 2010 and the three months ended March 31, 2010 and 2011:

 

     Year Ended December 31,     Three Months Ended
March 31,
 
     2008     2009     2010     2010     2011  
          

Net cash provided by (used in) operating activities

   $ (9,151   $ (685   $ (13,665   $ (4,343   $ (4,654

Net cash used in investing activities

     (8,209     (1,070     1,694        (49     (204

Net cash provided by (used in) financing activities

     23,776        (3,157     16,199        4,295        (375

Effect of foreign currency on cash and cash equivalents

     145        (10     45        (21     24   
                                        

Net increase (decrease) in cash and cash equivalents

   $ 6,561      $ (4,922   $ 4,273      $ (118     (5,228
                                        

Cash Flows from Operating Activities

Cash used in operating activities primarily consists of net losses adjusted for certain non-cash items including depreciation and amortization, non-cash interest expense, stock-based compensation expenses, the non-cash change in warrant and derivative liabilities and the effect of changes in working capital and other activities. Our cash flows from working capital items will fluctuate period to period due to the nature of our business. Specifically, cash flows from deferred revenue will fluctuate due to the timing of our invoicing and recognition of managed service revenue and cash flows related to accounts payable and accruals are dependent on payment terms with vendors. We have experienced fluctuations in the cash flows from working capital and expect to continue to experience these fluctuations in the future.

Cash used in operating activities for the three months ended March 31, 2011 was $4.7 million and consisted of a $5.4 million net loss and $3.2 million of cash used by working capital purposes, offset by $4.3 million in non-cash items. Non-cash items consisted primarily of $2.7 million in non-cash interest, $1.1 million of depreciation and amortization, $459,000 of stock-based compensation expenses, partially off-set by a $319,000 non-cash reduction in fair value of warrants and derivatives a $11,000 non-cash foreign currency gain on intercompany expenses. Cash used by working capital needs and other activities consisted primarily of an $2.1 million decrease in accounts payable, a $1.4 million increase in prepaids and other current assets, a $1.3 million increase in unbilled revenue, and a $553,000 decrease in deferred revenue, partially offset by a $1.2 million increase in accrued expenses, a $719,000 decrease in accounts receivable, and a $282,000 decrease in other assets.

Cash used in operating activities for the three months ended March 31, 2010 was $4.3 million and consisted of an $8.9 million net loss offset by $4.2 million in non-cash items and $376,000 in cash provided by working capital and other activities. Non-cash items consisted primarily of $1.1 million in non-cash interest, $1.0 million of depreciation and amortization, $787,000 in non-cash debt refinancing, $662,000 loss in non-cash foreign currency impact on intercompany expenses, $439,000 in non-cash stock-based compensation expenses, $109,000 in deferred income taxes, and $65,000 in non-cash change in fair value of warrant liability. Cash provided by working capital purposes and other activities consisted primarily of a $5.2 million increase in deferred revenue, $1.7 million increase in

 

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accounts payable, $1.3 million increase in accounts receivable, and a $615,000 decrease in unbilled revenue, partially offset by $3.6 million increase in prepaids and other current assets, $3.0 million decrease in accrued expenses, and a $1.9 million increase in other assets.

Cash used in operating activities for 2010 was $13.8 million and consisted of a $20.6 million net loss and $1.2 million used for working capital purposes and other activities offset by $8.0 in non-cash items. Non-cash items consist primarily of $5.0 million in non-cash interest expense, $3.3 million in amortization of intangible assets, $1.8 million in stock-based compensation expense, $823,000 in depreciation expense, $787,000 of non-cash debt extinguishment expense and $238,000 of non-cash pension expense partially offset by a $2.5 million non-cash reduction in the fair value of the warrant liability, $1.3 million non-cash foreign currency gain on intercompany expenses, a $99,000 non-cash change in the fair value of a derivative and $44,000 deferred income tax expense. Cash used for working capital purposes and other activities consisted primarily of a $6.9 million increase in prepaids and other current assets, a $7.3 million increase in other assets, a $1.5 million net decrease in accounts payable and accrued expenses, and a $319,000 increase in accounts receivable partially offset by a $12.1 million increase in deferred revenue and a $2.7 million decreased in unbilled revenue.

The cash provided by the increase in deferred revenue was the result of increased deferred revenue levels in the U.S. as well as our Israel and Turkey subsidiaries combined with the full year impact of our fourth quarter 2009 Swiss acquisition. The cash used by the increase in other assets is a result of a $4.4 million increase in long term deferred expenses related to the increase in deferred revenue and a $2.9 million increase in capitalized initial public offering expenses. The cash used by the increase in prepaids and other current assets is the result of a $6.9 million increase in short term deferred expenses related to our increase in deferred revenue.

Cash used in operating activities for 2009 was $685,000 and consisted of a $7.3 million net loss and $2.1 million used for working capital purposes and other activities offset by $8.8 million in non-cash items. Non-cash items consisted primarily of $4.4 million in non-cash interest, $3.5 million of depreciation and amortization, $1.1 million in stock-based compensation expenses and a $292,000 debt extinguishment charge, partially offset by a $527,000 non-cash foreign currency gain on intercompany expenses and a $101,000 non-cash reduction in the fair value of warrant liability. Cash used for working capital purposes and other activities consisted primarily of a $2.6 million decrease in accounts payable, a $2.6 million decrease in deferred revenue, a $1.6 million increase in other assets, partially offset by a $2.9 million increase in accrued expenses and a $1.7 million decrease in accounts receivable.

The decrease in deferred revenue, which resulted in an increase in cash used in operations, was the result of the timing of invoicing and delivery of our managed services. Deferred revenue fluctuates in periods based on the timing of new contracts, renewals and delivery of services. The cash used for other assets is the result of our capitalization of $875,000 of initial public offering costs and other recurring events. Cash provided by or used in working capital is a function of our growth rate and in high growth periods, we will have temporary working capital needs.

Cash used in operating activities for 2008 was $9.2 million and consisted of a $23.3 million net loss offset by $11.3 million of non-cash items and $2.9 million in cash provided from working capital and other activities. Non-cash items consisted primarily of $4.1 in non-cash interest, $3.6 million in depreciation and amortization, $2.7 million in stock-based compensation expense and a $2.5 million non-cash foreign currency loss on intercompany expenses, partially offset by a $1.6 million decrease in the fair value of warrants. Cash provided by working capital and other activities consisted primarily of a $6.9 million increase in deferred revenue, a $1.5 million decrease in unbilled revenue, partially offset by a $3.0 million decrease in accrued expenses, a $1.8 million increase in accounts receivable and a $1.3 million decrease in accounts payable.

 

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Accounts Receivable and Days Sales Outstanding

Our days sales outstanding for 2008, 2009 and 2010 and the three months ended March 31, 2011 and our accounts receivable balance at December 31, 2008, 2009, and 2010 and March 31, 2011 were as follows:

 

     December 31,      March 31  
     2008      2009      2010      2011  

Days sales outstanding

     79         86         81         65   

Revenue

   $ 85,058       $ 89,545       $ 98,938         29,826   

Accounts receivable

   $ 18,310       $ 21,054       $ 21,922         21,483   

Our decrease in days sales outstanding at March 31, 2011 as compared to our days sales outstanding at December 31, 2010 is the result principally of increased collection efforts and, to a lesser extent, the impact of our adoption of ASC 605-25. Prior to our adoption of ASC 605-25, we recognized multiple element revenue arrangements as one unit of accounting over the longest service period. Under ASC 605-25, we recognize the different elements of the multiple element arrangement as separate units of accounting based on their relative fair values. This results in our recognition of revenue related to third party products, being accelerated as it is now recognized upon the products being functional in the customers’ environment where as before the adoption of ASC 605-25 the revenue used to be recognized over the longest service time. The increase in revenue without an impact to accounts receivable has the impact of reducing days sales outstanding. The impact that our adoption of ASC 605-25 had on days sales outstanding was to reduce it by 4 days. Our days sales outstanding would have been 69 days without the impact of ASC 605-25. We expect our days sales outstanding generally to be in the 60-70 day range.

Our decrease in days sales outstanding at December 31, 2010 as compared to our days sales outstanding at December 31, 2009 is due to the impact of accounts receivable of our acquisitions in the fourth quarter of 2009. The accounts receivable balance acquired represented the average balance, but we only recognized a minimal amount of revenue in 2009 related to the acquisition. At December 31, 2010 we had a full year of revenue in our results. The net effect was to decrease our days sales outstanding.

Cash Flows from Investing Activities

Cash (used) in/provided by investing activities was ($8.2) million, ($1.1) million, $1.7 million, ($49,000) and ($204,000) for 2008, 2009, 2010, and the three months ended March 31, 2010 and 2011 respectively. Our principal cash investments have related to acquisitions and the purchase of property and equipment. Cash provided in 2010 is primarily the result of $2.3 million of restricted cash being released.

During 2009, cash used in investing activities consisted primarily of $539,000 of earnouts paid related to prior acquisitions and cash paid for acquisitions, net of cash acquired, $565,000 of purchases of property and equipment and a $34,000 decrease in restricted cash.

During 2008, cash used in investing activities consisted primarily of $5.0 million for cash paid for acquisitions, net of cash acquired, a $2.1 million increase in restricted cash and $1.1 million of purchases of property and equipment.

Cash Flows From Financing Activities

Cash flows provided by (used in) financing activities were, $23.8 million, $(3.2) million, $16.4 million $4.3 million and $(375,000) for 2008, 2009 and 2010 and the three months ended March 31, 2010 and 2011, respectively.

The following provides a discussion of these activities by major category.

Stock Repurchase

In June 2008, we purchased approximately 1,766,000 shares of our common stock and 238,000 shares of our series 1 convertible preferred stock for $4.0 million and $537,000, respectively, from certain of our officers and employees. The shares were purchased at $2.26 per share, the fair value at the time of the purchase.

Equity Financing Activities

In November 2008, we raised net proceeds of approximately $9.6 million through the sale of Series F preferred stock.

 

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In December 2010, we raised net proceeds of approximately $5.0 million through the sale of Series F preferred stock.

In July 2011, we raised net proceeds of approximately $6.0 million through the sale of Series F preferred stock.

Borrowings

As of March 31, 2011 we had outstanding debt in the amount of $58.1 million, including principal, accrued interest and final balloon payments, under loan agreements with our lenders. During 2008, 2009 and 2010 and the three months ended March 31, 2011, we made principal repayments of $6.3 million, $3.2 million, $6.0 million and zero. Principal repayments exclude repayments of borrowings made under our Israeli subsidiary credit line.

As summarized below, our debt consists of secured and unsecured debt. Our debt with Lighthouse Capital Partners is senior and secured. Our debt with Wellington Financial is junior and secured. The remainder of our debt is unsecured, except for our credit facilities in Israel, which are secured and senior to all other debt with respect to the assets of our Israeli subsidiary.

Debt Summary

 

Creditor

  

Seniority

   Maturity
Date
   Interest
Rate
    Outstanding
Principal (2)
     Balloon  
Lighthouse Capital Partners    Senior Secured (1)    06/01/12      13.50   $ 4,336,695       $ 1,687,750   
Wellington Financial L.P.    Junior Secured (1)    03/31/12      11.95     9,750,000         —     
Dell Products L.P.    Unsecured    09/16/11      22.50     35,124,724         —     
Venture Capital Investors    Unsecured    06/27/13      10.00     8,000,000         —     
Swiss Loan Agreement    Unsecured    01/01/15      4.75     173,891         —     
Bank Leumi    Secured by assets of our Israeli subsidiary    N/A      7.05     639,108      
Discount Bank    Secured by assets of our Israeli subsidiary    N/A      7.25     102,808      
                         
           $ 58,127,225       $ 1,687,750   
                         
                59,814,975   

 

(1) Junior to Bank Leumi and Discount Bank with respect to the assets of our Israeli subsidiary.
(2) As of June 30, 2011.

Bank Leumi and Israel Discount Bank. Our Israeli subsidiary has overdraft, credit lines and an on-call loan from Bank Leumi, and a term loan and an overdraft loan from Israel Discount Bank. At March 31, 2011, the total credit line from Bank Leumi was 3.5 million Israeli new shekels (NIS) ($996,000), the amount outstanding under the term loans and over-draft from Israel Discount Bank was approximately 500,000 NIS ($142,000) and there was nothing outstanding under the on-call loan, and NIS 8 million ($2.1 million) and NIS 1.5 million ($423,000) outstanding as an on-call loan at December 31, 2009 and 2010, respectively which were included in current portion of long-term debt.

The interest paid to Bank Leumi for years ended December 31, 2009 and 2010 and the three months ended March 31, 2011 was NIS 258,000 ($68,000), NIS 316,000 ($85,000) and NIS 21,000 ($5,800). Interest paid to Israel Discount Bank for the years ended December 31, 2009 and 2010 an the three months ended March 31, 2011 was NIS 50,000 ($13,000), NIS 39,000 ($10,000) and NIS 7,000 ($1,900). The interest rate on the term loans was equal to the rate of the Bank of Israel plus 1.5% (Rate) plus 2.2%, 2.2% and 2.2% as of March 31, 2011, December 31, 2010 and 2009, respectively. The interest rate on the on-call loans was the Rate plus 2.3%, 2.3% and 2.3% as of March 31, 2011, December 31, 2010 and 2009 respectively.

As of December 31, 2008, 2009 and 2010 and March 31, 2011 there was $2.0 million, $2.3 million, $631,000 and $182,000, respectively, outstanding under the loans which are included in the current portion of long-term debt. As of December 31, 2009, an additional amount of $74,000 was included in the long-term portion of debt.

The credit lines are secured by all of our Israeli subsidiary’s assets and was secured by a $2.0 million fully cash collateralized letter of credit shown as restricted cash on our balance sheet until October 2010. The lines have certain covenants.

On October 5, 2010 our Israeli subsidiary reached a new agreement with Bank Leumi. Under the new agreement we invested $2.0 million in the Israeli subsidiary and converted a loan of $1.8 million to the Israeli subsidiary into capital investment which the Israeli subsidiary used to pay down the line of credit. After the new investment was

 

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made Bank Leumi granted a line of credit of NIS 5.0 million ($1.4 million) which consisted of NIS 3.4 million ($938,000) of short term credit and NIS 1.6 million ($441,000) credit framework for bank guarantees.

The 2004 Loan Agreement. In June 2004, we entered into a Loan and Security Agreement (the 2004 Loan Agreement) with Lighthouse Capital Partners (Lighthouse). Under the 2004 Loan Agreement, we were allowed to borrow up to $6.0 million before June 2005. The 2004 Loan Agreement is secured by substantially all of our assets. Borrowings under the 2004 Loan Agreement bore interest at a fixed rate of 7.00% per annum and required interest only payments until June 30, 2005, followed by 36 consecutive monthly payments of principal and interest, payable monthly in advance. Interest during the repayment period is 7.5% per annum. In addition, there was a final non-principal balloon payment of $450,000 due at loan maturity. The final non-principal balloon payment was amortized as interest expense through its maturity date of June 2008. For the years ended December 31, 2008 and 2009, we amortized $59,000 and $0, respectively.

In July 2006, we amended the 2004 Loan Agreement (Amendment No. 2) to allow for an additional $3.0 million in borrowings before December 31, 2006. Borrowings under Amendment No. 2 bore interest at a fixed rate of 7.00% per annum and required interest only payments until October 31, 2007, followed by 36 consecutive monthly payments of principal and interest, payable monthly in advance. The per annum interest rate during the repayment period was equal to the prime rate at the beginning of the repayment period plus 1.75%. Prior to the restructuring in June 2009 as described below, this interest rate was 10% per annum. Subsequent to the restructuring the interest rate was fixed at 13.5% per annum. In addition, there was to be a final non-principal balloon payment of $233,000, due at loan maturity. At December 31, 2009 there was $1.24 million payable under Amendment No. 2, which includes $76,000 of interest and $344,000 of the non-principal balloon payment. The final non-principal balloon payment is being amortized as interest expense through its maturity date of July 2011, of which we amortized $70,000, $72,000, $73,000 and $18,000 in 2008, 2009, 2010 and the three months ended March 31, 2011, respectively.

In March 2007, we amended the 2004 Loan Agreement (Amendment No. 3) to allow for an additional $10.0 million in borrowings before August 31, 2007. Borrowings under Amendment No. 3 bore interest at a fixed rate of 10.00% per annum and required interest only payments until August 1, 2007 with 36 consecutive monthly payments of principal and interest, payable monthly in advance beginning September 1, 2007. In addition, there was to be a final non-principal balloon payment of $625,000 due at loan maturity. At December 31, 2009, there was $5.8 million payable under Amendment No. 3, which includes $421,000 of interest and $894,000 of final payment. The final non-principal balloon payment is being amortized as interest expense through its maturity date of July 2011, of which we amortized $183,000, $216,000, $239,000 and $60,000 in the years ended December 31, 2008, 2009, 2010 and the three months ended March 31, 2011, respectively.

In June 2009, we modified the terms of the 2004 Loan Agreement such that we will make interest-only payments during the period June 2009 through February 2010 at an annual interest rate of 13.5%. In March 2010, all amounts outstanding under the 2004 Loan Agreement, as amended, will be repaid based on a 15-month amortization schedule of principal and interest payment with a 10% interest rate. In consideration for the restructuring of the 2004 Loan Agreement, we will pay an additional $380,000 of final non-principal balloon payments to the lender upon maturity of the 2004 Loan Agreement, as amended, in July 2011. The payment date of the $1.2 million of final non-principal balloon payments outstanding was modified such that they are now due July 2011.

In connection with entering into the 2004 Loan Agreement along with the two additional amendments, we issued warrants to the lender to purchase shares of our Series C and Series D preferred stock, subject to certain anti-dilution adjustments. The purchase rights represented by the warrants are exercisable immediately and have a term of seven years. The warrants have been valued at their date of issuance using an option valuation model and at September 30, 2010 have a collective value of $1.0 million.

In June 2010, we modified the terms of the 2004 Loan Agreement such that we will make interest-only payments during the period June 2010 through September 2010 at an annual rate of 13.5%. In October 2010, all amounts outstanding under the 2004 Loan Agreement, as amended, were to be repaid based on a twelve month amortization schedule of principal and interest with a 10% interest rate. In consideration for the restructuring of the 2004 Loan Agreement, we will pay an additional $125,000 of final non-principal balloon payments to the lender upon maturity of the 2004 Loan Agreement as amended June 2010. The payment date of the cumulative $1.4 million of final nonprincipal balloon payments outstanding was modified such that they were to be due September 2011.

 

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In September 2010, we modified the terms of the 2004 Loan Agreement such that we will make interest-only payments during the period of October 2010 through June 2011 at an annual interest rate of 13.5%. In July 2011, all amounts outstanding under the 2004 Loan Agreement, as amended, will be repaid based on a nine month amortization schedule of principal and interest with a 10% interest rate. In consideration for the restructuring of the 2004 Loan Agreement, we will pay an additional $325,000 of final non-principal balloon payments to the lender upon maturity of the 2004 Loan Agreement as amended September 2010. The payment date of the cumulative $1.7 million of final non-principal balloon payments outstanding was modified such that they are now due March 2012. The 2004 Loan Agreement, as amended, does not require us to meet financial ratios, but does have certain affirmative covenants (for example, good standing, maintenance of collateral) and certain negative covenants (for example, payments of cash, cash dividends, restructuring, prohibited transactions).

In July 2011, we modified the terms of the 2004 Loan Agreement such that we will make interest-only payments through October 2011 at an annual interest rate of 13.5%. In October 2011, all amounts outstanding under the 2004 Loan Agreement, as amended, will be repaid based on a nine month amortization schedule of principal and interest with a 10% interest rate. In consideration for the restructuring of the 2004 Loan Agreement, we agreed to extend the exercise period under the warrants granted to Lighthouse for an additional year. The payment date of the cumulative $1.7 million of final non-principal balloon payments outstanding was modified such that they are now due June 2012. The 2004 Loan Agreement, as amended, does not require us to meet financial ratios, but does have certain affirmative covenants (for example, good standing, maintenance of collateral) and certain negative covenants (for example, payments of cash, cash dividends, restructuring, prohibited transactions).

The 2007 Loan Agreement. In August 2007, we entered into a loan agreement (2007 Loan Agreement) and a series of related secured promissory notes (BayStar Notes) with a syndicate of new lenders led by BayStar Capital III Investment Fund, L.P. (BayStar). Under the agreement, we were able to borrow up to a maximum of $14.0 million in three separate loans totaling $6.0 million, $4.0 million and $4.0 million. The $6.0 million borrowing was drawn in August 2007 and the first and second $4.0 million borrowings expired, without being drawn upon, on December 31, 2007 and March 31, 2008, respectively. Prior to the restructuring in June 2009 as described below, borrowings under this agreement bore interest at 9.75% per annum, which accrued for the lesser of a period of one year or until the next equity financing event. Subsequent to the restructuring the interest rate was fixed at 14.5% per annum. The BayStar Notes called for principal and interest payments to commence on the first anniversary of the respective BayStar Notes. The payments were scheduled as if it were a 36-month repayment period. On the third anniversary of the BayStar Notes, all unpaid principal and interest were to be due and payable. The aggregate principal amount of the BayStar Notes issued pursuant to the loan agreement, and all accrued but unpaid interest thereunder, were convertible into our common stock at the option of the lender upon the earlier of (1) the consummation of our next equity financing, (2) the date that is 15 months after the date of the respective BayStar Note, or (3) the maturity date of the respective BayStar Note. There were no specific financial covenants related to the BayStar loan agreement. At December 31, 2009 there was $6.2 million in the aggregate due under the BayStar Notes, which includes $689,000 of interest and $360,000 of final payments. The conversion feature of this loan agreement did not give rise to an initial beneficial conversion feature because the discounted conversion rate was contingent upon a future financing, that was not certain. If we were to have had a future financing, such that the conversion rate would be adjusted, the change in the value would have resulted in a beneficial conversion feature and would have been recognized as additional interest expense.

In June 2009, we modified the terms of the agreement such that we were to make interest only payments during the period June 2009 through February 2010 at an annual interest rate of 14.5%. We were to begin making principal and interest payments in March 2010. The payments were scheduled as if it were a 24-month repayment period with a 14.5% interest rate. In January 2011, all unpaid principal and interest would have been due and payable. In consideration for the modification of the agreement, we agreed to pay a $386,000 restructuring fee. Of this amount, $26,000 of the fee was paid at time of modification, $180,000 would have been due and payable January 2011 and $180,000 would have been due and payable upon a change in control of the Company or January 2012, whichever came earlier.

In March 2010, we negotiated a prepayment of the 2007 Loan Agreement. We paid the syndicate of lenders a total of approximately $5.8 million, which included accrued and unpaid interest, interest that would have accrued had the notes remained in place through maturity and the $360,000 restructuring fee. In addition, we issued the syndicate of lenders additional warrants to purchase up to 870,000 and 527,466 shares of our common stock at an

 

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exercise price of $2.86 and $2.5594 per share, respectively, in consideration of the syndicate foregoing the conversion feature of the BayStar Notes in connection with the prepayment of those notes. These payoff warrants expire five years from the date of issuance.

Dell Note. In March 2008, we entered into a securities purchase agreement (the Dell Purchase Agreement) and related promissory note (the Dell Note) with Dell Products L.P. (Dell) whereby we borrowed $25.0 million, the maximum amount provided for under the Dell Note. Borrowings bear interest at 10% per annum. The Dell Note was to mature on March 6, 2011, and does not require or permit principal or interest payments until maturity. In March 2011, we negotiated a three-month extension of the maturity date of our debt with Dell. During the extension period, interest accrues on the principal and accrued interest at an annual rate of 18%. The note now matures on June 6, 2011. We also agreed to pay approximately $650,000 in restructuring fees at maturity.

At Dell’s option, the outstanding principal, plus all accrued but unpaid interest, under the Dell Note are convertible as follows: (1) at any time after March 6, 2009, into shares of the most recently issued series of our preferred stock at a conversion price equal to the conversion rate of such series of preferred stock as of the date of conversion; (2) at the closing of a qualified public offering (as defined below) after March 6, 2009, into shares of our common stock at a conversion price equal to 90% of the initial public offering price per share; (3) at the closing of a sale of our preferred stock that results in aggregate proceeds of at least $10,000,000 (a qualified financing), at a price per share equal to 90% of the lowest price per share at which such shares of preferred stock were issued and sold in the qualified financing; or (4) at the closing of a corporate transaction involving a change of control or a sale of our assets, into, at Dell’s option, either (a) shares of our preferred stock at a price per share equal to the conversion price of such series of preferred stock as of the date of conversion or (b) the number of shares of our common stock issuable upon conversion of our preferred stock issuable pursuant to clause (a). Pursuant to the terms of the Dell Purchase Agreement, a qualified public offering means our first firm commitment underwritten offering to the public pursuant to an effective registration statement under the Securities Act of 1933, as amended, provided that such registration statement covers the offer and sale of our common stock of which the aggregate net proceeds exceed $35,000,000, our common stock is listed for trading on the New York Stock Exchange, the Nasdaq Global Market or the Nasdaq Global Select Market and the per share public offering price (net of underwriter discounts and commissions) exceeds $4.8636 (as adjusted for stock splits, stock dividends, recapitalizations and the like). We are unable to determine at this time whether the offering contemplated by this prospectus will satisfy the definition of a qualified public offering under the Dell Purchase Agreement.

Concurrent with the Dell Note, we entered into an agreement (the IP Agreement) to sell Dell Marketing USA L.P. (Dell USA) a perpetual irrevocable license to certain of our intellectual property (IP). The IP Agreement included a three-year support agreement whereby we are required to provide updates to our IP, when and if available, and provide a defined level of support (IP Support). Dell USA was obligated to pay us a total of $1.5 million over three years in equal installments of $500,000 in March 2008, 2009 and 2010. All payments were received in accordance with the payment schedule. We had not previously licensed our IP or related IP Support prior to the IP Agreement and at that time did not foresee the licensing of our IP and related IP Support being an ongoing or significant part of our business going forward. As such, we were unable to determine the fair value of the IP or the IP Support. As we could not determine the fair value of the IP nor the IP Support, we were unable to treat them as distinct and separate elements from the Dell Note and therefore treat the proceeds from the IP and related IP Support as contra interest expense. We will record the receivable and related contra interest expense as it is invoiced. We have determined that we should record the amount due under the IP Support contract as we invoice the amounts instead of recording the entire amount due as a receivable upon the execution of the IP Agreement. Our determination was based on the following factors: (1) we earn the amount due over time; (2) we do not have the right or ability to invoice except for annually; (3) the amounts are not due to us upon signing of the IP Agreement; (4) the amount is not deemed to be collectable until invoiced; and (5) Dell USA can cancel the IP Support (under defined circumstances) and not pay for the portion of the IP Support cancelled.

The embedded conversion feature of the Dell Note is considered a beneficial conversion feature. The embedded conversion feature was evaluated under FASB issued guidance now codified within FASB ASC Topic No. 480, Distinguishing Liabilities from Equity. The Dell Note has a mandatory repayment feature, and as such, is classified as a debt instrument with an embedded conversion feature. The embedded conversion feature was valued at $2.5 million and was recorded as additional paid in capital and a debt discount. The debt discount is shown net against the related Dell Note on the Consolidated Balance Sheet and is being amortized as additional interest expense over

 

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the life of the Dell Note. The Dell Warrant (see warrants and other equity rights issued in conjunction with borrowings section below) that was issued in conjunction with the Dell Note represents an additional beneficial conversion feature that is contingent upon the future vesting of the Dell Warrant. As the beneficial conversion feature is contingent, its value will be recorded only upon vesting of the Dell Warrant.

In March 2011, we amended the Dell Note and extended the maturity date until June 6, 2011. All accrued interest through March 6, 2011 ($7.8 million) will be converted to principal. Borrowings will bear an interest rate of 18% from March 6, 2011 through June 6, 2011 at which time all principal and accrued interest will be paid. This amendment also included a non-principal balloon payment of $100,000 (Extension Fee) and in consideration for the restructuring the Dell Note we also agreed to pay a non-principal balloon payment of $565,000 and shall be paid with the Extension Fee at the earlier of the date of maturity and the date of prepayment in whole of the Dell Note. Dell has extended the maturity date on the Dell Note through September 16, 2011. Per the terms of the agreement, we paid Dell $350,000 upon execution of definitive documentation formalizing the extension and paid an additional $1.3 million on July 21, 2011. Interest accrues at a simple annual rate of 22.5% effective June 13, 2011. We have agreed to repay the note in full upon the consummation of this offering and to provide Dell with certain rights of refusal in the event we receive an acquisition proposal prior to payment in full of the note.

Additionally, we issued Dell a warrant to purchase shares of common stock. The number of shares to be calculated by dividing $10,000,000 by a price equal to 90% of the initial public offering price per share at which Common Stock is issued and sold to the public in this offering). This warrant is only exercisable after the completion of a public offering and may only be exercised with a net share settlement.

Wellington Debt. We financed the prepayment of the 2007 Loan Agreement through a new loan agreement and related secured promissory note (Wellington Note) with WF Fund III Limited Partnership (c/o/b as Wellington Financial LP and Wellington Financial Fund III). Under the agreement, we borrowed $9.75 million through a single term loan which bears interest at 11.95% per annum. Interest is repaid monthly in arrears and the outstanding principal amount is to be repaid upon maturity of the Wellington Note. The initial term of the loan is two years and can be extended up to two additional years as long as we are not in default under the loan agreement and are in compliance with the leverage ratios included in the loan agreement. The loan agreement contains financial covenants that provide minimum revenue, EBITDA and liquidity requirements. In addition, we are not able to incur additional indebtedness beyond $1.0 million of unsecured debt incurred in the ordinary course of business without the consent of WF Fund III Limited Partnership.

Investor Debt. In June 2010 we entered into a Note and Warrant Purchase Agreement (“Investor Debt Agreement”) with several of our existing investors including GrandBanks Capital Venture Fund, LP, GrandBanks Capital SOFTBANK Fund, LP, GrandBanks Capital Advisors Fund, LP, Greenspring Crossover Ventures I, LP, Kodiak Venture Partners II-A, LP, Kodiak Venture Partners II-B, LP, Sigma Partners 6, LP, Sigma Associates 6, LP, Sigma Investors 6, LP (collectively “Purchasers”) in the amount of $3.0 million (the “Initial Facility Note”). The Initial Facility Note has a stated annual interest rate of 8%, which was raised to 10% on March 1, 2011, and is due the earlier of June 27, 2013, or such date on or after March 1, 2011 the Purchasers holding at least 60% of the outstanding principal (“Requisite Purchasers”) demand repayment. The Initial Facility Note may be converted into Series F Redeemable Preferred Stock (or a more recently issued Series of Preferred Stock) prior to an initial public offering of the company’s stock, or common stock after closing an initial public offering. The Initial Facility Note also includes a provision whereby the Requisite Purchasers can demand repayment of the outstanding principal, plus all accrued and unpaid interest thereon upon a change in control.

Under the Agreement, we borrowed an additional $5.0 million (the “October Facility Note”). The October Facility Note has a stated annual interest rate of 8% and is due the earliest of June 27, 2013, or such date on or after March 1, 2011 that Purchasers holding at least 60% of the outstanding principal demand repayment.

U.K. Debt. We acquired our U.K. subsidiary, Systems Group Integration Ltd. (SGI), in September 2009 and assumed its existing debt. Under the terms of the acquisition we may factor trade receivables up to a limit of £750,000 ($1.1 million), while advances of up to 80% of the gross invoice values are permitted. At December 31, 2009 and 2010 there were £43,000 ($68,000) and zero of factored receivables outstanding, respectively.

In June 2009, SGI entered into a loan agreement which provided for advances up to £120,000 ($191,000), secured by personal guarantees of the directors of SGI at that time. At December 31, 2009, there were unpaid advances totaling £66,000 ($105,000). This amount was repaid as of December 31, 2010.

 

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The Company also maintained a third party note with former directors of SGI that do not have formal agreements. The outstanding balance of this note of £17,000 ($27,000), zero and zero is included on the December 31, 2009 and 2010 and March 31, 2011 consolidated balance sheets, respectively.

Switzerland Debt. We acquired vcare Infosystems AG (vcare) in November 2009. Vcare had an existing Line of Credit (LOC) agreement including an overdraft facility. Under the LOC agreement vcare may borrow against qualified trade receivables and advances of up to 85% of the gross invoice values are permitted. At December 31, 2009, 2010 and March 31, 2011 there were Swiss Francs (CHF) 1.2 ($1.2) and CHF 1.8 million ($1.9 million) CHF1.4 million and $1.4 million receivables factored. At December 31, 2010 and March 31, 2011 the overdraft facility had a balance of CHF183,000 ($194,000) and CHF306,000 ($333,000).

Vcare has a loan agreement which provides up to CHF462,000 ($491,000) for advances, secured by personal guarantees of certain officers and former shareholders of vcare. At December 31, 2009, 2010 and March 31, 2011 there were unpaid advances totaling CHF435,000 ($419,000), CHF454,000 ($483,000) and CHF454,000 ($493,000) outstanding respectively.

As of March 31, 2011, we were in compliance with our debt covenants. As of December 31, 2010, our Israeli subsidiary was not in compliance with the monthly cash flow covenant of its Bank Leumi credit line and we were not in compliance with the EBITDA and certain notification of covenants of the Wellington Note. The covenant non-compliance caused a cross default under the Investor Debt and the Loan Agreements with Lighthouse. We subsequently received waivers for all debt covenant violations from the respective lenders and were required to pay a $1,000 administrative fee to Bank Leumi.

Warrants and Other Equity Rights Issued in Conjunction with Borrowings

In connection with entering into the 2004 Loan Agreement along with the two additional amendments, we issued warrants to the lender to purchase 352,940 shares of our Series C preferred stock and 322,807 shares of our Series D preferred stock at exercise prices ranging from $0.85 to $2.4318 per share, subject to certain antidilution adjustments. The purchase rights represented by the warrants are exercisable immediately and have a term of seven years. The warrants have been collectively valued as of the date of their issuance at $813,000 using an option valuation model. We recorded the fair value of the warrants as an original issue discount on the debt, which was amortized as interest expense through the loan maturity dates ranging from June 2008 to June 2011.

In connection with the 2007 Loan Agreement in August 2007, we issued warrants to the lenders to purchase common stock. Pursuant to these warrants, the purchase price will be equal to 80% of the per share price of the equity securities issued and sold by us in an equity financing in which we receive net proceeds of at least $10.0 million, including an initial public offering, and the number of shares available for purchase will be determined by dividing $450,000 by such purchase price. In the event that a qualifying equity financing does not take place within 15 months of the agreement, the purchase price will be adjusted to $2.5594 per share and the number of shares issuable under the warrant will be adjusted to 527,466 shares. The warrant expires six years from the date of issuance. The warrants were valued as of the date of their issuance at $482,000 using an option valuation model. We recorded the fair value of the warrants as an original issue discount on the debt assuming 527,466 shares will be issuable, which was amortized as interest expense through the loan maturity date of June 2009. As the qualifying equity financing did not take place within 15 months of the agreement, the Company cancelled the warrants and issued new warrants for 527,466 shares.

In connection with the Wellington Note in March 2010 we issued warrants to the lenders to purchase 448,070 shares of our Series F preferred stock at an exercise price of $2.72 per share. The purchase rights represented by these warrants are exercisable immediately and the warrants expire at the earlier of an acquisition or five years after an initial public offering. The warrants have been collectively valued at $601,000 using an option valuation model. We recorded the fair value of the warrants as an original issue discount on the debt, which will be amortized as interest expense through the loan maturity date of March 2012.

In connection with the Investor Note in June 2010 we issued warrants to the lenders to purchase 900,000 shares of common stock in the Initial Facility Loan at an exercise price of $3.00 per share. The purchase rights represented by these warrants are exercisable immediately and the warrants expire June 2013. The warrants have been collectively valued as of the date of their issuance at a $71,131 using and option valuation model. We recorded the fair value of the warrants as original issue discount on the debt, which will be amortized as interest expense through the loan

 

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maturity date of June 2013. In connection with the October Facility Note, we issued warrants to purchase an additional 166,663 shares of common stock with an exercise price of $3.00 per share that expire October 2013. As part of the Dell Purchase Agreement, we granted Dell a warrant to purchase shares of our common stock or preferred stock (the Dell Warrant). Because the Dell Warrant is considered to be issued as part of the Dell Note, it was recorded at its fair value as of the date of their issuance of $830,000 by recording a debt discount. The debt discount is shown net against the related Dell Note on our Consolidated Balance Sheets. As the Dell Warrant may be exercised for preferred stock and such underlying preferred stock would have a mandatory redemption feature, it is classified as a liability. The Dell Warrant is contingently exercisable and as such will be revalued and “marked to market” for each reporting period after these contingencies are removed. In connection with the sale of Series F preferred stock in December 2010, the Dell Warrant became exercisable. Also as part of the Dell Purchase Agreement, we granted Dell an option to purchase 5% of our common stock calculated on a fully-diluted basis (the Dell Option). Similar to the Dell Warrant, the Dell Option is considered to be issued as part of the Dell Note but is contingent upon a qualified public offering. Once the qualified public offering contingency is removed or met, we will record the fair value of the Dell option as additional debt discount and the offset will be recorded as a component of stockholders’ equity.

As part of the Dell Purchase Agreement, we granted Dell the Dell Option. The Dell Option will become exercisable as early as ten months after the date of a Qualified Public Offering upon which the closing price of our common stock as reported by the market upon which our shares of common stock are publicly traded (the Primary Market) on each trading day during a period of 20 consecutive trading days is not more than 10% higher or lower than the closing price of our common stock as reported on the Primary Market on the first day of such 20-trading day period. The exercise price per share of our common stock subject to the Dell Option will be equal to the average closing price of one share of our common stock as reported on the Primary Market for the 20 consecutive trading days ending on the date that is one trading day immediately preceding the date of exercise of the Dell Option. Also as part of the Dell Purchase Agreement, we granted Dell the Dell Warrant. The Dell Warrant is exercisable in connection with a Qualified Financing or a sale of our Company and expires upon the consummation of a Qualified Public Offering. We are unable to determine at this time whether the offering contemplated by this prospectus will satisfy the definition of a Qualified Public Offering under the Dell Purchase Agreement.

In connection with the maturity extension on the Dell Note, we issued Dell a warrant in March 2011 to purchase shares of our common stock. The warrant coverage amount is $10,000,000 and the strike price on the underlying shares will be equal to 90% of the price to public of the shares issued in this offering. This warrant only becomes exercisable upon completion of this offering and may only be exercised through a net share settlement.

Contractual Obligations

Our principal commitments consist of obligations under borrowings, leases for office space, computer equipment and furniture and fixtures. The following table summarizes our long-term contractual obligations as of December 31, 2010 (in thousands):

 

     Payments Due By Period             More than
5 years
 
     Total      1 year      2-3 years      4-5 years     

Debt principal repayments, contractual interest and balloon payments (1)

   $ 61,433       $ 37,546       $ 23,404       $ 483       $     —     

Capital lease obligations

     —           —           —           —           —     

Operating lease obligations

     3,283         2,169         1,114         —           —     
                                            

Total

   $ 64,788       $ 39,715       $ 24,518       $ 483       $ —     
                                            

 

(1) The debt principal has the following maturity dates:

 

   

Dell Note – Maturity date of September 16, 2011.

 

   

2004 Loan Agreement – Maturity date of June 1, 2012 (modified July 1, 2011).

 

   

Wellington Debt – Maturity date of March 29, 2012.

 

   

Investor Debt – Maturity date of June 27, 2013. Due on demand.

 

   

vCare Shareholder loans – Maturity date of January 1, 2015.

 

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Debt consists of various debt facilities maintained with Dell, Lighthouse, Wellington Financial LP, GrandBanks Capital Venture Fund, LP, GrandBanks Capital SOFTBANK Fund, LP, GrandBanks Capital Advisors Fund, LP, Greenspring Crossover Ventures I, LP, Kodiak Venture Partners II-A, LP, Kodiak Venture Partners II-B, LP, Sigma Partners 6, LP, Sigma Associates 6, LP and Sigma Investors 6, LP.

Of the $39.7 million in debt principal payments that will become due before December 31, 2011, we expect to pay approximately $35.0 million from the proceeds of our initial public offering. All other obligations in the above table are expected to be paid from our operating cash flows.

Operating leases consist primarily of leases on facilities with arrangements that expire in various years through March 2013.

Application of Critical Accounting Policies

Our financial statements are prepared in accordance with generally accepted accounting principles in the United States (GAAP). The preparation of these financial statements requires that we 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 period. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ significantly from these estimates under different assumptions or conditions. There have been no material changes to these estimates for the periods presented in this prospectus.

We believe that of our significant accounting policies, which are described in Note 1 to our consolidated financial statements included in this prospectus, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical in fully understanding and evaluating our financial condition and results of operations.

Revenue Recognition

Our revenues consist of both service revenues and product revenues. Service revenues consist of consulting services and managed services. Our contracts have different terms based on the scope, deliverables and complexity of the engagement, the terms of which frequently require us to make judgments and estimates in recognizing revenues. Amounts are considered to be earned once the following has occurred: (i) evidence of an arrangement has been obtained, (ii) services are delivered, (iii) fees are fixed or determinable and (iv) collectibility is reasonably assured.

Revenues recognized in excess of billings are recorded as unbilled revenue. Billings in excess of revenues recognized are recorded as deferred revenues until revenue recognition criteria are met. Client prepayments even if non-refundable are deferred (i.e., classified as a liability) and recognized over future periods as services are delivered or performed.

We also incur out-of-pocket expenses, which are generally reimbursed by the client. These reimbursements are classified as service revenues and cost of services in our consolidated statements of operations, and amounted to $1.7 million, $1.1 million, $1.6 million for the years ended December 31, 2008, 2009 and 2010, respectively, and $309,000 and $593,000 for the three months ended March 31, 2010 and 2011 respectively.

Consulting Services. We sell consulting services in all of the geographies in which we operate. Consulting services typically have a delivery cycle of less than a year and can be fixed fee or time and materials.

Consulting service revenues from fixed price contracts are recognized using the proportional performance method pursuant to the SEC’s Staff Accounting Bulletin (SAB) 104. Proportional performance accounting is based on an efforts expended method, based on hours incurred during the reporting period compared with the total estimated hours to be provided over the duration of the contract. This method is followed where reasonably dependable estimates of revenues and effort can be made. In cases where reasonably dependable estimates cannot be made, the completed contract method is used for revenue recognition. As part of our revenue recognition process, we perform monthly reviews of our fixed fee contracts whereby we evaluate the total hours of effort that are expected to be expended under each specific fixed fee project. Such reviews may result in increases or decreases to revenues and income and are reflected in our consolidated statements of operations in the periods in which they are first

 

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identified. Historically any changes to total hours of effort expected to be expended under a fixed fee contract have not been significant and have not required a change in revenue recognized in prior periods. Due to the nature of the fixed fee contracts that we enter into and our experience in executing similar contracts in the past, we believe that our estimates are reliable and accurate. If estimates indicate that a contract loss will occur, a loss provision will be recorded in the period in which the loss first becomes probable and reasonably estimable. Contract losses are determined to be the amount by which the estimated direct and indirect costs of the contract exceed the estimated total revenues that will be generated by the contract and are included in cost of services and classified in other accrued liabilities in our consolidated balance sheets. Consulting service revenues from time-and-materials contracts are recognized as services are provided, pursuant to FASB ASC Topic No 605-25.

Managed Services. Managed services consist of infrastructure operations services (IOS) contracts and multi-element contracts. Managed services contracts typically have a term of one to three years.

We sell IOS in all the geographies in which we operate. These contracts are fixed price contracts that have a consistent monthly fee and typically have a term of one to three years. Pursuant to FASB ASC Topic No 605-25, revenues from IOS contracts are recognized on a monthly basis as the monthly service is delivered. Certain of our IOS agreements include specified service levels which, if not achieved, could result in penalties, including refunds for services provided for the period the service level was not met. We monitor and review service-level commitments on a monthly basis for these agreements and through this process identify any service level not met before the related revenue is recognized. If during a period a service level is not met, the amount of the credit due to the client is accrued as a reduction of revenue in that period. We have not historically issued credits as we have met or exceeded contracted service-level agreements.

Our Israeli, Turkish and Swiss subsidiaries sell multi-element contracts. Multi-element contracts are comprised of the resale of either or both third-party hardware or software with related third party maintenance and our (i) consulting services, (ii) IOS or (iii) a combination of consulting and IOS. The consulting services included in the multi-element arrangements can be fixed fee or time-and-materials. The IOS included in the multi-element arrangements are fixed fee. In all multi-element arrangements, we have determined that we are the principal in the transaction and as such we recognize all revenue on a gross basis.

In multi-element service contracts that contain the resale of third-party hardware with related third party maintenance and either or both our consulting services and IOS managed services, we recognize revenue in accordance with ASC 605-25. Under ASC 605-25, revenues can be allocated to the different elements of the multi-element arrangement if there is objective and reliable evidence of the fair value of the different elements. In these multi-element service contracts, the fair value of each element cannot be objectively determined. As such, the total value of the arrangement is recognized ratably over the entire service period to the extent that all services were provided at the outset of the period.

We enter into multi-element service contracts that include the resale of licensed third-party software under perpetual license agreements. Such contracts have multiple elements, which could include consulting services, IOS, third-party hardware and related maintenance, or any combination of these elements. Revenue on these contracts can be allocated between the elements based on each element’s relative fair value, provided that each element meets specified criteria as a separate element. If the fair value of each element cannot be objectively determined by having vendor specific objective evidence of fair value, the total value of the arrangement is recognized ratably over the entire service period to the extent that all services were provided at the outset of the period. Under our multiple element arrangements where software products are sold in conjunction with managed services contracts, the fair value of each element has not been objectively determinable. Therefore, all revenues under these types of arrangements are recognized ratably over the estimated service period to the extent that all services have begun to be provided at the outset of the period.

Our Swiss subsidiary, vcare Infosystems AG, sells multi-element contracts that contain perpetual licenses of its software along with related maintenance provided by us. Such contracts may also include either or both our consulting or IOS. The consulting services can be fixed fee or time and material based contracts. Revenues are recognized for these contracts under the provisions of FASB ASC Topic No. 985, Software. Under FASB ASC Topic No. 985, revenues can be allocated between the elements based on each element’s relative fair value, provided that each element meets specified criteria as a separate element. If the fair value of each element cannot be objectively determined by having vendor specific objective evidence of fair value, the total value of the arrangement

 

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is recognized ratably over the entire service period to the extent that all services were provided at the outset of the period. Under our multi-element arrangements where our software is licensed in conjunction with managed services contracts, maintenance we provide, or both, the fair value of each element cannot be objectively determined. Therefore, all revenues under these types of arrangements are recognized ratably over the estimated service period to the extent that all services have begun to be provided at the outset of the period.

The consulting services included in the multi-element arrangements can be fixed fee or time and material contracts. Effective January 1, 2011, the Company adopted Accounting Standards Update (“ASU”) No. 2009-13, “Multiple-Deliverable Revenue Arrangements,” which amends FASB Accounting Standards Codification (“ASC”) “Topic 605,” “Revenue Recognition.” ASU 2009-13 amends FASB ASC Topic 605 to eliminate the residual method of allocation for multiple-deliverable revenue arrangements, and requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. ASU 2009-13 also establishes a selling price hierarchy for determining the selling price of a deliverable, which includes (1) vendor-specific objective evidence, if available, (2) third-party evidence, if vendor-specific objective evidence is not available, and (3) estimated selling price, if neither vendor-specific nor third-party evidence is available. Additionally, ASU 2009-13 expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. In accordance with ASU 2009-13, we allocate multi-element arrangement consideration to each deliverable in the arrangement based on its relative selling price. We determine selling price using vendor-specific objective evidence (“VSOE”), if it exists; otherwise, we use third-party evidence (“TPE”). If neither VSOE nor TPE of selling price exists for a unit of accounting, we use estimated selling price (“ESP”).

VSOE is generally limited to a median price of recent standalone transactions that are priced within a narrow range when the same or similar product is sold separately. We have reviewed our pricing history for the separate elements in its multi-element revenue arrangements and determined we didn’t have sufficient consistent pricing to support VSOE. If we develop consistent pricing such that we can support VSOE on the different elements of its multi-element revenue arrangements, we will use the VSOE of the relative fair value of the elements.

TPE is determined based on the prices charged by our competitors for a similar deliverable when sold separately. We believe that sufficient information on competitor pricing to substantiate TPE is not generally available.

Since we are currently unable to establish selling price using VSOE or TPE, orders received or materially modified after our ASU 2009-13 implementation date of January 1, 2011, we will use ESP in its allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact if the product or service were sold by us on a standalone basis.

Our determination of the ESP for the separate deliverables in our multi-element arrangements requires us to make significant estimates and judgments and involves a weighting of several factors based on specific facts and circumstances of the arrangements. These factors include:

 

   

Anticipated margins on specific deliverables. In determining ESP for our services and products, we use a cost plus method that depends heavily on target margins and our direct costs. Our direct costs are such that they are highly predictable on specific engagements and allow us to have a predictable margin range on our services and products.

 

   

Historical realized margins compared to anticipated margins. When evaluating ESP for new services or products or reevaluating the ESP for existing services and products, we analyze what we originally estimated our margins would be to what we actually realized. We use this analysis to help adjust our ESP, when required.

 

   

Pricing and profit margin on similar products or services. In determining and updating ESP, we look at similar services and products we offer on a stand-alone basis. In determining if services and products are similar, we look at various characteristics such as where they are in their life cycle and if there are substitute products.

 

   

Our on-going pricing and margin strategy. In our determination and ongoing evaluation of ESP, we consider our overall pricing and margin strategy for specific services and products. Specifically we evaluate what our target margins are based on where the service or product is in its life cycle and if we are achieving our desired market share.

 

   

Sales channel deliverable was sold through. In determining the ESP, we take into account the sales channel, direct or indirect. We target and realize higher margins and pricing when we sell direct. When selling indirect through a partner, we realize a lower margin. The different margins in the two sales channels are taken into account in our determination and evaluation of ESP.

 

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Competitive landscape. Although we see limited direct competition, we do evaluate alternatives to our services when developing and evaluating our pricing strategy and ESP. The competitive landscape may allow us to increase our price or force us to decrease our pricing on different services and products. This is most evident in new services and services that have become commoditized as they reach the end of their life cycle.

 

   

Different geographies. Although we operate and sell in various geographies resulting in different pricing, we target and realize a consistent margin on our products and services. When determining the ESP, we do so on a geography specific basis which takes into account where we sell the services and products from, the costs of the products and services, and where we deliver the services and products to.

We analyze the selling prices used in our allocation of arrangement consideration at a minimum on a quarterly basis. Selling prices will be analyzed on a more frequent basis if a significant change in our business necessitates a more timely analysis or if we experience significant variances in our selling prices.

Each deliverable within a multiple-deliverable revenue arrangement is accounted for as a separate unit of accounting under the guidance of ASU 2009-13 if both of the following criteria are met: (1) the delivered item or items have value to the customer on a standalone basis and (2) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. Further, our revenue arrangements generally do not include a general right of return relative to delivered products.

Deliverables not meeting the criteria for being a separate unit of accounting are combined with a deliverable that does meet that criterion. The appropriate allocation of arrangement consideration and recognition of revenue is then determined for the combined unit of accounting. The below table reflects the impact the adoption of ASU 2009-13 had on our first quarter 2011 results.

 

     Three Months Ended March 31, 2011  
     As Reported with
Adoption of ASU2009-13
    As Reported without
Adoption of ASU2009-13
 
     (in thousands, except per share data)  

Service revenues

   $ 26,451      $ 26,390   

Product revenues

     3,375        1,398   
                

Total revenues

     29,826        27,788   

Cost of services revenues

     20,004        19,911   

Cost of product revenues

     2,382        815   
                

Total cost of revenues

     22,386        20,726   

Gross profit

     7,440        7,052   

Operating loss

     (2,290     (2,668

Net loss to common shareholder

   $ (6,589   $ (6,967
                

Basic and diluted net loss to common shareholder

   $ (0.40   $ (0.42
                

We incur certain direct costs from third parties in conjunction with our multi-element arrangements. These costs include third-party product costs and third-party, post-contract support costs. The third party post-contract support costs are the costs of the third party maintenance for the third party equipment or software. The third-party maintenance agreements are typically one to three years. We defer the direct and incremental third-party costs associated with our multi-element arrangements and recognize the expense on a straight-line basis over the service period of the arrangement to properly match these costs with the related revenue. We report the revenues from multiple element arrangements as a component of service revenue in our consolidated statements of operations when the fair value of the hardware and software components cannot be reasonably determined. Revenues from multi-element arrangements were $24.6 million, $19.6 million and $22.2 million for 2008, 2009 and 2010 respectively and $4.8 million and $7.0 million for the three months ended March 31, 2010 and 2011 respectively. At December 31, 2009 and 2010 and March 31, 2010 and 2011 we recorded $8.5 million and $18.7 million, $11.0 million and $18.8 million of deferred third-party costs on our consolidated balance sheets. At December 31, 2009 and 2010 and March 31, 2011 respectively, we recorded $5.7 million, $10.9 million and $11.8 million as deferred third-party costs in current assets, with the remainder of $2.8 million, $7.9 million and $7.0 million in long-term assets.

 

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Product Revenues. Product revenues consist of selling perpetual licenses of our intellectual property (IP) and software products, and the resale of third party software and/or hardware with related third party maintenance. We have licensed our IP in the U.S. and in the U.K. Our Israeli, Turkish and Swiss subsidiaries resell third party software and/or hardware in the geographies in which they operate.

Revenues generated from the licensing of our IP or software products with no other element to the arrangement are recognized upon delivery to the client.

Revenues generated from the resale of hardware and/or software with related maintenance contracts sold without other consulting or managed services are recognized on a net basis upon delivery to the client assuming all provisions of SAB 104 have been met.

Allowance for Doubtful Accounts

The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We review our allowance for doubtful accounts on a regular basis, and all past due balances are reviewed individually for collectibility. Account balances deemed to be uncollectible are either recorded as a reduction of revenues or charged against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Provisions for allowance for doubtful accounts are recorded in general and administrative expenses. To date, we have not incurred any significant write-offs of accounts receivable. As of December 31, 2009 and 2010 and March 31, 2011, the allowance for doubtful accounts was $255,000, $21,000 and $8,000.

Impairment of Long-Lived Assets

Property and equipment and intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Indefinite-lived intangible assets are reviewed for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Intangible assets with determinable lives are amortized over their estimated useful lives, based upon the pattern in which the expected benefits will be realized, or on a straight-line basis, whichever is greater. We use estimates in determining the value of intangible assets, including estimates of useful lives, discounted future cash flows and fair values of the related operations. To date, we have not recorded any impairment charges on these long-lived assets.

Goodwill

Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired in a business combination. When accounting for acquisitions occurring prior to January 1, 2009 with earn-outs or when additional consideration can be earned based on future performance, we did not initially record the additional consideration as part of purchase accounting. Instead, these amounts were recorded as additional purchase consideration when it was deemed probable that the additional consideration would be earned. For acquisitions occurring on or after January 1, 2009, we will record the estimated fair value of any contingent consideration on the acquisition date and subsequent changes in the estimated fair value will be recorded in current earnings.

In accordance with FASB ASC Topic No. 350, Intangibles—Goodwill and Other, we evaluate goodwill for impairment annually, as well as whenever events or changes in circumstances suggest that the carrying amount may not be recoverable. We have evaluated our reporting units in accordance with ASC 350-10 and concluded that we have four components (United States, United Kingdom, Central Europe and Middle East) as defined in ASC Topic 350. We have aggregated these components into one reporting unit for purposes of our goodwill impairment analysis based on the guidance in ASC Topic 350. We believe aggregation of these components into one reporting unit is appropriate because they all deliver similar products and services using the same methods and technology and have similar economic characteristics. Since we are a private company and a public market for our stock does not exist, we have determined the fair value of our preferred and common stock using the probability weighted-expected return method to allocate the total value of the Company to the various classes of stock. This method requires us to make significant estimates and assumptions about future performance, future liquidity events and dates, and discount rates of future cash flows. We evaluated our goodwill impairment as of December 31, 2011 noting that the estimated fair value of our reporting substantially exceed the book value of the reporting unit. The significant assumptions and estimates used in our December 31, 2010 valuation were as follows:

 

   

Four possible liquidity events for the Company:

   

Initial public offering event weighted 50%

   

Strategic sale event weighted 35%

 

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Continue as a private company 10%

   

Liquidation of the business weighted 5%

   

Lack of marketability discount 0%

   

A discount rate of 18% was used to discount the values as of each anticipated event back to the valuation date

Stock-Based Compensation

Through December 31, 2005, we accounted for our stock-based awards to employees using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Under the intrinsic value method, stock-based compensation expenses are measured on the date of the grant as the difference between the deemed fair value of our common stock and the exercise price multiplied by the number of stock options or restricted stock awards granted.

Through December 31, 2005, we accounted for stock-based compensation expenses for non-employees using the fair value method prescribed by FASB ASC Topic No. 718 and the Black- Scholes option-pricing model, and recorded the fair value, for financial reporting purposes, of non-employee stock options as an expense over either the vesting term of the option or the service period.

In December 2004, the FASB issued guidance now codified within FASB ASC Topic No. 718, that requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. We adopted FASB ASC Topic No. 718 effective January 1, 2006. FASB ASC Topic No. 718 requires nonpublic companies that used the minimum value method in FASB ASC Topic No. 718 for either recognition or pro forma disclosures to apply FASB ASC Topic No. 718 using the prospective-transition method. As such, we will continue to apply APB Opinion No. 25 in future periods to equity awards outstanding on the date we adopted FASB ASC Topic No. 718 that were measured using the minimum value method. In accordance with FASB ASC Topic No. 718, we will recognize the compensation cost of stock-based awards on a straight-line basis over the vesting period of the award. Effective with our adoption of FASB ASC Topic No. 718, we have elected to use the Black-Scholes option pricing model to determine the weighted-average fair value of stock options granted on and after the date of adoption.

As there was no public market for our common stock prior to this offering, we have determined the volatility for options granted in 2006, 2007, 2008 and 2009 based on an analysis of reported data for a peer group of companies that issued options with substantially similar terms. The expected volatility of options granted has been determined using an average of the historical volatility measures of this peer group of companies. The expected volatility for options granted during 2006, 2007, 2008, 2009, 2010 and the three months ended March 31, 2011 was 50%, 43%, 42%, 42%, 42% and 36% respectively. The expected life of options granted in 2006 and 2007 was determined to be 6.25 years by utilizing the “simplified” method as prescribed by SAB No. 107, Share-Based Payment. The weighted average expected life of options granted in 2008, 2009, 2010 and the three months ended March 31, 2011 was 5.92, 5.10, 5.02 and 5.19 years respectively. For, 2008, 2009, 2010 and the three months ended March 31, 2011, the weighted-average risk free interest rate used was, 3.02%, 2.30%, 1.91% and 2.24% respectively. The risk-free interest rate is based on a treasury instrument whose term is consistent with the expected life of the stock options. We have not paid and do not anticipate paying cash dividends on our shares of common stock; therefore, the expected dividend yield is assumed to be zero. We applied an estimated forfeiture rate of 5.57% in 2006, 2007 and 2008 in determining the expenses recorded in our consolidated statements of operations. We used a forfeiture rate of 6.39%, 6.29% and 11.73% for 2009, 2010 and the three months ended March 31, 2011, respectively.

In connection with our issuance of stock options, our board of directors, with input from management, determined the fair market value of our common stock. Our board of directors exercised judgment in determining the estimated fair market value of our common stock on the date of grant based on several factors, including the liquidation preferences, dividend rights and voting control attributable to our then-outstanding preferred stock and the likelihood of achieving a liquidity event such as an initial public offering or sale of our company. We believe the methodology used was reasonable.

In connection with the preparation of our financial statements for the year ended 2006, 2007, 2008, 2009 and 2010 and in preparing for the initial public offering of our common stock, we examined the valuations of our common stock during those periods, in light of the Practice Aid of the American Institute of Certified Public Accountants entitled Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the Valuation Practice Aid.

 

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Since inception through December 31, 2010, we have granted stock options awards to employees to purchase a total of 22,580,321 shares of common stock at exercise prices ranging from $0.02 to $2.31 per share. On September 2, 2009, our board of directors approved a repricing of outstanding options such that all options for employees who were employed at August 31, 2009 with an exercise price per share above $1.38 would be repriced to have an exercise price per share equal to $1.38.

During 2001, we granted stock options to purchase shares of our common stock at exercise prices ranging from $0.02 to $0.08. Stock options granted to employees were granted with an exercise price equal to the estimated fair market value of our common stock on the date of issuance. Stock options were granted to non-employees at an exercise price greater than the estimated fair value of the common stock. Our board of directors had determined that the estimated fair market value of the common stock was $0.02 per share for all periods during 2001. This estimated fair market value was determined by our board of directors using the market approach, taking into consideration the sale price and associated liquidation preferences and rights of our Series A preferred stock, as well as the high degree of uncertainty surrounding our future prospects and markets. Our board of directors also took into consideration that 2001 was our first year of operations and we had $60,000 of revenues, a net loss of $800,000 and cash usage by operations of $700,000. The price of our Series A preferred stock on July 10, 2001 was $0.4464 per share. Each share of the Series A preferred stock is convertible into one share of our common stock and has a liquidation preference of $0.4464. Given the amount of the liquidation preference, the values assigned to stock-based awards at the time of grant time were deemed by our board of directors to be fair value.

In June and July of 2002 we completed two rounds of financing in which we sold Series B preferred stock at a price of $0.652 per share. During 2002, we granted stock options to purchase shares of our common stock at exercise prices ranging from $0.02 to $0.07 per share. Stock options granted to employees were granted with an exercise price equal to the estimated fair market value of our common stock on the date of issuance. Stock options were granted to non-employees at an exercise price greater than the estimated fair market value of the common stock. Our board of directors raised the estimated fair market value of our common stock in May 2002 to $0.04 per share, then to $0.07 per share in July 2002. The estimated fair market value of our common stock was determined by our board of directors using the market approach, taking into consideration the sale price of the Series B preferred stock and associated liquidation preferences and rights of our Series A and Series B preferred stock, as well as the high degree of uncertainty surrounding our future prospects and markets, and the sustainability of our increased revenues levels. Each share of Series B preferred stock is convertible into one share of our common stock and has a liquidation preference of $0.652. In 2002, our first full year of operations, we had $1.4 million of revenues, a net loss of $2.4 million and cash usage by operations of $2.5 million. In 2002, a fully vested option to purchase 150,000 shares of common stock was granted to an employee with an erroneous exercise price of $0.02 per share, instead of the then estimated fair market value of our common stock of $0.04 per share. The grant resulted in a stock-based compensation expenses of $3,000. Given the amount of the combined liquidation preferences of our Series A and Series B preferred stock, the values assigned to all other stock-based awards at the time of grant time were deemed by our board of directors to be fair value.

In September 2003, we completed a round of financing in which we sold Series C preferred stock at a price of $0.850 per share. During 2003, we granted stock options to purchase shares of our common stock at exercise prices ranging from $0.07 to $0.08 per share. Stock options granted to employees and consultants were granted with an exercise price equal to the estimated fair market value of our common stock on the date of issuance. Our board of directors increased the estimated fair market value of our common stock in September 2003 to $0.08 per share. The estimated fair market value of our common stock was determined by our board of directors using the market approach, taking into consideration the sale price of the Series C preferred stock and associated liquidation preferences and rights of our Series A, Series B and Series C preferred stock, as well as the high degree of uncertainty surrounding our future prospects and markets, and the sustainability of our increased revenues levels. Each share of Series C preferred stock is convertible into one share of our common stock and has a liquidation preference of $0.850. In 2003, our revenues increased 421% to $7.3 million, our net loss increased 50% to $3.6 million and cash used by operations increased 36% to $3.4 million. Given the amount of the combined liquidation preferences of our S