Item 1. BUSINESS
Introduction
We provide a wide range of information technology (IT) services and solutions to large financial services and insurance organizations, middle market companies and public sector organizations to support their evolving business needs. Our services are delivered through the use of seamless on-site and offshore consulting project teams. We strive to establish long-term client relationships and to secure additional engagements with existing clients by providing quality services and by being responsive to client needs. We are headquartered in Farmington, Connecticut and maintain offices in Hartford, New York, Boston and Stamford supported by an offshore technology resource center in Bangalore, India.
In 1996, through a joint venture with Phoenix Home Life Mutual Insurance Company, we created our offshore technology resource center in Bangalore, India. The facility, which we now wholly own, is ISO 9001 certified and is connected via a securepoint-to-point link to our headquarters, branch offices and customer sites. It offers our clients certain advantages as compared to domestic maintenance and/or development, including (1) cost savings; (2) faster response time and delivery, as larger teams can be deployed; (3) virtual 24-hour schedules, due to the time difference between North America and India; and (4) access to a larger pool of skilled, English-speaking IT professionals.
On February 3, 2000, we announced the formation of Command e-Solutions. The entire focus of Command e-Solutions is devoted to assisting clients who are creating e-businesses or are rethinking or expanding their existing businesses to integrate e-business capabilities. Command e-Solutions combines the e-business development talents of our United States and India based project teams and provides clients with high quality Internet technology capabilities.
We service a broad range of industries including consumer products, financial services, insurance, manufacturing, pharmaceuticals, professional services, retail and technology. In 1999, we provided services to over 100 customers.
Market Opportunity
Many businesses today are facing intense competition, accelerating technological change, personnel downsizing and widespread business process reengineering. Increasingly, these companies are turning to IT solutions to address these issues and to compete more effectively. As a result, the ability of an organization to integrate and deploy new information technologies has become critical. Although many companies have recognized the importance of IT systems and products to compete in this business climate, the process of designing, developing and implementing IT solutions has become increasingly complex. Companies are continuing to migrate away from centralized mainframes running proprietary software toward decentralized, scalable architectures based on personal computers, client/server architectures, local and wide area networks, the Internet, shared databases and packaged application software. These advances have greatly enhanced the ability of companies to benefit from the application of IT.
During this time of increasing reliance on IT, rapid technological change and other challenges have strained the capabilities of the internal departments within these organizations. At the same time, external economic factors have forced organizations to focus on core competencies and trim workforces in the IT management area. Accordingly, these organizations often lack the quantity or variety of IT skills necessary to design and develop emerging IT solutions. Consequently, businesses are increasingly
looking to outsource IT services. By outsourcing IT services, companies are able to focus on their core business, access specialized technical skills, implement IT solutions more rapidly, benefit from flexible staffing and reduce the cost of recruiting, training and retaining IT professionals.
The Internet has created numerous revenue growth and operating efficiency opportunities. As a result, a growing number of companies are turning to Internet professional services firms to design and implement their Internet and e-commerce solutions. According to Forrester Research, the market for such Internet and e-commerce services in the United States is projected to grow from $10.6 billion as of November 1999 to $64.8 billion in 2003, representing a compound growth rate of 59%.
The Command Systems Solution
Our solution is designed to enable large financial services and insurance organizations, middle market companies, and public sector organizations to use IT as a more effective business tool to support their evolving business needs. We deliver high-quality, cost-effective, full life-cycle solutions for complex IT problems, including e-business development, through the use of a seamless on- site and offshore project team. Our solutions give companies the insight and technology they need to evolve in increasingly competitive markets. The following are key attributes of our solution:
Broad Range of IT Services. We provide our customers with a single source for a broad range of IT services required to successfully design, develop and implement integrated solutions in the client/server, Internet and midrange computing environments including:
. e-business development, . Internet/intranet applications, . network design and deployment, . outsourcing solutions, . application and systems development, . database design and development, and . staff augmentation services.
In addition, we utilize leading technologies such as object-oriented development, database management systems and various Internet/intranet networking technologies.
Continually Expand Our Solution Offerings. We continually leverage our core competencies to develop new solution capabilities that we then market to existing and potential clients. For example, advances in technology and functionality have led to the widespread acceptance of the Internet as a new global medium that allows people to share information and conduct commerce. Much of the growth of the Internet has been driven by corporate recognition that the Internet can be used to achieve competitive advantage. To meet this demand, on February 3, 2000 we announced the formation of Command e-Solutions to expand our Internet/e-commerce service offerings. The focus of Command e-Solutions is to help companies gain competitive advantage through the use of the Internet and e-business solutions.
A Strategic Focus on the Financial Services Industry. By focusing on the financial services industry since 1985, and particularly on the needs of large insurance companies, we have developed expertise in a large vertical market dominated by large organizations with extensive IT needs. We seek to leverage our expertise in the financial services industry to increase our customer base and to increase our business from existing customers. By hiring personnel with experience in the financial services industry, we have been able to establish new relationships with customers in this industry as well as maintain or strengthen existing relationships.
Offshore Technology Resource Center. In 1996 we established the offshore technology resource center in Bangalore, India. It offers our clients certain advantages as compared to domestic maintenance and/or development, including (1) cost savings; (2) faster response time and delivery, as larger teams can be deployed; (3) virtual 24-hour schedules, due to the time difference between North America and India; and (4) access to a larger pool of skilled, English-speaking IT professionals.
Expertise in Key and Emerging Technologies. We hire highly skilled personnel who are experienced with key technologies, such as client/server development and design and network integration, and emerging technologies, such as data warehousing and object-oriented analysis and design. Additionally, our IT professionals receive training in a variety of technology platforms. We assist customers in understanding the latest IT developments and guide them through the implementation of the IT solutions best suited to their needs.
Business Strategy
Our objective is to become the preferred single-source provider of IT services to an expanding base of customers by establishing teams that quickly and cost effectively provide industry-based IT solutions. Our strategies to achieve this objective include the following:
Cross-Sell Services to Existing Customers. Our relationships with our customers provide us with an opportunity to market additional services and solutions to such customers. We seek to maximize our customer retention rate and secure additional engagements by providing high-quality responsive services.
Leverage Expertise in Insurance Market. We seek to leverage our expertise within the insurance industry into a larger, more diverse customer base within the broader financial services market, especially as deregulation encourages the creation of full-service financial services organizations. Large companies dominate the insurance, banking and other financial service industries, with extensive IT needs. We seek to leverage our industry-specific expertise and our existing accounts into a larger number of customers in these IT intensive markets. As we expand our customer base, we intend to open additional regional sales offices in the U.S. to enable us to sell to and support existing and new customers in expanded geographic areas and industries. To achieve these goals, we may seek strategic acquisitions of organizations that complement or enhance our core skills.
Migration to Higher Margin Services. We seek to derive a greater percentage of our revenue from higher margin services. A core element of our growth strategy is to derive an increasing percentage of our revenue from higher margin Command-managed projects as opposed to lower margin client-managed staff augmentation projects.
Utilize Offshore Technology Resource Center. We believe that our offshore infrastructure improves our access to IT professionals, reduces our clients' costs associated with IT services and enables us to provide better support to our customers. This facility utilizes state-of-the-art technology and is connected via a secure point to point link to our headquarters, branch offices and customer sites.
Continued Development of Long-Term Relationships with Customers. We seek to develop long-term strategic relationships with our customers and leverage these relationships into additional project opportunities. For example, the knowledge of customers' systems gained during the performance of Year 2000 solutions has provided us with a competitive advantage in securing additional projects from these customers. We continue to develop preferred provider relationships with our customers. Our on-site personnel are integrated into the operations of our customers' IT departments. In addition, we make significant investments in technology enhancements to support the strategic technical direction of our
customers. We also use several methods to obtain continuous customer feedback, including consultant performance surveys and regularly scheduled meetings with senior management of each customer. A significant portion of the compensation of our senior executives, sales executives, recruiters and senior solution and project managers is directly linked to customer satisfaction and the delivery of high quality, timely IT services at or below budget. We believe that these initiatives foster long-term customer satisfaction as evidenced by the fact that for each of the fiscal years ended December 31, 1999, 1998 and 1997 existing customers from the previous fiscal year generated over 60% of our revenue.
Attract, Train and Retain Highly Skilled IT Professionals. Our future success depends to a significant extent on our ability to attract, train, motivate and retain highly skilled IT professionals, particularly solution and project managers, software engineers and other technology leaders. To achieve this objective, we maintain programs and personnel to identify and hire the best available IT professionals. We conduct training of our IT professionals in both legacy systems and emerging technologies to enhance our methodologies. In order to attract , maintain and retain our employees, we focus on our corporate culture, incentive programs, compensation and benefits and provide a career and education management program to create an individualized structured career growth plan for our employees. We also have access to a large pool of IT professionals through our state-of-the-art Bangalore facility.
Services
We offer our clients a single source for a comprehensive range of IT services required to successfully design, develop and implement integrated IT solutions in diverse computing environments including: (1) e-business development; (2) Internet/intranet applications; (3) network design and deployment; (4) outsourcing solutions; (5) applications and systems development; (6) database design and development; and (7) staff augmentation. These services may be provided individually or as a combination of service offerings to provide complete solutions. We believe the successful implementation of major projects requires a wide range of skills and a comprehensive methodology for delivering these services. Accordingly, we employ senior consultants who possess industry-specific knowledge and a broad range of technical expertise. We have adopted an integrated approach to providing solutions to our customers. Each of our service offerings is led by a technology leader, supported by a team of dedicated IT consultants with focused expertise in the technologies specific to the service offering. Our dedicated teams of service providers work closely with each other, with our customers and with a wide variety of technology vendors. In this manner, we aim to ensure the availability of leading-edge technologies and capabilities, cost-efficient and timely delivery of services and the development of solutions for specific business needs and objectives. We believe that our integrated approach to designing, developing and implementing our service offerings promotes long-term customer satisfaction and a more complete understanding of customer requirements.
Our solutions are focused on providing integrated services in specific areas of expertise - Command e-Solutions, CommandWEB, CommandNET, CommandSOURCE, CommandAPPS, CommandDATA and CommandSTAFF. These groups also work together to provide cross-functional solutions. For example, solutions for the Internet may incorporate disciplines from the full spectrum of our services.
Following is a more detailed description of these services.
Command e-Solutions provides integrated e-business capabilities to clients who are creating e-businesses or expanding their existing businesses. These solutions give companies the insight and technology they need to evolve in increasingly competitive markets.
CommandWEB provides development of integrated Web-based applications that can increase market share and improve internal/external communications and services. Examples of CommandWEB
applications include Web-enabling legacy application development, Web page design, security protection and Internet application development.
CommandNET is a comprehensive, project-based consulting service that uses network computing strategies and technologies to develop business connectivity solutions that allow people, technology and organizations to work collaboratively, regardless of geographic location. The technical expertise of our architects and engineers is backed by reliable project planning, integrated design experience and the market knowledge to assure that the best solutions are implemented on time and within budget. As an independent integrator, we have the capability to implement the best of breed in each component category and integrate them seamlessly into the best solution. Examples of CommandNET include workstation migration, the design and deployment of LAN/WAN software and hardware and software management solutions.
CommandSOURCE provides and manages the long-term maintenance of application systems by utilizing a range of technology toolsets. CommandSOURCE takes responsibility for project management, systems analysis, programming and ongoing maintenance. An important component of CommandSOURCE is our offshore technology resource center in Bangalore, India.
CommandAPPS provides advanced technology application development and support and employs traditional approaches and software frameworks to develop applications that meet clients' needs rapidly and efficiently with high quality results.
CommandDATA provides advanced administration and support for application and database servers. Featured in this service are middleware and database products from Microsoft, Oracle and IBM.
CommandSTAFF contracts to provide both temporary and permanent personnel with highly specialized technical skills. In order to obtain the necessary technical personnel for our contract staffing business, we conduct extensive recruiting operations. We also use these recruiting services to fulfill our internal personnel requirements.
Customers
Our customers consist primarily of large financial services and insurance organizations, middle-market companies and public sector organizations. We have maintained ongoing relationships with many of our customers over several years, spanning multiple projects and services. Our strategy is to maximize our customer retention rate and secure follow-on engagements by providing high-quality services and client responsiveness. For the year ended December 31, 1999, two customers accounted for approximately 16% and 12% of revenue. For the year ended December 31, 1998, two customers accounted for approximately 15% and 10% of revenue. For the year ended December 31, 1997, three customers accounted for approximately 13%, 13% and 10% of revenue.
Business Development
We market and sell our services to large financial service and insurance organizations, middle market companies and the public sector through a direct sales force located throughout our offices in Farmington and Stamford, Connecticut, Needham, Massachusetts and New York, New York, our technical delivery team and senior management. A significant amount of our business comes from additional projects from existing customers, referrals from existing customers, and from relationships within our target industries. We identify sales prospects through a variety of marketing activities, including attendance at targeted conferences and trade shows, mailings to senior business and IT executives, advertising, private briefings with individual companies, and seminars that demonstrate our unique capabilities. The sales executives work with our technical delivery team to:
. define the scope, deliverables, assumptions and execution of strategies for the proposed project; . develop project estimates; . prepare pricing and margin analyses; and . finalize sales proposals.
Management reviews and approves all proposals, which are then presented to the prospective customer. The sales executive remains actively involved in the project through the execution phase.
In order to develop an in-depth understanding of each customer's individual needs and to form strong customer relationships, sales executives are assigned to a limited number of customers that generally does not exceed twelve. These executives are responsible for providing highly responsive service and ensuring that our applications solutions achieve customer objectives. Commissions based upon the gross profit generated from each business transaction constitute a substantial portion of the total compensation for each sales executive.
Our maintenance and application services require a substantial financial commitment by customers and, therefore, typically involve a long sales cycle. Once a lead is generated, we endeavor to understand quickly the potential customer's business needs and objectives in order to develop the appropriate solution and bid, accordingly. Our technology leaders are involved throughout the sales cycle to ensure mutual understanding of customer goals, including time to completion, and technological requirements. The sales cycle for complex solutions projects typically range from one to six months from the time we initially meet with a prospective customer until the customer decides whether to authorize commencement of an engagement.
As of December 31, 1999, we had 15 persons engaged in sales and marketing full-time.
Human Resources
Our future success depends to a significant extent on our ability to attract, train, motivate and retain highly skilled IT professionals. Qualified technical employees are in great demand and are likely to remain a limited resource for the foreseeable future. We dedicate significant resources to recruiting consultants in the United States and India. Recruiting methods include advertisement on television, on the radio, in leading newspapers, in trade magazines and on our web site and through participation in career fairs. Each candidate is screened through a rigorous process comprising detailed interviews by our recruiting and technical personnel and technical testing. We also utilize stock options as part of our recruitment and retention strategy.
Our strategy for employee retention includes:
. career planning, . thorough initial and ongoing training, . allocation of assignments in accordance with employee skills and career objectives and . a comprehensive benefits package, including incentive-based compensation and tuition reimbursement.
As part of our retention efforts, we seek to minimize turnover by emphasizing:
. competitive salaries, . employee stock options and
. contractual limitations effective upon termination of employment.
Our IT professionals receive on-going training on a variety of technology platforms and in new technologies. In addition to comprehensive technical training, we provide extensive training in software quality implementation processes.
As of December 31, 1999, we had 259 employees comprised of 204 salaried IT professionals, 15 sales and marketing personnel, 14 recruiting and human resources personnel and 26 general and administrative personnel. As of December 31, 1999, we also utilized 50 independent contractors to supplement our workforce.
Our employees are not represented by any labor unions. We consider our relations with our employees to be good.
Our Competition
The market for IT services includes a large number of competitors, is subject to rapid change and is highly competitive. Primary competitors include participants from a variety of market segments, including publicly and privately held firms, "Big Five" accounting firms, systems consulting and implementation firms, application software firms, general management consulting firms and programming companies. In addition, we compete with our clients' internal resources, particularly where these resources represent a fixed cost to the client. Such competition may impose additional pricing pressures. Many of our competitors have significantly greater financial, technical and marketing resources and generate greater revenue.
We believe that the principal competitive factors in the IT services industry include quality of service, availability of qualified technical personnel, responsiveness to client requirements and needs, price, ability to deliver large multi-year contracts, breadth of product and service offering, timely completion of projects, capital resources and perceived value.
Intellectual Property Rights
In order to protect our ownership rights in our various intellectual properties, we rely upon a combination of:
. copyright and trade secret laws and . non-disclosure and other contractual arrangements.
We presently hold no patents or registered copyrights. Although we believe that our intellectual property rights do not infringe on the intellectual property rights of others, we cannot be sure of this and we may be sued in the future. If this situation arises, we may lose and may have to attempt to settle with third parties by trying to obtain a license for an infringed intellectual property, which might not be available at commercially reasonable terms.
Our ability to enforce our intellectual property rights in India may depend on India law. India is a member of the Berne Convention, an international treaty. As a member of the Berne Convention, the Government of India has agreed to extend copyright protection under its domestic laws to foreign works, including works created or produced in the United States. We believe that laws, rules, regulations and treaties in effect in the United States and India are adequate to protect us from unauthorized use of our intellectual property.
We cannot assure you, however, that:
. the steps taken by us to protect our rights will be adequate to deter theft of our intellectual property, . we will be able to detect unauthorized use and take appropriate steps to enforce our rights or . the laws of India or the United States will remain the same and , in particular, that the laws of India will not change in ways that affect us negatively.
Additionally, we may in the future license certain technologies to our customers. We cannot be certain that we will be able to:
. successfully license these technologies, . protect them from infringement and . prevent lawsuits against us relating to our licensing efforts.
We expect that the risk of such lawsuits will increase if more of our competitors are able to successfully obtain patents for software products and processes. See "Risk Factors -- We Have Limited Protection for and May Be Sued Over Our Use of Intellectual Property."
More About Command
We incorporated in Delaware on July, 1, 1997. Prior to that time, we conducted our business as Command Systems Incorporated, a corporation organized under the laws of the State of Connecticut on April 2, 1985 which was merged into Command Systems, Inc. in December 1997. In 1996, we established two subsidiaries:
. Command International Holdings, LLC, a corporation organized under the laws of Mauritius, and . Command International Software Pvt., an India unlimited liability company.
We wholly own Command International Holdings, LLC, which in turn wholly owns our India subsidiary. Our Bangalore facility and its employees are operated through our India subsidiary. Our executive offices are located at 76 Batterson Park Road, Farmington, Connecticut, 06032 and our telephone number is (860) 409-2000.
RISK FACTORS
Please remember to be cautious in reading forward-looking statements.
Important Factors Regarding Forward-Looking Statements
In addition to other information in this Annual Report on Form 10-K and in the documents we are incorporating by reference, the following risk factors should be carefully considered in evaluating Command and our business because such factors currently have a significant impact or may have a significant impact on our business, operating results or financial condition. This Form 10-K contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below and elsewhere in this form.
We May Fail to Obtain More Profitable Service Contracts
During 1999, 1998 and 1997, Year 2000 projects constituted most of our higher margin services. For the years ended December 31, 1999, 1998 and 1997 we realized 14%, 27% and 21%, respectively, of revenue related to Year 2000 solutions. There is no longer a demand for our Year 2000 solutions, and as a result, our financial performance has been adversely affected.
A core element of our growth strategy is to derive an increasing percentage of our revenue from higher margin Command-managed projects as opposed to lower margin client-managed staff augmentation projects. The sales and marketing methods for obtaining projects that we manage are different than those for our historical businesses and involve a longer sales process. In addition, we assume greater responsibility in coordinating and completing these larger, more complex projects that we manage. Consequently, we may not be successful in obtaining Command-managed projects.
We May Fail To Recruit and Retain IT Professionals
Our business involves the delivery of professional services and is labor-intensive. Our future success depends to a significant extent on our ability to attract, train, motivate and retain highly skilled IT professionals and project managers who possess the technical skills and experience necessary to deliver our services. Qualified technical employees are in great demand and are likely to remain a limited resource for the foreseeable future. There can be no assurance that qualified IT professionals will continue to be available to us in sufficient numbers, or that we will be successful in retaining current or future employees. Failure to attract or retain qualified IT professionals in sufficient numbers could have a material adverse effect on our business, operating results and financial condition.
Our Quarterly Financial Results May Vary Significantly
Our revenue and operating results are subject to significant variation from quarter to quarter depending on a number of factors, including the timing and number of client projects commenced and completed during the quarter; the number of working days in a quarter; employee hiring, attrition and utilization rates and the mix of time-and-materials projects versus fixed-price projects during the quarter. We recognize revenue on time-and-materials projects as the services are performed, while revenue on fixed-price projects are recognized using the percentage of completion method. Although fixed-price projects have not contributed significantly to revenue to date, operating results may be adversely affected in the future by cost overruns on fixed-price projects. Because a high percentage of our expenses are relatively fixed, variations in revenue may cause significant variations in operating results. Hiring and employment practices and applicable law in India make it difficult for us to effect reductions in staffing at our Bangalore, India facility. As a result, we are unable to quickly adjust these costs in the event that our revenue is unexpectedly lower in any quarter. Additionally, we periodically incur cost increases due to both the hiring of new employees and strategic investments in our infrastructure in anticipation of future opportunities for revenue growth. No assurances can be given that our quarterly results will not fluctuate, causing a material adverse effect on our business and financial condition.
The Internet Economy and the Market for E-Commerce Solutions is Still Developing
The Internet has experienced, and is expected to continue to experience, significant growth in the number of users and volume of traffic. The Internet infrastructure may not continue to be able to support the demands placed on it by this continued growth. In addition, critical issues concerning the use of Internet and e-commerce solutions, including security, reliability, cost, ease of deployment and administration and quality of service, remain unresolved and may affect the acceptance of these technologies to operate a business, expand product marketing, improve corporate communications and increase business
efficiencies. The adoption of Internet solutions for these purposes can be capital intensive and generally requires the acceptance of a new way of conducting business and exchanging information. If critical issues concerning the ability of Internet solutions to improve business positioning and processes are not resolved or if the necessary infrastructure is not developed, our business could be adversely affected.
Even if these issues are resolved, businesses may not elect to outsource the design, development and maintenance of their Web sites to Internet professional services firms. If independent providers of Internet professional services prove to be unreliable, ineffective or too expensive, or if software companies develop tools that are sufficiently user-friendly and cost-effective, enterprises may choose to design, develop or maintain all or part of their intranets, extranets or web sites themselves. If the market for such services does not continue to develop or develops more slowly than expected, our business could be adversely affected.
We Depend on Our Bangalore, India Facility and Doing Business in India May be Risky
A significant element of our business strategy is to increase the utilization of our Bangalore, India facility. The Indian government exerts significant influence over its economy. In the recent past, the Indian government has provided significant tax incentives and relaxed certain regulatory restrictions in order to encourage foreign investment in certain sectors of the economy, including the technology industry. Certain of these benefits include, among others, tax holidays (temporary exemptions from taxation on operating income), liberalized import and export duties and preferential rules on foreign investment and repatriation. If any of these benefits are eliminated or diminished, it could have a material adverse effect on our business, financial condition and results of operations.
In the past, India has been subject to civil unrest and acts of terrorism. Changes in inflation, interest rates, taxation or other social, political, economic or diplomatic developments affecting India in the near future could have a material adverse effect on our business, financial condition and results of operations.
We May Lose Business to Many Competitors
The IT services industry is highly competitive and served by numerous national, regional and local firms, all of which are either existing or potential competitors. Primary competitors include participants from a variety of market segments, including publicly and privately held firms, "Big Five" accounting firms, systems consulting and implementation firms, application software firms, general management consulting firms and programming companies. Many of our competitors have significantly greater financial, technical and marketing resources and greater name recognition than Command. There are relatively few barriers to entry into our markets and we may face competition from new entrants. In addition, there is a risk that clients may elect to increase their internal IT resources to satisfy their applications solutions needs. Furthermore, the IT services industry is undergoing consolidation that may result in increasing pressure on margins. These factors may limit our ability to increase prices commensurate with increases in compensation. There can be no assurance that we will compete successfully with existing or new competitors.
We Rely On Significant Customers Without Long-Term Contracts
We have derived a significant portion of our revenue from a limited number of large corporate customers. Moreover, our industry has shifted away from the use of long-term contracts, which might otherwise provide steady work at a time of decreasing demand for our services. If a significant customer decides to terminate or reduce the use of our services, our business, financial condition and results of operations could be materially and adversely affected. See "---Customers".
We are Potentially Liable to Customers for Project Work
We perform many projects that are critical to the operations of our customers' businesses and provide benefits that may be difficult to quantify. If a customer's system fails, it could result in a claim for substantial damages against us, regardless of our responsibility for such failure. In addition, if we fail to complete projects on time, customers may sue us for substantial damages.
We generally attempt to limit our liability for damages arising from errors, mistakes or omissions in rendering our IT services in our contracts. These contract provisions may not effectively shield us from liability for damages. We maintain general liability insurance coverage, including coverage for errors or omissions in the amount of $5.0 million. However, we cannot be certain that:
. insurance coverage will continue to be available on reasonable terms, . such coverage will be available in sufficient amounts to cover one or more large lawsuits or . the insurer will not disclaim coverage as to any future lawsuit.
Our business, financial condition and results of operations could be adversely affected if any of the following occurred:
. one or more successful large lawsuits against us exceeds our insurance coverage or . changes are made in our insurance policies, including premium increases, larger deductibles or coinsurance requirements.
Our Strategy of Expansion Could Adversely Affect Our Business
As an integral part of our business strategy, we intend to continue to expand by acquiring IT businesses. We continuously evaluate potential business combinations and aggressively pursue attractive transactions. During 1999, we completed one relatively small business combination. The success of this strategy depends not only upon our ability to identify and acquire businesses on a cost-effective basis, but also upon our ability to integrate acquired operations into our organization effectively, to retain and motivate key personnel and to retain clients of acquired businesses. There can be no assurance that we will be able to identify, acquire or profitably manage additional businesses or successfully integrate any acquired businesses without substantial expense, delays or other operational or financial problems.
We Depend on Key Executives
Our success will largely depend upon the continued availability and services of key executive officers, particularly Edward G. Caputo, our President and Chief Executive Officer. In addition, Mr. Caputo is instrumental to most of our customer relationships relating to the delivery of more profitable, complete project and solution services. If we lose Mr. Caputo or other key executives, it could have an adverse effect on our customer relationships in this area. Accordingly, losing Mr. Caputo or other key executives could have a material adverse effect on our business, financial condition and results of operations. We maintain key person life insurance on Mr. Caputo in the amount of $10.0 million. This amount of insurance, however, may not be sufficient to offset our loss of Mr. Caputo's services.
Our Principal Stockholder Controls Us and Can Influence Many Key Decisions
Mr. Caputo beneficially owns approximately 51.9% of the outstanding shares of our common stock. Accordingly, Mr. Caputo can control the election of members of the board of directors. Mr. Caputo can also control any decision whether:
. to merge or sell our assets, . to change our charter and by-laws and . to take other actions requiring the vote or consent of our stockholders.
In addition, Mr. Caputo's voting power may delay or prevent a future merger or change in control. He may also impede or prevent transactions in which stockholders might otherwise receive a premium for their shares over current market prices.
We Have Limited Protection for and May be Sued Over Our Use of Intellectual Property
As an IT service provider, we are dependent on using our own intellectual property and the intellectual property of others to provide our services. In doing so, we run the risk that our intellectual property may be inadequately protected from infringement. We also may be sued with claims of unauthorized use of our own intellectual property and/or third party intellectual property. Moreover, since we do business in India, we are also subject to a change to the status of our rights under India's law and may be subject to India's jurisdiction on some matters. Any lawsuits, regardless of outcome, could greatly divert our focus on our business and would be costly. Thus, any intellectual property lawsuits would have a material adverse effect on our business, financial condition and results of operations. For a more detailed discussion, please see "---Intellectual Property Rights."
Our Common Stock Price is Subject to Significant Market Volatility
We cannot assure you that an active trading market for our stock will be sustained. Market prices for securities of IT service companies similar to Command are highly volatile. The market price of our common stock has been adversely affected in response to:
. variations in quarterly operating results and . our failure to achieve earnings estimates of securities analysts.
The market price of the common stock may experience further volatility in the future.
Difficulties in Acquiring Control of Our Company Under Our Charter and Delaware Law May Discourage Future Transactions Generating Significant Shareholder Value
Anyone seeking to acquire control of Command may encounter difficulties because of anti-takeover provisions in our charter and under Delaware law. These provisions are intended to encourage any person interested in acquiring us to negotiate with and obtain the approval of our board of directors in connection with the transaction. These provisions could have the effect of delaying, deterring or preventing a merger or change in control. Some of these provisions may also discourage a future acquisition of Command even if stockholders would receive an attractive value for their shares and even if a substantial number, or even if a majority, of our stockholders might believe the transaction to be in their best interest. As a result, stockholders who desire to participate in such a transaction may not have the opportunity to do so.
Item 2.
Item 2. PROPERTIES
Command Systems, Inc. leases approximately 12,922 square feet of office space in Farmington, Connecticut which is used by our senior management, administrative personnel, human resources and sales and marketing functions. This lease expires on March 31, 2003. We also lease facilities in Stamford, Connecticut, Needham, Massachusetts, and New York, New York.
In addition, we lease approximately 23,450 square feet of office space in downtown Bangalore, India for our offshore technology resource center; we have sublet approximately 12,600 square feet related thereto for a period of one year. This lease expires on September 15, 2000 and is renewable at our option for a two-year period.
We believe that these facilities will be adequate for our presently anticipated future needs.
Item 3.
Item 3. LEGAL PROCEEDINGS
On or about May 6, 1998, plaintiffs Don M. Doney, Jr. and Madelyn J. McCabe filed a lawsuit in the United States District Court for the Southern District of New York. The lawsuit was filed against the Company, certain of its officers and directors (Edward G. Caputo, Stephen L. Willcox, Robert B. Dixon, John J.C. Herndon, James M. Oates and Joseph D. Sargent) and the managing underwriters of the initial public offering (Cowen & Company and Volpe Brown Whelan & Company LLC). On or about June 22, 1998, the same plaintiffs amended their complaint in the lawsuit they had filed with the United States District Court for the Southern District of New York. On or about May 8, 1998, another plaintiff, Chaile B. Steinberg, filed a new lawsuit against the same defendants in the same court. On or about June 26, 1998, named plaintiff Michael Makinen, filed a lawsuit in the same court against the same defendants. Each of the plaintiffs purported to represent a class consisting of purchasers of common stock pursuant to the initial public offering. These lawsuits were consolidated into one lawsuit by order of the United States District Court for the Southern District of New York. Consequently, the plaintiffs filed a consolidated complaint named In Re Command Systems, Inc. Securities Litigation on September 30, 1998, seeking to represent a class of purchasers of common stock from March 12, 1998, the date of the initial public offering, through April 29, 1998. The consolidated complaint alleged that the defendants violated the Securities Act of 1933 in that the Company failed to properly register 345,000 shares of common stock that were sold in the initial public offering, and consequently the defendants sold unregistered securities to the public, and the prospectus for the initial public offering contained untrue statements of material fact and omitted to state other facts necessary to make the statements made in the prospectus not misleading with respect to the unregistered shares, the Company's business strategy and other matters.
The plaintiffs sought rescission of the sales of the shares in the initial public offering and unspecified damages, including rescissionary damages, interest, costs and fees. On May 20, 1999, a definitive settlement agreement (the "Stipulation of Settlement" or "Stipulation") was executed by the parties via their counsel. Pursuant to the terms of the Stipulation, the parties agreed to a total payment from the Company to the plaintiffs of $5.75 million in cash plus accrued interest, minus approved attorneys' fees and related expenses. The $5.75 million accumulated interest as of June 11, 1999, the date of the preliminary court approval of the Stipulation of Settlement. The court entered a judgment approving this settlement on August 11, 1999, which became final and no longer subject to appeal on September 10, 1999. On September 10, 1999 the settlement fund was also established. The Company may also be responsible for certain legal fees and related expenses incurred in connection with the litigation. The Company recognized a charge to operations of $1.8 million in the fourth quarter of 1998 for costs of the settlement and related expenses.
Of the $5.75 million deposited in the settlement fund established September 10, 1999 by the Company, the Company has been reimbursed for all but $1.65 million. This reimbursement came in part from the Company's insurance carrier and the rest pursuant to the indemnification agreement with the Company's former counsel in the initial public offering.
In the settlement, the members of the class represented by plaintiffs gave up their right to assert individual claims against the Company or its underwriters, based on their purchase of the Company's common stock in the initial public offering and in the open market during the period from March 12, 1998 through April 29, 1998. In return for this concession, class members became entitled to share pro rata in the $5.75 million cash settlement fund, plus interest, minus approved attorneys' fees and related expenses. No class member chose not to participate in, or to "opt-out" of, the settlement.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been trading on the Nasdaq National Market under the symbol CMND since our initial public offering on March 12, 1998. The following tables set forth the closing high and low sales price for our common stock during 1998 and 1999:
High Low ---- ---
- ---- First Quarter from (March 12, 1998).. $14 3/4 $13 Second Quarter........................... 18 3/4 4 Third Quarter............................ 5 11/16 2 7/8 Fourth Quarter........................... 3 11/16 2 7/8
- ---- First Quarter............................ $3 27/32 $1 7/8 Second Quarter........................... 2 1/8 1 1/2 Third Quarter............................ 2 7/16 1 1/2 Fourth Quarter........................... 2 23/32 1 1/4
As of March 27, 2000, there were approximately 24 holders of record of our common stock.
We have never declared or paid any dividends on our common stock. We were, however, obligated to pay a 10% dividend on our Series A and Series B redeemable convertible preferred stock. Accrued and unpaid dividends were paid with a portion of the net proceeds of the initial public offering upon the conversion of the preferred stock. We do not anticipate paying any other cash dividends in the foreseeable future and intend to retain any earnings to fund future growth and the operation of our business. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources."
Item 6.
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data as of December 31, 1999, 1998, 1997, 1996, and 1995 and for the years then ended are derived from and are qualified by reference to our audited consolidated financial statements and the notes thereto. The audited consolidated financial statements include all adjustments, consisting only of normal recurring accruals, which we consider necessary for a fair presentation of financial position and results of operations. Historical results are not necessarily
indicative of results to be expected in the future. The data should be read in conjunction with our consolidated financial statements, including the notes thereto, appearing elsewhere in this report, "Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with "Item 6 - -Selected Consolidated Financial Data" and our consolidated financial statements, including the notes thereto, appearing elsewhere in this report.
Overview
We provide a wide range of IT services and solutions to large financial service and insurance organizations, middle market companies, and public sector organizations. We strive to establish long-term client relationships and to secure additional engagements with existing clients by providing quality services and by being responsive to client needs. We offer our clients with a single source for a comprehensive range of IT services including (1) e-business development; (2) Internet/intranet applications; (3) network design and deployment; (4) outsourcing solutions; (5) applications and systems development; (6) database design and development; and (7) staff augmentation. Our revenue is derived from fees paid by clients for our professional services. Historically, we have derived the majority of our revenue from traditional client-managed staff augmentation projects. On client-managed projects, we provide professional services as a member of the project team on a time-and-materials basis. We recognize revenue on time-and-material projects as the services are performed. On Command-managed projects, we assume responsibility for project management and bill our clients on a time-and-materials or fixed-price basis. Revenue on fixed- price contracts is recognized by the percentage of completion method.
Our most significant cost is our personnel expense, which consists primarily of salaries and benefits of our billable personnel. The number of IT professionals assigned to projects may vary depending on the size and duration of each engagement. Project terminations, completions and scheduling delays may result in periods when personnel are not assigned to projects. Additionally, hiring and employment practices and applicable law in India make it difficult to affect staff reductions at our Bangalore, India facility. We manage our personnel costs by closely monitoring our clients' needs. While the number of IT professionals may be adjusted to reflect active projects, we must maintain a sufficient number of professionals to respond to demand for our services on both existing and new engagements.
The results of operations for 1999 were adversely affected primarily due to diminished demand for Year 2000 services, a general slowdown in the overall demand for traditional IT services, a reduction in hardware and software sales, low rates of employee utilization at our Bangalore, India facility, and a less profitable mix of business.
Results of Operations
The following table sets forth certain operating data as a percentage of revenue for the periods indicated.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Revenue. Revenue for the year ended December 31, 1999 decreased 22.8% to $27,192,000 from $35,215,000 for the year ended December 31, 1998. The decrease in revenue is attributed to diminished demand for Year 2000 services, a general slowdown in the overall demand for traditional IT services due to the reluctance of customers to implement new projects as they focused on their internal Year 2000 compliance efforts and a reduction in hardware and software sales.
Gross Profit. Gross profit of $7,372,000 for the year ended December 31, 1999 represented a decrease of $3,315,000 or 31.0% over gross profit of $10,687,000 for the year ended December 31, 1998. Gross margin decreased to 27.1% for the year ended December 31, 1999 from 30.3% for the year ended December 31, 1998. The decrease in gross margin is attributed to diminished demand for our higher margin Year 2000 services, low rates of employee utilization at our Bangalore, India facility and a less profitable mix of business.
Selling, General and Administrative Expense. Selling, general and administrative expense consists primarily of salaries and employee benefits for our sales, marketing, recruiting, human resource, finance and administrative personnel, as well as travel, telecommunications and occupancy costs for our U.S. and India operations. These expenses are relatively fixed in advance of any particular quarter. To the extent revenue does not increase at a rate commensurate with these expenses, our results of operations could be materially and adversely affected. Selling, general and administrative expense decreased 4.9% to
$11,346,000 from $11,926,000 for the year ended December 31, 1998. The decrease was attributed to a reduction in support staff.
Shareholder litigation and related expenses. During 1998 we recognized a one-time charge to operations of $1,800,000 relating to the proposed settlement of stockholder litigation and related costs. This matter was settled during 1999.
Other Income (Expense), Net. Other income (expense), net consists primarily of interest earned on our marketable securities from the proceeds of our initial public offering and foreign exchange activity. Other income, net, was $1,104,000 for the year ended December 31, 1999 compared to $954,000 for the year ended December 31, 1998.
Income Tax (Provision) Benefit. The income tax provision for the year ended December 31, 1999 was $66,000 compared to an income tax benefit of $318,000 for the year ended December 31, 1998. The current year provision represents a tax computed based on our capital structure. The prior year benefit resulted from the utilization of deferred tax credits.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue. Revenue for the year ended December 31, 1998 increased by 41.0% to $35,215,000 from $25,057,000 for the year ended December 31, 1997. This resulted primarily from an increase in revenue generated from Year 2000 compliance services. As compared to the year ended December 31, 1997, revenue from Year 2000 projects and other higher margin services for the year ended December 31, 1998 increased as a percentage of our revenue. We have decided to de-emphasize our hardware solutions services and, therefore, hardware solutions may constitute a decreasing percentage of our revenue.
Gross Profit. Gross profit for the year ended December 31, 1998 increased by 32.2% to $10,687,000 from $8,084,000 for the year ended December 31, 1997. Gross profit as a percentage of revenue decreased to 30.3% for the year ended December 31, 1998 from 32.3% for the year ended December 31, 1997. This decrease resulted primarily from a smaller amount of our revenue being derived from Year 2000 compliance services, which typically carry higher margins than our traditional staff augmentation services. It was also impacted by low rates of employee utilization in India, a less profitable mix of business and reduced margins in our traditional staff augmentation business
Selling, General and Administrative Expense. Selling, general and administrative expense consists primarily of salaries and employee benefits for selling, marketing, recruiting, human resources, finance and administrative personnel, as well as travel, telecommunications and occupancy costs for our U.S. and India operations. These expenses are relatively fixed in advance of any particular quarter. To the extent revenue does not increase at a rate commensurate with these expenses, our results of operations could be materially and adversely affected. Selling, general and administrative expense, net of amortization for goodwill, for the year ended December 31, 1998 increased by 64.4% to $11,926,000 from $7,255,000 for the year ended December 31, 1997. The increase was attributable to additional sales and project management personnel, which were added in anticipation of growth in complete projects and solutions business which, did not materialize to the extent expected.
Amortization of goodwill for the year ended December 31, 1998 was $456,000, relating to our purchase of the 49% minority interest in our Bangalore facility from PHL Global Holding Co. on December 31, 1997. We accounted for this transaction as a purchase and recognized the $6,845,000 excess of the purchase price over the fair value of the assets acquired and liabilities assumed as goodwill.
Stockholder litigation and related expenses. During the fourth quarter of 1998, we recognized a one-time charge to operations for costs and expenses of $1,800,000 relating to the proposed settlement of shareholder litigation.
(Loss) Income From Operations. Operations for the year ended December 31, 1998 lost $3,039,000 compared to income of $829,000 for the year ended December 31, 1997. Loss from operations as a percentage of revenue was (8.6)% for the year ended December 31, 1998 as compared to income of 3.3% for the year ended December 31, 1997. Absent the recognition of the one-time settlement and litigation expenses, the Company would have reported at $1,227,000 loss from operations for the year ended December 31, 1998.
Other Income (Expense), Net. Net other income was $954,000 for the year ended December 31, 1998 compared to net other expense of $277,000 for the year ended December 31, 1997. Net other income was comprised of interest income and a foreign currency exchange gain. The interest income was attributable to interest earned from investment in commercial paper of the net proceeds of our initial public offering and other cash equivalent instruments during the year ended December 31, 1998. Interest expense in 1997 was a result of bank borrowings required to provide us with working capital and accrued interest expense associated with subordinated notes issued to Phoenix Home Life Mutual Insurance Company. In addition, during the nine months ended December 31, 1998, we recognized an $87,000 foreign currency exchange gain in connection with our U.S. Dollar-denominated cash and receivable balances of the offshore technology resource center in Bangalore, India.
Income Tax (Provision) Benefit. The income tax benefit for the year ended December 31, 1998 was $318,000, as a result of the utilization of deferred tax credits. We compute our income tax provision on a quarterly basis and provide for deferred income taxes based upon the difference between the financial statement and tax basis of assets and liabilities. A valuation allowance is provided when necessary to reduce the deferred tax asset to the amount expected to be realized.
From our inception through August 23, 1997, we had elected to be taxed under the S Corporation provisions of the Internal Revenue Code of 1986, as amended. An S Corporation generally is not subject to income tax at the corporate level with certain exceptions under state income tax laws. This election was terminated in conjunction with our formation as a Delaware holding corporation and the issuance of our Series A redeemable convertible preferred stock.
In connection with the termination of our S Corporation status, we were required by the Internal Revenue Code to change our method of accounting for tax reporting purposes from the cash method to the accrual method. This change resulted in a one-time charge to earnings in the year ended December 31, 1997 of $693,000 resulting from differences of approximately $2.0 million in the tax treatment of certain of our assets and liabilities under the cash and accrual methods of accounting and is reflected through an increase in current and deferred income tax liabilities. Under current statutes, this liability will be payable over a period of four years.
The offshore technology resource center in Bangalore, India is eligible for certain favorable tax treatment provided under India law including (a) an exemption from payment of corporate income taxes for a period of five consecutive years in the first eight years of operation or (b) an exemption from income taxes on the profits derived from sources outside India, know as an export exemption.
The export exemption remains available after expiration of the tax holiday. As a result of the availability of these exemptions, we have not recorded deferred income taxes applicable to the undistributed earnings of the offshore technology resource center. We consider these earnings to be permanently invested in India and do not anticipate repatriating any of these earnings to the U.S. If any earnings of our subsidiary,
Command International Software Pvt., are repatriated to the U.S. in the future, we will be required to record a provision for income taxes on such amounts and, upon repatriation of the funds, pay U.S. taxes thereon. See Note 9 to our consolidated financial statements.
Preferred Stock Dividends and Accretion. Preferred stock dividends and accretion was $260,000 in 1998 and $80,000 in 1997.
(Loss) Income Applicable to Common Stockholders. As a result of the foregoing, loss applicable to common stockholders was $2,027,000 for the year ended December 31, 1998 as compared to a net income of $56,000 on a pro-forma basis for the year ended December 31, 1997. Therefore, basic and diluted loss per share were $0.29 for the year ended December 31, 1998 as compared to pro-forma earnings of $0.01 for the year ended December 31, 1997. Pro-forma earnings give rise to the effect of the change in corporate tax status. Absent the recognition of the one-time settlement and litigation expense, the net loss for the year ended December 31, 1998 would have been $91,000 or $0.01 per share. The weighted average number of shares outstanding used in the calculation of basic and diluted earnings per share increased over the comparable period as a result of shares issued in conjunction with our March 12, 1998 initial public offering.
Quarterly Results of Operations
Our revenue and operating results are subject to significant variation from quarter to quarter depending on a number of factors, including the timing and number of client projects commenced and completed during the quarter; the number of working days in a quarter; employee hiring, attrition and utilization rates and the mix of time-and-materials projects versus fixed-price projects during the quarter. We recognize revenue on time-and-materials projects as the services are performed, while revenue on fixed-price projects are recognized using the percentage of completion method. Although fixed-price projects have not contributed significantly to revenues to date, operating results may be adversely affected in the future by cost overruns on fixed-price projects. Because a high percentage of our expenses are relatively fixed, variations in revenue may cause significant variations in operating results. Hiring and employment practices and applicable law in India make it difficult for us to effect reductions in staffing at our Bangalore, India facility. As a result, we are unable to quickly adjust these costs in the event that our revenue is unexpectedly lower in any quarter. Additionally, we periodically incur cost increases due to both the hiring of new employees and strategic investments in our infrastructure in anticipation of future opportunities for revenue growth. No assurances can be given that our quarterly results will not fluctuate, causing a material adverse effect on our business and financial condition.
Liquidity and Capital Resources
Our revolving line of credit agreement for our U.S. operations, as amended October 13, 1999, limits borrowings to a maximum of $4,000,000. The agreement expires on October 15, 2000 and bears interest at the Bank Rate, as defined, or the London Interbank Offered Rate plus 1.75 points. Under the terms of the agreement, we are required, among other things, to maintain certain financial ratios and minimum levels of net worth. In addition, Command International Software Pvt., our wholly owned Indian subsidiary, has available borrowings under a credit facility of approximately $176,500. At December 31, 1999, there were no outstanding amounts under these credit facilities.
In March 1998, we issued and sold 2,200,000 shares of common stock in our initial public offering. We received net proceeds of $24,552,000 after underwriters' discounts and before other offering expenses of $1,341,000. Simultaneously with the initial public offering, the holders of the Series A and B redeemable convertible preferred stock exchanged their 200 shares for 1,181,750 shares of our common stock.
Proceeds were used to pay preferred stock dividends of $298,000 related thereto and to repay a bank loan of $528,000 and borrowings of $858,000 under a revolving line of credit.
Historically, we have financed our working capital requirements through internally generated funds, borrowings under our credit facilities, the issuance of subordinated notes to the Phoenix Home Life Mutual Insurance Company and with the proceeds from the issuance of our common stock.
At December 31, 1999 we had cash and cash equivalents and marketable securities of $18,248,000 compared to $18,994,000 at December 31, 1998. For the year ended December 31, 1999 we met our liquidity needs primarily through cash generated from a reduction of our accounts receivable balances. Cash provided by operating activities was $103,000 for the year ended December 31, 1999 compared to cash used in operating activities of $1,635,000 for the year ended December 31, 1998. The primary uses of cash during the year ended December 31, 1999 were to fund a net loss of $2,936,000 and pay the shareholder litigation settlement, offset by decreases in accounts receivable and prepaid expenses and other assets.
Cash used in investing activities of $12,349,000 for the year ended December 31, 1999 included $250,000 for the purchase of equipment and improvements and $11,645,000 of net purchases of available-for-sale securities.
In addition, on August 1, 1999, we acquired 100% of the outstanding stock of Nova Technology, Inc. (Nova), a privately owned Oracle IT consulting, systems integration and custom software application developer for approximately $454,000. The acquisition has been accounted for as a purchase; accordingly, the excess of the purchase price over the fair value of the net assets acquired has been recorded as goodwill and is being amortized on a straight line basis over three years. The results of operations of Nova are included in our financial statements from the date of acquisition. This acquisition did not materially affect our financial statements in 1999 nor would it have materially effected our financial statements of prior periods had the results of its operations been included in them.
Concurrent with the acquisition, we entered into employment agreements with the former shareholders of Nova. The agreements, which are for a period of four years, provide for specific salary levels and additional incentive bonuses that are contingent upon the Nova business achieving certain performance criteria; performance based payments are not expected to exceed $250,000 annually.
We believe that the net proceeds from the initial public offering, together with other available funds, will be adequate to satisfy our current and planned operations over the next 12 months.
Legal Proceedings
See "Item 3. Legal Proceedings"
Inflation
Our most significant costs are the salaries and related benefits for our consultants and other professionals. Competition in India and the U.S. for IT professionals with the advanced technological skills necessary to perform our service offerings have caused wages to increase at a rate greater than the general rate of inflation. As with other IT service providers, we must adequately anticipate wage increases. Further, India has in the past experienced significant inflation. Historically, our wage costs in India have been significantly lower than our wage costs in the U.S. for comparably skilled employees, although wage costs in India are presently increasing at a faster rate than in the U.S. We may not be able to recover cost increases through increases in the prices that we charge for our services in the U.S.
Impact of the Year 2000 Issue
Previously, we discussed the nature and progress of our plans to become Year 2000 ready. In late 1999, we completed our remediation and testing of our systems. As a result of those planning and implementation efforts, we experienced no significant disruptions in mission critical IT and non-IT systems and believe these systems successfully responded to the Year 2000 date change. The costs incurred in connection with remediating our systems were not material. We are not aware of any material problems resulting from Year 2000 issues, either with our internal systems, or with products and services provided to us by third parties. We will continue to monitor our mission critical computer applications and those of our suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Risk
Included in our sales are services performed by our Bangalore, India facility. As a result, our financial results could be affected by factors such as a change in the foreign exchange rate between the U.S. dollar and the Indian Rupee, or by weak economic conditions in India. When the U.S. dollar strengthens against the Indian Rupee, the value of revenues in India decreases. When the U.S. dollar weakens against the Indian Rupee, the value of revenues in India increases. The monetary assets and liabilities in our foreign subsidiary which are impacted by foreign currency fluctuations are principally cash, accounts receivable, fixed assets, accounts payable and certain accrued liabilities. A hypothetical 2% increase or decrease in the exchange rate between the U.S. dollar and the Indian Rupee from the December 31, 1999 rate would cause the fair value of such monetary assets and liabilities in India to change by an insignificant amount. We are not currently engaged in any foreign currency hedging activities.
Interest Rate Risk
Our marketable securities are invested in United States Treasury Notes. These investments are subject to interest rate risk and will decrease in value if market interest rates increase. A hypothetical increase or decrease in market interest rates by 2% from the December 31, 1999 rates would cause the fair value of these investments to change by an insignificant amount. Risk is mitigated through limits regarding investment concentration in particular securities and investments in varying maturities. We do not invest in any financial derivatives or any other complex financial instrument. We do not own any equity investments. Therefore, we do not currently have any direct equity price risk.
Our revolving line of credit facility for our U.S. operations is based upon the London Interbank Offered Rate and, as such, is sensitive to changes in interest rates.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Supplementary Data required by this item are filed as part of this Form 10-K. See List of Financial Statements and Financial Statement Schedule on page of this Form 10-K.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this item is incorporated by reference from the information under the captions "Election of Directors" and "Executive Officers" in our proxy statement to be filed in connection with our annual meeting of stockholders.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the information under the caption "Compensation of Executive Officers and Directors" contained in our proxy statement to be filed in connection with our annual meeting of stockholders.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the information under the caption "Beneficial Ownership of Common Stock" contained in our proxy statement to be filed in connection with our annual meeting of stockholders.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the information under the caption "Certain Transactions" contained in our proxy statement to be filed in connection with our annual meeting of stockholders.
PART IV
Item 14.
Item 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a)(1) Consolidated Financial Statements. Reference is made to the List of Consolidated Financial Statements on Page. (a)(2) Consolidated Financial Statement Schedule. Reference is made to the List of Consolidated Financial Statements on Page.
(b) Reports on Form 8-K: None
(c) Exhibits
*1.1 Form of Underwriting Agreement. *3.1 Amended and Restated Certificate of Incorporation of the Registrant *3.2 Certificate of Amendment to Registrant's Amended and Restated Certificate of Incorporation filed on February 5, 1998. *3.3 By-Laws of the Registrant. *4.1 Specimen Certificate for shares of the Company's Common Stock. *10.1 1997 Employee, Director and Consultant Stock Plan. *10.2 Registration Rights Agreement dated August 26, 1997 between Registrant and Phoenix Home Life Mutual Insurance Company. *10.3 Registration Rights Agreement dated December 31, 1997 between Registrant and PHL Global Holding Co.
*10.4 Co-Sale Agreement dated August 26, 1997 between Registrant, Edward G. Caputo and Phoenix Home Life Mutual Insurance Company. *10.5 Amendment No. 1, dated December 31, 1997 to Co-Sale Agreement between Registrant, Edward G. Caputo and Phoenix Home Life Mutual Insurance Co. *10.6 Co-Sale Agreement dated December 31, 1997 between Registrant, Edward G. Caputo and PHL Global Holding Co. *10.7 Employment Contract dated January 1, 1998 between Registrant and Edward G. Caputo. *10.8 Assumption Agreement dated December 1997 by and between Registrant and People's Bank. *10.9 Loan Agreement by and between Command International Software Pvt. and Deutsche Bank. *10.10 Employment Agreement dated January 1, 1998 between Registrant and Stephen L. Willcox. **10.11 Indemnification Agreement, by and among Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. and Registrant, Phoenix Home Life Mutual Insurance Company, PHL Global Holding Co. and Edward G. Caputo. *10.12 Employment Agreement, dated as of December 1, 1997 by and between Registrant and Glenn M. King. *10.13 Loan/and Security Agreement dated October 29, 1998 by and between Registrant and People's Bank. 10.14 First Amendment to Loan and Security Agreement dated October 29, 1998 by and between Registrant and People's Bank. 10.15 First Amendment to 1997 Employee, Director and Consultant Stock Plan dated January 5, 2000. --------------- *21.1 Subsidiaries of the Company. 23.1 Consent of Ernst & Young, LLP 27.1 Financial Data Schedule.
- --------------------------------------------------------------------------------
* Incorporated by reference from registration statement on Form S-1, Registration No. 33-53877. ** Incorporated by reference from the Registrant's Quarterly Report on Form 10Q/A for the three months ended March 31, 1998.
(d) Financial Statement Schedule-- The response to this portion of Item 14. is submitted as a separate section of this report.
EXHIBIT INDEX
Exhibit Number Description
*1.1 Form of Underwriting Agreement. *3.1 Amended and Restated Certificate of Incorporation of the Registrant *3.2 Certificate of Amendment to Registrant's Amended and Restated Certificate of Incorporation filed on February 5, 1998. *3.3 By-Laws of the Registrant. *4.1 Specimen Certificate for shares of the Company's Common Stock. *10.1 1997 Employee, Director and Consultant Stock Plan. *10.2 Registration Rights Agreement dated August 26, 1997 between Registrant and Phoenix Home Life Mutual Insurance Company. *10.3 Registration Rights Agreement dated December 31, 1997 between Registrant and PHL Global Holding Co. *10.4 Co-Sale Agreement dated August 26, 1997 between Registrant, Edward G. Caputo and Phoenix Home Life Mutual Insurance Company. *10.5 Amendment No. 1, dated December 31, 1997 to Co-Sale Agreement between Registrant, Edward G. Caputo and Phoenix Home Life Mutual Insurance Co. *10.6 Co-Sale Agreement dated December 31, 1997 between Registrant, Edward G. Caputo and PHL Global Holding Co. *10.7 Employment Contract dated January 1, 1998 between Registrant and Edward G. Caputo. *10.8 Assumption Agreement dated December 1997 by and between Registrant and People's Bank. *10.9 Loan Agreement by and between Command International Software Pvt. and Deutsche Bank. *10.10 Employment Agreement dated January 1, 1998 between Registrant and Stephen L. Willcox. **10.11 Indemnification Agreement, by and among Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. and Registrant, Phoenix Home Life Mutual Insurance Company, PHL Global Holding Co. and Edward G. Caputo. *10.12 Employment Agreement, dated as of December 1, 1997 by and between Registrant and Glenn M. King. *10.13 Loan/and Security Agreement dated October 29, 1998 by and between Registrant and People's Bank. 10.14 First Amendment to Loan and Security Agreement dated October 29, 1998 by and between Registrant and People's Bank. 10.15 First Amendment to 1997 Employee, Director and Consultant Stock Plan dated January 5, 2000. --------------- *21.1 Subsidiaries of the Company. 23.1 Consent of Ernst & Young, LLP 27.1 Financial Data Schedule. - -------------
* Incorporated by reference from Registration Statement on Form S-1, Registration No. 333- 53877.
** Incorporated by reference from the Registrant's Form 10-Q/A for the three months ended March 31, 1998.
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 29, 2000. ---
COMMAND SYSTEMS, INC.
By: /s/ Edward G. Caputo ------------------------------------ Edward G. Caputo President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ----
/s/ Edward G. Caputo - ---------------------------- Edward G. Caputo President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)
/s/ Stephen L. Willcox - ---------------------------- Stephen L. Willcox Executive Vice President, Chief Financial Officer, Secretary and Director (Principal Financial and Accounting Officer)
/s/ John J.C. Herndon - ---------------------------- John J.C. Herndon Director
/s/ James M. Oates - ---------------------------- James M. Oates Director
/s/ Joseph D. Sargent - ---------------------------- Director Joseph D. Sargent
/s/ Jack Crawford - ---------------------------- Jack Crawford Director
Command Systems, Inc.
List of Financial Statements and Financial Statement Schedule
The report of Ernst & Young LLP, independent auditors, dated February 15, 2000, and the following consolidated financial statements of Command Systems, Inc. are included in Item 8:
Consolidated Balance Sheets - December 31, 1999 and 1998
Consolidated Statements of Operations - Years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity (Deficit) - Years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows - Years ended December 31, 1999, 1998 and 1997
Notes to Consolidated Financial Statements - December 31, 1999
The following consolidated financial statement schedule of Command Systems, Inc. is included in Item 14(a):
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
Report of Independent Auditors
The Board of Directors and Stockholders Command Systems, Inc.
We have audited the accompanying consolidated balance sheets of Command Systems, Inc. as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Command Systems, Inc. at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Hartford, Connecticut February 15, 2000
Command Systems, Inc.
Consolidated Balance Sheets
See accompanying notes.
Command Systems, Inc.
Consolidated Statements of Operations
See accompanying notes.
Command Systems, Inc.
Consolidated Statements of Stockholders' Equity (Deficit)
See accompanying notes.
Command Systems, Inc.
Consolidated Statements of Cash Flows
Command Systems, Inc.
Consolidated Statements of Cash Flows (continued)
See accompanying notes.
Command Systems, Inc.
Notes to Consolidated Financial Statements
December 31, 1999
1. Organization
Command Systems, Inc. (the "Company") is an information technology company which provides a wide range of computer consulting services primarily to large financial services organizations.
Through December 31, 1997, the Company held a 51% interest in Command International Software Pvt. ("CIS"), an India unlimited liability company, with the remaining 49% interest held by Phoenix Home Life Mutual Insurance Co. ("Phoenix"). On December 31, 1997, the Company purchased Phoenix's holdings (see Note 10).
2. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Revenue Recognition and Warranty Costs
Revenue on time-and-materials contracts is recognized as the services are performed. Revenue on fixed-price contracts is recognized using the percentage of completion method based on the labor costs incurred to total estimated labor costs for the contract. Under this method revenue on such contracts is recognized concurrently with cost incurred thereon. The Company bears the risk of cost overruns and inflation with respect to its fixed-price projects. If estimates indicate a probable ultimate loss on a fixed price contract, provision is made at that date for the entire estimated loss. The Company provides for estimated future warranty costs for its year 2000 solutions as services are performed.
Revenues from product sales are recognized upon shipment.
Billings in excess of revenue earned are classified as deferred revenue.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Advertising Costs
Advertising costs are expensed as incurred and are included in selling, general and administrative expense. Advertising costs were $195,000, $300,000 and $141,000 in 1999, 1998 and 1997, respectively.
Income Taxes
The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recorded to reflect the tax consequences of future years differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. A valuation allowance is provided against the future benefit of deferred tax assets if it is determined that it is more likely than not that the future tax benefits associated with the deferred tax asset will not be realized (see Note 9). Prior to August 1997, the Company had elected to be taxed as an S Corporation in accordance with the provisions of the Internal Revenue Code. As an S Corporation, the taxable income of the Company is reportable on the individual stockholder's federal tax return. In conjunction with the formation of the Company as a Delaware holding corporation (see Note 6) and the issuance of its Series A convertible preferred stock, the S Corporation election was terminated and the Company became subject to U.S. federal income taxes in 1997.
Foreign Currency Translation
The financial statements of the Company's foreign subsidiaries which have a functional currency other than the U.S. dollar reflect the translation of assets and liabilities into U.S. dollars at current exchange rates with income and expense accounts being translated at average rates of exchange prevailing during the period. The resulting adjustments are recorded as a separate component of accumulated other comprehensive loss. Foreign currency transaction gains and losses are not material and are included in the determination of net loss when incurred.
Earnings Per Share
In 1997, the Company adopted Financial Accounting Statement (FAS) No. 128, "Earnings Per Share." All per share amounts for all periods have been presented to conform with this Statement.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Pro forma earnings per common share reflect adjustments in the U.S. federal income tax provision assuming the Company had always had C corporation status and the realization of pre-existing net operating losses.
Cash Equivalents
Highly liquid investments purchased with a maturity of three months or less are considered cash equivalents.
Concentration of Credit Risk
The Company markets its services primarily to the financial services industry. The Company performs periodic credit evaluations of a customer's financial condition and generally does not require collateral. Credit losses have been within management's expectations.
Marketable Securities
Marketable securities are classified as available-for-sale and are available to support current operations or to take advantage of other investment opportunities. Unrealized gains and losses, net of tax, are recorded as a separate component of accumulated other comprehensive loss. Realized gains and losses are included in interest expense. The cost of securities sold is based on the specific identification method.
Fair Value of Financial Instruments
The carrying amounts reported in the balance sheet for cash and cash equivalents, accounts receivable, accounts payable, and other accrued liabilities approximate fair value due to the short maturity of these items. The fair value of marketable securities is based on quoted market prices for those or similar investments.
Equipment and Improvements
Equipment and improvements are stated at cost. Depreciation on equipment is calculated on a straight-line basis over the estimated useful lives of the assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the assets.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Goodwill
Goodwill is being amortized using the straight-line method over periods ranging from three to fifteen years.
Impairment of Long-Lived Assets
Long-lived assets, including goodwill, are reviewed for impairment and written down to fair value whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. At December 31, 1999, no such impairment existed. The Company measures the potential impairment of long-lived assets, including goodwill, by the undiscounted value of expected operating cash flow in relation to the assets to which it applies.
Stock-Based Compensation
During 1997, the Company adopted FAS No. 123, "Accounting for Stock-Based Compensation." This statement defines a fair value based method of accounting for employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans in accordance with Accounting Principles Board ( "APB ") Opinion No. 25, "Accounting for Stock Issued to Employees." Under APB No. 25, compensation cost is the excess, if any, of the market price of the stock at the grant date over the amount the employee must pay to acquire the stock. The Company has elected to continue to account for awards granted under the Command Systems, Inc. 1997 Employee, Directors and Consultant Stock Option Plan under APB No. 25.
Reclassifications
Certain reclassifications, including those relating to the adoption of FAS No. 130, "Reporting Comprehensive Income," have been made to the prior year to conform to the current year presentation.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
3. Acquisition
On August 1, 1999, the Company acquired 100% of the outstanding stock of Nova Technology, Inc. (Nova), a privately owned Oracle IT consulting, systems integration and custom software application developer for approximately $454,000. The acquisition has been accounted for as a purchase; accordingly, the excess of the purchase price over the fair value of the net assets acquired has been recorded as goodwill and is being amortized on a straight line basis over three years. The results of operations of Nova are included in the accompanying financial statements from the date of acquisition. This acquisition did not materially affect the financial statements of the Company in 1999 nor would it have materially effected the financial statements of prior periods had the results of its operations been included in them.
Concurrent with the acquisition, the Company entered into employment agreements with the former shareholders of Nova. The agreements, which are for a period of four years, provide for specific salary levels and additional incentive bonuses that are contingent upon the Nova business achieving certain performance criteria; performance based payments are not expected to exceed $250,000 annually.
4. Marketable Securities
The Company invests in only high quality, short-term investments. The Company views its available-for-sale portfolio as available for use in its current operations; therefore, all marketable securities have been classified as current assets. Marketable securities consist of:
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
4. Marketable Securities (continued)
There were no significant differences between cost and fair value at December 31, 1998. Gross realized losses in 1999 were $22,797; there were no gross realized gains or losses in 1998.
The following is a summary of contractual maturities:
Amortized Estimated Cost Fair Value -------------------------
Amounts maturing within one year $ 7,479,634 $ 7,449,224 Amounts maturing after one year, within three years 6,966,989 6,898,604 ------------------------- $14,446,623 $14,347,828 =========================
5. Debt
The Company's revolving line of credit agreement, as amended October 13, 1999, limits borrowings to a maximum of $4,000,000; no amount related thereto is outstanding at December 31, 1999. The agreement expires October 15, 2000 and bears interest at the Bank Rate, as defined, or the London Interbank Offered Rate ("LIBOR") plus 1.75 basis points. Under the terms of the revolving line of credit agreement, the Company is required, among other things, to maintain certain financial ratios and minimum levels of net worth. Borrowings under the line of credit agreement are secured by all the Company's business assets, except for the assets of CIS.
On July 1, 1996, the Company and its wholly-owned subsidiary Command International Holdings ("CIH") entered into a note purchase agreement (the "Agreement") with Phoenix under which the Company could issue up to $3 million aggregate principal amount of its 15% Subordinated Secured Series Notes (the "C Notes"), accrued and capitalized interest on such notes and its Zero Coupon Receivables-Based Subordinated Secured Series Notes (the "Z Notes"). Also, under this Agreement, CIH was authorized to issue up to $3 million aggregate principal amount of its 15% Guaranteed Senior Secured Series Notes (the "M Notes") and accrued capitalized interest on such notes. The payment obligations of the Company in respect to the C Notes and the Z Notes ranked junior and subordinate in right of payment to the senior indebtedness of the Company under the M Notes.
On August 26, 1997, the Company entered into an agreement with Phoenix whereby the Company issued to Phoenix 100 shares of its Series A convertible preferred stock in exchange for the aggregate outstanding indebtedness of $2,186,137 of the C, Z, and M Notes, including accrued capitalized interest of $171,044.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
5. Debt (continued)
In June 1998, CIS entered into a Funded and Non Funded Credit facility. The Funded Facility provides for a maximum of Rs. 7.5 MM ($176,500) based upon monthly export billing and an overdraft facility of Rs. .5MM. The export billing facility is at a base FEDAI rate plus 10% interest; the overdraft facility is at an interest rate of 17.85%. The Non Funded Facility provides for a letter of credit line in the amount of Rs. 3MM and a guarantee letter of credit line in the amount of Rs. 3MM. The letter of credit facility is at a base FEDAI rate plus 15% interest; the guarantee letter of credit facility charge is at the Central Bank of India's internal rate plus 25%. These credit facilities are secured primarily by accounts receivable and a lien on the fixed assets of CIS; no amounts related thereto were outstanding at December 31, 1999.
6. Stockholders' Equity
On July 1, 1997 Command Systems, Inc., a Delaware corporation, was established and exchanged 4,275,000 shares of its common stock for the 100 shares of issued and outstanding common stock of the Company held by its sole stockholder and became the ultimate holding company for the Command group of companies. The Company was authorized to issue 10,650,000 shares of $0.01 par value common stock and 1,000 shares of $0.01 par value preferred stock. This transaction was accounted for at historical cost in a manner similar to a pooling of interests. The number of common shares authorized, issued and outstanding have been restated for all periods to reflect this capitalization. Effective December 31, 1997 the Company was authorized to issue up to 25,000,000 shares of its common stock and 5,000,000 shares of preferred stock. The consolidated financial statements have been adjusted to reflect this change.
The Company made its initial public offering on March 12, 1998, pursuant to an effective registration statement covering 2,400,000 shares of $0.01 par value common stock (of which 300,000 shares were sold by certain shareholders) plus an additional 360,000 shares for an over-allotment option granted to the underwriters. Shortly before the effective date, the size of the offering was increased by 300,000 shares plus an additional 45,000 shares to increase the over-allotment option. The additional 345,000 shares were sold by the Company (100,000 shares) and selling stockholders (245,000 shares). All of these shares were sold at the public offering price of $12.00 per share.
Of the 3,105,000 shares sold in the initial public offering, 2,760,000 shares were properly registered, but the remaining 345,000 shares were not registered. Persons who had purchased unregistered shares in the initial public offering had rescission rights under the Securities Act of 1933. However, the Company has been released from any liability for rescission by terms of the judgement entered by the court on August 11, 1999, in the purported consolidated class action discussed in Note 13.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
6. Stockholders' Equity (continued)
On August 26, 1997, the Company issued 100 shares of its Series A redeemable convertible preferred stock to Phoenix. The Series A redeemable convertible preferred stock had a liquidation preference of $2,186,137 and had a dividend requirement of 10% per annum which accrued on a cumulative basis. Accrued and unpaid dividends amounted to $75,474 at December 31, 1997. These shares were convertible at any time into 522,500 shares of the Company's common stock and were redeemable by Phoenix after July 31, 1999.
On December 31, 1997, the Company issued 100 shares of Series B redeemable convertible preferred stock to Phoenix. The Series B redeemable convertible preferred stock had a liquidation preference of $8,000,000 and had a dividend requirement of 10% per annum which accrued on a cumulative basis. These shares were convertible at any time into 659,250 shares of the Company's common stock.
Simultaneously with the initial public offering, Phoenix exchanged its 200 shares of Series A and B redeemable convertible preferred stock for 1,181,750 shares of common stock. Dividends accrued during the period and previously unamortized offering expenses have been recognized as a reduction to net income for 1998. The Company paid preferred stock dividends in 1998 of $298,000 from the initial public offering proceeds.
The Company has 4,999,800 shares of $.01 par value undesignated preferred stock. The Board of Directors of the Company is authorized to establish, among other things, the rate of dividends payable, redemption rights and voting rights prior to issuance.
7. Stock Options
In March 1997 the Company issued options to purchase 61,500 shares of its common stock, the number of units previously outstanding under the Shadow Stock Incentive Plan (the Shadow Plan), exercisable at a price of $4.00 per share (the fair market value as determined by the Board of Directors of such stock at the date of grant) to certain persons who, upon such issuance, relinquished their rights under the Company's Shadow Plan.
In August 1997, the Company created the Command Systems, Inc. 1997 Employee, Director and Consultant Stock Option Plan (the "Plan"). The Company reserved 427,500 shares of its common stock for issuance under the Plan. Options granted under the Plan generally have a five year term and generally vest in increments of 20% on the anniversary of the date of grant.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
7. Stock Options (continued)
Options outstanding at December 31, 1999 had exercise prices as follows: 255,000 options at $1.75, 9,350 options at $2.81, 56,500 options at $4.00, 85,275 options at $9.00, and 17,500 options at $12.00. The weighted average remaining contractual life of these options is 4 years.
If compensation costs for the Company's stock-based compensation plans had been determined based on the fair value at the grant dates for 1999, 1998 and 1997 consistent with the method prescribed by FAS No. 123, the Company's net loss applicable to common stockholders and loss per share would have been adjusted to the pro forma amounts indicated below:
1999 1998 1997 --------------------------------------- Net loss applicable to common stockholders As reported $(2,936,036) $(2,027,560) $(577,044) Pro forma (3,048,954) (2,185,807) (605,444) Basic and diluted loss per share As reported $(0.38) $(0.29) $(0.13) Pro forma $(0.40) $(0.31) $(0.13)
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
7. Stock Options (continued)
The fair value of each stock option grant was estimated using a Black-Scholes option valuation model with the following weighted-average assumptions:
1999 1998 1997 ------------------------
Risk free interest rate 6% 6% 6% Expected volatility 81.5% 68.5% 40.4% Expected option life 5 5 5 Dividend yield 0% 0% 0%
The risk-free interest rate is based on short-term treasury bill rates. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
8. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:
1999 1998 1997 --------------------------------------- Numerator: Net loss $(2,936,036) $(1,767,257) $ (496,693) Preferred stock dividends and accretion (260,303) (80,351) --------------------------------------- Numerator for basic and diluted loss per share-loss applicable to common stockholders (2,936,036) (2,027,560) (577,044)
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
8. Earnings Per Share (continued)
1999 1998 1997 ----------------------------------------- Denominator: Weighted-average shares outstanding for basic and diluted loss per share 7,656,750 7,017,937 4,275,000 ----------------------------------------- Basic and diluted loss per share applicable to common stockholders $ (0.38) $ (0.29) $ (0.13) =========================================
Options to purchase 423,625, 214,400 and 150,550 shares of the Company's common stock in 1999, 1998 and 1997, respectively, and 223,233 and 1,181,750 shares of the Company's common stock issuable upon the conversion of the Series A and B redeemable convertible preferred stock in 1998 and 1997, respectively, were not included in the computation of diluted earnings per share because the effect of their inclusion would be antidilutive.
9. Income Taxes
Components of the income tax (provision) benefit for income taxes follow:
Year ended December 31 1999 1998 1997 -----------------------------------
Current: Federal $ 66,440 $(334,871) State $ (51,500) (78,814) (5,012) Foreign (14,253) ----------------------------------- Total current (65,753) (12,374) (339,883)
Deferred: Federal 305,991 (293,078) State 23,972 35,210 Foreign ----------------------------------- Total deferred 329,963 (257,868) ----------------------------------- Total (provision) benefit $ (65,753) $ 317,589 $(597,751) ===================================
With the issuance of the Series A redeemable convertible preferred stock in 1997, the Company's ability to be taxed as an S Corporation automatically terminated and the ability to report on the cash basis of accounting ceased. The Company recognized additional taxable income in 1997 as a result and incurred a liability of approximately $693,000 in 1997.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
9. Income Taxes (continued)
The effective income tax rate differed from the federal statutory rate for the following reasons:
Year ended December 31 1999 1998 1997 -----------------------------
Federal statutory rate 34.0% 34.0% 34.0% State income taxes, net of federal benefit 2.2 3.6 (5.5) No federal income tax benefit (provision) for S Corporation period income (loss) 15.9 Tax effect of conversion from S Corporation to C Corporation, related primarily to accounting method change 125.5 Foreign profits and (losses) not subject to tax (8.2) 15.4 (56.7) Goodwill (5.3) (7.4) Other (1.7) (2.2) Valuation allowance (23.2) (28.2) (5.0) ----------------------------- Effective income tax rate (2.2)% 15.2% 108.2% =============================
Significant components of the Company's deferred income tax assets and (liabilities) are as follows:
December 31 1999 1998 --------------------------- Deferred tax assets: Federal and state net operating loss carryforwards $1,095,952 $ 42,510 Allowance for doubtful accounts 199,073 41,231 Shareholder litigation accrual 680,701 Accrued warranty, legal and other 271,297 276,847 Accrued wages 33,881 Unrealized gains 34,806 --------------------------- 1,635,009 1,041,289
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
9. Income Taxes (continued)
December 31 1999 1998 --------------------------- Deferred tax liabilities: Tax effect of conversion from S Corporation to C Corporation, related primarily to accounting method change $ (212,552) $ (444,745) Equipment and improvements (19,274) (9,365) Cash to accrual conversions (134,174) --------------------------- (366,000) (454,110) --------------------------- Net deferred income tax asset 1,269,009 587,179
Less valuation allowance 1,269,009 587,179 =========================== Net deferred income tax asset (liability) $ -- $ -- ===========================
The Company has net operating loss ("NOL") carryforwards for federal and state tax purposes of approximately $2,700,000 and $2,800,000 respectively at December 31, 1999 and $618,000 for state tax purposes at December 31, 1998 which expire through 2019. The valuation allowance increased by $681,830 during 1999.
Under Indian tax laws CIS's export income is fully exempt from income tax. The exemption is available for a period of 10 years from the year in which it commenced business (exemption period March 31, 1997 through March 31, 2006). The foreign income tax provision in 1999 relates to income from sources other than export of software (e.g. interest income, rental income). CIH is also eligible for certain tax exemptions under the laws of Mauritius. As a result of such exemptions, no deferred tax asset or liability is recognized. During 1999, 1998 and 1997, (loss) income of the Company's foreign subsidiaries before minority interest which is exempt from income taxes was $(708,930), $943,104 and $921,287, respectively.
Undistributed foreign earnings of approximately $704,000 at December 31, 1999 are considered to be indefinitely reinvested. Accordingly, no provision for U.S. federal and state income taxes has been provided thereon, nor is it practicable to determine the amount. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
10. Related Party Transactions
During 1996, the Company entered into an agreement with Phoenix to establish a joint venture in India which would provide software services on a subcontracting basis to the Company. Under the terms of the agreement, the Company owned a 51 percent interest. Phoenix invested $391,098 in this venture during 1997.
On December 31, 1997, Phoenix exchanged its 49% interest for 100 shares of the Company's Series B redeemable convertible preferred stock valued at $8,000,000. The Company recorded this as a purchase and recognized the excess of the purchase price over the fair value of the assets acquired and liabilities assumed of $6,845,338 as goodwill.
The Company provides various information technology services to Phoenix; revenues related thereto were $1,690,000, $2,165,000 and $2,600,000 for 1999, 1998 and 1997, respectively. At December 31, 1999 and 1998, receivables from Phoenix approximated $199,000 and $263,000, respectively.
11. Leases
The Company has non-cancelable long-term operating leases for various office facilities and equipment.
Rent expense under operating leases was $795,887, $618,425 and $543,700 in 1999, 1998 and 1997, respectively.
Future minimum lease payments at December 31, 1999 for these non-cancelable operating leases, net of minimum rentals to be received under noncancelable subleases of $233,072, $240,060 and $189,298 in 2000, 2001 and 2002, respectively, follow:
2000 $ 577,800 2001 544,900 2002 445,000 2003 83,000 ----------- $1,650,700 ===========
The Company is required to maintain security deposits for office space rented in Bangalore, India; amounts related thereto were $403,402 and $408,235 at December 31, 1999 and 1998, respectively.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
12. Reportable Segments
The Company operates in one industry segment - providing a wide range of computer consulting services to large financial services organizations primarily in North America. The Company operates in two geographic areas; the United States and India. The accounting policies of each geographic area are substantially the same as those described in Note 2.
United States India Elimination Consolidated ----------------------------------------------------- Revenue $27,049,120 $1,064,274 $ (921,116) $27,192,278 Operating (loss) (3,025,487) (948,874) (3,974,361) Identifiable assets 27,698,022 2,770,521 30,468,543
Revenue $35,214,586 $3,942,217 $(3,942,217) $35,214,586 Operating (loss) income (3,863,899) 825,286 (3,038,613) Identifiable assets 31,004,269 4,643,422 35,647,691
Revenue $25,057,039 $2,870,150 $(2,870,150) $25,057,039 Operating (loss) income (99,974) 929,209 829,235 Identifiable assets 12,173,801 2,251,286 14,425,087
For the year ended December 31, 1999, two customers accounted for approximately 16% and 12% of revenue. For the year ended December 31, 1998, two customers accounted for approximately 15% and 10% of revenue. For the year ended December 31, 1997, three customers accounted for approximately 13%, 13% and 10% of revenue.
The following table sets forth the revenue percentages by line of business:
Year ended December 31 1999 1998 1997 ---------------------------------
Staff augmentation 68% 57% 59% Year 2000 14% 27% 21% Software and hardware 2% 10% 12% Projects 15% Other 1% 6% 8% --------------------------------- Total 100% 100% 100% =================================
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
13. Legal Proceedings
On or about May 6, 1998, plaintiffs Don M. Doney, Jr. and Madelyn J. McCabe filed a lawsuit in the United States District Court for the Southern District of New York. The lawsuit was filed against the Company, certain of its officers and directors (Edward G. Caputo, Stephen L. Willcox, Robert B. Dixon, John J.C. Herndon, James M. Oates and Joseph D. Sargent) and the managing underwriters of the initial public offering (Cowen & Company and Volpe Brown Whelan & Company LLC). On or about June 22, 1998, the same plaintiffs amended their complaint in the lawsuit they had filed with the United States District Court for the Southern District of New York. On or about May 8, 1998, another plaintiff, Chaile B. Steinberg, filed a new lawsuit against the same defendants in the same court. On or about June 26, 1998, named plaintiff Michael Makinen, filed a lawsuit in the same court against the same defendants. Each of the plaintiffs purported to represent a class consisting of purchasers of common stock pursuant to the initial public offering. These lawsuits were consolidated into one lawsuit by order of the United States District Court for the Southern District of New York. Consequently, the plaintiffs filed a consolidated complaint named In Re Command Systems, Inc. Securities Litigation on September 30, 1998, seeking to represent a class of purchasers of common stock from March 12, 1998, the date of the initial public offering, through April 29, 1998. The consolidated complaint alleged that the defendants violated the Securities Act of 1933 in that the Company failed to properly register 345,000 shares of common stock that were sold in the initial public offering, and consequently the defendants sold unregistered securities to the public, and the prospectus for the initial public offering contained untrue statements of material fact and omitted to state other facts necessary to make the statements made in the prospectus not misleading with respect to the unregistered shares, the Company's business strategy and other matters.
The plaintiffs sought rescission of the sales of the shares in the initial public offering and unspecified damages, including rescissionary damages, interest, costs and fees. On May 20, 1999, a definitive settlement agreement (the "Stipulation of Settlement" or "Stipulation") was executed by the parties via their counsel. Pursuant to the terms of the Stipulation, the parties agreed to a total payment from the Company to the plaintiffs of $5.75 million in cash plus accrued interest, minus approved attorneys' fees and related expenses. The $5.75 million accumulated interest as of June 11, 1999, the date of the preliminary court approval of the Stipulation of Settlement. The court entered a judgment approving this settlement on August 11, 1999, which became final and no longer subject to appeal on September 10, 1999. On September 10, 1999 the settlement fund was also established. The Company may also be responsible for certain legal fees and related expenses incurred in connection with the litigation. The Company recognized a charge to operations of $1.8 million in the fourth quarter of 1998 for costs of the settlement and related expenses.
Command Systems, Inc.
Notes to Consolidated Financial Statements (continued)
13. Legal Proceedings (continued)
Of the $5.75 million deposited in the settlement fund established September 10, 1999 by the Company, the Company has been reimbursed for all but $1.65 million. This reimbursement came in part from the Company's insurance carrier and the rest pursuant to the indemnification agreement with the Company's former counsel in the initial public offering.
In the settlement, the members of the class represented by plaintiffs gave up their right to assert individual claims against the Company or its underwriters, based on their purchase of the Company's common stock in the initial public offering and in the open market during the period from March 12, 1998 through April 29, 1998. In return for this concession, class members became entitled to share pro rata in the $5.75 million cash settlement fund, plus interest, minus approved attorneys' fees and related expenses. No class member chose not to participate in, or to "opt-out" of, the settlement.
14. Risks and Uncertainties of Doing Business
Many of the Company's engagements involve projects that are critical to the operations of its customers' businesses and provide benefits that may be difficult to quantify. Any failure in a customer's system could result in a claim for substantial damages against the Company, regardless of the Company's responsibility for such failure. Although the Company attempts to limit contractually its liability for damages arising from errors, mistakes or omissions in rendering its information technology services, there can be no assurance that the limitations of liability set forth in its services contracts will be enforceable in all instances or would otherwise protect the Company from liability for damages. Although the Company maintains general liability insurance coverage, including coverage for errors or omissions in the amount of $5.0 million, there can be no assurance that such coverage will continue to be available on reasonable terms or will be available in sufficient amounts to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. The successful assertion of one or more large claims against the Company that exceed available insurance coverage, or changes in the Company's insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could adversely affect the Company's business, financial condition and results of operations.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS COMMAND SYSTEMS, INC.
Years Ended December 31, 1999, 1998 and 1997