Innovaro, Inc. 10-Q

ITEM 1. Financial Statements Innovaro, Inc. Consolidated Balance Sheets March 31, 2011 (Unaudited) December 31, 2010 ASSETS Current assets: Cash and cash equivalents $ 635,254 $ 262,619 Accounts receivable, net 1,722,780 1,796,454 Contracts in process 335,023 214,734 Available-for-sale securities 121,443 171,139 Prepaid expenses and other assets 693,848 791,432 Total current assets 3,508,348 3,236,378 Cost method investments 95,589 95,589 Equity method investments 303,454 303,454 Note receivable and accrued interest 1,700,000 1,700,000 Fixed assets, net 6,686,126 6,736,567 Goodwill 6,455,152 6,407,640 Intangible assets, net 5,909,262 6,174,792 Total assets $ 24,657,931 $ 24,654,420 LIABILITIES Current liabilities: Accounts payable $ 1,014,658 $ 1,078,088 Accrued expenses 658,688 420,707 Deferred revenue 1,100,781 987,624 Current maturities of long-term debt 198,325 433,964 Total current liabilities 2,972,452 2,920,383 Long-term debt, less current maturities 5,334,757 5,358,173 Derivative liabilities 2,934,013 1,140,005 Deferred tax liability 1,209,554 1,220,687 Total liabilities 12,450,776 10,639,248 EQUITY Innovaro stockholders’ equity: Preferred stock, $.01 par value, 1,000,000 shares authorized; none issued and outstanding Common stock, $.01 par value, 29,000,000 shares authorized; 14,756,950 and 14,631,950 shares issued; 14,585,261 and 14,585,261 shares outstanding at March 31, 2011 and December 31, 2010, respectively 145,853 145,853 Additional paid-in capital 85,107,282 85,024,704 Accumulated deficit (73,724,599 ) (71,829,344 ) Accumulated other comprehensive income (loss) 155,009 147,922 Total Innovaro stockholders’ equity 11,683,545 13,489,135 Noncontrolling interest 523,610 526,037 Total equity 12,207,155 14,015,172 Total liabilities and equity $ 24,657,931 $ 24,654,420 See accompanying notes 1 Innovaro, Inc. Consolidated Statements of Operations (Unaudited) Three Months Ended March 31, 2011 2010 Revenue: Strategic services $ 3,027,861 $ 1,430,042 Technology services 574,868 840,389 3,602,729 2,270,431 Expenses: Direct costs of revenue – Strategic services 1,681,562 1,004,424 Direct costs of revenue – Technology services 333,242 443,948 Salaries and wages 324,508 679,526 Professional fees 88,279 201,289 Research and development 303,577 199,159 Sales and marketing 61,235 246,296 General and administrative 504,686 595,250 Depreciation and amortization 341,088 400,495 3,638,177 3,770,387 Other (income) and expense: Other (income) expense 1,728,645 (2,074 ) Interest expense, net 141,587 135,154 1,870,232 133,080 Loss before income taxes (1,905,680 ) (1,633,036 ) Provision for income tax benefit (7,998 ) (55,711 ) Net loss from operations (1,897,682 ) (1,577,325 ) Net loss attributable to the noncontrolling interest (2,427 ) (927 ) Net loss attributable to Innovaro stockholders $ (1,895,255 ) $ (1,576,398 ) Net loss attributable to Innovaro stockholders per share: Basic and diluted $ (0.13 ) $ (0.13 ) Weighted average shares outstanding: Basic and diluted 15,022,761 11,797,140 See accompanying notes 2 Innovaro, Inc. Consolidated Statement of Changes in Equity (Unaudited) Innovaro Stockholders' Equity Common Stock Accumulated Other Non Shares Issued Shares Outstanding Par Value Paid-In Capital Comprehensive Income (Loss) Accumulated Deficit Comprehensive Income (Loss) controlling Interest Totals Balances at December 31, 2010 14,631,950 14,585,261 $ 145,853 $ 85,024,704 $ (71,829,344 ) $ 147,922 $ 526,037 $ 14,015,172 Comprehensive loss: - Net loss - - - - $ (1,895,255 ) (1,895,255 ) - (2,427 ) (1,897,682 ) Other comprehensive income (loss): Unrealized gain (loss) from available-for-sale securities - - - - (49,496 ) - - - - Foreign currency translation adjustments - - - - 56,583 - - - - Other comprehensive income (loss) - - - - 7,087 - 7,087 - 7,087 Comprehensive loss $ (1,888,168 ) Issuance of restricted stock 125,000 - - - - - - - Stock-based compensation expense - - - 82,578 - - - 82,578 Balances at March 31, 2011 14,756,950 14,585,261 $ 145,853 $ 85,107,282 $ (73,724,599 ) $ 155,009 $ 523,610 $ 12,207,155 See accompanying notes 3 Innovaro, Inc. Consolidated Statements of Cash Flows (Unaudited) Three Months Ended March 31, 2011 2010 Operating Activities: Net loss attributable to Innovaro stockholders $ (1,895,255 ) $ (1,576,398 ) Adjustments to reconcile net loss attributable to Innovaro stockholders to net cash flows from operating activities: Net loss attributable to noncontrolling interest (2,427 ) (927 ) Depreciation and amortization 341,088 400,495 Amortization of debt discount from investor warrants 32,582 45,614 Loss on sale and impairment of available-for-sale securities 201 134,557 Loss (gain) on derivative liabilities 1,794,008 (54,309 ) Stock-based compensation 82,578 147,745 Deferred income taxes (7,998 ) (55,711 ) Other 7,512 7,511 Changes in operating assets and liabilities: Accounts receivable (45,140 ) 152,330 Prepaid expenses and other assets 97,584 (34,824 ) Deferred revenue 113,157 (69,906 ) Accounts payable and accrued expenses 174,551 61,652 Net cash flows from operating activities 692,441 (842,171 ) Investing Activities: Capital expenditures (22,758 ) (29,729 ) Proceeds from sale of available-for-sale securities - 35,074 Net cash flows from investing activities (22,758 ) 5,345 Financing Activities: Payments on long-term debt (291,637 ) (101,015 ) Net cash flows from financing activities (291,637 ) (101,015 ) Effect of foreign exchange rates (5,411 ) (1,986 ) Increase (decrease) in cash and cash equivalents 372,635 (939,827 ) Cash and cash equivalents at beginning of period 262,619 2,118,970 Cash and cash equivalents at end of period $ 635,254 $ 1,179,143 See accompanying notes 4 Innovaro, Inc. Consolidated Statements of Cash Flows (continued) (Unaudited) Three Months Ended March 31, 2011 2010 Supplemental Disclosures of Non-Cash Investing and Financing Activities Unrealized gain (loss) from available-for-sale securities $ (49,496 ) $ 79,831 The Company transferred certain equity interests in a subsidiary to satisfy a severance obligation resulting in the following: Noncontrolling interest $ 532,132 Increase to additional paid-in capital 17,868 $ 550,000 Supplemental Disclosures of Cash Flow Information Cash paid for taxes $ - $ - Cash paid for interest $ 125,053 $ 84,690 See accompanying notes 5 INNOVARO, INC. Notes to Consolidated Financial Statements (Unaudited) 1. Basis of Presentation and Significant Accounting Policies Interim Financial Information The financial information for Innovaro, Inc. (the “Company”, “we”, “us” or “Innovaro”) as of March 31, 2011 and 2010 and for the three month periods then ended is unaudited, but includes all adjustments (consisting only of normal recurring accruals), which, in the opinion of management are necessary in order to make the consolidated financial statements not misleading at such dates and for those periods. These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and, therefore, do not include all information and notes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete consolidated financial statements. These consolidated financial statements should be read in conjunction with the consolidated audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 . Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the entire year. Organization We commenced operations in 1997 and were originally incorporated under the laws of the State of Florida, and subsequently under the laws of the State of Delaware in July 1999. The Company The Company provides services that help clients become stronger innovators, develop compelling strategies to drive and catalyze growth, rapidly source externally developed technologies, create value from their intellectual property (“IP”) and gain foresight into marketplace and technology developments that affect their business. These services are provided internationally from our offices in the United States and the United Kingdom. Principles of Consolidation The consolidated financial statements include the accounts of Innovaro and its wholly owned subsidiaries: Innovaro Europe, Ltd. (formerly UTEK Europe, Ltd.) and UTEK Real Estate Holdings, Inc. and its subsidiaries: Ybor City Group, Inc., 22nd Street of Ybor City, Inc., ABM of Tampa Bay, Inc., and Cortez 114, LLC (collectively “UTEK Real Estate”). All intercompany transactions and balances are eliminated in consolidation. Accounts Receivable The Company provides an allowance for losses on trade receivables based on a review of the current status of existing receivables and management’s evaluation of periodic aging of accounts. The Company charges off accounts receivable against the allowance for losses when an account is deemed to be uncollectible. The Company determines the allowance based on historical bad debt experience, current receivables aging, expected future write-offs, as well as an assessment of specific identifiable customer accounts considered at risk or uncollectible. It is not the Company’s policy to accrue interest on past due receivables. The expense associated with the allowance for doubtful accounts is recognized as general and administrative expense in the consolidated statements of operations . The provision for doubtful accounts and notes was approximately $12,000 and $15,000 as of March 31, 2011 and December 31, 2010, respectively. Cost Method Investments Cost method investments were not evaluated for impairment as of March 31, 2011. The Company does not estimate the fair value of a cost method investment if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value because it is not practicable to estimate fair value on a quarterly basis. 6 Reclassifications Certain reclassifications have been made to the 2010 balances to conform to the 2011 financial statement presentation. In particular, reclassifications were made to the revenue line items on the consolidated statement of operations to conform to the Company’s new business segments. In addition, reclassifications were made to the expense line items on the consolidated statement of operations to move the direct costs associated with these business lines into two separately captioned line items: direct costs of revenue – strategic services and direct costs of revenue – technology services. In addition, reclassifications were made to the equity section of the December 31, 2010 consolidated balance sheet and the consolidated statement of changes in equity to conform to the March 31, 2011 presentation. Reclassifications were made to combine the total accumulated loss under investment company accounting of $(52,073,915) with the accumulated deficit under operating company accounting of $(19,755,429) into one accumulated deficit line item with a balance of $(71,829,344) as of December 31, 2010. Earnings per Share (EPS) Basic earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding plus the potential dilutive effect of outstanding stock options, warrants and unvested shares of restricted stock. Components of basic and diluted per share data are as follows: Three Months Ended March 31 2011 2010 Weighted average outstanding shares of common stock (1) 15,022,761 11,797,140 Dilutive effect of stock options, warrants and unvested shares of restricted stock - - Common stock and common stock equivalents 15,022,761 11,797,140 Shares excluded from calculation of diluted EPS (2) 2,942,023 1,647,900 __________ (1) Included in basic earnings per share are 437,500 fully vested common stock warrants at $0.01 per share. (2) These shares attributable to outstanding stock options, warrants and unvested restricted stock were excluded from the calculation of diluted EPS because their inclusion would have been anti-dilutive, primarily as a result of the net loss during the periods presented. Financial Instruments and Concentrations of Credit Risk The Company’s financial instruments consist of investments, cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, long-term debt and derivative liabilities. The fair value of accounts receivable, accounts payable and certain accrued expenses approximate their carrying amounts in the financial statements due to the short-term nature of such instruments. The estimated fair value of the Company’s long-term debt at March 31, 2011 and December 31, 2010 is not materially different from its carrying values of $5.5 million and $5.8 million, respectively. The fair value of available-for-sale securities and derivative liabilities are determined as described in Note 5. Financial instruments with significant credit risk include investments and cash and cash equivalents. The Company maintains its cash and cash equivalents with high credit quality financial institutions in the United States and, at times, balances may exceed federally insured limits. The Company has not experienced any losses related to these balances. The Company had two major customers during the three months ended March 31, 2011 and two major customers during the three months ended March 31, 2010, all of which were customers of the strategic services line of business. Major customers, those generating greater than 10% of total revenue, accounted for approximately 54% and 29% of the Company’s revenue during the three months ended March 31, 2011 and 2010, respectively. In addition, three customers accounted for approximately 44% of accounts receivable at March 31, 2011. 7 Use of Estimates The preparation of the Company’s consolidated financial statements in conformity with Financial Accounting Standards Board “FASB” Accounting Standards Codification “ASC” Topic 275 Risks and Uncertainties requires management to make estimates and assumptions that could affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The Company’s most significant estimates relate to revenue recognition, the valuation and impairment of certain investments, stock-based compensation, the valuation and impairment of goodwill and intangible assets, and the derivative liabilities. Actual results could differ from those estimates. 2. Accounts Receivable Accounts receivable consist of the following as of March 31, 2011 and December 31, 2010: March 31, 2011 December 31, 2010 Trade accounts receivable $ 1,298,807 $ 1,408,047 Less: allowance for doubtful accounts (12,403 ) (14,926 ) Unbilled receivables 99,001 - Unbilled client costs 337,375 403,333 Total accounts receivable $ 1,722,780 $ 1,796,454 3. Contracts in Process Contracts in process consist of the following as of March 31, 2011 and December 31, 2010: March 31, 2011 December 31, 2010 Contract costs and estimated profits on contracts in process $ 2,391,145 $ 3,712,143 Less advances and progress payments 2,056,122 3,497,409 Total contracts in process $ 335,023 $ 214,734 4. Available-for-Sale Securities The Company classifies its investments in freely tradable equity securities as available-for-sale in accordance with FASB ASC Topic 320 Investments – Debt and Equity Securities and its intentions regarding these instruments. A summary of the estimated fair value of available-for-sale securities is as follows as of March 31, 2011 and December 31, 2010. Unrealized (1) Realized Cost Gains Losses Losses Fair Value As of March 31, 2011 $ 42,100 $ 79,544 $ - $ (201 ) $ 121,443 As of December 31, 2010 $ 225,400 $ 129,132 $ (93 ) $ (183,300 ) $ 171,139 (1) The net unrealized gain (loss) is included in equity as a component of accumulated other comprehensive income (loss) in the consolidated balance sheets. Proceeds from the sale of available-for-sale securities were approximately $0 and $35,000 for the three months ended March 31, 2011 and 2010, respectively. As of March 31, 2011, none of our five available-for-sale securities were in an unrealized loss position. Gross realized gain (loss) as a result of the sale of available-for-sale securities was approximately $(200) and $11,000 for the three months ended March 31, 2011 and 2010, respectively. In addition, the Company recognized an impairment loss to available-for-sale securities of approximately $146,000 for the three months ended March 31, 2010. The realized gain (loss) related to available-for-sale securities is included as a component of other (income) expense in the consolidated statements of operations. 8 Unrealized gain (loss) on available-for-sale securities for the three months ended March 31, 2011 is shown in the accompanying statement of changes in equity net of the reclassification adjustment. Disclosure of the gross amounts of the current period gain (loss) and amounts that were reclassified out of accumulated other comprehensive income (loss) into earnings are as follows: Three Months Ended March 31, 2011 Unrealized holding gain (loss) arising during the period $ (49,588 ) Add back: reclassification adjustment for net gains included in net income 92 Unrealized gain (loss) from available-for-sale securities, net $ (49,496 ) 5. Fair Value Measurements The Company performs fair value measurements in accordance with the guidance provided by FASB ASC Topic 820 Fair Value Measurements and Disclosures . Topic 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, management considers the principal or most advantageous market in which the Company would transact and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. Topic 820 establishes a fair value hierarchy that encourages and is based on the use of observable inputs, but allows for unobservable inputs when observable inputs do not exist. When there are multiple inputs for determining the fair value of an investment, the Company classifies the investment in the fair value hierarchy based on the lowest level input that is significant to the fair value measurement. Inputs are classified into one of three categories: · Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities. · Level 2—Quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability. · Level 3—Unobservable inputs for the asset or liability. Assets measured at fair value on a recurring basis by level within the fair value hierarchy as of March 31, 2011 and December 31, 2010 are as follows: Fair Value Measurements at March 31, 2011 Using Fair Value Measurements at December 31, 2010 Using Level 2 Total Level 2 Total Assets: Available-for-sale securities $ 121,443 $ 121,443 $ 171,139 $ 171,139 Total assets $ 121,443 $ 121,443 $ 171,139 $ 171,139 Liabilities: Derivative liabilities $ (2,934,013 ) $ (2,934,013 ) $ (1,140,005 ) $ (1,140,005 ) Total liabilities $ (2,934,013 ) $ (2,934,013 ) $ (1,140,005 ) $ (1,140,005 ) The Company’s investments in available-for-sale securities are classified within Level 2 of the fair value hierarchy. Our equity interests in companies for which there is no liquid public market are valued using quoted market prices for identical or similar instruments in markets that are not active. The determined values are generally discounted to account for the illiquid nature of the investment and minority ownership positions. The value of our equity interests in public companies for which market quotations are readily available is based on quoted market prices for similar instruments in an active market. These securities are generally thinly traded and/or carry discounts from the public market value for certain restrictions on resale. The Company utilizes the market approach in determining the fair value of these securities. The Company’s derivative liabilities are classified within Level 2 of the fair value hierarchy. The Company utilizes the Black-Scholes Option Pricing Model to value the derivative liabilities utilizing observable inputs such as the Company’s common stock price, the exercise price of the warrants, and expected volatility, which is based on historical volatility. The Black-Scholes model employs the market approach in determining fair value. 9 6. Derivative Liabilities In accordance with FASB ASC Topic 815 Derivatives and Hedging , the Company has recorded two derivative liabilities for certain stock warrants with variable exercise prices. Derivative liabilities are recorded at fair value at inception and then are adjusted to reflect fair value at the end of each reporting period, with any increase or decrease in the fair value being recorded as a component of other (income) expense in the consolidated statements of operations. The Company recognized a gain (loss) related to these derivatives of approximately $(1,794,000) and $54,000 for the three months ended March 31, 2011 and 2010, respectively. The Company uses the Black-Scholes option pricing model to estimate the fair value of the derivative instrument, for which we employed the following assumptions at March 31, 2011 and December 31, 2010: March 31, 2011 December 31, 2010 Expected dividend yield 0% 0% Expected volatility 52-55% 53-54% Risk-free interest rate 1.29 - 2.24% 2.01% Expected life of options 3.5 - 4.8 years 3.8 - 5.0 years Fair value $1.16 - $2.77 $0.35 - $ 1.42 7. Accumulated Other Comprehensive Income (Loss) Components comprising the accumulated other comprehensive income (loss) balance for the three months ended March 31, 2011 are as follows: Unrealized gain (loss) from available- for- sale securities Foreign currency translation adjustment Accumulated other comprehensive income (loss) Balance at December 31, 2010 $ 129,040 $ 18,882 $ 147,922 Gain (loss) for the period (49,496 ) 56,583 7,087 Balance at March 31, 2011 $ 79,544 $ 75,465 $ 155,009 8. Other (Income) Expense Components comprising the balance in other (income) expense for the three months ended March 31, 2011 and 2010 are as follows: Three Months Ended Mar 31, 2011 Mar 31, 2010 Loss on sale and impairment of investments $ 201 $ 134,557 Loss (gain) on derivative liabilities 1,794,008 (54,309 ) Rental income (70,686 ) (61,351 ) Other 5,122 (20,971 ) Other (income) expense $ 1,728,645 $ (2,074 ) 10 9. Segment Reporting FASB ASC Topic 280 Segment Reporting establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company is organized geographically and by line of business. The line of business management structure is the primary basis for which the allocation of resources and financial results are assessed. A summary of revenue and other financial information by reportable geographic operating segment is shown below: United Kingdom United States Total Long-lived assets March 31, 2011 $ 1,743,743 $ 17,306,797 $ 19,050,540 Total assets March 31, 2011 1,871,784 22,786,147 24,657,931 Long-lived assets December 31, 2010 1,711,729 17,607,270 19,318,999 Total assets December 31, 2010 1,796,827 22,857,593 24,654,420 For the Three Months Ended March 31, 2011 United Kingdom United States Total Revenue $ 132,009 $ 3,470,720 $ 3,602,729 Loss before income taxes (51,356 ) (1,854,324 ) (1,905,680 ) Depreciation and amortization 28,872 312,216 341,088 For the Three Months Ended March 31, 2010 United Kingdom United States Total Revenue $ 239,874 $ 2,030,557 $ 2,270,431 Loss before income taxes (232,304 ) (1,400,732 ) (1,633,036 ) Depreciation and amortization 107,590 292,905 400,495 From time to time, the Company will reorganize its internal organizational structure to better align its service offerings. In 2010, we reorganized into two new lines of business: Strategic Services and Technology Services. As a result, business segment information for the three months ended March 31, 2010 has been restated to reflect the new business segments. A summary of revenue and other financial information by reportable line of business segment is shown below: For the Three Months Ended March 31, 2011 Strategic Services Technology Services Administrative and Other Total Revenue $ 3,027,861 $ 574,868 $ - $ 3,602,729 Income (loss) before income taxes 1,202,674 (3,022 ) (3,105,332 ) (1,905,680 ) For the Three Months Ended March 31, 2010 Strategic Services Technology Services Administrative and Other Total Revenue $ 1,430,042 $ 840,389 $ - $ 2,270,431 Income (loss) before income taxes 294,995 (63,812 ) (1,864,219 ) (1,633,036 ) 11 10. Subsequent Events Appointment of Chief Executive Officer Effective April 17, 2011, the Company’s Board of Directors appointed Mr. Asa Lanum as the Company’s permanent Chief Executive Officer and a member of the Board of Directors. Mr. Lanum has served as the Interim Chief Executive Officer since August 2010. The Company agreed to pay Mr. Lanum an annual base salary of $325,000 and awarded him options to purchase 250,000 shares of the Company’s common stock. The Company has also agreed to pay his moving expenses to the Tampa area. Departure of Managing Director Effective April 22, 2011, Peter C. Skarzynski resigned from his position as Managing Director of the strategic services division. In accordance with the terms of his employment agreement, Mr. Skarzynski remains bound by a covenant regarding the protection of our confidential information and a one-year covenant not to solicit our clients or employees. Mr. Skarzynski continues to act as a consultant to the Company. The Company has appointed Mr. Gary Getz as Managing Director of the strategic services division. Mr. Getz has held a management position at Innovaro since its acquisition of Strategos in 2008, and held a management position at Strategos since the company’s founding. Warrant Exercise Effective April 6, 2011, 437,500 of the Company’s $0.01 fully vested common stock warrants were exercised in a cashless exercise. The derivative liability related to the warrants was adjusted to fair value on that date of approximately $1.3 million and then reclassified from derivative liabilities into additional paid-in capital. 12