UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 000-29239
INFORTE CORP.
(Exact name of registrant as specified in its charter)
Delaware 36-3909334
(State of incorporation) (IRS Employer Identification No.)
150 North Michigan Avenue, Suite 3400, Chicago, Illinois 60601
(Address of principal executive offices, including ZIP code)
(312) 540-0900
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
The number of shares outstanding of the Registrant's Common Stock as of
September 30, 2005 was 11,892,039.
INFORTE CORP.
INDEX
Page No.
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PART I. Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - September 30, 2004,
December 31, 2004, March 31, 2005, June 30, 2005,
September 30, 2005 1
Consolidated Statements of Operations - Three and Nine
Months Ended September 30, 2004 and 2005 2
Consolidated Statements of Cash Flows - Three and Nine
Months Ended September 30, 2004 and 2005 3
Notes to Consolidated Financial Statements 4-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-24
Item 3. Qualitative and Quantitative Disclosure about Market Risk 24
Item 4. Controls and Procedures 25
PART II. Other Information
Item 1. Legal Proceedings 25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 26
Item 3. Defaults of Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits 27
Signature 28
Exhibit 10.13 Stock Purchase Agreement, Dated July 15, 2005 29-69
Exhibit 10.14 Lease Agreement, Dated August 19, 2005 70-117
Exhibit 31.1 Section 302 Certification of the Chief Executive Officer 118
Exhibit 31.2 Section 302 Certification of the Chief Financial Officer 119
Exhibit 32 Section 906 Certification of the Chief Executive Officer
and Chief Financial Officer 120
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
INFORTE CORP.
CONSOLIDATED BALANCE SHEETS
(000's)
SEPT 30, DEC 31, MAR 31, JUNE 30, SEPT 30,
2004 2004 2005 2005 2005
-------- -------- -------- -------- --------
(Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 18,889 $ 20,817 $ 22,041 $ 9,471 $ 12,107
Short-term marketable securities 25,457 24,657 24,036 20,022 18,996
Accounts receivable 7,469 7,491 6,760 7,875 8,707
Allowance for doubtful accounts (500) (450) (450) (450) (450)
-------- -------- -------- -------- --------
Accounts receivable, net 6,969 7,041 6,310 7,425 8,257
Note receivable from affiliate - - - - 429
Prepaid expenses and other current assets 985 875 1,163 1,212 1,066
Interest receivable on investment Securities 389 383 399 261 204
Deferred income taxes 622 2,662 2,424 1,053 1,073
Income taxes recoverable 501 1,025 1,042 1,013 218
-------- -------- -------- -------- --------
Total current assets 53,812 57,460 57,415 40,457 42,350
Computers, purchased software and property 3,113 3,218 2,642 2,602 2,111
Less accumulated depreciation and amortization 1,907 2,125 1,623 1,754 1,091
-------- -------- -------- -------- --------
Computers, purchased software and property, net 1,206 1,093 1,019 848 1,020
Long-term marketable securities 14,136 12,106 6,086 3,543 492
Intangible assets 38 - - - 64
Goodwill 11,737 11,726 11,726 11,726 14,307
Deferred income taxes 295 207 366 1,495 1,565
Investment in affiliate - - - 2,000 1,924
-------- -------- -------- -------- --------
Total assets $ 81,224 $ 82,592 $ 76,612 $ 60,069 $ 61,722
======== ======== ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 995 $ 756 $ 710 $ 413 $ 666
Income taxes payable - 1,309 148 260 359
Accrued expenses 2,738 2,364 2,274 2,890 3,012
Accrued loss on disposal of leased property 346 2,278 1,826 1,492 1,106
Current portion of deferred acquisition payments 3,150 3,150 3,150 3,150 3,650
Dividends declared - - 17,375 - -
Deferred revenue 2,209 1,667 1,085 1,166 1,084
-------- -------- -------- -------- --------
Total current liabilities 9,438 11,524 26,568 9,371 9,877
Non current liabilities:
Non-current portion of deferred acquisition payment 3,150 3,150 - - 500
Stockholders' equity:
Common stock, $0.001 par value
authorized- 50,000,000 shares; issued and
outstanding (net of treasury stock)- 11,892,039 as
of Sept. 30, 2005 11 11 11 12 12
Additional paid-in capital 80,384 80,652 74,015 74,170 74,168
Cost of common stock in treasury (2,720,823 shares as
of Sep. 30, 2005) (24,997) (24,997) (24,997) (24,997) (24,997)
Stock-based compensation 180 181 585 823 1,011
Retained earnings 12,742 11,462 - 454 999
Accumulated other comprehensive income 316 609 430 236 152
-------- -------- -------- -------- --------
Total stockholders' equity 68,636 67,918 50,044 50,698 51,345
-------- -------- -------- -------- --------
Total liabilities and stockholders' equity $ 81,224 $ 82,592 $ 76,612 $ 60,069 $ 61,722
======== ======== ======== ======== ========
See notes to consolidated financial statements
1
CONSOLIDATED STATEMENTS OF OPERATIONS
(000's, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2004 2005 2004 2005
---------- ---------- ---------- ----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Revenues:
Revenue before reimbursements (net revenue) $ 11,516 $ 9,711 $ 34,160 $ 28,160
Reimbursements 1,675 922 4,886 2,912
-------- -------- -------- --------
Total revenues 13,191 10,633 39,046 31,072
Cost of services:
Project personnel and related expenses 7,085 5,187 19,842 16,267
Reimbursements 1,675 922 4,886 2,912
-------- -------- -------- --------
Total cost of services 8,760 6,109 24,728 19,179
-------- -------- -------- --------
Gross profit 4,431 4,524 14,318 11,893
Other operating expenses:
Sales and marketing 1,178 638 3,757 1,942
Recruiting, retention and training 370 324 1,104 785
Management and administrative 3,142 2,788 9,037 9,382
-------- -------- -------- --------
Total other operating expenses 4,690 3,750 13,898 12,109
-------- -------- -------- --------
Operating income (loss) (259) 774 420 (216)
Loss on investment in affiliate - (76) - (76)
Interest income, net and other 267 214 772 671
-------- -------- -------- --------
Income before income tax 8 912 1,192 379
Income tax expense 3 367 476 150
-------- -------- -------- --------
Net income $ 5 $ 545 $ 716 $ 229
======== ======== ======== ========
Earnings per share:
-Basic $ 0.00 $ 0.05 $ 0.06 $ 0.02
-Diluted $ 0.00 $ 0.05 $ 0.06 $ 0.02
Weighted average common shares outstanding:
-Basic 11,056 11,260 11,030 11,209
-Diluted 11,183 11,694 11,302 11,516
See notes to consolidated financial statements
2
INFORTE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(000's)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ----------------------
2004 2005 2004 2005
---------- --------- ---------- ----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Cash flows from operating activities
Net income $ 5 $ 545 $ 716 $ 229
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 435 293 1,216 979
Loss on investment in affiliate - 76 - 76
Stock based compensation 19 188 180 830
Deferred income taxes 48 (90) 74 231
Changes in operating assets and liabilities
Accounts receivable 1,424 (722) (464) (1,106)
Prepaid expenses and other current assets 84 158 (237) (8)
Unbilled revenue - 463 - 463
Accounts payable (346) (78) (607) (421)
Income taxes (41) 894 (1,142) (143)
Accrued expenses and other (650) (264) (1,823) (524)
Deferred revenue (569) (82) (556) (583)
-------- -------- -------- --------
Net cash provided by (used in) operating
activities 409 1,381 (2,643) 23
Cash flows from investing activities
Note receivable from affiliate - (375) - (425)
Investment in affiliate - - - (2,000)
Acquisition of businesses, net of cash acquired (1) (2,177) (5,677) (5,327)
Decrease in marketable securities 981 3,981 3,315 16,715
Purchases of property and equipment (431) (116) (841) (278)
-------- -------- -------- --------
Net cash provided by (used in)
investing activities 549 1,313 (3,203) 8,685
Cash flows from financing activities
Proceeds from stock option and purchase plans 178 - 593 202
Dividends - - - (17,375)
-------- -------- -------- --------
Net cash provided by (used in) financing
activities 178 - 593 (17,173)
-------- -------- -------- --------
Effect of changes in exchange rates on cash (14) (58) 71 (245)
Increase (decrease) in cash and cash equivalents 1,122 2,636 (5,182) (8,710)
Cash and cash equivalents, beginning of period 17,767 9,471 24,071 20,817
-------- -------- -------- --------
Cash and cash equivalents, end of period $ 18,889 $ 12,107 $ 18,889 $ 12,107
======== ======== ======== ========
See notes to consolidated financial statements
3
Notes to consolidated financial statements
(Unaudited)
September 30, 2005
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
by Inforte Corp. ("Inforte") pursuant to the rules and regulations of the
Securities and Exchange Commission regarding interim financial reporting.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete consolidated financial
statements and should be read in conjunction with the consolidated financial
statements and notes thereto for the year ended December 31, 2004 included in
Inforte's annual report on Form 10-K (File No. 000-29239). The balance sheet at
December 31, 2004 has been derived from the audited consolidated financial
statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The accompanying consolidated financial statements reflect
all adjustments (consisting solely of normal, recurring adjustments) which are,
in the opinion of management, necessary for a fair presentation of results for
the interim periods presented. The results of operations for the three-month and
nine-month period ended September 30, 2005 are not necessarily indicative of the
results to be expected for the full fiscal year. Certain previously reported
amounts have been reclassified to conform with current presentation format.
(2) DILUTED EARNINGS PER COMMON SHARE
Inforte computes basic earnings per share by dividing net income (loss) by the
weighted average number of common shares outstanding. Diluted earnings per
common share are computed by dividing net income by the weighted average number
of common shares and dilutive common share equivalents outstanding.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2004 2005 2004 2005
-------------------------- --------------------------
(Unaudited) (Unaudited)
Basic weighted average shares 11,056,289 11,259,791 11,029,781 11,209,243
Effect of dilutive stock options
and contingently issuable shares 127,050 434,631 272,141 306,664
-------------------------- -------------------------
Diluted common and common
equivalent shares 11,183,340 11,694,422 11,301,922 11,515,907
========================== =========================
(3) COMPREHENSIVE INCOME
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" (SFAS 130), establishes standards for reporting comprehensive income.
Comprehensive income includes net income as currently reported under generally
accepted accounting principles, and also considers the effect of additional
economic events that are not required to be recorded in determining net income,
but rather are reported as a separate component of stockholders' equity. Inforte
reports foreign currency translation gains and losses, and unrealized gains and
losses on investments, as components of comprehensive income. Total
comprehensive income was $31,266 and $460,963 for the three months ended
September 30, 2004 and 2005, respectively. Total comprehensive income was
$659,568 for the nine months ended September 30, 2004 and total comprehensive
loss was $227,797 for the nine months ended September 30, 2005.
(4) CONTINGENCIES
Inforte; Philip S. Bligh, Inforte's Chairman of the Board; and Stephen C.P. Mack
and Nick Padgett, each a former executive officer of Inforte, have been named as
defendants in Mary C. Best v. Inforte Corp.; Goldman, Sachs & Co.; Salomon Smith
Barney, Inc.; Philip S. Bligh; Stephen C.P. Mack and Nick Padgett, Case No. 01
CV 10836, filed on November 30, 2001 in Federal Court in the Southern District
of New York (the "Case"). The Case is among more than 300 putative class actions
against certain issuers, their officers and directors, and underwriters with
respect to such issuers' initial public offerings, coordinated as In re Initial
Public Offering Securities Litigation, 21 MC 92 (SAS) (collectively, the
4
"Multiple IPO Litigation"). An amended class action complaint was filed in the
Case on April 19, 2002. The amended complaint in the Case alleges violations of
federal securities laws in connection with Inforte's initial public offering
occurring in February 2000 and seeks certification of a class of purchasers of
Inforte stock, unspecified damages, interest, attorneys' and expert witness fees
and other costs. The amended complaint does not allege any claims relating to
any alleged misrepresentations or omissions with respect to our business. The
individual defendants (Messrs. Bligh, Mack and Padgett) have been dismissed from
the case without prejudice pursuant to a stipulated dismissal and a tolling
agreement. We have moved to dismiss the plaintiff's case. On February 19, 2002,
the Court granted this motion in part, denied it in part and ordered that
discovery in the case may commence. The Court dismissed with prejudice the
plaintiff's purported claim against Inforte under Section 10(b) of the
Securities Exchange Act of 1934, but left in place the plaintiff's claim under
Section 11 of the Securities Act of 1933.
Inforte has entered into a Memorandum of Understanding (the "MOU"), along with
most of the other defendant issuers in the Multiple IPO Litigation, whereby such
issuers and their officers and directors (including Inforte and Messrs. Bligh,
Mack and Padgett) will be dismissed with prejudice from the Multiple IPO
Litigation, subject to the satisfaction of certain conditions. Under the terms
of the MOU, neither Inforte nor any of its formerly named individual defendants
admit any basis for liability with respect to the claims in the Case. The MOU
provides that insurers for Inforte and the other defendant issuers participating
in the settlement will pay approximately $1 billion to settle the Multiple IPO
Litigation, except that no such payment will occur until claims against the
underwriters are resolved and such payment will be paid only if the recovery
against the underwriters for such claims is less than $1 billion and then only
to the extent of any shortfall. Under the terms of the MOU, neither Inforte nor
any of its named directors will pay any amount of the settlement. The MOU
further provided that participating defendant issuers will assign certain claims
they may have against the defendant underwriters in connection with the Multiple
IPO Litigation. The MOU is subject to the satisfaction of certain conditions,
including, among others, approval of the Court. In an order dated February 15,
2005, the Court certified settlement classes and class representatives and
granted preliminary approval to the settlement contemplated by the MOU with
certain modifications, including that the "bar order," or claims that would be
barred by the settlement, be modified consistent with the Court's opinion.
Amended settlement documents were subsequently presented to the Court and, on
August 31, 2005, the Court entered an order approving the form, substance and
program of notice of the settlement to class members and further set a hearing
concerning the fairness of the settlement on April 26, 2006. Certain of the
underwriters that are defendants in the lawsuit have appealed the Court's ruling
granting class certification.
(5) SEGMENT REPORTING
Inforte engages in business activities in one operating segment, which provides
consulting services either on a fixed-price, fixed-timeframe basis or on a
time-and-materials basis. Inforte's services are delivered to clients in North
America and Europe, and Inforte's long-lived assets are located in North
America, Europe and India. Domestic and foreign operating revenues are based on
the location of customers. Inforte's European operations had $2,120,237 and
$3,741,373 of revenues for the three months ending September 30, 2004 and 2005,
respectively, and $6,531,831 and $9,602,339 of revenues for the nine months
ending September 30, 2004 and 2005, respectively. Asset information by operating
segment is not reported to or reviewed by the chief operating decision maker;
therefore, Inforte has not disclosed asset information for each operating
segment or geographical location.
(6) STOCK BASED COMPENSATION
Inforte accounts for stock-based employee compensation in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
("SFAS 123") related to options. Stock-based compensation expense of $19,000 was
recognized in the quarter ending September 30, 2004, $7,000 of which was related
to option grants related to the acquisition of COMPENDIT, Inc. ("COMPENDIT") and
$12,000 was related to grants of restricted stock. During the first nine months
of 2004 we recognized a stock-based compensation expense of $180,000, $104,000
which was related to the COMPENDIT acquisition and $76,000 was related to grants
of restricted stock. Stock-based compensation expense of $188,000 was recognized
in the quarter ending September 30, 2005 all of which was related to grants of
restricted stock. Stock-based compensation expense was $830,000 in the first
nine months of 2005, $417,000 of which was related to common stock grants,
$399,000 was related to grants of restricted stock and $14,000 was related to
5
stock options grants. Had we applied the fair value recognition provisions of
SFAS 123 to stock-based employee compensation during the three and nine months
ended September 30, 2004 and 2005, net income and net income per share would
have been as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2004 2005 2004 2005
---------- ---------- ---------- ----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Net income, as reported $ 5,020 $ 544,947 $ 715,241 $ 229,311
Add: Stock-based compensation expense
recorded, net of related tax effects 19,135 - 179,871 13,637
Deduct: Total stock-based compensation
expense determined under fair value
based method for all awards, net of
related tax effects (1) (1,026,914) (4,059) (3,671,840) 229,102
Pro forma net income (loss) $(1,002,759) $ 540,888 $(2,776,728) $ 472,050
========== ========= ========== ===========
Net income, per share:
Basic -- as reported 0.00 0.05 0.06 0.02
========== ========= ========== ===========
Basic -- pro forma (0.09) 0.05 (0.25) 0.04
========== ========= ========== ===========
Diluted -- as reported 0.00 0.05 0.06 0.02
========== ========= ========== ===========
Diluted -- pro forma (0.09) 0.05 (0.25) 0.04
========== ========= ========== ===========
(1) Total stock-based compensation, under the fair value based method for
the nine months ending September 30, 2005, is a net benefit due to a
reversal of previously expensed amounts related to stock options canceled
in the first half of 2005 due to the capital restructuring plan executed in
March 2005 and certain other arrangements with individual employees
executed in April 2005.
(7) ACQUISITIONS
On July 15, 2005 Inforte acquired all of the outstanding shares of capital stock
of GTS Consulting, Inc. ("GTS"), a marketing analytics services firm. Inforte
paid $2.1 million in cash at closing. As part of the purchase price, Inforte
will pay an additional $1 million, payable in two installments of $500,000 on
the first and second anniversary date of the closing. Depending on GTS's
achievement of certain revenue levels per customer or of aggregate revenue
during the 12-month period following the closing, Inforte will be further
obligated to pay an additional $1 million, payable in two installments of
$500,000 on the third and fourth anniversary dates of the closing. All
post-closing payments under the stock purchase agreement will be made 80% in
cash and 20% in unregistered common stock of Inforte, subject to contractual
restrictions on resale of such stock for two years after its receipt.
The unaudited consolidated financial statements reflect a total purchase price
of $3.2 million, consisting of the following: (i) the payment of the initial
cash consideration of $2.1 million, (ii) transaction costs of $0.1 million,
(iii) a deferred acquisition payment of $1 million payable in two installments,
80% cash and 20% unregistered common stock each, in July 2006 and July 2007.
Under the purchase method of accounting, the purchase price is allocated to GTS'
net tangible and intangible assets based upon their estimated fair value as of
the date of the acquisition. The purchase price allocation is as follows:
6
Tangible assets:
Cash and cash equivalents....................... $ 19,000
Accounts receivable and other current assets.... 582,000
Property and equipment.......................... 263,000
----------
Total tangible assets...................... 864,000
Intangible assets:
Goodwill and other intangible assets............ 2,663,000
----------
Total assets............................... 3,527,000
----------
Liabilities assumed: 331,000
----------
Net assets acquired........................ $ 3,196,000
==========
Intangible assets of $82,000 were recorded at the date of the acquisition, of
which $18,000 was charged as amortization in the third quarter of 2005. The
acquisition has been treated as a purchase of assets and liabilities; therefore
the intangible assets, including goodwill, are deductible for tax purposes.
On March 12, 2004, by way of a merger of a wholly owned subsidiary of Inforte
with COMPENDIT, Inforte acquired all of the outstanding shares of COMPENDIT, a
leading provider of SAP Business Intelligence implementation consulting
services, for initial cash consideration of $5.5 million on closing. An
additional payment of $0.5 million was paid in cash in May 2004 based on a
closing statement calculation of cash less transaction costs. The first
installment of a supplementary cash amount of $3.2 million was paid in January
2005 and the second installment of $3.2 million will be paid in January 2006.
This acquisition enhanced Inforte's ability to offer analytics and business
intelligence solutions through COMPENDIT's services partnership with SAP.
The unaudited consolidated financial statements reflect a total purchase price
of $12.5 million, consisting of the following: (i) the payment of the initial
cash consideration of $5.5 million, (ii) transaction costs of $0.2 million,
(iii) additional cash consideration paid after closing of the acquisition of
$0.5 million, and (iv) the first installment of an earnout of $3.2 million paid
in January 2005 and the second installment of an earnout of $3.2 million payable
in January 2006. Under the purchase method of accounting, the purchase price is
allocated to COMPENDIT's net tangible and intangible assets based upon their
estimated fair value as of the date of the acquisition. The purchase price
allocation is as follows (in thousands):
Tangible assets:
Cash and cash equivalents....................... $ 547
Accounts receivable and other current assets.... 2,269
Property and equipment.......................... 156
--------
Total tangible assets...................... 2,972
Intangible assets:
Goodwill and other intangible assets............ 11,853
--------
Total assets............................... 14,825
--------
Liabilities assumed: 2,310
--------
Net assets acquired........................ $ 12,515
========
7
Intangible assets related to customer contracts existing as of the date of the
acquisition of COMPENDIT were fully amortized as of December 31, 2004.
The following is a summary of total intangible assets and goodwill as of
September 30, 2005 (in thousands except for amortization life):
Gross Accumulated Net book Weighted average
carrying amortization value amortization life
amount (months)
----------- -------------- ---------- -----------------
Customer contracts, $ 209 145 64 15
Goodwill, 14,307 - 14,307 N/A
----------- -------------- ---------- -----------------
Total $ 14,516 $ 145 $ 14,371
=========== ============== ==========
Goodwill represents the excess of the purchase price over the fair value of the
tangible and intangible assets acquired. In accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets," goodwill will not be amortized but will
be tested for impairment at least annually.
Inforte and GTS had one contractual agreement prior to acquisition, according to
which Inforte was a subcontractor on a client service engagement originally
owned by GTS. All intercompany payables and receivables were eliminated at
acquisition.
There were no historical transactions between Inforte and COMPENDIT.
(8)INVESTMENT IN AFFILIATE
Inforte has entered into a Limited Liability Company Agreement of PROVANSIS LLC
An Inforte Company (PROVANSIS), dated May 20, 2005, by and among Inforte,
Primary Knowledge, Inc. (PKI), and Mr. Ronald Meyer.
Pursuant to the Agreement, Inforte, PKI and Mr. Meyer, the Chief Executive
Officer of the newly formed entity, are members in PROVANSIS LLC. Initially,
Inforte contributed $2,000,000 in cash for a 19% membership interest. For an
initial 76% membership interest, PKI contributed to PROVANSIS the right to
market, on an exclusive basis, processing rights to use certain licensed
technology in connection with the underwriting of applications for term life
insurance, and has agreed to present to PROVANSIS, on an exclusive basis, new
technology using prescription data that may be developed by PKI or an affiliate
of PKI. The remaining 5% of membership interest is owned by Mr. Meyer. The
ownership units transferred to Mr. Meyer vest over a period of 5 years. In the
event that Mr. Meyer's employment with PROVANSIS is terminated for any reason,
unvested units held by Mr. Meyer will be forfeited and returned to PROVANSIS.
Further, vested units held by Mr. Meyer, will, at the option of PROVANSIS, be
sold by Mr. Meyer to PROVANSIS.
As of September 30, 2005 Inforte recorded the initial contribution of $2,000,000
as a non-current asset on the Consolidated Balance Sheet. Under the terms of the
Agreement, Inforte has one seat on the board of directors, with special voting
rights and other privileges, and, therefore, used the equity method of
accounting for this investment. Losses in equity of the investee included in
Inforte's statement of operations were $76,000 for the three months and nine
months ending September 30, 2005.
Inforte has two options to acquire from PKI, for an additional $2,000,000 of
cash, membership interests in PROVANSIS sufficient to give Inforte a 51%
interest in PROVANSIS. Under Inforte's first option, which expires November 21,
2005, Inforte, at its election, could acquire from PKI, for $1,000,000 cash,
membership interests sufficient to give Inforte a 35% interest in PROVANSIS.
Under Inforte's second option, which expires February 20, 2006 and may be
exercised only after exercise of the first option, Inforte, at its election,
could acquire from PKI, for additional $1,000,000 cash, membership interests
sufficient to give Inforte a 51% interest.
If Inforte does not exercise its options to acquire majority control,
PROVANSIS's right to market certain processing services will become
non-exclusive, as will PROVANSIS's right to certain new technology developed by
PKI. In addition, if Inforte does not exercise both of its options, PKI will
have the right to buy out Inforte's interest in PROVANSIS for an amount equal to
the greater of (i) $2,000,000 plus any amount paid in connection with Inforte's
options or (ii) Inforte's capital account balance.
Generally, the economic benefits of PROVANSIS will be allocated in accordance
with the respective membership interests of PROVANSIS's members. As of September
30, 2005 the only owners of membership interests were PKI, Inforte and Mr. Meyer
8
and the respective ownership percentages as of that date were 76%, 19% and 5%,
respectively.
Subject to terms and conditions, Inforte will be obligated to advance certain
unsecured working capital loans to PROVANSIS at an interest rate equal to the
prime rate, payable generally from 70% of available cash flow, if any, of
PROVANSIS. As of September 30, 2005 Inforte has provided PROVANSIS with $429,000
of such loans presented on the Consolidated Balance Sheet as Note receivable
from affiliate.
Inforte will provide services to PROVANSIS, including, but not limited to,
accounting, human resources and information technology services. Inforte will
charge PROVANSIS for such services at cost plus 25%. Inforte billed PROVANSIS
$2,000 for services provided in the third quarter of 2005.
(9) RESTRUCTURING
During 2001 Inforte took major steps to reduce its costs to better align its
overall cost structure and organization with anticipated demand for its
services. These steps included consolidating office space at the Chicago
location where Inforte had multiple contractual rental commitments. Estimated
costs for the consolidation of Chicago facilities consist of contractual rental
commitments for office space being vacated and unamortized leasehold
improvements related to this space less estimated sublease income. The total
reduction of office space resulting from this consolidation of our Chicago
office space was approximately 17,770 square feet, all of which were vacated as
of December 31, 2001. Total charges related to this reduction of office space in
2002 were $605,062 and there was a reversal of previously recognized losses of
$145,978 in 2003. These charges as well as the loss reversal were recorded as a
component of Management and Administrative expenses in the 2002 and 2003
Consolidated Statement of Operations. At September 30, 2004 and 2005 the Company
recorded $345,858 and $128,577, respectively, as accrued expenses on the
Consolidated Balance Sheet.
Charges for this restructuring for the three months ended September 30, 2004 and
2005 were as follows:
3 months ended Sept. 30, 2004 Balance 06/30/04 Expense Cash payments Adjustments Balance 09/30/04
Lease termination $ 418,564 $ - $ (72,706) $ - $ 345,858
3 months ended Sept. 30, 2005 Balance 06/30/05 Expense Cash payments Adjustments Balance 09/30/05
Lease termination $ 182,932 $ - $ (54,355) $ - $ 128,577
In October 2004, Inforte's executive team authorized a plan to consolidate
office space at its Southern California office and the two Chicago locations
where Inforte had separate contractual rental obligations. Estimated costs for
the consolidation of the facilities consist of contractual rental commitments
for office space being vacated less estimated sub-lease income. The total
reduction of office space resulting from this consolidation of office space was
approximately 43,881 square feet at the time the plan was executed. During the
third quarter of 2005 two of the original lease agreements were amended reducing
total abandoned office space to 27,341 square feet and terminating a lease for
4,357 square feet of additional office space. Total charges related to this
reduction of space are still estimated at $2.0 million and were recognized at
the date the plan for office space consolidation was executed.
Charges for this restructuring for the three months ended September 30, 2005
were as follows:
3 months ended Sept. 30, 2005 Balance 06/30/05 Expense Cash payments Adjustments Balance 09/30/05
Lease termination $ 1,309,527 $ 50,627 $ (207,442) $ (174,987) $ 977,725
(10) CAPITAL RESTRUCTURING AND CASH DISTRIBUTION TO STOCKHOLDERS
On January 27, 2005 Inforte announced that its board of directors had approved a
capital restructuring plan that included (1) a special one-time dividend of
$1.50 per share and (2) a program to offer employees, with respect to certain
stock options, the opportunity to convert stock options to restricted stock or
to cash out stock options. On March 21, 2005 Inforte completed its offer to
exchange options for cash or restricted stock. 509,636 options were exchanged
for a total cash consideration, including applicable payroll taxes, of $848,000,
of which $292,000 was charged to project personnel and related expenses,
$119,000 to sales and marketing expenses, $8,000 to recruiting, retention, and
training expenses and $429,000 was charged to management and administrative
expenses. Further, 707,112 options were exchanged for 310,394 shares of
restricted stock and the related prorated compensation expense charged in the
three months and the nine months ending September 30, 2005 was $173,000 and
$296,000, respectively. The total non-cash compensation expense related to the
restricted stock grants will be expensed ratably over a four-year period as the
9
stock vests over a four-year period, starting on the grant date of March 21,
2005. The maximum total compensation charges associated with the restricted
stock grants related to this capital restructuring are $110,000, $438,000,
$438,000, $438,000 and $95,000 for the fourth quarter of 2005 and the years
ending 2006, 2007, 2008 and 2009, respectively.
Inforte also paid $90,000 in professional fees associated with the
implementation of the capital restructuring plan. Inforte granted common stock
to employees who had unexercised vested stock options as of the dividend payment
date. The total compensation expense related to these common stock grants was
$378,000 and was recorded as part of management and administrative expenses on
the statement of operations for the first quarter of 2005. On April 20, 2005
Inforte issued 106,586 shares of common stock related to this grant.
On March 21, 2005, Inforte announced that the record date for Inforte
stockholders for the previously declared special one-time cash distribution of
$1.50 per share of common stock would be the close of business on Tuesday, April
5, 2005. Total cash payable to eligible stockholders of $17.4 million was
recorded as a liability as of March 31, 2005 and allocated to retained earnings
and additional paid-in capital. The one-time cash distribution to stockholders
was made on April 15, 2005.
(11) INCOME TAXES
Inforte has deferred tax assets which have arisen primarily as a result of
foreign tax credits related to taxes paid in 2002, 2003 and 2004 in the United
Kingdom, as well as other temporary differences between book and tax accounting.
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes," requires the establishment of a valuation allowance to reflect the
likelihood of realization of deferred tax assets. Significant management
judgment is required in determining Inforte's provision for income taxes, its
deferred tax assets and liabilities and any valuation allowance recorded against
the net deferred tax assets. As of September 30, 2005 based on historical
performance and future projections of taxable income in the jurisdictions where
Inforte and its affiliates operate all deferred tax assets were deemed
realizable and therefore no valuation allowance was recorded.
Inforte's effective tax rate may vary from period to period based on changes in
estimated taxable income or loss, changes to federal, state or foreign tax laws,
future expansion into areas with varying country, state, and local income tax
rates, deductibility of certain costs and expenses by jurisdiction, recording of
a valuation allowance and as a result of acquisitions.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
You should read the following discussion in conjunction with our consolidated
financial statements, together with the notes to those statements, included
elsewhere in this Form 10-Q. The following discussion contains forward-looking
statements that involve risks, uncertainties, and assumptions such as statements
of our plans, objectives, expectations and intentions. Our actual results may
differ materially from those discussed in these forward-looking statements
because of the risks and uncertainties inherent in future events that include,
but are not limited to, those identified under the caption "Risk Factors"
appearing in this 10-Q as well as factors discussed elsewhere in this Form 10-Q.
Actual results may differ from forward-looking results for a number of reasons,
including but not limited to, Inforte's ability to: (i) effectively forecast
demand and profitably match resources with the demand during a period where
information technology spending is not strong and when worldwide economic and
geopolitical uncertainty is high; (ii) attract and retain clients and satisfy
our clients' expectations; (iii) recruit and retain qualified professionals;
(iv) accurately estimate the time and resources necessary for the delivery of
our services; (v) build and maintain marketing relationships with leading
software vendors while competing with their professional services organizations;
(vi) compete with emerging alternative economic models for delivery, such as
offshore development; (vii) effectively integrate acquired businesses; (viii)
grow new areas of its business, such as business intelligence and managed
analytics; (ix) identify and successfully offer the solutions that clients
demand; (x) effectively compete with larger and established competitors; (xi)
retain significant clients and collect sizeable accounts receivable; and (xii)
implement legislative and regulatory requirements in a timely and cost efficient
manner, as well as other factors discussed from time to time in our other
Securities and Exchange Commission filings. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those anticipated, estimated or
projected. All forward-looking statements included in this document are made as
10
of the date hereof, based on information available to Inforte on the date
thereof, and Inforte assumes no obligation to update any forward-looking
statements.
Overview
Inforte Corp. increases the competitive strength of its clients by providing
them with insight, intelligence and an infrastructure to enable more timely and
profitable decision-making. Inforte consultants combine real-world experience,
strong industry, functional and analytical expertise with innovative
go-to-market strategies and technology solutions, working to help ensure that
our clients can drive transformational, measurable results in their customer
interactions. Founded in 1993, Inforte is headquartered in Chicago and has
offices in Atlanta; Dallas; Delhi, India; Hamburg, Germany; London; Los Angeles;
San Francisco; Walldorf, Germany; and Washington, D.C.
Our revenue is derived almost entirely through the performance of professional
services. The majority of our services are performed on a time and materials
basis; however, we also perform services on a fixed-price basis if this
structure best fits our clients' preferences or the requirements of the project.
Typically, the first portion of an engagement involves a strategy project or a
discovery phase lasting 30 to 60 days. This work enables us to determine with
our clients the scope of successive phases of work. These successive phases of
work can be additional strategy phases, or phases for technology design and
implementation, and generally last three to nine months. If a project is to be
performed on a fixed price basis, the fixed price is based upon estimates from
senior personnel in our consulting organization who project the length of the
engagement, the number of people required to complete the engagement and the
skill level and billing rates of those people. We then adjust the fixed price
based on various qualitative risk factors such as the aggressiveness of the
delivery deadline, the technical complexity of the solution and the value of the
solution delivered to the client. We ask clients to pay 10% to 50% of our fixed
price projects in advance to enable us to secure a project team in a timeframe
that is responsive to the client's needs.
RESULTS OF OPERATIONS
The following table sets forth the percentage of net revenues of certain items
included in Inforte's statement of income:
% of Net Revenue % of Net Revenue
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30,
2004 2005 2004 2005
----- ----- ----- -----
Revenues:
Revenue before reimbursements (net revenue) 100.0% 100.0% 100.0% 100.0%
Reimbursements 14.5 9.5 14.3 9.7
----- ----- ----- -----
Total revenue: 114.5 109.5 114.3 109.7
Cost of services
Project personnel and related expenses 61.5 53.4 58.1 57.8
Reimbursements 14.5 9.5 14.3 9.7
----- ----- ----- -----
Total cost of services 76.0 62.9 72.4 67.5
Gross profit 38.5 46.6 41.9 42.2
Other operating expenses:
Sales and marketing 10.2 6.6 11.0 6.9
Recruiting, retention and training 3.2 3.3 3.2 2.8
Management and administrative 27.3 28.7 26.5 33.3
----- ----- ----- -----
Total other operating expenses 40.7 38.6 40.7 43.0
----- ----- ----- -----
Operating income (loss) (2.2) 8.0 1.2 (0.8)
Loss on investment in joint venture 0.0 (0.8) 0.0 (0.3)
Interest income, net and other 2.3 2.2 2.3 2.4
----- ----- ----- -----
Pretax income 0.1 9.4 3.5 1.3
Income tax expense 0.1 3.8 1.4 0.5
----- ----- ----- -----
Net income 0.0% 5.6% 2.1% 0.8%
===== ===== ===== =====
11
NON-GAAP SUPPLEMENTAL INFORMATION (UNAUDITED) (1)
STATEMENTS OF OPERATIONS
(000's, except per share data)
% of Net Revenue
Nine Months Ended
Sept. 30,
2004 2005
----- -----
Revenue before reimbursements (net revenue) 100.0% 100.0%
Operating income (loss) 1.2 (0.8)
Add: one-time charges related to capital
restructuring - 4.7
----- -----
Non-GAAP operating income 1.2% 3.9%
===== =====
Net income 2.1 0.8
Add: one-time charges related to capital
restructuring, net of tax effect - 2.8
----- -----
Non-GAAP net income 2.1% 3.6%
===== =====
(1) The Non-GAAP supplemental information shows results excluding the impact of
one-time charges related to the tender offer to convert certain stock options
into cash and restricted stock and a one-time cash distribution to stockholders
that occurred in the first quarter of 2005. The total expense of $1,316
included: (i)$848 for charges related to the exchange of stock options for cash;
(ii) $378 for common stock grants to employees who had chosen not to exercise
options prior to the one-time cash distribution; and (iii) $90 for professional
services. The non-GAAP results are provided in order to enhance the user's
overall understanding of the company's current and future financial performance
by excluding certain items that management believes are not indicative of its
core operating results and by providing results that provide a more consistent
basis for comparison between quarters. Inforte presents these non-GAAP financial
measures to complement results provided in accordance with GAAP, as management
believes the measures help to illustrate underlying trends in our business.
Inforte's management uses these measures to establish budgets and operational
goals that are communicated internally and externally, to manage our business
and evaluate its performance and to assess compensation for executives. The
presentation of this additional information should not be considered in
isolation or as a substitute for results prepared in accordance with accounting
principles generally accepted in the United States of America.
Nine and three months ended September 30, 2004 and 2005
-------------------------------------------------------
Net revenue. "Net revenue" is revenue excluding reimbursable expenses that are
billed to our clients. We exclude reimbursements from revenue because we believe
net revenue, i.e., total revenues less reimbursements, is a more meaningful
representation of our economic activity than total revenues, since the former
excludes zero-margin pass-through expenses that in our opinion are not pertinent
to business fundamentals, financial statement analysis, or the investment
decision and, in fact, may mask trends in underlying performance and moreover
are not controllable.
Net revenue decreased 16% to $9.7 million for the quarter ended September 30,
2005 from $11.5 million for the quarter ended September 30, 2004. We attribute
this decrease in revenues to lower demand for services in some of our
competencies, particularly our customer management competency, as well as to
winding down of project engagements with significant clients, offset partially
by revenue contributed by GTS Consulting after the acquisition. Net revenue
decreased 18% to $28.2 million for the nine months ended September 30, 2005 from
$34.2 million for the nine months ended September 30, 2004. For the quarter
ended September 30, 2005, we had 28 significant clients with each of these
clients contributing, on average, $1.4 million to revenue on an annualized
basis.
12
For the quarter ended September 30, 2004, we had 43 significant clients with
each of these clients contributing, on average, $1.0 million to revenue on an
annualized basis. Sequentially, net revenue decreased 1% to $9.7 million in the
September 2005 quarter from $9.8 million in the June 2005 quarter. In the third
quarter of 2005, excluding the impact of the GTS Consulting acquisition, revenue
decreased 4% sequentially and 19% year over year.
Project personnel and related expenses. Project personnel and related expenses
consist of compensation and benefits for our professional employees who deliver
consulting services, non-reimbursable costs and any estimated revisions for our
allowance for doubtful accounts. All labor costs for project personnel are
included in project personnel and related expenses. These expenses dropped 27%
to $5.2 million for the quarter ended September 30, 2005 from $7.1 million for
the quarter ended September 30, 2004. Year to date, project personnel and
related expenses were $16.3 million, a 18% drop from $19.8 million for the first
nine months of 2004. These decreases resulted from a decline in consulting
headcount offset by increased compensation expense due to the buyout of stock
options in the first quarter of 2004. Total costs associated with the buyout of
stock options were $292,000 in the nine months ended September 30, 2005.
Excluding these one-time charges, project personnel and related expenses for the
first nine months of 2005 were $16.0 million or 56.7% of net revenue. We
employed 186 consultants on September 30, 2005, down from 260 one year earlier.
This decrease in the number of chargeable consultants was due to actions to
realign personnel to different service offerings and voluntary attrition.
Project personnel and related expenses represented 53.4% of net revenue for the
quarter ended September 30, 2005, down from 61.5% of net revenue for the quarter
ended September 30, 2004, as revenue decreased at a slower rate than project
personnel and related expenses did. Project personnel and related expenses for
the nine months ended September 30, 2005 represented 57.8% of net revenue down
from 58.1% of net revenue in the prior year period as project personnel and
related expenses decreased at a faster rate than revenue did.
Sales and marketing. Sales and marketing expenses consist primarily of
compensation, benefits, bonus and travel costs for employees in the marketing
and sales groups and costs to execute marketing programs. Sales and marketing
expenses decreased 46% to $0.6 million, or 6.6% of net revenue, for the quarter
ended September 30, 2005 from $1.2 million, or 10.2% of net revenue, in quarter
ended September 30, 2004. This decrease is due to a reduction in sales and
marketing headcount as well as a reduction in incentive bonuses. Sales and
marketing expenses decreased by 48% to $1.9 million for the nine months ended
September 30, 2005 from $3.8 million for the nine months ended September 30,
2004. Year to date, sales and marketing expenses were 6.9% of net revenue
compared to 11.0% of net revenue in the prior year period. Total costs
associated with the buyout of stock options were $119,000 in the first nine
months of 2005. Excluding these one-time charges, sales and marketing expenses
were $1.8 million or 6.5% of net revenue. The primary reason for this decrease
in sales and marketing expenses for the nine months ending September 30 2004 and
2005 is the headcount reduction in this area. We employed 9 people in sales and
marketing on September 30, 2005, down from 15 one year earlier.
Recruiting, retention and training. Recruiting, retention and training expenses
consist of compensation, benefits and travel costs for personnel engaged in
human resources activities; costs to recruit new employees; costs of human
resource programs; and training costs. These expenses decreased 12% to $324,000
for the quarter ended September 30, 2005 from $370,000 for the quarter ended
September 30, 2004. As a percent of net revenue, these costs increased to 3.3%
in the quarter ended September 30, 2005 from 3.2% of net revenue in the quarter
ended September 30, 2004. The increase in spending results primarily from higher
recruiting costs due to an increase in both the number of personnel recruited
and the cost per new hire, partially offset by lower human resources spending
due to lower company-wide headcount. Total headcount was 230 as of September 30,
2005 and 310 as of September 30, 2004.
Management and administrative. Management and administrative expenses consist
primarily of compensation, benefits and travel costs for management, finance,
information technology and facilities personnel, together with rent,
telecommunications, audit, legal, business insurance and depreciation and
amortization of capitalized computers, purchased software and property. These
expenses were at $3.1 million and $2.8 million for the quarters ended September
30, 2004 and 2005, respectively. As a percent of net revenue, management and
administrative expenses were 28.7% for the quarter ended September 30, 2005, up
from 27.3% of net revenue for the quarter ended September 30, 2004, as
management and administrative expenses decreased at a slower rate than revenue
declined. Management and administrative expenses for the three months ending
September 30, 2005 declined as increased compensation related to restricted
stock grants as well as higher professional services fees were offset by savings
resulting from lower headcount and the office space restructuring plan.
13
Year to date, management and administrative expenses increased 4% to $9.4
million for the nine months ended September 30, 2005 from $9.0 million for the
nine months ended September 30, 2004. As a percent of net revenue, management
and administrative expenses increased to 33.3% for the nine months ended
September 30, 2005 from 26.5% of net revenue for the nine months ended September
30, 2004. Total costs associated with the capital restructuring plan were
$897,000 in the first nine months of 2005. Excluding these one-time charges,
management and administrative expenses were $8.5 million or 30.1% of net
revenue. Management and administrative employees were 28 and 31 as of September
30, 2004 and September 30, 2005, respectively.
Interest income, net and other. During the quarter ended September 30, 2005,
interest income, net and other, was $214,000, down from $267,000 for the quarter
ended September 30, 2004. Year to date interest income, net and other was
$671,000, down from $772,000 for the same period in 2004. These declines in
investment earnings were due to the impact of lower average cash balances offset
partially by the reinvestment of matured securities into similar type securities
at higher market interest yields. We expect interest income, net and other, to
decline further in the fourth quarter of 2005 due to lower cash balances as of
the end of the third quarter of 2005 relative to prior quarters. The decline in
cash and investments balances is primarily a result of the payment of dividends
of $17.4 million in April 2005, the cash resources invested in PROVANSIS of $2.0
million and the acquisition of GTS Consulting of $2.2 million.
Income tax expense. Inforte's effective tax rate for the September 30, 2005
quarter was 40.2% compared to a rate of 40.0% for the September 30, 2004
quarter. The effective tax rate of 40% in the third quarters of 2005 and 2004
approximates our blended statutory tax rate, reflecting immaterial permanent
differences between taxable income for financial reporting and tax purposes.
Year to date effective tax rate was 39.5% compared to 40.0% for the same period
in 2004.
Liquidity and capital resources. Cash and cash equivalents increased from $9.5
million on June 30, 2005 to $12.1 million on September 30, 2005. Short-term
marketable securities decreased from $20.0 million to $19.0 million over the
same period. Long-term marketable securities decreased from $3.5 million to $0.5
million during the third quarter of 2005. In total, cash and cash equivalents,
short-term and long-term marketable securities dropped to $31.6 million on
September 30, 2005 compared to $33.0 million on June 30, 2005. This was
primarily due to the payments made to acquire GTS, offset partially by positive
cash flow from operations. Short-term and long-term marketable securities are
available-for-sale securities consisting of commercial paper, U.S. government or
municipal notes and bonds, corporate bonds and corporate auction preferreds.
During the September 2005 quarter, Inforte's cash flow from operations was $1.4
million. This resulted primarily from an increase in net income and accrued
expenses, a decrease in interest receivable on investment securities and a
change in the provision for income taxes, primarily offset by an increase in
accounts receivable and a decrease in accrued loss on disposal of leased
property.
There were no cash flows from financing activities in the third quarter of 2005
as employees did not exercise any stock options.
Net cash provided by investing activities for the three months ending September
30, 2005 was $1.3 million and resulted primarily from conversions of marketable
securities into cash of $4.0 million, partially offset by the acquisition of GTS
Consulting of $2.2 million and the note receivable from PROVANSIS LLC of $0.4
million.
In January 2005 Inforte announced a capital restructuring plan that included a
one-time distribution of cash to shareholders and an offer to Inforte's
employees to exchange certain other stock options for cash. On March 21, 2005
Inforte completed its offer to exchange options for cash or restricted stock and
509,636 options were exchanged for a total consideration of $848,000.
Our board of directors approved a $25.0 million stock repurchase program on
January 24, 2001 and as of August 2002, the entire amount authorized was
repurchased. The board of directors approved an additional $5.0 million stock
repurchase program on August 22, 2002, although we stated at that time that we
had no present plans to make additional repurchases of stock. The entire $5.0
million remains authorized for repurchases as of September 30, 2005. As of
September 30, 2005, the public float (shares not held by executive officers and
directors) totaled 8.1 million shares or 68% of total outstanding shares.
14
Inforte believes that its current cash, cash equivalents and marketable
securities will be sufficient to meet working capital and capital expenditure
requirements for the foreseeable future.
All highly liquid investments with maturities of three months or less when
purchased are considered cash equivalents. Cash and cash equivalent balances
consist of obligations of U.S. and other overseas banks, high-grade commercial
paper and other high quality, short-term obligations of U.S. companies.
Short-term and long-term marketable securities are available-for-sale securities
that are recorded at fair market value. The difference between amortized cost
and fair market value, net of tax effect, is shown as a separate component of
stockholders' equity. The cost of available-for-sale securities is adjusted for
amortization of premiums and discounts to maturity. Interest and amortization of
premiums and discounts for all securities are included in interest income.
As of September 30, 2005, Inforte had a total of $4.0 million in deferred
business acquisition obligations payable in cash. The first acquisition payment
of $3.2 million is related to the acquisition of COMPENDIT and will be paid out
in January 2006. The second and the third payments, $400,000 each, are related
to the acquisition of GTS Consulting and are due in July 2006 and 2007. Inforte
believes that it will have sufficient funds to satisfy obligations related to
the deferred consideration. We expect to fund these contingent payments,
primarily from the cash generated from the operations of the acquired
businesses. In addition to the purchase price obligation for the acquisitions,
Inforte assumed two operating leases from COMPENDIT and one operating lease from
GTS Consulting, all related to office space.
Inforte has several operating leases that have contractual cash obligations for
future payments. There are no other contractual obligations that require future
cash obligations or other commitments. The table below identifies all future
commitments.
Contractual Obligations Payments Due by Period (in thousands)
--------------------------------------------------------------------------------------------------------------------------
Total Q4 2005 2006 2007 2008 2009 2010
--------------------------------------------------------------------------------------------------------------------------
Long-term debt 0 0 0 0 0 0 0
Capital lease obligations 0 0 0 0 0 0 0
Operating leases 4,043 808 1,244 627 618 379 367
Deferred acquisition payments 3,950 0 3,550 400 0 0 0
Unconditional purchase obligations 0 0 0 0 0 0 0
Other long-term obligations 0 0 0 0 0 0 0
Total contractual cash obligations 7,993 808 4,794 1,027 618 379 367
Inforte has several sublease agreements for unused office space located in
Chicago and Irvine, California. Total rent receivable on these sublease
contracts is $190,550 for the remaining months of 2005 and $490,701, $111,368
and $67,180 for and the years 2006, 2007 and 2008, respectively.
Critical Accounting Policies
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Management bases its estimates on
historical experience and other assumptions, which it believes are reasonable.
If actual amounts are ultimately different from these estimates, the revisions
are included in the Company's results of operations for the period in which the
actual amounts become known.
Accounting policies are considered critical when they require management to make
assumptions about matters that are highly uncertain at the time the estimate is
made and when different estimates than management reasonably could have used
have a material impact on the presentation of our financial condition, changes
in financial condition or results of operations.
Revenue recognition, losses on fixed-price contracts, deferred revenue. We
recognize revenue when all of the following four criteria are met: persuasive
evidence exists that we have an agreement, service has been rendered, our price
is fixed or determinable and collectibility is reasonably assured. We recognize
net revenue from fixed-price contracts based on the ratio of hours incurred to
15
total estimated hours. The cumulative impact of any change in estimated hours to
complete is reflected in the period in which the changes become known. We
recognize time-and-materials net revenue as we perform the services. In November
2001, the Financial Accounting Standards Board's Emerging Issues Task Force
issued Topic 01-14, "Income Statement Characterization of Reimbursements
Received for `Out-of-Pocket' Expenses Incurred" stating these costs should be
characterized as revenue in the income statement if billed to customers.
We recognize revenues related to reimbursable expenses as the reimbursable
expenses are billed. We only recognize reimbursable expenses when all of the
following three criteria are met: persuasive evidence exists that we have an
agreement that includes the reimbursement of such expenses, the reimbursable
expenses have been incurred, and collectibility is reasonably assured.
For each quarter beginning with the March 31, 2002 quarter, we included
reimbursable expenses in revenue and expense and we have reclassified prior
periods in the comparative consolidated financial statements as required by the
Financial Accounting Standards Board. This reclassification had no effect on
current or previously reported net income (loss) per share. For presentation
purposes, we show two components of total revenue: 1) revenue before
reimbursements, which we call net revenue, consisting of revenue for performing
consulting services; and 2) reimbursements, consisting of reimbursements we
receive from clients for out-of-pocket expenses incurred. We break out
reimbursements in our presentation of revenue because we believe net revenue,
i.e., total revenues less reimbursements, is a more meaningful representation of
our economic activity than total revenues, since the former excludes zero-margin
pass-through expenses that in our opinion are not pertinent to business
fundamentals, financial statement analysis, or the investment decision and, in
fact, may mask trends in underlying performance and moreover are not
controllable.
Financial instruments. Short-term and long-term marketable securities are
available-for-sale securities which are recorded at fair market value. The
difference between amortized cost and fair market value, net of tax effect, is
shown as a separate component of stockholders' equity. The cost of securities
available-for-sale is adjusted for amortization of premiums and discounts to
maturity. Interest and amortization of premiums and discounts for all securities
are included in interest income.
Allowance for doubtful accounts. An allowance for doubtful accounts is
maintained for potential credit losses. The amount of the reserve is established
analyzing all client accounts to determine credit risk. In establishing a
client's creditworthiness we consider whether the client has a deteriorating or
poor financial condition, limited financial resources, poor or no payment
history, a large relative accounts receivable balance or a non-U.S. location.
Stock compensation. At September 30, 2005, Inforte has three stock-based
employee compensation plans. We account for stock-based employee compensation in
accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and have adopted the disclosure-only provisions of
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("SFAS 123") related to options issued to employees. All options
granted under our plans had an exercise price equal to the market value of the
underlying common stock on the date of grant, except for the option grants
related to the acquisition of COMPENDIT.
In January 2005 Inforte announced a capital restructuring plan that included an
offer to Inforte's employees to convert certain outstanding stock options into
restricted stock and to exchange certain other stock options for cash. In the
case where eligible employees had elected to cancel their options and receive
cash, Inforte recognized the related compensation expense at the time when the
offer was made, February 9, 2005. On the date of the offer, February 9, 2005,
the maximum cash settlement amount was accrued as a liability. For the options
where the cash offer was later accepted, the liability was settled with the cash
payment. The cash offer was not declined for any of the eligible options. In the
alternative case when employees elected to cancel their options and receive
restricted stock, the total non-cash compensation expense would be expensed
ratably over a four-year period. This amount would be expensed over four years
because the stock would vest over a four-year period, starting in the first
quarter of 2005. The options in this category were subject to variable
accounting treatment from the date of the offer until the offer was accepted.
Those options for which the restricted stock offer had been declined were
immediately vested and would continue to be subject to variable accounting
treatment thereafter until those options would be exercised or cancelled or
expire unexercised or until after January 1, 2006 when we adopt SFAS 123(r).
Variable accounting treatment means that the value of each option will be
measured and adjusted each reporting period based on the intrinsic value of the
option in the reporting period. Employees with unexercised vested options after
the one-time distribution with a strike price less than $9.00 were granted
16
common stock as compensation for the estimated loss in option value due to the
one-time distribution. On April 20, 2005 Inforte issued 106,586 such shares.
Bonus accruals. We have several bonus programs that are based on individual and
company performance. Revenue bonuses are earned based on individual billing or
revenue credit assigned to salespeople, client executives and delivery
personnel. Margin bonuses are earned by all employees based on company or
business unit operating income performance. In addition, senior management may
award discretionary bonuses. All of these bonuses are expensed in the period in
which they are earned. A corresponding accrual is included on the balance sheet
in accrued expenses until the bonus is paid.
Goodwill and other intangible assets. SFAS 142, Goodwill and Other Intangible
Assets, requires that goodwill be tested for impairment at the reporting unit
level (operating segment or one level below an operating segment) on an annual
basis (December 31 for us) and between annual tests if an event occurs or
circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying value. These events or circumstances could
include a significant change in the business climate, legal factors, operating
performance indicators, competition, sale or disposition of a significant
portion of a reporting unit. Application of the goodwill impairment test
requires judgment, including the identification of reporting units, assignment
of assets and liabilities to reporting units, assignment of goodwill to
reporting units, and determination of the fair value of each reporting unit. The
fair value of each reporting unit is estimated using a valuation methodology
based on historical performance and industry specific multiples. This requires
significant judgments and changes in these estimates and assumptions could
materially affect the determination of fair value and/or goodwill impairment for
each reporting unit.
Restructuring and other related charges. SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," was effective for exit or disposal
activities that are initiated after December 31, 2002. SFAS 146 requires that a
liability for a cost that is associated with an exit or disposal activity be
recognized when the liability is incurred. SFAS 146 supersedes the guidance in
EITF Issue No. 94-3. In October 2004, Inforte's executive team authorized a plan
to reduce its office space to better align with its space needs. These steps
included consolidating office space at its Southern California office and the
two Chicago locations where Inforte had separate contractual rental obligations.
Estimated costs for the consolidation of the facilities consist of contractual
rental commitments for office space being vacated less estimated sub-lease
income. The total reduction of office space resulting from this consolidation of
our office space was approximately 43,881 square feet at the time the plan was
executed. On July 1, 2005 one of the original lease agreements was amended to
reduce total abandoned office space to 27,341 square feet. Total charges related
to this reduction of space are still estimated at $2.0 million and were
recognized at the date the plan for office space consolidation was executed. If
we vacate additional space, if future sub-lease income is less than estimated,
if we buy-out of leases or if we are unable to sublease our vacated space,
additional charges or credits in future periods will be necessary.
Income taxes. We account for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS
109"), which requires the recognition of deferred income taxes based upon the
tax consequences of temporary differences between financial reporting and income
tax reporting by applying enacted statutory tax rates applicable to future years
to differences between the financial statement carrying amounts and the tax
basis of existing assets and liabilities. SFAS 109 also requires that deferred
tax assets be reduced by a valuation allowance if it is more likely than not
that some portion of the deferred tax asset will not be realized.
In connection with the preparation of our consolidated financial statements, we
are required to estimate our income tax liability for each of the tax
jurisdictions in which we operate. This process involves estimating our actual
current income tax expense and assessing temporary differences resulting from
differing treatment of certain income or expense items for income tax reporting
and financial reporting purposes. We also recognize as deferred tax assets the
expected future tax benefits of net operating loss carry forwards. In evaluating
the realizability of deferred tax assets associated with net operating loss
carry forwards, we consider, among other things, expected future taxable income,
the expected timing of the reversals of existing temporary reporting
differences, and the expected impact of tax planning strategies that may be
implemented to prevent the potential loss of future tax benefits. Changes in,
among other things, income tax legislation, statutory income tax rates or future
taxable income levels could materially impact the valuation of income tax assets
and liabilities and could cause our income tax provision to vary significantly
among financial reporting periods.
17
Recently Issued Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123R, Share-Based Payment ("SFAS
123R"). This Statement is a revision of SFAS No. 123, Accounting for Stock-
Based Compensation, and supersedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and its related implementation
guidance. SFAS No. 123R focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
The Statement requires entities to recognize compensation expense for awards of
equity instruments to employees based on the grant-date fair value of those
awards (with limited exceptions). SFAS No. 123R is effective for the first
interim or annual reporting period that begins after December 15, 2005. Inforte
expects to adopt SFAS No. 123R on January 1, 2006, using the Statement's
modified prospective application method. Adoption of SFAS No. 123R will not
affect Inforte's cash flows or financial position, but it will reduce, although
not materially, reported income and earnings per share because Inforte currently
uses the intrinsic value method as permitted by Accounting Public Board Opinion
No. 25. Accordingly, no compensation expense is recognized, in the third quarter
of 2005, for share purchase rights granted under the Inforte's employee stock
option and employee share purchase plans. After the implementation of the
capital restructuring plan, Inforte has significantly reduced its exposure to
option expensing by reducing options outstanding from 2.6 million at the end of
2004 to 684,000 at the end of the third quarter of 2005. The estimated total
expense related to unvested outstanding stock options at the time we adopt SFAS
123R, January 1, 2006, is immaterial.
Risk Factors
In addition to other information in this Form 10-Q, the following risk factors
should be carefully considered in evaluating Inforte and its business because
such factors currently may have a significant impact on Inforte's business,
operating results and financial condition. As a result of the risk factors set
forth below and elsewhere in this Form 10-Q, and the risk factors discussed in
Inforte's other Securities and Exchange Commission filings, actual results could
differ materially from those projected in any forward-looking statements.
If we fail to identify and successfully transition to the latest and most
demanded solutions or keep up with an evolving industry, we will not compete
successfully for clients and our profits may decrease. If we fail to identify
the latest solutions, or if we identify but fail to successfully transition our
business to solutions with growing demand, our reputation and our ability to
compete for clients and the best employees could suffer. If we cannot compete
successfully for clients, our revenues may decrease. Also, if our projects do
not involve the latest and most demanded solutions, they would generate lower
fees. Because our market changes constantly, some of the most important
challenges facing us are the need to:
o develop new services that meet changing customer needs;
o identify and effectively market solutions with growing demand
during a period of slower technological advancement and adoption;
o enhance our current services;
o continue to develop our strategic expertise;
o effectively use the latest technologies; and
o influence and respond to emerging industry standards and other
technological changes.
All of these challenges must be met in a timely and cost-effective manner. We
cannot assure you that we will succeed in effectively meeting these challenges.
If we fail to satisfy our clients' expectations, our existing and continuing
business could be adversely affected. If we fail to satisfy the expectations of
our clients, we could damage our reputation and our ability to retain existing
clients and attract new clients. In addition, if we fail to perform adequately
on our engagements, we could be liable to our clients for breach of contract.
Although most of our contracts limit the amount of any damages based upon the
fees we receive we could still incur substantial cost, negative publicity, and
diversion of management resources to defend a claim, and as a result, our
business results could suffer.
18
We may be unable to hire and retain employees who are highly skilled, which
would impair our ability to perform client services, generate revenue and main-
tain profitability. If we are unable to hire and retain highly skilled individu-
als, our ability to retain existing business and compete for new business will
be harmed. Individuals who have successfully sold and delivered services similar
to those we provide to our clients are limited and competition for these
individuals is intense. Further, individuals who were previously successful in a
different business environment may no longer be successful. Identifying
individuals who will succeed in this environment is extraordinarily difficult.
To attract and retain these individuals, we invest a significant amount of time
and money. In addition, we expect that both bonus payments and equity ownership
will be an important component of overall employee compensation. In the current
economic and market environment, overall bonus payments have been below target,
increasing the risk that key employees will leave Inforte. Also, if our stock
price does not increase over time, it may be more difficult to retain employees
who have been compensated with equity-based awards.
In the first quarter of 2005 Inforte's board of directors approved a capital
restructuring plan that, among other things, offered employees the opportunity
to convert certain stock options to restricted stock and to cash out other
options. On March 21, 2005 Inforte completed its offer to exchange options for
cash or restricted stock. 509,636 options were exchanged for a total
consideration of $848,000 and 707,112 options were exchanged for 310,394 shares
of restricted stock. As a result of this restructuring plan, total outstanding
options were reduced from 2.6 million at December 31, 2004 to approximately
684,000 as of September 30, 2005. Inforte intends to favor restricted stock
grants over stock options in the future. These actions could reduce net income
per share and may cause Inforte to become unprofitable.
If we fail to adequately manage rapid changes in demand, our profitability and
cash flow may be reduced or eliminated. If we cannot keep pace with the rapid
changes in demand, we will be unable to effectively match resources with demand,
and maintain high client satisfaction, which may eliminate our profitability and
our ability to achieve positive free cash flow, which we define as cash flow
from operations minus capital expenditures. Our business grew dramatically from
1993 through 2000. For example, our net revenue increased by 100% or more for
seven consecutive years, reaching $63.8 million in 2000. As a result of the
pricing pressures from competitors and from clients facing pressure to control
costs, net revenue has declined in each of the years 2001, 2002 and 2003,
dropping to $32.7 million in 2003 and then increasing to $43.9 million in 2004.
If our revenues decline, we may not be profitable or achieve positive free cash
flow. If, on the other hand, our growth exceeds our expectations, our current
resources and infrastructure may be inadequate to handle the growth.
If our marketing relationships with software vendors deteriorate, we would lose
their client referrals. If these vendors become subject to industry
consolidation or continue to increase their professional services revenue, our
revenue could be adversely affected. We currently have marketing relationships
with software vendors, including SAP, Siebel Systems, Inc., Salesforce.com,
Vignette and Unica. Although we have historically received a large number of
business leads from these and other software vendors to implement their
products, they are not required to refer business to us and they may terminate
these relationships at any time. If our relationships with these software
vendors deteriorate, we may lose their client leads and our ability to develop
new clients could be negatively impacted. Any decrease in our ability to obtain
clients may cause a reduction in our net revenues. Historically our software
partners have primarily relied on licensing fees and maintenance contracts to
generate revenue. However, more recently as software licensed sales have
declined, software vendors have sought to supplement their revenue through
increased implementation services for their software. This business strategy
puts us in competition with our software partners on some deals, reducing client
leads and our ability to develop new clients and revenue. Currently, we do not
receive a significant portion of our leads through our software vendor
relationships.
If we are unable to rapidly integrate third-party software, we may not be able
to deliver solutions to our clients on a timely basis, resulting in lost
revenues and potential liability. In providing client services, we recommend
that our clients use software applications from a variety of third-party
vendors. If we are unable to implement and integrate this software in a fully
functional manner for our clients, we may experience difficulties that could
delay or prevent the successful development, introduction or marketing of
services. Software often contains errors or defects, particularly when first
introduced or when new versions or enhancements are released. Despite internal
testing and testing by current and potential clients, our current and future
solutions may contain serious defects due to third-party software or software we
develop or customize for clients. Serious defects or errors could result in lia-
bility for damages, lost revenues or a delay in implementation of our solutions.
19
Our revenues could be negatively affected by the loss of a large client or our
failure to collect a large account receivable. At times, we derive a significant
portion of our revenue from large projects for a limited number of varying
clients. During the third quarter of 2005 our five largest clients accounted for
44% of net revenue and our ten largest clients accounted for 68% of net revenue.
In the same quarter we had one client contributing more than 10% of net revenue
for the year. Although these large clients vary from time to time and our
long-term revenues do not rely on any one client, our revenues could be
negatively affected if we were to lose one of our top clients or if we were to
fail to collect a large account receivable. In addition, many of our contracts
are short-term and our clients may be able to reduce or cancel our services
without incurring any penalty. If our clients reduce or terminate our services,
we would lose revenue and would have to reallocate our employees and our
resources to other projects to attempt to minimize the effects of that reduction
or termination. Accordingly, terminations, including any termination by a major
client, could adversely impact our revenues. The valuation of businesses that we
have recently acquired is based on revenues drawn from a small number of
engagements with significant clients. The loss of such a significant client
engagement may result in negative adjustments to goodwill which in turn will
affect our results from operations. We believe the uncertain economic
environment increases the probability that services may be reduced or canceled.
If we estimate incorrectly the time required to complete our projects, we will
lose money on fixed-price contracts. A portion of our contracts are fixed-price
contracts, rather than contracts in which the client pays us on a
time-and-materials basis. We must estimate the number of hours and the materials
required before entering into a fixed-price contract. Our future success will
depend on our ability to continue to set rates and fees accurately and to
maintain targeted rates of employee utilization and project quality. If we fail
to accurately estimate the time and the resources required for a project, any
required increase in the time and resources to complete the project could cause
our profits to decline.
Fluctuations in our quarterly revenues and operating results due to cyclical
client demand may lead to reduced prices for our stock. Our quarterly revenues
and operating results have fluctuated significantly in the past and we expect
them to continue to fluctuate significantly in the future. Historically, we have
experienced our greatest sequential growth during the first and second quarters.
We typically experience significantly lower sequential growth in the third and
fourth quarters. We attribute this to the budgeting cycles of our customers,
most of whom have calendar-based fiscal years and as a result are more likely to
initiate projects during the first half of the year. In 2001, this traditional
seasonal pattern was overwhelmed by a cyclical decline in information technology
spending, causing our net revenue to decline sequentially in each quarter of
2001. In February and March 2002, we did experience an increase in demand which
did allow our net revenue in the second quarter 2002 to exceed the first quarter
2002 level. We believe that increase in demand was due to positive seasonal
effects, while the subsequent lower revenue in the third quarter 2002 was due to
negative seasonal effects. In 2003, our net revenue declined sequentially for
the first three quarters of the year. We believe our traditional seasonal
pattern was overwhelmed by geopolitical events that took place early in 2003,
the most notable of these events being the war in Iraq. In the beginning of 2004
there was increased demand due to our development of new service offerings and a
general pick-up in the economy; the third and fourth quarter of 2004 were
impacted by normal seasonal effects and the commoditization of one of our
service offerings. In the first quarter of 2005 demand for one of our service
offerings declined again and out net revenue dropped. The increase in our second
quarter revenue was due to an increase in the demand for one of our service
offerings, which more than offset the decline in the demand for another of our
other practice areas. This existence of seasonal, cyclical and service offering
effects makes it more difficult to predict demand, and if we are unable to
predict client demand accurately in a slower growth or distressed economic
environment, our expenses may be disproportionate to our revenue on a quarterly
basis and our stock price may be adversely affected.
Others could claim that we infringe on their intellectual property rights, which
may result in substantial costs, diversion of resources and management
attention, and harm to our reputation. A portion of our business involves the
development of software applications for specific client engagements. Although
we believe that our services do not infringe on the intellectual property rights
of others, we may be the subject of claims for infringement, which even if
successfully defended could be costly and time-consuming. An infringement claim
against us could materially and adversely affect us in that we may:
o experience a diversion of our financial resources and management attention;
20
o incur damages and litigation costs, including attorneys' fees;
o be enjoined from further use of the intellectual property;
o be required to obtain a license to use the intellectual property, incurring
licensing fees;
o need to develop a non-infringing alternative, which could be costly and
delay projects; and
o have to indemnify clients with respect to losses incurred as a result of our
infringement of the intellectual property.
Because we are newer and smaller than many of our competitors, we may not have
the resources to effectively compete, causing our revenues to decline. Many of
our competitors have longer operating histories, larger client bases, longer
relationships with clients, greater brand or name recognition, and significantly
greater financial, technical, marketing, and public relations resources than we
do. We may be unable to compete with full-service consulting companies,
including the former consulting divisions of the largest global accounting
firms, who are able to offer their clients a wider range of services. If our
clients decide to take their strategy and technology projects to these
companies, our revenues may decline. It is possible that in uncertain economic
times our clients may prefer to work with larger firms to a greater extent than
normal. In addition, new professional services companies may provide services
similar to ours at a lower price, which could cause our revenues to decline.
Our expansion and growth internationally could negatively affect our business.
For the quarter ending September 30, 2005, our international net revenue was 39%
of total net revenue. There are additional risks associated with international
operations, which we do not face domestically and we may assume even higher
levels of such risk as we expand our ventures in Europe and India. Risk factors
associated with international operations include longer customer payment cycles,
adverse taxes and compliance with local laws and regulations. Further, the
effects of fluctuations in currency exchange rates may adversely affect the
results of operations. These risk factors, among others not cited here, may
negatively impact our business.
As offshore development becomes accepted as a viable alternative to doing work
domestically, our pricing and revenue may be negatively affected. Gradually,
over the past several decades, numerous IT service firms have been founded in
countries such as India, which have well-educated and technically trained
English-speaking workforces available at wage rates that are only a fraction of
U.S. and European wages rates. Additionally, some larger clients have
established internal IT operations at offshore locations. While traditionally we
have not competed with offshore development, presently this form of development
is seeing rapid and increasing acceptance in the market, especially for routine
and repetitive types of development. While offshore development has greater risk
due to distance, geopolitical and cultural issues, we believe its lower cost
advantage will likely overwhelm these risks. If we are unable to evolve our
service offerings to a more differentiated position or if the rate of acceptance
of offshore development advances even faster than we anticipate, then our
pricing and our revenue may be negatively affected. We have established an
offshore development capability in New Delhi, India. If we are unable to
adequately manage the additional complexity of these operations and this model
for project delivery, it may impact project quality and overall company
profitability.
Recent changes in the executive team and strategic modifications in business
structure could lead to inferior financial results if this transition does not
occur smoothly. Over the past two years Inforte has implemented several
strategic reorganization plans that comprised of simplification of the business
structure and changes in Inforte's executive management team. In December 2003,
Inforte announced the hiring of new President and Chief Operating Officer, David
Sutton, and the stepping down of Stephen Mack, both effective on that date. In
addition, in January 2005, Inforte announced in a press release and a form 8-K
that Inforte Chief Operating Officer and President David Sutton had assumed the
position of Chief Executive Officer and that Philip Bligh, while remaining as
Chairman of the Board, was stepping down as Chief Executive Officer. Mr. Sutton
has relinquished the Chief Operating Officer title and Inforte does not plan any
appointment to this position at this time. Should these changes in the executive
team adversely affect relationships with current partners and clients or lead to
higher turnover rates, we may be unable to maintain the present level of
profitability.
21
Current or future legislative and regulatory requirements, such as the
Sarbanes-Oxley Act of 2002, may lead to increased insurance, accounting, legal
and other costs, which may cause our profitability to decline. We have already
switched some supplier relationships, including our audit and tax advisor
relationship to mitigate these cost increases, and other relationships are under
review. On September 8, 2003, the Audit Committee of the Board of Directors
approved (1) the dismissal of Ernst & Young LLP (E&Y) as the Company's
independent accountants, effective November 15, 2003, and (2) the replacement of
E&Y with Grant Thornton LLP as the Company's independent accountants, commencing
upon the dismissal of E&Y. The replacement of E&Y with Grant Thornton LLP was
based on economic reasons related to possible future fees escalation in current
and forthcoming engagements of the Company's independent accountants. Further,
efforts started in 2004 to document the implementation of the requirements of
the Sarbanes-Oxley Act and for that purpose Inforte has incurred additional
costs related to the hiring of outside consultants. We expect these costs to
increase even further in 2006 and 2007 when, starting 2007, under section 404 of
the Sarbanes-Oxley Act we will be required to include, for the first time in our
Annual Report and Form 10-K management's assessment of the effectiveness of our
internal controls over financial reporting, and our independent auditors'
attestation of that assessment.
If we experience significant delays in our project plan for compliance with
Section 404 of the Sarbanes-Oxley Act of 2002, these delays could prevent us
from obtaining an unqualified attestation from our auditors. As of the date of
this report, we have developed a detailed plan coordinating the efforts required
for the management's assessment of the effectiveness of our internal controls
over financial reporting, and our independent auditors' attestation of that
assessment. If we do not timely complete and document our work, our auditors
might not have sufficient time to successfully test the management's assessment
before our Form 10-K filing for the year 2007, which would prevent us from
obtaining an unqualified attestation from our auditors. Because opinions on
internal controls have not been required in the past, it is uncertain what
impact our failure to timely complete our management's assessment of the
effectiveness of our internal controls over financial reporting could have on
our financial results, regulatory filings or our stock price.
We may not be able to integrate successfully the business of recently acquired
companies with Inforte's business. While we believe that acquisition deals
enhance our ability to offer analytics and business intelligence solutions to
our customers, acquired businesses may not be integrated successfully. This
could lead to the loss of key employees, customers or service partners or other
negative impacts. Failure to integrate newly acquired businesses successfully
could result in an inability to maintain revenue levels or to realize certain
synergies of the acquisition, which, in turn, may negatively impact our
operating results.
If PORVANSIS LLC does not generate positive cash flows from operations Inforte's
earnings may be negatively impacted and, in addition, Inforte may suffer losses
related to the note receivable from PROVANSIS LLC with respect to Inforte's
advances covering initial setup and early operations of PROVANSIS LLC. As of
September 30, 2005 Inforte owned 19% of PROVANSIS and had two options
exercisable over the next six months to increase its ownership percentage to
51%. If Inforte exercises the options to increase its ownership, the risk of
Inforte's earnings to be materially and adversely affected by PROVANSIS's losses
will significantly increase.
If an event occurs or circumstances change that would more likely than not
reduce the fair value of an acquired reporting unit below its carrying value we
may have to charge a portion of any associated goodwill balance against profits,
causing current net earning to become significantly lower or negative. The fair
value of each reporting unit is estimated quarterly using a valuation
methodology based on historical performance, forward looking performance and
industry specific multiples. If a significant change in the business climate,
legal factors, operating performance indicators, competition, sale or
disposition of a significant portion of a reporting unit causes the fair value
of the reporting unit to decline, Inforte may have to reduce the balance of any
associated goodwill, which, in turn, will negatively impact our operating
results.
If confidential personal data is lost, destroyed or mishandled in a way giving
access to unauthorized users, Inforte, and its affiliate companies may suffer as
a result of negative publicity and legal action against the company. Some of
Inforte's affiliate companies are directly involved in processing and transfer
of significant quantities of confidential personal data. Even if Inforte and its
affiliate companies are following strict procedures and guidelines for
protection of confidential personal data from unauthorized use, a possible
breach of security could result in liability for Inforte or its affiliate
companies.
22
RISKS RELATED TO OUR INDUSTRY
If the rate of adoption of advanced information technology slows substantially,
our revenues may decrease. We market our services primarily to firms that want
to adopt information technology that provides an attractive return on investment
or helps provide a sustainable competitive advantage. Our revenues could
decrease if companies decide not to integrate the latest technologies into their
businesses due to economic factors, governmental regulations, financial
constraints or other reasons. Inforte's market research suggests that the level
of information technology spending in the United States is closely linked with
the growth rate of the Gross Domestic Product (GDP). We expect information
technology spending and Inforte revenue to be highly dependent on the health of
the U.S. economy. If the overall level of business capital investment declines
this may cause our revenue to decline and remain at a lower level.
If the supply of information technology companies and personnel continues to
exceed demand, this may adversely impact the pricing of our projects and our
ability to win business. Over the last several years many firms in our industry
announced significant employee layoffs and lower rates of utilization of
billable personnel. An oversupply of technology professionals may reduce the
price clients are willing to pay for our services. An oversupply may also
increase the talent pool for potential clients who may choose to complete
projects in-house rather than use an outside consulting firm such as Inforte.
Lower utilization rates increase the likelihood that a competitor will reduce
their price to secure business in order to improve their utilization rate. The
extent to which pricing and our ability to win business may be impacted is a
function of both the magnitude and duration of the supply and demand imbalance
in our industry.
Geopolitical instability may cause our revenues to decrease. Our clients often
avoid large spending commitments during periods of geopolitical instability and
economic uncertainty. The possibility of terrorists attacking United States'
interests or geopolitical concerns in other areas such as the Middle East, south
Asia and North Korea may cause clients to freeze or slow their decision making
processes. This would slow demand for our services and would negatively impact
our revenue.
RISKS RELATED TO THE OWNERSHIP OF OUR COMMON STOCK
Our stock price could be extremely volatile, like many technology stocks. The
market prices of securities of technology companies, particularly information
technology services companies, have been highly volatile. We expect continued
high volatility in our stock price, with prices at times bearing no relationship
to Inforte's operating performance. Inforte's average trading volume during the
third quarter of 2005 averaged approximately 24,000 shares per day. On any
particular day, Inforte's trading volume can be less than 3,000 shares,
increasing the potential for volatile stock prices.
Volatility of our stock price could result in expensive class action litigation.
If our common stock suffers from volatility like the securities of other
technology companies, we have a greater risk of further securities class action
litigation claims. One such claim is pending presently. Litigation could result
in substantial costs and could divert our resources and senior management's
attention. This could harm our productivity and profitability.
Officers and directors own a significant percentage of outstanding shares and,
as a group, may control a vote of stockholders. As of September 30, 2005 our
executive officers and directors beneficially own 32.2% of the outstanding
shares of our common stock. The largest owners and their percentage ownership
are set forth below:
o Philip S. Bligh 19.8%
o Stephen C.P. Mack 9.9%
If the stockholders listed above act or vote together with other employees who
own significant shares of our common stock, they will have the ability to
control the election of our directors and the approval of any other action
requiring stockholder approval, including any amendments to the certificate of
incorporation and mergers or sales of all or substantially all assets, even if
the other stockholders perceive that these actions are not in their best
interests. Our stock repurchase program has had the effect of increasing the
concentration of insider ownership. If we make further repurchases, the
23
percentage of insider ownership could increase further. Over time, the influence
or control executive officers and directors have on a stockholder vote may
decrease as they diversify overall equity wealth with sales of Inforte stock. As
permitted by SEC Rule 10b5-1, Inforte executive officers and directors have or
may set up a predefined, structured stock trading program. The trading program
allows brokers acting on behalf of company insiders to trade company stock
during company blackout periods or while the insiders may be aware of material,
non-public information, if the transaction is performed according to a
pre-existing contract, instruction or plan that was established with the broker
during a non-blackout period and when the insider was not aware of any material,
non-public information. Inforte executive officers and directors may also trade
company stock outside of plans set up under SEC Rule 10b5-1, however, such
trades would be subject to company blackout periods and insider trading rules.
The authorization of preferred stock, a staggered board of directors and
supermajority voting requirements will make a takeover attempt more difficult,
even if the takeover would be favorable for stockholders. Inforte's certificate
of incorporation and bylaws may have the effect of deterring, delaying or
preventing a change in control of Inforte. For example, our charter documents
provide for:
o the ability of the board of directors to issue preferred stock and to
determine the price and other terms, including preferences and voting
rights, of those shares without stockholder approval;
o the inability of our stockholders to act by written consent or to call
a special meeting;
o advance notice provisions for stockholder proposals and nominations to
the board of directors;
o a staggered board of directors, with three-year terms, which will
lengthen the time needed to gain control of the board of directors; and
o supermajority voting requirements for stockholders to amend provisions
of the charter documents described above.
We are also subject to Delaware law. Section 203 of the Delaware General
Corporation Law prohibits us from engaging in a business combination with any
significant stockholder for a period of three years from the date the person
became a significant stockholder unless, for example, our board of directors
approved the transaction that resulted in the stockholder becoming an interested
stockholder. Any of the above could have the effect of delaying or preventing
changes in control that a stockholder may consider favorable.
Item 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
In all categories of cash, cash equivalents and short-term and long-term
marketable securities, Inforte invests only in highly liquid securities of high
credit quality. All short-term investments bear a minimum Standard & Poor's
rating of A1 or Moody's investor service rating of P1. All long-term investments
bear a minimum Standard & Poor's rating of A or Moody's investor service rating
of A2.
Inforte has a large cash and marketable securities balance that generates
substantial interest income. Historically, a considerable portion of Inforte's
pretax income was from interest income. Declining short-term market interest
rates will have a significant impact on Inforte's profitability as interest
income drops. Thus, a drop in short-term market interest rates will increase the
revenue level required to be profitable, and increases the risk that Inforte
will lose money.
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Item 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934,
Inforte's management, including Inforte's Chief Executive Officer and Chief
Financial Officer, conducted an evaluation, as of the end of the period covered
by this report, of the effectiveness of Inforte's disclosure controls and
procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934. Based on that evaluation, Inforte's Chief Executive Officer and Chief
Financial Officer concluded that Inforte's disclosure controls and procedures
were effective as of the end of the period covered by this report. As required
by Rule 13a-15(d) under the Securities Exchange Act of 1934, Inforte's
management, including Inforte's Chief Executive Officer and Chief Financial
Officer, also conducted an evaluation of Inforte's internal control over
financial reporting to determine whether any changes occurred during the quarter
covered by this report that have materially affected, or are reasonably likely
to materially affect, Inforte's internal control over financial reporting. Based
on that evaluation, there has been no such change during the quarter covered by
this report.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Inforte; Philip S. Bligh, Inforte's Chairman of the Board; and Stephen C.P. Mack
and Nick Padgett, each a former executive officer of Inforte, have been named as
defendants in Mary C. Best v. Inforte Corp.; Goldman, Sachs & Co.; Salomon Smith
Barney, Inc.; Philip S. Bligh; Stephen C.P. Mack and Nick Padgett, Case No. 01
CV 10836, filed on November 30, 2001 in Federal Court in the Southern District
of New York (the "Case"). The Case is among more than 300 putative class actions
against certain issuers, their officers and directors, and underwriters with
respect to such issuers' initial public offerings, coordinated as In re Initial
Public Offering Securities Litigation, 21 MC 92 (SAS) (collectively, the
"Multiple IPO Litigation"). An amended class action complaint was filed in the
Case on April 19, 2002. The amended complaint in the Case alleges violations of
federal securities laws in connection with Inforte's initial public offering
occurring in February 2000 and seeks certification of a class of purchasers of
Inforte stock, unspecified damages, interest, attorneys' and expert witness fees
and other costs. The amended complaint does not allege any claims relating to
any alleged misrepresentations or omissions with respect to our business. The
individual defendants (Messrs. Bligh, Mack and Padgett) have been dismissed from
the case without prejudice pursuant to a stipulated dismissal and a tolling
agreement. We have moved to dismiss the plaintiff's case. On February 19, 2002,
the Court granted this motion in part, denied it in part and ordered that
discovery in the case may commence. The Court dismissed with prejudice the
plaintiff's purported claim against Inforte under Section 10(b) of the
Securities Exchange Act of 1934, but left in place the plaintiff's claim under
Section 11 of the Securities Act of 1933.
Inforte has entered into a Memorandum of Understanding (the "MOU"), along with
most of the other defendant issuers in the Multiple IPO Litigation, whereby such
issuers and their officers and directors (including Inforte and Messrs. Bligh,
Mack and Padgett) will be dismissed with prejudice from the Multiple IPO
Litigation, subject to the satisfaction of certain conditions. Under the terms
of the MOU, neither Inforte nor any of its formerly named individual defendants
admit any basis for liability with respect to the claims in the Case. The MOU
provides that insurers for Inforte and the other defendant issuers participating
in the settlement will pay approximately $1 billion to settle the Multiple IPO
Litigation, except that no such payment will occur until claims against the
underwriters are resolved and such payment will be paid only if the recovery
against the underwriters for such claims is less than $1 billion and then only
to the extent of any shortfall. Under the terms of the MOU, neither Inforte nor
any of its named directors will pay any amount of the settlement. The MOU
further provided that participating defendant issuers will assign certain claims
they may have against the defendant underwriters in connection with the Multiple
IPO Litigation. The MOU is subject to the satisfaction of certain conditions,
including, among others, approval of the Court. In an order dated February 15,
2005, the Court certified settlement classes and class representatives and
granted preliminary approval to the settlement contemplated by the MOU with
certain modifications, including that the "bar order," or claims that would be
barred by the settlement, be modified consistent with the Court's opinion.
Amended settlement documents were subsequently presented to the Court and, on
August 31, 2005, the Court entered an order approving the form, substance and
program of notice of the settlement to class members and further set a hearing
concerning the fairness of the settlement on April 26, 2006. Certain of the
underwriters that are defendants in the lawsuit have appealed the Court's ruling
granting class certification.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matter to a Vote of Security Holders
None
Item 5. Other Information
None
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Item 6. Exhibits
(a) Exhibits
Exhibit Number Exhibit
10.13 Stock Purchase Agreement, dated July 15, 2005,
by and between Inforte Corp. and Dr. Glenn T.
Stoops for all of the issued and outstanding
capital stock of GTS Consulting, Inc.
10.14 Lease Agreement, dated August 19, 2005, between
The Boyce Building Group L.L.C., acting through
its managing agent Friedman Properties, Ltd.,
and Inforte Corp.
31.1 Certification by Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 and Rule 13a-14(a) and 15d-14(a)
under the Securities and Exchange Act of 1934.
31.2 Certification by Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 and Rule 13a-14(a) and 15d-14(a)
under the Securities and Exchange Act of 1934.
32 Written statement of the Chief Executive
Officer and Chief Financial Officer pursuant to
18 U.S.C. ss.1350.
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SIGNATURE
Pursuant to the requirements 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.
Inforte Corp.
By: /s/ Nick Heyes
November 14, 2005 ---------------------------------
Nick Heyes,
Chief Financial Officer
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