Patent Properties, Inc. 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the Fiscal Year Ended December 31, 2008
For the transition period from __________________ to __________________
Commission file number: 001-33700
Registrant’s telephone number, including area code: (212) 445-6262
(Former name and former address, if changed since last report)
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No x
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 o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act): Yes o No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter ($2.36) was $19,144,322. Solely for the purposes of this calculation, shares held by directors and executive officers of the registrant have been excluded. Such exclusion should not be deemed a determination or an admission by the registrant that such individuals are, in fact, affiliates of the registrant.
As of March 6, 2009, there were 13,208,210 shares of the registrant’s common stock outstanding.
GLOBALOPTIONS GROUP, INC. AND SUBSIDIARIES
December 31, 2008
TABLE OF CONTENTS
This Annual Report on Form 10-K contains forward-looking statements (as defined in Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). To the extent that any statements made in this Annual Report on Form 10-K contain information that is not historical, these statements are essentially forward-looking. Forward-looking statements may be identified by the use of words such as “expects,” “plans,” “will,” “may,” “anticipates,” “believes,” “should,” “intends,” “estimates” and other words or phrases of similar meaning. Although we believe that the expectations reflected in these forward-looking statements are reasonable and achievable, these statements are subject to a number of risks and uncertainties discussed under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Annual Report on Form 10-K. All forward-looking statements attributable to us are expressly qualified by these and other factors. We cannot assure you that actual results will be consistent with these forward-looking statements.
Information regarding market and industry statistics contained in this Annual Report on Form 10-K is included based on information available to us that we believe is accurate. Forecasts and other forward-looking information obtained from this available information is subject to the same qualifications and the additional uncertainties accompanying any estimates of future market size, revenue and market acceptance of products and services. The forward-looking statements made in this Annual Report on Form 10-K relate only to events as of the date on which the statements are made. We do not undertake any obligation to publicly update any forward-looking statements. As a result, you should not place undue reliance on these forward-looking statements.
(Dollar amounts in thousands, except per share amounts)
GlobalOptions is an integrated provider of risk mitigation and management services to government entities, Fortune 1,000 corporations and high net-worth and high-profile individuals. We enable clients to identify, assess and prevent natural and man-made threats to the well-being of individuals and the operations of governments and corporations. In addition, we assist our clients in recovering from the damages or losses resulting from the occurrence of acts of terror, natural disasters, fraud and other risks. Our vision is to continue to build a comprehensive risk mitigation solutions company through both organic growth and acquisitions. In pursuit of our strategy, we have acquired and integrated nine complementary risk mitigation businesses since August 2005 that contributed an aggregate of approximately $103,000, $84,800 and $58,900, respectively, in revenues to our business during the years ended December 31, 2008, 2007 and 2006.
We believe our reputation, credentials and personal relationships provide us with a competitive advantage in securing new business opportunities. Our senior management team and advisory boards have extensive industry backgrounds and include former generals in the military, top government officials and corporate officers, intelligence and law enforcement officers, professional investigators and legal and crisis communications specialists.
We deliver risk mitigation and management services through four business units: Preparedness Services; Fraud and SIU Services; Security Consulting and Investigations; and International Strategies. The Preparedness Services unit develops and implements crisis management and emergency response plans for disaster mitigation, continuity of operations and other emergency management issues for governments, corporations and individuals. The Fraud and SIU Services unit provides investigative surveillance, anti-fraud solutions and business intelligence services to the insurance industry, law firms and multinational organizations. The Security Consulting and Investigations unit delivers specialized security and investigative services, such as security assessments, threat analyses and forensic DNA analysis and casework, to governments, corporations and individuals. The International Strategies unit provides a full range of security and risk management services, such as global business intelligence, investigations and litigation support, and personal protection, to foreign and domestic governments, corporations and individuals.
We compete in the global security industry, focused on providing comprehensive risk mitigation and management services to government entities, Fortune 1,000 corporations and high net-worth and high-profile individuals throughout the world. The risk mitigation industry encompasses a broad range of services enabling governments, corporations and individuals to enhance security, reduce exposure to overt and covert threats and optimize preparation for and response to critical events.
Until recently, risk mitigation was defined by the actions taken by organizations following the occurrence of a critical incident. Risk mitigation firms were traditionally engaged to assess damage once a serious event, loss or security breach had occurred. Engagements were typically non-recurring in nature and usually involved a service provider offering both assistance with primarily reactive measures and high-level analysis of incidents in order to reduce losses following an event.
In recent years, the risk mitigation industry has experienced significant growth, primarily driven by the occurrence of natural and man-made disasters, heightened regulatory and compliance standards and flaws and gaps in existing risk mitigation policies and procedures. The importance of risk mitigation has evolved as governments, corporations and individuals are faced with actively managing a broad variety of elements of risk, including terrorism, litigation, fraud, compliance, business continuity, brand protection, cyber attacks, industrial espionage and regulatory issues. In response, the focus of risk mitigation has shifted to proactively evaluating, identifying, quantifying and managing elements of risk, in addition to reacting to critical events.
The risk mitigation industry is highly fragmented, comprised primarily of smaller, specialized providers of a particular service. Historically, purchasers of risk mitigation services have relied upon multiple vendors to satisfy their requirements. However, due to the growing importance of risk mitigation, we believe governments, corporations and individuals are seeking to address proactively all of their risk mitigation needs through a single solutions provider. Despite this trend, there are currently few large, independent providers capable of delivering the full range of services sought by clients. As the risk mitigation market continues to grow, we anticipate the pace of industry consolidation will increase.
We categorize the risk mitigation industry into four primary service areas: investigations and background screening; preparedness and continuity planning; security consulting; and litigation and compliance support. There are other services, such as security guard services and alarm monitoring, that are lower-margin areas of the risk mitigation industry and outside the scope of our operational focus.
Collectively, these risk mitigation services enable organizations to protect constituents, employees and stockholders as well as optimize preparation for and response to critical events. We believe these services have become vital to the operational effectiveness of organizations worldwide and that they will continue to be a primary point of emphasis going forward.
As a result of geo-political events, corporate scandals, natural and man-made disasters and increasing litigation costs, we believe proactive risk mitigation has become critical for government entities, corporations and individuals. Our target clients are now actively addressing their security needs, thereby driving increased demand for outsourced risk mitigation and management services. The emerging trend towards outsourcing these services represents a fundamental shift in demand and we believe has created a compelling opportunity for market growth in the risk assessment and mitigation industry. We believe the following key market trends define our opportunity.
Natural Disasters and Emergency Preparedness. Governments, corporations and individuals have increased their focus on disaster preparedness and prevention after witnessing the loss of life and financial impact of natural disasters and acts of terror, including Hurricane Katrina and the terror attacks of September 11, 2001. According to The Federal Emergency Management Agency (“FEMA”), in 2008, there were 75 major disaster declarations in the U.S., and public assistance for major disasters in the U.S. has averaged approximately $275,000,000 annually since 1998. While major catastrophes capture the attention of a global audience, smaller regional and localized disasters can be equally damaging to governments, corporations and individuals. We believe most government entities, corporations and individuals are not equipped to address communications continuity, coordinate a rapid response and handle insurance related issues effectively enough to satisfy their constituents, employees and stockholders.
Market Inefficiencies Created by Fraud. According to the Insurance Information Institute, the total annual cost of insurance fraud, including life and health insurance, is more than $100,000,000. The Coalition Against Insurance Fraud estimates insurance fraud’s overall impact on the consumer to be the equivalent of a hidden tax of approximately $1 per U.S. family on the cost of goods and services. We believe these market inefficiencies and the financial strain upon businesses as a result of insurance fraud have created a demand for expertise in investigative surveillance, business intelligence and other anti-fraud services.
Regulatory Complexity and Increased Litigation. We believe heightened focus on regulatory activity and corporate governance scrutiny will drive demand for risk mitigation and management services. Ineffective compliance management in today’s stringent regulatory environment can result in severe civil and criminal penalties for a company and its officers and directors. We believe the financial and business risk borne by a company, its corporate officers and directors from legislation such as the USA Patriot Act, the Federal Information Security Act, the Gramm-Leach-Bliley Act, the Health Insurance Portability and Accountability Act and the Sarbanes-Oxley Act of 2002, increases the need for industry experts to help organizations manage regulatory requirements.
Lack of Full Service Provider in a Fragmented Market. We believe the heightened focus on emergency preparedness and response, the escalating costs of fraud and the proliferation of regulatory scrutiny have created the need for an efficient provider of comprehensive risk mitigation and management services. Several of the traditional leaders in our industry have been acquired or evolved their business model, and we believe niche providers that offer limited services on a local scale are unable to meet the full range of their clients’ needs, leaving a service gap. We believe the drivers of increased risk assessment and mitigation spending are likely to continue into the foreseeable future and, as a provider of a comprehensive suite of customized services, we should benefit as the market opportunity grows.
We are committed to providing comprehensive risk mitigation and management services. We believe the following factors are strengths of our company and provide us with key competitive advantages.
Comprehensive Risk Mitigation Solutions. We have assembled what we believe to be core services utilized by clients seeking risk mitigation solutions. We are therefore able to offer a comprehensive suite of customized services designed to address each client’s specific needs. Our service offerings have been enhanced through our proprietary systems, such as GlobalTrak™, which provides both client and internal personell access to real-time, web-based reporting, communications and fraud program management tools, and through advanced technologies, such as the forensic DNA capabilities of the Bode Technology Group (“Bode”), part of our Security Consulting Investigations Unit.
Reputable and Resourceful Management and Advisory Boards. Due to the critical and sensitive nature of risk mitigation and investigative engagements, we believe the ability to provide services and retain clients is driven largely by reputation and personal relationships. Our senior management and advisory boards have exceptional credentials and well-established relationships. Their experience and former titles include: a Brigadier General in the U.S. Air Force; a Director of FEMA; a New York City Police Commissioner; a Director of the FBI; a U.S. Secretary of Transportation; a Director of the CIA; and U.S. Ambassadors and high-ranking corporate executives. We believe this level of expertise provides credibility with clients and access to key decision-makers within government and industry.
Experienced Senior Management Team and Professionals. Our senior management team and professionals include individuals with vast industry experience. These individuals have the operational experience to execute sensitive and critical engagements, enabling us to effectively deliver solutions to our clients. Our management team has demonstrated the ability to lead the integration of acquisitions, retain top talent and drive organic growth from the combined business units.
Demonstrated Success with Strategic Acquisitions. Since August 2005, we have executed and integrated nine strategic acquisitions and retained selected key professionals, many as senior management. These acquisitions have contributed to our rapid growth in revenues, number of professionals, vertical industry coverage, areas of functional expertise, geographic presence and brand recognition. We believe our success with these acquisitions to be a key competitive advantage when pursuing additional acquisitions to broaden and deepen the scope of our services.
Our goal is to build a company with the risk mitigation industry’s most comprehensive solutions offering through a balance of organic growth and acquisitions. We intend to grow our business in the following manner.
Leverage Our Relationships and Expertise. Our highly trained professionals have deep domain expertise and exceptional credentials. Further, our advisory boards are comprised of thought leaders in their respective fields. Since our industry relies heavily on reputation and trust, we believe our senior management team’s and advisory boards’ experience and relationships will help us gain access to an increasing number of opportunities.
Cross-sell and Integrate Businesses. We intend to continue our aggressive efforts to integrate the operations of companies we have acquired and will acquire, providing the framework necessary for our senior managers to focus on identifying, prospecting and winning new opportunities across all business units. We believe our operational expertise and comprehensive service offerings enable us to cross-sell over industry verticals as well as leverage our existing client base, thereby enhancing our ability to execute on our organic growth initiatives.
Selectively Acquire Companies. We will continue to pursue complementary acquisitions of companies that enable us to increase our share of those markets in which we already operate and to enter new markets and service segments. We believe there are numerous opportunities to acquire quality companies because of the fragmented nature of our industry and that our past acquisitions track record will assist us in executing this strategy. We expect these acquisitions to be geographically diverse, provide synergies within units and allow for cross-selling opportunities across all of our business units. We structure our acquisitions to ensure that key selected individuals from the acquired company are retained and integrated after the transaction is consummated.
Develop New Solutions. We will continue to develop and seek solutions to meet unique client and dynamic market segment needs by expanding and bundling our product and service offerings. As we continue to grow both organically and through acquisitions, we expect to meet additional needs of our clients. Evidence of this strategy is the continuing expansion of the capabilities of our enterprise-oriented solution, GlobalTrak. Through our GlobalTrak platform we are building more enhanced client interface and support capabilities and additional tools to help us more efficiently manage our investigations. Our DNA technology service we offer through Bode continues to develop new tools and technologies.
Expand Internationally. We intend to pursue additional opportunities to offer our services outside the United States. We believe international markets provide a substantial opportunity for growth given the increasing risks that businesses and governments face around the world. We expect that by expanding our offerings to other countries we will also enhance our ability to compete in the United States for the business of global organizations.
Our Business Units
We deliver risk mitigation and management services through four business units: Preparedness Services; Fraud and SIU Services; Security Consulting and Investigations; and International Strategies.
The Preparedness Services unit develops and implements crisis management and emergency response plans for disaster mitigation, continuity of operations and other emergency management issues for governments, corporations and individuals. We offer a full range of services to help our clients better prepare for, respond to and recover from disasters. We believe our ability to mobilize management, security and communications resources in an expedited manner differentiate us from our competitors. Services we provide include:
The Preparedness Services unit is comprised of James Lee Witt Associates, LLC (“JLWA”) and is led by former FEMA Director James Lee Witt. Our staff includes seasoned crisis and emergency management leaders with significant experience in the public sector. Our Preparedness Services unit has 63 full-time employees and 4 part-time employees and is headquartered in Washington, D.C.
For the year ended December 31, 2008, we completed 98 crisis management and emergency response projects with average revenue of approximately $399. Preparedness Services accounted for approximately 38% of our revenues for the year ended December 31, 2008.
Fraud and SIU Services
The Fraud and SIU Services unit provides investigative surveillance, anti-fraud solutions and business intelligence services to the insurance industry, law firms and multinational organizations. We provide services to clients both nationally and regionally through licensed investigators in all 50 states, as well as internationally through affiliates. Our investigators provide reports and intelligence on subjects such as workman’s compensation surveillance, unfair trade practices, political trends, economic forecasts, profiles on competitors and satellite reconnaissance. Services we provide include:
Our proprietary GlobalTrak technology enables us to deliver real-time, web-based reporting, communications and fraud program management. By automating and streamlining investigative processes, GlobalTrak provides our clients with more expedient and cost-effective service. Our comprehensive software enables adjusters, claims representatives, risk managers and SIU departments to securely access and download status updates, including case receipts, assignments, work schedules, results of investigative activity, investigative reports and streaming video and audio. We believe GlobalTrak is a significant competitive differentiator and offers our clients a valuable enterprise solution.
The Fraud and SIU Services unit is comprised of the following acquired companies: Confidential Business Resources (“CBR”); Hyperion Risk, Inc. (“Hyperion Risk”); Secure Source, Inc (“Secure Source”); Facticon, Inc. (“Facticon”); and First Advantage Investigative Services (“FAIS”). This unit is led by Halsey Fischer, a 20-year industry veteran and former President and Chief Executive Officer of CBR. Our investigative team includes highly educated and trained investigators who utilize extensive public and proprietary databases to uncover factual circumstances surrounding sensitive investigations. Our experts are capable of handling any type of investigative need anywhere in the world. Our anti-fraud services are national in scope, but local in expertise. Headquartered in Nashville, TN, the Fraud and SIU Services unit has 267 full-time and 115 part-time employees and has offices in southern California, Chicago, Dallas, Detroit, Orlando and Philadelphia.
For the year ended December 31, 2008, we completed 34,891 investigations and anti-fraud projects with average revenue of just under $1. Fraud and SIU Services accounted for approximately 30% of our revenues for the year ended December 31, 2008.
Security Consulting and Investigations
The Security Consulting and Investigations unit delivers specialized security and investigative services to governments, corporations and individuals. We provide security assessments, anti-terrorism training, threat analyses, fraud prevention techniques, special event security, private travel management and the design, implementation and management of security systems. Services we provide include:
Through Bode we are able to provide forensic DNA analysis, highly advanced and proprietary DNA collection products and research services to law enforcement agencies, federal and state governments, crime laboratories and disaster management organizations.
Our Security Consulting and Investigations unit is comprised of the following acquired companies: Safir Rosetti, LLC (“Safir”); Bode and SPZ Oakland Corporation, dba On Line Consulting Services, Inc. (“On Line Consulting”). This unit is led by Howard Safir, former New York City Police Commissioner. Our national network of security and investigative personnel has extensive backgrounds in the fields of security, investigations, intelligence, law enforcement and public safety. Headquartered in New York, NY, we have 141 full-time and 11 part-time employees in the Security Consulting and Investigations unit and have offices in Chicago, Dallas, Los Angeles Oakland, San Francisco and Lorton, VA.
For the year ended December 31, 2008, we completed 1,175 security and investigation projects (excluding Bode) with average revenue of $15. During the year ended December 31, 2008, Bode completed 112,085 DNA related projects with average revenue of about $1. Security Consulting and Investigations (including Bode) accounted for approximately 32% of our revenues for the year ended December 31, 2008.
The International Strategies unit provides multidisciplinary, international risk management and business solutions. We offer a full range of security and risk management services to foreign and domestic governments, corporations and individuals. We are experts at managing problems, clarifying decision-support situations and protecting or saving value and reputations, or even human lives. Services we provide include:
The International Strategies unit was our original core business and is led by Thomas Ondeck, a founder of GlobalOptions. Our management team, staff and advisory boards are comprised of legal experts, military and intelligence veterans, former senior policy makers, private investigators, security professionals and public relations experts who have deep relationships and extensive database expertise. Our security professionals have experience securing everything from pipelines and financial centers to chemical weapons factories, corporate headquarters and major sports and entertainment venues. Our private investigators assist law firms and corporations in managing legal battles in the U.S. and abroad. Headquartered and operated in Washington, D.C., we employ nine full-time employees and one part-time employee.
International Strategies is not a separate reporting segment and as such we attribute its revenues to the Fraud and SIU Services unit. We believe the unit has attractive prospects as we continue to execute our growth strategy.
GlobalOptions, Inc., our wholly-owned operating subsidiary, was initially formed as a limited liability company in the state of Delaware in November 1998 and converted into a Delaware corporation on January 24, 2002. On June 24, 2005, we became a public company by completing a reverse merger transaction, in which GlobalOptions Acquisition Corp., a Delaware corporation and our newly created, wholly owned subsidiary, merged with and into GlobalOptions, Inc. As a result of the reverse merger, GlobalOptions, Inc. became our wholly owned operating subsidiary, with GlobalOptions, Inc.’s former security holders acquiring a majority of the outstanding shares of our common stock. At the time of the reverse merger, our corporate name was Creative Solutions with Art, Inc., a Nevada corporation. Following the reverse merger, we changed our name to GlobalOptions Group, Inc. On December 8, 2006, we completed a reincorporation merger whereby we changed our state of incorporation from Nevada to Delaware.
History of Acquisitions
Since becoming a public company in June 2005, we have actively pursued our acquisition strategy.
On August 14, 2005, we purchased substantially all of the assets and liabilities of CBR, a nationwide investigations firm based in Nashville, Tennessee. CBR was the foundation acquisition for our Fraud and SIU Services unit. The CBR acquisition provides us with significant capabilities in the intelligence gathering, surveillance, investigation, risk reduction and litigation exposure reduction fields.
On March 10, 2006, we purchased substantially all of the assets and liabilities of JLWA, a crisis and emergency consulting management firm based in Washington, D.C. JLWA is the only business within our Preparedness Services unit. The JLWA acquisition bolsters our presence in the public safety, crisis and disaster management markets.
On May 12, 2006, we acquired substantially all of the business and assets of Safir, a security consulting, investigative and intelligence firm headquartered in New York City with seven additional offices nationwide. Safir was the foundation acquisition for our Security Consulting and Investigations unit. The Safir acquisition provides us with expertise in corporate and government risk management and the protection of critical infrastructure.
On May 12, 2006, we acquired substantially all of the business and assets of Secure Source, an international risk consulting firm with offices in Washington D.C. and Dallas, Texas. The Secure Source acquisition augments our Fraud and SIU Services unit by providing key capabilities in crisis management, business intelligence, due diligence, executive protection and computer forensics.
On August 10, 2006, we acquired substantially all of the business and assets of Hyperion Risk, a security consulting, investigative and intelligence firm based in Orlando, Florida. The Hyperion Risk acquisition provides additional investigative services such as surveillance, fraud protection and threat assessment to our Fraud and SIU Services unit.
On January 9, 2007, we acquired substantially all of the business and assets of On Line Consulting, a full-service security and fire alarm consulting and design firm headquartered in Oakland, California. The On Line Consulting acquisition adds security and communications systems expertise to our Security Consulting and Investigations unit.
On February 28, 2007, we acquired all of the outstanding common stock of Bode, which provides forensic DNA analysis, proprietary DNA collection products and related research services to law enforcement agencies, federal and state governments, crime laboratories and disaster management organizations. The Bode acquisition significantly expands the size of our Security Consulting and Investigations unit.
On February 28, 2007, we acquired substantially all of the business and assets of Facticon, a surveillance, investigative and business intelligence firm based in Chadds Ford, Pennsylvania. The Facticon acquisition expands our Fraud and SIU Services unit’s risk mitigation expertise in the insurance, legal, business and financial industries.
On April 21, 2008, we acquired substantially all of the business and assets of FAIS related to our Fraud and SIU Services unit. The FAIS acquisition expands our Fraud and SIU Services unit’s risk mitigation expertise in the legal, business and insurance industries.
Underwritten Public Offering
On October 29, 2007, we completed an underwritten public offering of 4,500,000 shares of our common stock, receiving approximately $20,250 in gross proceeds ($18,200 in net proceeds).
We used a portion of the net proceeds from the proposed underwritten public offering to repay $4,300 of notes and $38 of related accrued interest and have been using the balance of the net proceeds for working capital and general corporate purposes.
In connection with the underwritten public offering, on October 29, 2007 we entered into an agreement with Canaccord Adams Inc. and Morgan Keegan & Company, Inc., as underwriters, who were paid aggregate fees of $1,418.
We have completed engagements for clients globally, including foreign, federal, state and local government entities, domestic and foreign Fortune 1,000 corporations, and high net-worth and high-profile individuals. We frequently work with clients on multiple assignments. As required by the highly confidential nature of our work, we keep the identities of our clients strictly confidential.
For the years ended December 31, 2008, 2007 and 2006, a limited number of clients accounted for a substantial percentage of our total revenues. For the year ended December 31, 2008, our two largest clients accounted for approximately 26% and 8% of our revenues. For the year ended December 31, 2007, our two largest clients accounted for approximately 29% and 9% of our revenues. For the year ended December 31, 2006, our two largest clients accounted for approximately 51% and 11% of our revenues. Revenues from our largest client, the State of Louisiana,. accounted for 68%, 83%, and 84% of the revenues generated by our Preparedness Services unit during the years ended December 31, 2008, 2007 and 2006, respectively.
Sales and Marketing
Our business is intensely personal due to the highly confidential nature of the engagements and the critical nature of the brands, reputations, competitive positions and overall market perceptions that our services support. We believe our ability to provide services and retain clients is driven largely by reputation and personal relationships. Our senior management team and advisory boards have exceptional backgrounds and include former generals in the military, top government officials and corporate officers, intelligence and law enforcement officers, professional investigators and legal and crisis communications specialists, each of whom can leverage relationships with leaders in both the corporate and government markets.
We believe these relationships give us the opportunity to bring in high-margin, well-known clients and our operational experience allows us to successfully complete these critical engagements. The success of this strategy is demonstrated by the recurring nature of our business with established clients. New opportunities typically arise from the ongoing relationships that our management personnel have with their client counterparts. As executives move to different companies or agencies, they often call upon us in their new environment.
Our sales and marketing strategy is to maintain and expand our reputation and track record, the quality of the services we deliver and the skills and character of the people we deploy on client engagements. In doing so, we intend to provide the high level of investigative, litigation support, crisis management, risk management and protective services demanded by our clients.
The market for risk mitigation services is very competitive, highly fragmented and subject to rapid change. We operate in a number of geographic and service markets, all of which are highly competitive. We believe the principal competitive factors and key differentiators in this market are reputation, relationships, expertise, quality and scope of service and size of institution. Therefore, new market entrants as well as existing competitors that have strong brand recognition or highly recognized principals in the risk mitigation industry likely pose the greatest threat to our business. We believe, however, our reputation and the breadth and depth of our services provide us with key competitive strengths and differentiate us from our competitors.
Competitors in the risk management and security market include Control Risks Group Limited, ArmorGroup International plc, Kroll Inc., Toribos GmbH and Olive Security (UK) Ltd. Additionally, many of the national and international accounting and consulting firms, along with other companies such as FTI Consulting, Inc., Securitas AB and its subsidiary, Pinkerton Consulting & Investigations, Inc., Alvarez & Marsal, LLC, AlixPartners LLC, XRoads LLC, and LexisNexis Applied Discovery, provide investigative, consulting and other services that are similar to services we provide.
As of February 18, 2009 the Company had 480 full-time and 131 part-time employees. We enjoy good employee relations. None of our employees are members of any labor union, and we are not a party to any collective bargaining agreement.
Due to our participation in government contracts, we are subject to audit from time to time for our compliance with government regulations by various agencies. Government agencies may also periodically conduct inquiries or investigations that may cover a broad range of our activities. We believe we operate our business in material compliance with all applicable federal, state and local government regulations and contracts.
We hold a number of General Services Administration (“GSA”) Federal Schedules, which enable federal and state agencies to buy services and products from us. We are required to be in compliance with the Federal Acquisition Regulations (“FAR”) in providing these services and products to our federal and state government clients. We are subject to audit by the GSA to assure we maintain compliance with these requirements.
In addition to maintaining our compliance with the FAR and the GSA, some contracts we have with state agencies contain additional requirements. While most states follow the FAR, in each contract, the state may require additional rules and regulations to maintain compliance with each contract. In providing services under each contract, we must be in compliance with contract rules and regulations before we can invoice under the contract. Before making any payments under a contract, a state will review our compliance.
Our investigation and surveillance business must be in compliance with each state’s licensing requirements for providing these services. In each state that we operate our investigation and surveillance business, we maintain the necessary licensing requirements to do business.
Any investment in our common stock involves a high degree of risk. You should consider carefully the specific risk factors described below in addition to the other information contained in this prospectus, including our consolidated financial statements and related notes included elsewhere in the prospectus, before making a decision to invest in our common stock. If any of these risks actually occurs, our business, financial condition, results of operations or prospects could be materially and adversely affected. This could cause the trading price of our common stock to decline and a loss of all or part of your investment.
(Dollar amounts in Thousands, except per share amounts)
Risks Related to Our Business and Industry
We are an emerging company with a history of operating losses and may not become profitable.
We were founded in 1998 and are still in the process of developing our four business units: Preparedness Services; Fraud and SIU Services; Security Consulting and Investigations; and International Strategies. We have incurred significant operating losses since inception, including net losses available to common stockholders of approximately $7,956, $27,928 and $42,259 for the years ended December 31, 2008, 2007 and 2006, respectively. We cannot anticipate when or if we will achieve profitability in the future. We may not generate sufficient revenues to meet our expenses, operate profitably or utilize our net operating losses in the future.
Our arrangements with members of our senior management team, or our failure to retain or recruit key personnel, could negatively impact our ability to sell our products and services and grow our business.
Our success will depend to a significant extent upon the abilities, level of service, reputation and relationships of members of our senior management team, our Board of Directors and our advisory boards. Some members of our senior management team work on a part-time basis and some do not have non-competition agreements with us. These arrangements, or any reduction or loss of these individuals’ services, could have a material adverse effect upon our business, particularly if any of our key personnel sought to compete against us.
Our future success and growth also largely depends upon our ability to attract, motivate and retain additional highly competent technical, management, service and operations personnel. The marketplace for these qualified individuals is highly competitive in the risk mitigation industry, and we cannot guarantee that we will be successful in attracting and retaining this personnel. Departures and additions of key personnel may be disruptive to and detrimentally affect our business, operating results and financial condition.
Because a small number of clients account for a substantial portion of our revenues, the loss of any of these clients, or a decrease in their use of our services, could cause our revenues to decline and losses to increase substantially.
Revenues from our services to a limited number of clients have accounted for a substantial percentage of our total revenues. For the year ended December 31, 2008, our largest client accounted for approximately 26% of revenues. For the year ended December 31, 2007, our largest client accounted for approximately 29% of revenues. For the year ended December 31, 2006, our two largest clients accounted for approximately 51% and 11% of revenues. Revenues from our largest client, the State of Louisiana, accounted for 68%, 83%, and 84% of the revenues generated by our Preparedness Services unit during the years ended December 31, 2008, 2007 and 2006, respectively. Our contract with the State of Louisiana, is a time and materials contract under which the State is not required to purchase a minimum amount of our services. Therefore, this contract could cease producing revenues at any time with little or no notice.
The concentration of our clients can cause our revenues and earnings to fluctuate from quarter-to-quarter and year-to-year, based on the requirements of our clients and the timing of delivery of services. Although the particular clients are likely to change from period to period, we believe that large engagements by a limited number of clients will continue to account for a substantial portion of our revenues in any period or year. In any period or year, the unexpected loss of or decline in business from a major client, or the failure to generate significant revenues from other clients, could have a material adverse effect on our consolidated financial results.
The integration of acquired companies may be difficult and may result in a failure to realize some of their anticipated potential benefits.
We may not be able to integrate or manage businesses that we have acquired or may acquire. Any difficulty in successfully integrating or managing the operations of acquired businesses could have a material adverse effect on our business, financial condition, results of operations or liquidity, and could lead to a failure to realize any anticipated synergies. Our management team also will be required to dedicate substantial time and effort to the integration of any acquisitions. These efforts could divert management’s focus and resources from other strategic opportunities and operational matters.
We may have difficulty pursuing our acquisition strategy.
A key part of our growth strategy is to acquire complementary businesses. However, we may not be able to identify suitable acquisition candidates, obtain the capital necessary to pursue our acquisition strategy or complete acquisitions on satisfactory terms or at all. A number of competitors have also adopted a strategy of expanding and diversifying through acquisitions, including National Security Solutions Inc., blank check company of which Howard Safir, our Chief Executive Officer of our Security Consulting and Investigations Unit, and Adam Safir, our Chief Operating Officer of our Security Consulting and Investigations Unit, are the Chairman of the Board and a director, respectively. Such persons may have conflicting interests in presenting acquisition opportunities to National Security Solutions Inc. and us. In addition, we will likely experience significant competition in our effort to execute our acquisition strategy. As a result, we may be unable to continue to make acquisitions or may be forced to complete acquisitions on less favorable terms.
Our business is vulnerable to fluctuations in government spending and subject to additional risks as a result of the government contracting process, which often involves risks not present in the commercial contracting process.
Because many of our contracts are with government entities, our business is subject to a number of risks, including global economic developments, wars, political and economic instability, election results, changes in the tax and regulatory environments, foreign exchange rate volatility and fluctuations in government spending. Because many clients are federal, state or municipal government agencies with variable and uncertain budgets, the amount of business that we might receive from them may vary from year to year, regardless of the perceived quality of our business.
Moreover, competitive bidding for government contracts presents a number of risks that are not typically present in the commercial contracting process, including:
If we are unable to consistently win new government contract awards over an extended period, or if we fail to anticipate all of the costs and resources that will be required to secure such contract awards, our growth strategy and our business, financial condition and operating results could be materially adversely affected.
Our professional reputation, which is critical to our business, is especially vulnerable to circumstances outside our control>.
We depend upon our reputation and the individual reputations of our senior management team and advisory boards to obtain new client engagements. We also obtain a substantial number of new engagements from existing clients or through referrals from existing clients. Anything that diminishes our reputation or the reputations of our senior management team and advisory boards may make it more difficult to compete for new engagements or to retain existing clients and, therefore, could materially adversely affect our business. For example, a national television news story in 2007 that contained allegations regarding JLWA’s performance and billing practices under our contract with the State of Louisiana prompted a State auditor to review these allegations. Although we were awarded and subsequently executed a renewal contract with the State, the State may terminate this new contract without penalty upon limited notice. Any circumstances, including those where we are not at fault, and including any repercussions from the above events, that might publicly damage our goodwill, injure our reputation or damage our business relationships may lead to a broader material adverse effect on our business or prospects through loss of business, goodwill, clients, agents or employees. In particular, if the State of Louisiana were to terminate our contract, it may have a material adverse effect on our business.
Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse effect on our business and operating results. In addition, current and potential stockholders could lose confidence in our financial reporting, which could cause our stock price to decline.
Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our business could be harmed.
As a public company, we are required to document and test our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management assessments of the effectiveness of our internal control over financial reporting. Furthermore, our registered independent public accounting firm will be required to report on our assessment of the effectiveness of our internal control over financial reporting and separately report on the effectiveness of our internal control over financial reporting beginning with our fiscal year ending December 31, 2009.
Failure to maintain an effective internal control environment could cause us to face regulatory action, result in delays or inaccuracies in reporting financial information or cause investors to lose confidence in our reported financial information, any of which could cause our stock price to decline.
In order to comply with public reporting requirements, we may need to strengthen the financial systems and controls of any business we acquire, and the failure to do so could adversely affect our ability to provide timely and accurate financial statements.
Immediately upon the acquisition of any company, we will be responsible for ensuring that the disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) of any acquired company are effectively designed, operated and integrated with our disclosure controls and procedures. Our management and our independent registered public accounting firm may be required to test any acquired business’s internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing of internal control by our independent registered public accounting firm, may reveal deficiencies in an acquired company’s financial systems that are deemed to be material weaknesses with respect to our financial systems. The existence of these material weaknesses or any failure to improve an acquired company’s financial systems could result in delays or inaccuracies in reporting financial information, or non-compliance with SEC reporting and other regulatory requirements, any of which could subject us to sanctions from the SEC and The NASDAQ Stock Market LLC and adversely affect our business and stock price.
Our business depends, in part, on the occurrence of unpredictable events.
Our Preparedness Services unit assists governments, corporations and individuals in connection with, among other things, emergency management issues and natural and other disaster preparedness and recovery efforts. Our revenues may fluctuate significantly depending upon the occurrence, or anticipated occurrence, of events of this nature. For example, for the years ended December 31, 2008 and 2007, 26% and 29% of the Company’s revenues, or 52% and 61% of the Company’s revenues from government contracts, respectively, were generated by one contract with the State of Louisiana. Accordingly, any decrease in demand for our services in this area could materially adversely affect our results of operations.
We may not be able to manage our growth or meet marketplace demands effectively.
We have expanded significantly in the past few years and intend to maintain our focus on growth. However, our growth will place additional demands on our resources and we cannot be sure that we will be able to manage our growth effectively. In order to successfully manage our growth, we will need to:
Continued growth could place a strain on our management, operations and financial resources. In addition, this growth may adversely affect our ability to service the demands of our clients or the quality of services we provide. If we are unable to meet these demands or our clients’ expectations, our competitors may be able to gain a greater market share in the risk mitigation markets generally, as well as gain a greater share of our clients’ business. We cannot assure you that our infrastructure, operational, financial and management controls, reporting systems and procedures, facilities and personnel will be adequate to support our future operations or to effectively adapt to future growth. Our expected addition of personnel and capital investments will increase our fixed costs, which will make it more difficult for us to offset any future revenue shortfalls with short-term expense reductions. If we cannot manage our growth effectively, our business and results of operations may be adversely affected.
We may not be able to realize the entire book value of goodwill from acquisitions.
As of December 31, 2008, we had approximately $19,968 of goodwill, which represented approximately 29% of our total assets. All of this goodwill resulted from previous acquisitions, and it is possible that future acquisitions will result in additional goodwill. We have implemented the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142), which requires that existing goodwill not be amortized, but instead be assessed annually for impairment or sooner if circumstances indicate a possible impairment. We determined that, at December 31, 2007, the amount of goodwill carried by our Fraud and SIU Services segment was in excess of fair value by approximately $5,144. As a result, we recorded a $5,144 impairment charge during the year ended December 31, 2007. In the event that we again determine the book value of goodwill is further impaired, any such impairment would be charged to earnings in the period of impairment. Any such future impairment of goodwill under SFAS No. 142 could have a material adverse effect on our results of operations.
Competitive conditions could adversely affect our business.
We operate in a number of geographic and service markets, all of which are highly competitive. There are relatively few barriers preventing companies from competing with us and we do not own any patents or other technology that, by itself, precludes or inhibits others from entering our markets. As a result, new market entrants, particularly those who already have recognizable names in the risk mitigation industry, will likely pose a threat to our business. If we are unable to respond effectively to our competitors, some of which have greater financial resources or name recognition, our business and results of operations will be materially adversely affected. In the risk management and security market, our competitors include Control Risks Group Limited, ArmorGroup International plc, Kroll Inc., Toribos GmbH and Olive Security (UK) Ltd. Many of the national and international accounting and consulting firms, along with other companies such as FTI Consulting, Inc., Securitas AB and its subsidiary, Pinkerton Consulting & Investigations, Inc., Alvarez & Marsal, LLC, AlixPartners LLC, XRoads LLC, and LexisNexis Applied Discovery, provide investigative, consulting and other services which are similar to services we provide. Some of these firms have indicated an interest in providing services on a broader scale similar to ours and may prove to be formidable competitors if they elect to devote the necessary resources to these competitive businesses. The national and international accounting, consulting and risk management firms have significantly larger financial and other resources than we have, greater name recognition and long-established relationships with their clients, which also are likely to be clients or prospective clients of our company.
We are a worldwide business and are therefore influenced by factors and regulations in many countries.
We undertake our business worldwide. The occurrence of any of the following risks relating to the conduct of our business in foreign countries could have a material adverse effect on the market for our services, their value to our clients or our ability to provide them:
The occurrence of any of these risks could materially adversely affect our results of operations or financial condition.
Clients can terminate engagements with us on short notice or with no notice.
A majority of our engagements are project-based and are generally terminable by either party on short-term notice. As a result, our clients, including the State of Louisiana under the contract that it awarded to us in September 2007, are not obligated to continue using our services at historical levels or at all, and may cancel their arrangements with us without penalty. Identifying and engaging new clients can be a lengthy and difficult process. If a significant amount of our clients cease using our services around the same time, we could experience an adverse effect on our results of operations.
Our inability to accurately forecast costs of fixed price contracts could result in lower than expected margins and profitability.
The profitability of fixed price projects is primarily determined by our success in correctly estimating and thereafter controlling project costs. Costs may in fact vary substantially as a result of various factors, including underestimating costs, need for unforeseen specialized subcontractors, difficulties with new technologies and economic, regulatory and other changes that may occur during the term of the contract. If for any reason the costs are substantially higher than expected, we may incur losses on fixed price contracts and our profitability could be adversely affected.
We may need to raise additional funds to consummate an acquisition or continue our operations.
An unforeseen reduction in our revenues or cash flows, an increase in operating expenses or the consummation of an acquisition may require us to raise additional funds. To the extent we identify additional opportunities to raise cash, we may sell additional equity or convertible debt securities, which would result in further dilution of our stockholders. Stockholders may experience substantial dilution due to our current stock price and the amount of financing we may need to raise, and any securities we issue may have rights senior to our common stock. Any future indebtedness may contain covenants that restrict our operating flexibility.
We have limited access to the capital markets. The capital markets have been unpredictable in the past, especially for smaller companies or for unprofitable companies such as ours, and recent contractions in the capital markets have generally made financing more difficult to obtain. In addition, the amount of capital that a company such as ours is able to raise often depends on variables that are beyond our control, such as the share price of our stock and its trading volume. As a result, efforts to secure financing on terms attractive to us may not be successful, and we may not be able to secure additional financing on any terms.
If we are able to consummate a financing arrangement, the amount raised may not be sufficient to meet our future needs. If adequate funds are not available on acceptable terms, or at all, our business, results of operations and financial condition may be materially adversely affected.
Compliance with changing corporate governance and public disclosure regulations may result in additional expenses.
Keeping abreast of, and in compliance with, changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and The NASDAQ Stock Market LLC’s marketplace rules, require a substantial amount of management attention and financial and other resources. We intend to continue to invest all reasonably necessary resources to comply with evolving standards, which may result in increased general and administrative expenses and divert management from revenue-generating activities.
We may become subject to significant legal proceedings.
We are subject from time to time to litigation and other adverse claims related to our businesses, some of which may be substantial. These claims have in the past been, and may in the future be, asserted by persons who are screened by us, regulatory agencies, clients or other third parties. Matters such as these, in which we may become defendants, may negatively impact our results of operations or cash flows, as well as our reputation.
Our exposure in a future liability action could exceed our insurance coverage>.
Some of our service offerings involve high risk activities. We may not be able to maintain insurance at levels of risk coverage or policy limits that we deem adequate for any of our activities and cannot guarantee that every contract contains or will contain limitations on our liability below these policy limits. Because of the increasing cost of liability insurance, purchasing sufficient amounts of insurance coverage, or additional insurance when needed, could be prohibitively expensive. If we are sued for any injury caused by our business offerings, our liability could exceed our total assets. Any claims against us, regardless of their merit or eventual outcome, could have a detrimental effect upon our business, operating results and financial condition.
We may be subject to increased regulation regarding the use of personal information.
Some of the data and services that we provide, including DNA testing conducted by Bode, are subject to regulation by various federal, state and local regulatory authorities, which may become more stringent in the future. Federal, state and local laws and regulations in the United States designed to protect the public from the misuse of personal information in the marketplace, and adverse publicity or potential litigation concerning the commercial use of such information, may negatively affect our operations and could result in substantial regulatory compliance expense, litigation expense or revenue loss.
If we are unable to manage successfully our relationships with our information suppliers, the quality and availability of our services may be harmed.
We obtain some of the data used in our services from third-party information suppliers, some of which are government entities. If a supplier is no longer able or willing to provide us with data, we may need to find alternative sources. There is no assurance that we will obtain new agreements with third-party suppliers on favorable terms, if at all. If we are unable to identify and contract with suitable alternative data suppliers and integrate these data sources into our service offerings, we could experience service disruptions, increased costs and reduced quality of our services. Loss of such access or the availability of data in the future due to increased government regulation or otherwise could have a material adverse effect on our business, financial condition or results of operations.
Risks Related to Our Common Stock
Our common stock price has fluctuated considerably and stockholders may not be able to resell their shares at or above the price at which their shares were purchased.
Since our reverse merger in June 2005, the high and low bid price for our common stock has been $32.00 and $1.34 per share, respectively. The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including the following:
The stock market in general has experienced extreme price fluctuations. The market prices of shares of companies in the security industry have experienced fluctuations that often have been unrelated or disproportionate to the operating results of these companies. Continued market fluctuations could result in extreme volatility in the price of our common stock, which could cause a decline in the value of our common stock. Price volatility might be worse if the trading volume of our common stock continues to be low.
Our common stock has historically been sporadically or thinly traded. While our common stock became listed on the NASDAQ Capital Market on September 26, 2007, there is no guarantee that our trading volume will increase. As a result, the number of persons interested in purchasing our common stock at or near ask prices at any given time may be relatively small or non-existent. This situation is attributable to a number of factors, including the fact that stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume may be reluctant to follow an unproven company such as ours or purchase or recommend the purchase of our common stock until we demonstrate that we can consistently operate profitably. As a consequence, there may be periods of several days or more when trading activity in our shares is low and a stockholder may be unable to sell his shares of common stock at an acceptable price, or at all. We cannot give stockholders any assurance that a broader or more active public trading market for our common stock will develop or be sustained, that current trading levels will be sustained or that we will continue to meet the requirements for listing on the NASDAQ Capital Market.
A significant number of our shares recently became eligible for sale, and their sale could depress the market price of our common stock.
On February 17, 2009, we issued 2,817,235 shares of our common stock upon the conversion of 42,258.53 shares of our Series D Convertible Preferred Stock.
As of March 6, 2009, there were approximately 13,208,210 shares of our common stock outstanding and, subject to a 4.99% beneficial ownership limitation, an additional 875,317 shares of our common stock will be issuable upon conversion of the remaining shares of our Series D Convertible Preferred Stock. In addition, if we undertake any additional financings involving securities convertible into shares of our common stock, the aggregate number of shares into which those securities are convertible will further increase our overhang.
As these shares of our common stock are resold in the public market, the supply of our common stock will increase significantly, which could decrease its price.
Our executive officers, directors and 10% stockholders have significant voting power and may vote their shares in a manner that is not in the best interest of other stockholders.
Our executive officers, directors and 10% stockholders control approximately 43% of the voting power represented by our outstanding shares (which voting power may decrease to 40% upon the conversion of all outstanding Series D Preferred Stock into common stock). If these stockholders act together, they may be able to exert significant control over our management and affairs requiring stockholder approval, including approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of all our stockholders.
We do not anticipate paying cash dividends for the foreseeable future, and the lack of dividends may have a negative effect on our stock price.
We have never declared or paid any cash dividends or distributions on our common stock and our senior credit facility prohibits us from paying dividends. We currently intend to retain our future earnings, if any, to support operations and to finance our growth strategy and therefore we do not anticipate paying any cash dividends on our common stock in the foreseeable future.
Provisions in our certificate of incorporation and by-laws may deter third parties from acquiring us and could lead to the entrenchment of our Board of Directors.
Our certificate of incorporation and by-laws contain provisions that may make the acquisition of our company more difficult without the approval of our Board of Directors, including the following:
These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and cause us to take other corporate actions that you desire. The anti-takeover defenses in our certificate of incorporation and by-laws could discourage, delay or prevent a transaction involving a change in control of our company.
Our operational headquarters is located in Washington, D.C. and our administrative headquarters is located in New York, New York. We have additional offices in Arkansas, California, Florida, Georgia, Illinois, Massachusetts, Michigan, Tennessee, Texas and Virginia. All of our offices are leased and we do not consider any specified leased facility to be material to our operations. We believe that equally suited facilities are available in several other areas throughout the U.S. The following table summarizes information with respect to our material facilities:
(1) The Company’s leases its Corporate Headquarters on a month to month basis.
From time to time, we are involved in litigation arising in the ordinary course of business. We do not believe that we are involved in any litigation that is likely, individually or in the aggregate, to have a material adverse effect on our consolidated financial condition, results of operations or cash flows.
The Company was added as a defendant in federal and state litigation matters related to Facticon, which were initially filed prior to the Company’s acquisition of the assets of Facticon.
In the federal matter, Anchondo vs. Facticon Inc. and GlobalOptions Group, Inc. filed in the U.S. District Court for the Central District of California, Peter Anchondo (the “Federal Plaintiff”), in a class action, alleged that Facticon failed to pay overtime wages. Subsequent to the acquisition of the assets of Facticon by the Company, the Company was added as a defendant in said case, under the successor liability theory. A Motion for Summary Judgment was filed with the Court to contest the Company’s liability as a successor liable company. On March 7, 2008, the Court issued a ruling denying the Company’s Motion for Summary Judgment and issued a ruling granting a Motion for Summary Judgment in favor of the Federal Plaintiff ruling that the Company was in fact a successor party to the Federal Plaintiff’s actions. This ruling by the Court was in opposition to the Court’s original ruling dated March 3, 2008, wherein it granted the Company’s Motion for Summary Judgment. The Company filed a Motion for Reconsideration and the Judge reversed his opinion but ruled that the issue of successor liability must be litigated. In July 2008, the Company reached a tentative agreement with the Federal Plaintiff to settle this matter and on December 22, 2008, the matter was settled in full with a cash payment of $657.
In the State Court matter, Wonsch, et al. vs. Facticon Inc. and GlobalOptions Group, Inc., filed in the State Court for the Central District of California, the plaintiffs in a class action (the “State Plaintiffs”), alleged that Facticon failed to pay overtime wages under the California Civil Code. This action was similar to the Anchondo case, but was limited to the state laws of California. Subsequent to the acquisition, the Company was added as a defendant in said case, under the successor liability theory. On December 30, 2008, the Company and the State Plaintiffs agreed to settle this matter for the cash sum of $170, payable during the first quarter of 2009.
Under the terms of an escrow agreement, as amended, by and between GlobalOptions and Facticon, 85,700 shares of common stock and a note payable of $100 were held in escrow to satisfy the above mentioned legal matters and other pre-acquisition obligations of Facticon. In connection with the settlement of these Facticon legal matters, on December 22, 2008, the 85,700 shares of the Company’s common stock reverted back to the Company as treasury stock with a cost basis of $158 and the $100 note payable obligation to Facticon was canceled. The Company has established a reserve in the amount of $193 to cover the Company for the settlement of the State Court matter.
Market for Common Equity
Our common stock is quoted on the NASDAQ Capital Market under the symbol “GLOI”. From June 27, 2005 to March 6, 2007, when we effectuated a 1-for-8 reverse stock split, our common stock was quoted on the OTC Bulletin Board under the symbol “GLOI.OB”, and from March 7, 2007 to September 25, 2007, our common stock was quoted on the OTC Bulletin Board under the symbol “GOPG.OB”. Prior to June 27, 2005, there was no active market for our common stock. Based upon information furnished by our transfer agent, as of March 6, 2009, we had 207 holders of record of our common stock.
The following table sets forth the high and low sales prices for our common stock for the periods indicated as reported by the OTC Bulletin Board (as adjusted for the reverse stock split) and NASDAQ, as applicable:
We have not declared or paid any cash dividends on our common stock and do not anticipate declaring or paying any cash dividends in the foreseeable future. Our senior credit facility prohibits us from paying dividends. We currently expect to retain future earnings, if any, for the development of our business. Dividends may be paid on our common stock only if and when declared by our Board of Directors and paid on an as-converted basis to the holders of our Series D Convertible Preferred Stock.
(1) From January 1, 2009 through March 6, 2009.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table contains information about our common stock that may be issued upon the exercise of options and upon the vesting of restricted stock units (“RSUs”) under all of our equity compensation plans as of December 31, 2008. See “Executive Compensation—Benefit Plans” for a description of our stock option and incentive plans.
Sale of Unregistered Securities
On December 22, 2008, pursuant to a settlement agreement entered into in connection with the settlement of the Facticon legal matters discussed in detail in Item 3 of this Annual Report on Form 10-K, Facticon’s sellers forfeited back to the Company 87,500 shares of the Company’s common stock that had been part of the consideration paid to such sellers in connection with the Company’s acquisition of substantially all of the business and assets of Facticon in February of 2007. Such shares had been held in escrow pursuant to an asset purchase agreement and an escrow agreement entered into in connection with such acquisition. The following table provides information about such forfeiture:
The following discussion of results of operations and financial condition is based upon, and should be read in conjunction with, our consolidated financial statements and accompanying notes thereto included elsewhere in this Form 10-K. This discussion contains forward-looking statements. Actual results could differ materially from the results discussed in the forward-looking statements. Please see “Forward-Looking Statements” and “Risk Factors” for a discussion of some of the uncertainties, risks and assumptions associated with these statements.
(Dollar amounts in thousands, except per share amounts)
GlobalOptions is an integrated provider of risk mitigation and management services to government entities, Fortune 1,000 corporations and high net-worth and high-profile individuals. We enable clients to identify, assess and prevent natural and man-made threats to the well-being of individuals and the operations of governments and corporations. In addition, we assist our clients in recovering from the damages or losses resulting from the occurrence of acts of terror, natural disasters, fraud and other risks. Our vision is to continue to build a comprehensive risk mitigation solutions company through both organic growth and acquisitions. In pursuit of our strategy, we have acquired and integrated nine complementary risk mitigation businesses since August 2005 that contributed an aggregate of approximately $103,000, $84,800, and $58,900 in revenues to our business during the years ended December 31, 2008, 2007 and 2006, respectively.
We believe our reputation, credentials and personal relationships provide us with a competitive advantage in securing new business. Our senior management team and advisory boards have extensive industry backgrounds and include former generals in the military, top government officials and corporate officers, intelligence and law enforcement officers, professional investigators and legal and crisis communications specialists.
We deliver risk mitigation and management services through the following four business units:
Our Preparedness Services, Fraud and SIU Services, and Security Consulting and Investigations units represent our three financial reporting segments. Our International Strategies business unit, on the basis of its relative materiality, is included in our Fraud and SIU Services segment.
The following table represents the revenue contribution by each of these three reporting segments as a percentage of our total revenues:
Principally, we generate our revenues through providing risk mitigation solutions to our clients. For our Preparedness Services and Security Consulting and Investigations engagements, we typically invoice on a time and materials basis. For most of our Fraud and SIU Services engagements, we invoice on a fixed fee basis. We enter into contractual arrangements with most of our clients, on both an exclusive and non-exclusive basis. The duration of our engagements ranges from one week to two or more years. Over half of our revenues are generated from repeat client relationships that we have had for more than one year. In addition to our services, we also generate revenues from the sale of kits and supplies principally used by law enforcement to collect DNA materials. Generally, we must compete in the market for our clients based upon our reputation, service history and relationships. There are limited cases within all of our business segments that we are considered by our clients to be the sole source provider, based principally upon the experience of our personnel or, in the case of Bode and certain DNA investigations, our technical expertise. Our clients consist of government entities, corporations and high net-worth and high-profile individuals. We provide our services domestically through our own employees and through a network of approved subcontractors to achieve scale, geographic coverage or a specialized expertise. Currently, a small portion of our revenues is generated by services provided outside the United States.
Our gross profit represents our revenues less the costs of revenues incurred to provide services to our clients. The most significant components of our costs of revenues are the costs of our direct labor, our third-party consultants and our reimbursable costs, which principally consist of travel expenses. For the most part, our costs of revenues are variable and based upon the type of services performed or the amount of revenues generated. Where possible, we structure our personnel arrangements to compensate our employees and our consultants on the basis of work performed. This enables us to maintain a variable cost structure and relatively consistent gross margins in our business segments from year to year. The variability in our gross margins results primarily from changes in our client mix. For our DNA analysis business, we incur fixed costs for our equipment and dedicated personnel.
Our selling and marketing expenses primarily include salaries and commissions, as well as travel and other expenses, incurred by our employees who are involved in selling and promoting our services. The accrued earnout expenses related to the acquisition of JLWA are also reflected in our selling and marketing expenses. Our general and administrative expenses consist primarily of salaries, bonuses, depreciation and amortization, and stock-based compensation for our employees not performing work directly for our clients. Also included in general and administrative expenses are corporate support expenses such as legal and professional fees, investor relations, human resources, facilities, telecommunication support services, information technology, stock option expenses, salaries for members of our senior management team and impairment losses recognized on goodwill.
Results of Operations
The following is a summary of our operating results as a percentage of our total consolidated revenues for the periods indicated:
GlobalOptions’ Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007
We had overall revenues of $104,187 for the year ended December 31, 2008, as compared to revenues of $87,131 for the year ended December 31, 2007, for an overall increase of $17,056 or 20%. The increase in revenues for the year ended December 31, 2008 was principally attributable to a combination of organic growth and to our new client account relationships that we have obtained through the execution of our acquisition plan.
Preparedness Services revenues were $39,117 for the year ended December 31, 2008, as compared to $30,823 for the year ended December 31, 2007. The increase of $8,294 or 27% was primarily attributable to an increase in revenues related to response and recovery efforts in Louisiana in connection with Hurricane Gustav as well as the flooding in Iowa and Indiana. The State of Louisiana, which retained JLWA to manage the state’s relief program related to Hurricanes Katrina, Rita, and Gustav, represented $26,647 of revenues for the year ended December 31, 2008, as compared to $25,536 of revenues for the year ended December 31, 2007.
Fraud and SIU Services revenues were $31,388 for the year ended December 31, 2008, as compared to $24,493 for the year ended December 31, 2007. The increase of $6,895 or 28% was primarily attributable to the expansion of our client base through the acquisition of FAIS in April 2008 and benefitting from a full year of revenues from the Facticon acquisition, as well as through the addition of new program accounts.
Security Consulting and Investigations revenues were $33,682 for the year ended December 31, 2008, as compared to $31,815 for the December 31, 2007. The increase of $1,867 or 6% was principally attributable to a full year of revenues from the acquisition of Bode, as well as through the expansion of our physical safety and security consulting practice.
Our consolidated gross profit for the years ended December 31, 2008 and 2007 was $44,248 and $38,162, reflecting gross profit margins of 42% and 44%, respectively. Preparedness Services gross profit was $17,323 or 44% of this segment’s revenues for the year ended December 31, 2008, as compared to $13,559 or 44% of this segment’s revenues for the year ended December 31, 2007. Fraud and SIU Services gross profit was $13,152 or 42% of this segment’s revenues for the year ended December 31, 2008, as compared to $11,117 or 45% of this segment’s revenues for the year ended December 31, 2007, due to changes in customer programs and product mix. Security Consulting and Investigations gross profit was $13,773 or 41% of this segment’s revenues for the year ended December 31, 2008, as compared to $13,486 or 42% of this segment’s revenues for the year ended December 31, 2007, due primarily to changes in product mix at Bode.
Selling and marketing expenses were $11,504 or 11% of revenues for the year ended December 31, 2008, as compared to $14,821 or 17% of revenues for the year ended December 31, 2007, representing a decrease of $3,317 or 22%. During the years ended December 31, 2008 and December 31, 2007, we incurred earnout charges of $720 and $6,330 respectively, in connection with the May 11, 2007 JLWA Modification Agreement. The $5,610 decrease in earnout is offset by an increased emphasis on selling and marketing activities in 2008, including additional personnel dedicated to these activities.
General and administrative expenses were $40,348 or 39% of revenues for the year ended December 31, 2008, as compared to $44,908 or 52% of revenues for the year ended December 31, 2007. The decrease of $4,560 or 10% is principally due to personnel reductions implemented at the operating levels and corporate cost savings attributable to lower professional fees on account of reduced restructuring activities and fewer acquisitions in 2008.
Other Income (Expense), Net
Interest expense, net, was $352 for the year ended December 31 2008, as compared to $516 for the year ended December 31, 2007. The decrease of $164 or 32% was attributable to a net decrease in debt related to acquisitions.
GlobalOptions’ Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
We had overall revenues of $87,131 for the year ended December 31, 2007, as compared to revenues of $61,924 for the year ended December 31, 2006, for an overall increase of $25,207 or 41%. The increase in revenues for the year ended December 31, 2007 was primarily attributable to our new client account relationships that we obtained through the execution of our acquisition plan.
Preparedness Services revenues were $30,823 for the year ended December 31, 2007, as compared to $37,556 for the year ended December 31, 2006. The decrease of $6,732 or 18% was primarily attributable to a decrease in revenue from the State of Louisiana (principally in the third quarter of 2007), partially offset by JLWA’s revenues only being included since its March 10, 2006 acquisition date. In the aftermath of Hurricane Katrina, JLWA was retained by the State of Louisiana to provide advice on the state’s overall response and recovery efforts. Subsequently, JLWA was retained to establish and manage the State’s relief program related to Hurricanes Katrina and Rita. The State of Louisiana represented $25,536 of revenues for the year ended December 31, 2007, as compared to $31,690 of revenues for the year ended December 31, 2006. The reduction in revenue in 2007 of $6,154 or 19% for the State of Louisiana was due to the scope of our work being narrowed and the transfer of certain of our personnel to the State of Louisiana. Furthermore, the contract renewal process, which coincided with a request by the State to bring in more contractors and locally-hired personnel, took more time than expected to complete. As a result, our 2007 revenues were adversely affected, as a portion of the revenues we expected to recognize in 2007 under this contract were delayed until 2008.
Fraud and SIU Services revenues were $24,493 for the year ended December 31, 2007, as compared to $17,901 for the year ended December 31, 2006. The increase of $6,592 or 37% was primarily attributable to the expansion of our client base through the acquisitions of Hyperion Risk in August 2006 and Facticon on February 28, 2007, including the addition of a significant new third party administrator client, through whom we generated $1,705 of investigation related revenue for the year ended December 31, 2007.
Security Consulting and Investigations revenues were $31,815 for the year ended December 31, 2007, as compared to $6,467 for the December 31, 2006. The increase of $25,348 or 392% was attributable to the client base that we acquired in connection with the acquisitions of Safir in May 2006 for security consulting and investigations, On Line Consulting in January 2007 for fire and other building security, and Bode at the end of February 2007 for data banking and DNA investigations.
Our consolidated gross profit for the years ended December 31, 2007 and 2006 was $38,162 and $29,681, reflecting gross profit margins of 44% and 48%, respectively. Preparedness Services gross profit was $13,559 or 44% of this segment’s revenues for the year ended December 31, 2007, as compared to $18,710 or 50% of this segment’s revenues for the year ended December 31, 2006. The reduction in gross profit percentage was attributable to certain price reductions that we provided to Louisiana in order to competitively position ourselves for the 2007 contract renewal. Fraud and SIU Services gross profit was $11,117 or 45% of this segment’s revenues for the year ended December 31, 2007, as compared to $8,340 or 47% of this segment’s revenues for the year ended December 31, 2006 due to changes in customer programs. Security Consulting and Investigations gross profit was $13,486 or 42% of this segment’s revenues for the year ended December 31, 2007, as compared to $2,631 or 41% of this segment’s revenues for the year ended December 31, 2006.
Selling and marketing expenses were $14,821 or 17% of revenues for the year ended December 31, 2007, as compared to $8,635 or 14% of revenues for the year ended December 31, 2006. The increase of approximately $6,186 or 72% is primarily attributable to the increase in the JLWA acquisition earnout expense of $2,517, from $5,228 for the year ended December 31, 2006 to $7,745 for the year ended December 31, 2007. The substantial increase in earnout expense is due to the acceleration of earnout expense of $6,330 incurred in connection with the May 11, 2007 JLWA Modification Agreement. General and administrative expenses were $44,908 or 51% of revenues for the year ended December 31, 2007, as compared to $25,354 or 41% of revenues for the year ended December 31, 2006. The increase of $19,080 or 75% is attributable to increased personnel, our 2007 and 2006 acquisitions, legal, accounting and other professional fees incurred in order to fulfill our responsibilities as a public company, costs incurred for our equity restructuring and costs incurred for due diligence related to the execution of our acquisition plan.
Other Income (Expense), Net
Interest expense was $813 for the year ended December 31 2007, as compared to $653 for the year ended December 31, 2006. The increase of $160 or 25% was attributable to higher balances on the Company’s line of credit as well as an increase in debt related to acquisitions during 2007.
Other expenses of $700 for the year ended December 31, 2007 is attributable to a prepayment premium of $800 incurred in connection with the accelerated payment of a $4.5 million promissory note due to the JLWA sellers, offset by a gain resulting from a lease settlement.
We also incurred costs in conjunction with notes payable issued on March 10, 2006, May 12, 2006 and June 28, 2006. These costs were capitalized to deferred financing costs, amortized over the term of the related debt and are presented as other income (expense), net. Additionally, in accordance with Emerging Issues Task Force Issue No. 00-27 “Application of Issue 98-5 to Certain Convertible Instruments,” the notes issued on June 28, 2006 were considered to have a beneficial conversion premium feature. For the year ended December 31, 2006, we recorded a debt discount of $6,922 related to this conversion premium and we recorded a debt discount of $600 as the value of the beneficial conversion feature related to the 8% promissory note issued in conjunction with the acquisition of Safir on May 12, 2006.
The aggregate of $2,694 of deferred financing costs, as well as the aggregate of $7,523 of deferred debt discounts, were amortized through June 29, 2006, the date the notes were exchanged for our Series B Convertible Preferred Stock.
Deemed Dividends to Series B Convertible Preferred Stockholders
At June 29, 2006, the date of issuance of our Series B Convertible Preferred Stock and related warrants, the fixed conversion price of the Series B Convertible Preferred Stock of $16.00 represented a discount to the market value of our common stock of $17.60 per share. In accordance with EITF 00-27 and EITF 98-5, we determined the relative fair value of the Series B Convertible Preferred Stock and warrants and allocated the proceeds received on a relative fair value basis. Based upon this calculation, the effective conversion price of the Series B Convertible Preferred Stock was determined to be $10.24 per common share, resulting in a beneficial conversion feature for a deemed dividend of $24,413 for the year ended December 31, 2006.
Liquidity and Capital Resources
We had a cash and cash equivalent balance of $5,276 as of December 31, 2008.
Cash used in operating activities was approximately $839 and $5,466 for the years ended December 31, 2008 and 2007, respectively. Cash used in operating activities for the year ended December 31, 2008 resulted primarily from our net loss of $7,956 as well as an increase in the use of funds to finance accounts receivable of $1,219, offset by non-cash charges for depreciation and amortization of $4,366 and for stock based compensation of $4,258.
Cash used in operating activities for the year ended December 31, 2007 resulted primarily from our net loss of $27,928, offset by non-cash charges of $3,917 for depreciation and amortization, $3,330 for stock based compensation, $5,144 related to the impairment of goodwill and intangible assets, and $7,732 related to the JLWA earnout accrual.
Cash used in investing activities for the year ended December 31, 2008 was $4,430, of which $2,548 related to the Company’s acquisition of FAIS. Cash used in investing activities for the year ended December 31, 2007 was $17,635, of which $15,195 related to the Company’s acquisitions of On Line Consulting, Bode and Facticon.
We have been added as defendants in a litigation with certain entities that have brought actions against Facticon, arising from conditions that existed prior to our acquisition of Facticon in February 2007. As of February 28, 2009, we have settled and paid the federal portion of this litigation at a gross cost of approximately $657 and have agreed to settle the state portion of the litigation for approximately $170 plus certain other payroll related taxes. In connection with the settlement, the sellers have forfeited back to us their interests in the $100 note receivable and the 87,500 shares of stock that we had held in escrow. At December 31, 2008, we have reserved approximately $190 to settle this matter.
On April 21, 2008, GlobalOptions Group acquired substantially all of the business and net assets of FAIS to expand our Fraud and SIU services. Consideration for this transaction consisted of cash in the amount of $2,548.
Financing activities provided net funds of $6,123 and $5,994 for the years ended December 31, 2008 and 2007, respectively. Cash provided for the year ended December 31, 2008 was primarily due to the proceeds from our line of credit of $7,093, less repayment of notes payable of approximately $800, and the repurchase of common stock of approximately $208. Cash provided for the year ended December 31, 2007 was primarily due to the proceeds from issuance of common stock of $18,177, less repayment of notes payable of $12,231.
On May 11, 2007, we entered into the JLWA Modification Agreement with the JLWA Sellers. Under the modification, we agreed to make additional payments in the form of cash, promissory notes and common stock to the JLWA Sellers in exchange for eliminating the earnout provisions of the asset purchase agreement, which provided for a maximum additional payout of $15,400. The additional payments under the JLWA Modification Agreement consisted of (i) a cash payment of $2,000, which was paid on May 14, 2007, (ii) a promissory note in the principal amount of $4,500, accruing interest at 5.65% per annum, due on January 15, 2008, subject to a 5% penalty fee if not paid on that due date, (iii) 300,000 shares of common stock, which were issued and subsequently registered on February 14, 2008, and (iv) a promissory note in the principal amount of $4,300, accruing interest at 11.0% per annum, due on August 11, 2008. The JLWA Sellers could request acceleration of the $4,300 promissory note upon the consummation of a Qualified Public Offering (as defined in the JLWA Modification Agreement) or any other qualified capital raise and they did request acceleration. On October 20, 2007, we reached an agreement with the JLWA Sellers under which the JLWA Sellers agreed to the prepayment of the principal and accrued interest on the $4,500 promissory note, originally due on January 15, 2008. In connection with this acceleration, on October 29, 2007, the Company paid a negotiated prepayment premium of $800 to compensate the JLWA Sellers for, among other things, foregone interest and the cost of accelerated tax payments. The JLWA Sellers requested acceleration of this promissory note in connection with our separate underwritten public offering. Further, in connection with the execution of the JLWA Modification Agreement, we executed an amendment of the employment and non-competition agreement with Mr. Witt. Under the terms of the amendment, upon his voluntary termination of employment without good reason, Mr. Witt would be obligated to reimburse us in an amount equal to (i) 25% of the number of shares issued to the JLWA Sellers within 12 months prior to such termination and (ii) 25% of the base salary of Mr. Witt paid within 12 months prior to such termination.
Effective as of March 31, 2008, the financial institution that provides a line of credit for us and our wholly owned subsidiaries entered into an amendment to our $20,000 working capital line of credit. The applicable interest rate with respect to the amount outstanding under the line of credit ranges from 0.75% to 1.50%, based upon our liquidity, plus the greater of 6.25% or the lender’s most recently announced “prime rate.” As of December 31, 2008, our net borrowings were $7,093 under the line of credit and based upon the amount of qualifying accounts receivable, we were eligible to draw up to a total of $18,594 under the line of credit. The line of credit and all obligations outstanding thereunder are due and payable not later than March 30, 2009. We are currently in discussions with respect to the renewal or replacement of this line of credit. We anticipate that any renewal or replacement would be in an aggregate amount sufficient for our current working capital requirements. There can be no assurance that we will successfully renew or replace this line of credit.
On October 29, 2007, we completed an underwritten public offering of 4,500,000 shares of our common stock, receiving approximately $20,250 in gross proceeds ($18,200 in net proceeds). We used a portion of the net proceeds from the proposed underwritten public offering to repay $4,300 of notes and $38 of related accrued interest and have been using the balance of the net proceeds for working capital and general corporate purposes. In connection with the underwritten public offering, on October 29, 2007 we entered into an agreement with Canaccord Adams Inc. and Morgan Keegan & Company, Inc., as underwriters, who were paid aggregate fees of $1,418.
On October 29, 2007, the Company borrowed $5,400 under the line of credit for the pre-payment of the JLWA $4,500 promissory note, pre-payment fee and accrued interest, and such amount was subsequently repaid.
For the year 2008, we have met our cash needs through operating cash flows and through borrowings under our line of credit. At December 31, 2008, we had working capital of $16,747. We believe that a combination of cost reductions that we have implemented during 2008 and will continue to implement in 2009, along with our targeted improvements in revenues in 2009, will allow us to generate improvements in 2009 cash flows from operations, as compared to 2008. Furthermore, we believe that these improved operating cash flows, along with the proceeds from our line of credit arrangement, will be sufficient to finance our operations through December 31, 2009.
Off-Balance Sheet Arrangements
We have not entered into any transactions with unconsolidated entities in which we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities or any other obligations under a variable interest in an unconsolidated entity that provides us with financing, liquidity, market risk or credit risk support.
Critical Accounting Policies
Our significant accounting policies, including the assumptions and judgments underlying them, are more fully described in our “Notes to Consolidated Financial Statements” included elsewhere within this Annual Report on Form 10-K. Some of our accounting policies require the application of significant judgment by management in the preparation of the consolidated financial statements and, as a result, they are subject to a greater degree of uncertainty. In applying these policies, management uses its judgment to determine the appropriate assumptions to be used in calculating estimates that affect the reported amounts of assets, liabilities, revenues and expenses. Management bases its estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. We have identified certain of our accounting policies as the ones that are most important to the portrayal of our consolidated financial condition and results of operations and which require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Our critical accounting policies include the following:
Revenue Recognition and Related Costs
For investigation, crisis management and non-DNA related security, revenue is recognized on a time and materials or fixed price arrangement and is recognized as the services are performed pursuant to the applicable contractual arrangements. Revenue related to time and materials arrangements is recognized in the period in which the services are performed. Revenue related to fixed price arrangements is recognized based upon the achievement of certain milestones or progress points within the project plan. The impact of any revisions in estimated total revenue and direct contract costs is recognized in the period in which they become known. Expenses incurred by professional staff in the generation of revenue are billed to the client and recorded as revenue when incurred.
For DNA related revenues, revenue is recognized when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when it has persuasive evidence that an agreement exists, prices are fixed or determinable, services and products are provided to the client, and collectability is reasonably assured. The Company reduces revenue for estimated discounts and other allowances.
Revenues earned on DNA related services are derived from the following sources: (1) forensic DNA analysis; (2) research and development projects; and (3) sales of DNA collection products. The Company recognizes revenues from forensic DNA analysis at the time tests are completed and the results are reported to the client. Revenues from research and development projects are recognized as the related research is completed and when the Company has satisfied specific obligations under the terms of the respective agreements. Revenues from the sales of DNA collection products are recognized upon delivery of the products to the client.
Forensic DNA analysis is billed on a per sample fixed fee arrangement. Research and development projects are billed on a cost plus fixed fee arrangement.
Costs incurred in the performance of forensic DNA analysis are recorded as inventories and charged to cost of revenues upon the completion of the project, which generally ranges from one to three months. Costs related to research and development projects are expensed as incurred and costs related to DNA collection products are maintained as inventory and charged to operations when the products are delivered.
Intangible Assets, Goodwill and Impairment
In accordance with the requirements of Statement of Financial Accounting Standards No. 141 (SFAS No. 141), “Business Combinations,” we recognize certain intangible assets acquired in acquisitions, primarily goodwill, trade names, covenants not to compete and client relationships. In accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets, (SFAS 142)” on a regular basis, we perform impairment analysis of the carrying value of goodwill and certain other intangible assets by assessing the recoverability when there are indications of potential impairment based on estimates of undiscounted future cash flows.
At December 31, 2007, the Company performed an evaluation of its goodwill. The Company performed its annual impairment tests of goodwill for three of its reporting segments: Preparedness Services, Fraud and SIU Services and Security Consulting Investigations, as required under SFAS 142. As a result of these tests, the Company determined that the amount of goodwill recorded in connection with the Fraud and SIU Services segment was impaired or not fully recoverable, as the current performance and future expectations do not support the carrying value of goodwill. As a result, the Company recorded a $5,144 impairment charge during the year ended December 31, 2007 for the Fraud and SIU Services segment.
At December 31, 2006, the Company performed an evaluation of goodwill. We performed our annual impairment tests of goodwill for our reporting segments: Preparedness Services, Fraud and SIU Services and Security Consulting and Investigations, as required under SFAS 142. As a result of these tests, we determined that the remaining amount of goodwill recorded in connection with two of the three reporting segments was impaired or not fully recoverable, as the current performance and future expectations did not support the carrying value of goodwill for these reporting segments. The impairment affects Fraud and SIU Services and Security Consulting and Investigations. As a result, we recorded a $3,029,000 impairment charge for the year ended December 31, 2006 of which $1,135,000 is for Fraud and SIU Services and $1,894,000 is for Security Consulting and Investigations.
Allowance for Doubtful Accounts
The number of clients that comprise our client base, along with the different industries, governmental entities and geographic regions, including foreign countries, in which our clients operate, limits concentrations of credit risk with respect to accounts receivable. We do not generally require collateral or other security to support client receivables, although we do require retainers, up-front deposits or irrevocable letters of credit in certain situations. We have established an allowance for doubtful accounts based upon facts surrounding the credit risk of specific clients and past collections history. Credit losses have been within management’s expectations.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified prospective transition method and therefore has not restated prior years results. Under this transition method, employee stock-based compensation expense for the year ended December 31, 2006 included compensation expense for all stock-based compensation awards granted, but not yet fully vested, prior to January 1, 2006. The fair value of the options granted was determined at the original grant date in accordance with the provisions of SFAS 123R. Stock-based compensation expense for all share-based payment awards granted after December 31, 2005 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes these compensation costs over the requisite service period of the award, which is generally the vesting term of the options associated with the underlying employment agreement, where applicable.
As a result of adopting SFAS 123R, the impact to the consolidated financial statements for the year ended December 31, 2006 was to record an expense of approximately $2,258 greater than if the Company had continued to account for stock-based compensation under APB 25 and is reflected within general and administrative expenses. The impact of the adoption of SFAS 123R on both basic and diluted net loss per share for the year ended December 31, 2006 was $1.01 per share.
In addition, SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. Prior to the adoption of SFAS No. 123(R), the Company accounted for forfeitures as they occurred.
We account for equity instruments issued to non-employees in accordance with the provisions of Statement of Financial Accounting Standards No. 123R “Share-Based Payment” (SFAS 123R) and the Emerging Issues Task Force (EITF) Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or In Conjunction with Selling, Goods or Services” (EITF 96-18) which require that such equity instruments be recorded at their fair value on the measurement date, which is typically the date the services are performed. Stock-based compensation for non-employees is accounted for under EITF 96-18 and is reflected within general and administrative expenses.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements” (“SFAS 157”). SFAS 157 clarifies the definition of fair value, establishes a framework for measurement of fair value and expands disclosure about fair value measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the Financial Accounting Standards Board ("FASB") having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. We applied the provisions of the FASB Staff Position (“FSP”) on FASB No. 157, "Effective Date of FASB Statement 157" (“FSP FAS 157-2”) which defers the provisions of SFAS 157 for nonfinancial assets and liabilities to the first fiscal period beginning after November 15, 2008. The deferred nonfinancial assets and liabilities include items such as goodwill. We are required to adopt SFAS 157 for nonfinancial assets and liabilities in the first quarter of fiscal 2009 and we believe that the adoption of SFAS 157 will not be material to the consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standard 159 “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” ("SFAS 159"), which permits entities to choose to measure many financial instruments and certain other items at fair value. The fair value option established by this statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Adoption is required for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of FASB Statement No. 157, Fair Value Measurements. The Company did not elect the fair value reporting option for any assets and liabilities not previously recorded at fair value.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS 141R”), which establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, goodwill acquired in the business combination or a gain from a bargain purchase. SFAS 141R is effective for business combinations with an acquisition date on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We expect SFAS 141R to have an impact on the accounting for any future business acquisitions as of the effective date.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for the noncontrolling interest (minority interest) in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires (a) the ownership interest in the subsidiary held by parties other than the parent to be clearly identified and presented in the consolidated balance sheet within equity, but separate from the parent’s equity, (b) the amount of consolidated net income attributable to the parent and to the noncontrolling interest to be clearly identified and presented on the face of the consolidated statement of operations and (c) changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary to be accounted for consistently. Entities must provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for financial statements issued for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. We expect SFAS 160 to have an impact on the accounting for any future business acquisitions as of the effective date.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flow. The guidance in SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We are evaluating the implications of SFAS 161 and its impact on the financial statements has not yet been determined.
In April 2008, the FASB issued FASB Staff Position (“FSP”) SFAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). The guidance of FSP 142-3 is intended to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), and the period of expected cash flows used to measure the fair value of the asset under SFAS 141R when the underlying arrangement includes renewal or extension of terms that would require substantial costs or result in a material modification to the asset upon renewal or extension. Companies estimating the useful life of a recognized intangible asset must now consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, must consider assumptions that market participants would use about renewal or extension as adjusted for SFAS 142’s entity-specific factors. FSP 142-3 is effective for financial statements issued for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. We expect that the impact of the adoption of FSP 142-3 will not be material.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with Generally Accepted Accounting Principles (“GAAP”) for nongovernmental entities. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” We do not expect SFAS 162 to have a material impact on our consolidated financial statements.
In June 2008, the FASB issued EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“EITF 03-6-1”). EITF 03-6-1 clarified that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders. Awards of this nature are considered participating securities and the two-class method of computing basic and diluted earnings per share must be applied. EITF 03-6-1 is effective for financial statements issued for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. We do not expect EITF 03-6-1 to have a material impact on our consolidated financial position and results of operations.
In November 2008, the EITF issued EITF No. 08-6, “Equity Method Investment Accounting Considerations” (“EITF 08-6”). This Issue addresses the impact that SFAS 141(R) and SFAS 160 might have on the accounting for equity method investments, including how the initial carrying value of an equity method investment should be determined, how it should be tested for impairment, and how changes in classification from equity method to cost method should be treated. This Issue is effective on a prospective basis in fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years, consistent with the effective dates of SFAS 141(R) and SFAS 160. The Company does not anticipate that EITF No. 08-6 will have a significant impact on the reporting of our results of operations.
Our consolidated financial statements and the related notes to the financial statements called for by this item appear under the caption “Index to Consolidated Financial Statements” beginning on Page F-1 attached hereto of this Annual Report on Form 10-K.
GLOBALOPTIONS GROUP, INC. AND SUBSIDIARIES
Table of Contents to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
GlobalOptions Group, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of GlobalOptions Group, Inc. and Subsidiaries (the “Company”) as of December 31, 2008 and 2007 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years ended December 31, 2008, 2007 and 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of GlobalOptions Group, Inc. and Subsidiaries as of December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for the years ended December 31, 2008, 2007 and 2006 in conformity with United States generally accepted accounting principles.
/s/ Marcum & Kliegman LLP
New York, New York
March 10, 2009
GLOBALOPTIONS GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands, except per share amount)
See notes to these consolidated financial statements.
GLOBALOPTIONS GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(dollars in thousands, except per share amount)
See notes to these consolidated financial statements.
GLOBALOPTIONS GROUP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Year Ended December 31, 2008
(dollars in thousands)