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PIMO > SEC Filings for PIMO > Form 10-K/A on 18-Oct-2013All Recent SEC Filings

Show all filings for PREMIER ALLIANCE GROUP, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K/A for PREMIER ALLIANCE GROUP, INC.


18-Oct-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT ON FORWARD-LOOKING INFORMATION

The Annual Report on Form 10-K contains certain statements relating to our future results that are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties, including, but not limited to, changes in political and economic conditions; interest rate fluctuation; competitive pricing pressures within our market; equity and fixed income market fluctuation; technological change; changes in law; changes in fiscal, monetary regulatory and tax policies; monetary fluctuations as well as other risks and uncertainties detailed elsewhere in the Form 10-K or from time-to-time in our filings with the Securities and Exchange Commission. Such forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

CERTAIN TERMS USED IN THIS REPORT

When this report uses the words "we," "us," "our," "Premier," and the "Company," they refer to Premier Alliance Group, Inc. "SEC" refers to the Securities and Exchange Commission

Results of Operations - 2012 As Compared to 2011

The result of operations described below includes the Risk/Compliance Solutions segment for the entire years of 2012 and 2011. The Energy and Sustainability Solutions segment began with the acquisition of Greenhouse Holdings, Inc. on March 5, 2012; hence, operating results for this segment are only included from March 5, 2012 through December 31, 2012. We acquired Ecological, LLC, also part of our Energy and Sustainability Solutions segment ("ESS"), on December 31, 2012; and accordingly, only the balance sheet accounts have been consolidated and no operating results are included in the financial results for the year ended December 31, 2012.

Total revenue for the fiscal year ended December 31, 2012 was $19,472,000 as compared to $17,946,000 for the fiscal year ended December 31, 2011, a net increase of $1,526,000, or 8.5%. This net increase is the result of several factors. During the period March 5, 2012 through December 31, 2012, the ESS segment generated revenue of $2,947,000. But for the ESS segment, total revenues (for the Risk/Compliance segment) would have been $16,525,000 for the fiscal year ended December 31, 2012 compared to $17,946,000 for the fiscal year ended December 31, 2011, a decrease of $1,421,000 or 8%. An overview of each of our markets comprising the Risk/Compliance segment is necessary to understand the dynamics of this decrease.

Our largest decrease was in the Charlotte market in 2012 versus 2011 where total revenue declined from $10,100,000 in 2011 to $8,009,000 in 2012, a decrease of $2,091,000 or 20.1%. This market is heavily involved in the financial institutions industry and we anticipated significant Governance, Risk & Compliance ("GRC") revenue in 2012 based on executed statements of work with large clients that did not materialize as clients continued to defer projects that had been discussed and put in place. We believe this deferral from 2012 agreements in place was largely due to an uncertain political environment and the election year. However, we did manage the fixed and variable costs of the Charlotte office and the gross and net margins were 21.8% and 15.7%, respectively, for 2012 compared to 24.5% and 19.1% for 2011. Net contribution from Charlotte decreased by $675,000 on a decrease in sales of $2,091,000.

The next largest decrease was in the Kansas City market. Revenue dropped from $2,800,000 in 2011 to $1,648,000 in 2012, a decrease of $1,152,000 or 41.1%. The Kansas City market has struggled since the loss of three large customers in early 2011 due to the customers taking their IT operations offshore and in-house, respectively. These customers accounted for $2,500,000 in annual revenue. The operating loss was reduced from $338,000 in 2011 to $73,000 in 2012, but after much analysis, the decision was made to close the office in Kansas City in September 2012 due to poor future prospects in the market


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The Winston-Salem market continued its steady growth with revenue at $2,295,000 in 2012 compared to $1,897,000 in 2011, an increase of $398,000 or 21.0%. The Winston-Salem market showed good growth in all of our service offerings.

The San Diego market reported a decrease in revenue from $2,205,000 in 2011 to $1,875,000 in 2012, as a result of less focus and emphasis on pure financial consulting engagements as more emphasis was placed on risk, compliance efforts, which we believe will position us better in 2013. However, we were successful in managing through this and achieved an increase in overall gross margin from 28.6% in 2011 to 31.1% in 2012 and significantly improved its contribution margin from a negative 4.5% in 2011 to a positive 7.7%, or $144,000, in 2012.

The Los Angeles market showed strong growth in all of our service offerings and increased revenue to $2,700,000 in 2012 from $909,000 in 2011. The Los Angeles market also increased their gross margin from 27.9% to 28.3% from to 2011 to 2012. The contribution margin from the Los Angeles market increased from 3.8% in 2011, $34,500, to 13.3%, $360,000, in 2012.

Importantly and as further discussed below, selling, general and administrative costs for all Risk/Compliance markets discussed above, on a combined basis, decreased from 14.54% of revenue in 2011 to 11.34% of revenue in 2012.

Gross margin (revenue less cost of revenues, defined as all costs for billable staff for the Risk/Compliance Solutions segment and cost of goods for the ESS Solutions segment) increased from $4,688,000 in 2011 to $4,798,000 in 2012, but declined on a percentage basis, from 26.1% in 2011 to 24.6% in 2012 on a company-wide basis. This improvement of $110,000 in absolute dollars was negatively impacted on a gross margin basis primarily caused by the overall decline in revenue in the Risk/Compliance segment discussed above; gross margin in the Risk/Compliance Solutions segment dropped from 26.1% in 2011 to 24.9% in 2012. The primary drivers of this revenue decline were the Charlotte and Kansas City markets discussed above. Excluding the Risk/Compliance Solutions segment, the ESS segment only achieved a gross margin of 23.3%. This is well below management's targeted gross margin of 30% for this segment. The Company has spent a great deal of focus and time since the March 5, 2012 acquisition integrating Greenhouse Holdings, Inc., evaluating its revenue targets and streams, operations and key personnel. As of mid to late fourth quarter, the Company believes it has the business model aligned for optimal growth, as evidenced by the recent execution of over $10,000,000 million in contracts as of March 2013 (already more than three times the entire revenue for 2012). We acquired Greenhouse Holdings, LLC as a platform for our EES business and are committed to this platform.

Selling, general and administrative ("SG&A") expenses increased from $5,845,000 and 32.6% of revenue for the fiscal year ended December 31, 2011 to $8,187,000 and 42.0% of revenue for the fiscal year ended December 31, 2012; an increase of $2,342,000 or 40%. Of this increase in 2012, the EES business segment alone accounted for $2,214,000 or 94.5% of the total increase (discussed below). But for the SG&A expenses from the EES segment, SG&A expenses would have been $5,973,000 or 30.7% of revenue for the fiscal year ended December 31, 2012 compared to $5,845,000 and 32.6% of revenue for the fiscal year ended December 31, 2011, or an increase of $128,000. It is important to note that all SG&A expenses related to the Company as a whole (executive compensation, all back office accounting, finance, human resources, costs of being a public company, etc.) are recorded in the Risk/Compliance Solutions segment. To properly evaluate SG&A expenses, an analysis of i) Risk/Compliance Solutions segment SG&A expenses, ii) "corporate" level Risk/Compliance segment SG&A expenses, and iii) EES segment costs must be examined.

i. On a combined basis, the Risk/Compliance segment markets reduced SG&A expenses from $2,607,000 and 14.5% of revenue in 2011 to $1,874,000 and 11.3% of revenue in 2012, a decrease of $733,000. This reflects management's emphasis on closely managing market level variable costs.

ii. "Corporate" SG&A expenses, included in the Risk/Compliance business segment, for 2012 was $4,217,000 and 21.6% of revenue compared to $3,237,000 and 18% of revenue in 2011. This increase of $980,000 is primarily comprised of i) non-cash charges, ii) non-recurring charges and iii) natural increases from the expansion of the business and our board of directors.

o Total accounting fees were $227,000 in 2012 compared to $146,000 in 2011. We had to pay the accounting firm for the completion of the audit of Greenhouse Holdings, Inc. ("GHH") for the year ending December 31, 2011 in 2012 totaling approximately $48,000 - a nonrecurring cost. In addition, surrounding the acquisition in March 2012, we engaged the financial advisor used by GHH to assist with the accounting integration, resulting in a nonrecurring cost of $45,000.

o As discussed above, we acquired Ecological, LLC on December 31, 2012. As a result of our agreement with a registered investment advisor, we paid $240,000 in referral fees related to this transaction. The referral fee consisted of $120,000 payable in cash and $120,000 payable in stock, with the total referral fee of $240,000 included in our statement of operations as a nonrecurring charge.

o We continued to seek the best qualified independent Board of Directors for the Company. In 2012, we added five (5) highly regarded individuals to our Board of Directors. We have a policy of compensating independent Board of Directors members for their attendance at meetings and for serving on Board of Directors committees, as well as reimbursing out-of-pocket expenses. Total director fees and expenses were $149,000 in 2012 compared to $75,000 in 2011, an increase of $74,000. We also compensate Board of Directors members with warrants and options (see discussion immediately below). In 2012 our non-cash stock option / warrant expense was $779,000 compared to $218,000 in 2011, an increase of $533,000 (or 77% of the total corporate SG&A expenses increase between 2011 and


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2012). Of this $786,000 expense incurred, $538,000 was directly related to grants to new and existing Board of Directors members.

o Corporate personnel costs, including payroll taxes and benefits, increased $194,000 from 2011 to 2012 and is primarily attributable to 2012 representing a full year for the Company's new CFO, Controller and a Business Development professional.

o Immediately subsequent to the GHH acquisition, our public relations / branding firm was engaged to help integrate GHH / Energy and Sustainability Solutions into our overall corporate presentation. This one-time cost incurred was $57,000. We also engaged an IR/PR firm to do a separate campaign for investor awareness. This onetime cost was $20,000.

o Professional services - other increased by $22,000 and reflects the additional cost of SEC compliance as in July 2012, the Company had to comply with XBRL mandates to the financial statements.

o Business insurance increased $35,000 over 2011 to $163,000 and is primarily attributable to coverages associated with the EES business segment.

o Legal fees were $138,000 in 2012 compared to $88,000 in 2011, an increase of $50,000. This increase was all associated with one-time legal costs related to the 2012 financings which could not be capitalized, a filing with the SEC to increase the authorized common shares from 45,000,000 to 90,000,000 and the preferred shares from 5,000,000 to 10,000,000, answering inquiries from the California Securities Commission relative to GHH and costs associated with the inquiry by the Depository Trust Company.

i. In the EES business segment, acquired in March 2012, SG&A expenses totaled $2,096,000 or 71.1% of total EES revenue.

o This amount is due to a one-time cost incurred for a GHH legal settlement that arose during the acquisition process which was described in the Registration Statement on Form S-4 filed February 6, 2012. This litigation was settled in late 2012, but resulted in out of pocket legal expenses of $154,000 and a settlement of $199,400 (comprised of $30,000 in cash and $169,400 in Premier stock).

o GHH also had a number of smaller lawsuits that came forth after the acquisition. In 2012 we incurred over $50,000 in non-recurring costs in resolving these matters. As of year-end December 31, 2012, we have no outstanding litigation related to GHH.

o The EES segment engaged a financial advisor to perform a business plan analysis on the Company's holdings in Mexico. This nonrecurring cost totaled $15,000.

o Also, with the market opportunity in the government sector, the EES segment engaged a consultant for part of 2012 for DOD research. This arrangement was completed in October 2012, and this nonrecurring cost totaled $60,000 in 2012.

o Finally, nonrecurring costs of $36,000 was paid to GHH's proxy firm to complete the acquisition transaction in March of 2012.

But for the significant lawsuit settlement and other one-time charges, SG&A expenses would have been $1,581,600 or 53.7% of EES revenue. We are committed to the EES segment and based on the refinement of the business strategy and recent contract successes, we believe we are well positioned for the next 24 months.

Other income (expense) for 2012 is comprised of the following items, substantially all of which are noncash expenses recorded as a result of FASB ASC requirements.

We completed an annual goodwill impairment evaluation for 2012 applying both the Step 1 and Step 2 tests as prescribed by FASB ASC 350. In determining impairment charges, the Company uses various valuation techniques including both the income approach and market approach for each reporting unit. During 2012, the Company recorded a goodwill impairment write-down of $4,378,000 related to its Energy and Sustainability Solutions business segment / reporting unit, which is reflected in the Statement of Operations. After executing the letter of intent for GHH, finalizing the Agreement of Plan and Merger and during the SEC registration statement process, it became necessary, and our Board of Directors approved, secured loans to GHH up to the date of the acquisition, which ultimately totaled $1,030,000. This was


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additional consideration to the 7,114,770 shares issued at $0.90 per share in the transaction. In addition, in calculating goodwill in accordance with FASB purchase accounting rules, GHH had liabilities assumed in excess of assets acquired at the date of acquisition of $1,259,000 which increased the goodwill recorded at date of acquisition. We moved forward with the transaction as we believe that GHH is the appropriate platform for our Energy and Sustainability Solutions business segment to be developed. Since the acquisition, management has worked closely with the Energy and Sustainability Solutions business segment to focus and refine its revenue targets and streams, business plan and cross selling opportunities with the Risk/Compliance business segment. Management believes at this time, that the proper groundwork has now been accomplished and the returns will be achieved in the future. Based on the Step 1 and Step 2 testing for the EES business segment, with assistance provided by an experienced independent valuation firm, we concluded that a noncash impairment write-down in 2012 of $4,378,000 was appropriate.

In 2010 and 2011, respectively, the Company issued Debentures, Series B and Series C Preferred Stock with detachable warrants, respectively, that were deemed to be derivative instruments. On November 16, 2012 we issued 7% Redeemable Convertible Promissory Notes ("Promissory Notes"), which had 750,000 detachable warrants associated directly with the Promissory Notes plus 120,000 detachable warrants that were issued to the registered investment advisor. On December 26, 2012, we issued our first round of 8% Redeemable Convertible Series D Preferred Stock ("Series D Preferred Stock"); the Promissory Notes were mandatorily converted to Series D Preferred Stock. In conjunction with the issuance of the Series D Preferred Stock, we issued warrants to purchase an aggregate of 2,348,685 shares of our common stock plus a warrant to purchase the aggregate of 939,467 shares of our common stock to our registered investment advisor. All of the above warrants are considered derivative instruments and must be valued at initial issuance and then adjusted to fair value at each reporting date. As a result, including the original Debentures, the Preferred B and Preferred C warrants, the Company also valued the warrants associated with the Promissory Notes at issuance, conversion into Series D Preferred Stock and the original issuance of the Series D Preferred Stock. As a result, for the year ended December 31, 2012, we recognized non-cash derivative expense of $895,000 related to the market value fluctuation inherent in the valuation of the detachable warrants issued with the various financings aforementioned.

As a result of the initial recording of the Promissory Notes described above, we were required to record a debt discount (contra-liability account) at issuance of the Promissory Notes. Inasmuch as the Promissory Notes were mandatorily converted into Series D Preferred Stock only 46 days after their issuance, accounting rules required that the unamortized balance of the debt discount be written off (noncash) and charged to the statement of operations for the year ended December 31, 2012 as interest expense - debt discount in the amount of $354,000 was recorded.

As a cumulative result of the above discussion, loss before income taxes in 2012 was $9,298,000 (comprised of $3,631,000 loss from operations and $5,667,000 loss from total other expense) compared to a loss of $653,000 in 2011. As aforementioned, the $5,667,000 loss from the total other expense, was substantially all comprised of non-cash charges related to a write-down of goodwill ($4,378,000), derivative expense ($895,000) and the write-off of debt discount associated with the initial issuance of the promissory notes ($354,000) which were converted into Series D Preferred Stock only 46 days after their initial issuance.

The effective income tax rate for 2012 was a tax expense of (4.3%) versus a benefit of 109.1% in 2011. The effective tax rate is impacted by "permanent" differences between "book" taxable income and "tax" taxable income, and is primarily due to: i) the book recording of the noncash goodwill impairment write-down of $4,378,000, ii) the book recording of the noncash derivative expense of $895,000 , iii) the 2012 increase in the deferred tax asset valuation allowance of $1,506,000 , iv) state taxes, net of federal benefit of ($237,000 ), and v) noncash stock warrant and option compensation expense of $776,000.

Income tax expense was $396,000 in 2012 versus a benefit of $713,000 in 2011. We account for income taxes under FASB ASC Topic 740 "Income Taxes". Under FASB ASC Topic 740-10-30,


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deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. We regularly assess the likelihood that our deferred tax assets will be realized from recoverable income taxes or recovered from future taxable income. To the extent that the we believe any amounts are not more likely than not to be realized through the reversal of the deferred tax liabilities and future income, we record a valuation allowance to reduce its deferred tax assets. We made the assessment in the fourth quarter of 2012 that a full valuation allowance for the all deferred tax assets should be provided based on consideration of the net operating losses for the past two years, the results of the ASC 350 analysis and resulting goodwill impairment charge of $4,378,000 in its Energy and Sustainability Solution business segment and the uncertainty surrounding the potential future integration of expenses associated with the acquisition of Ecological, LLC on December 31, 2012, that it was no longer, at this time, more likely than not that the deferred tax assets would be recoverable. In accordance with FASB ASC 740, management will continue to monitor the status of the recoverability of deferred tax assets. Hence, this position resulted in tax expense of $396,000 for 2012 as compared to the tax benefit recognized in 2011.

As a result of the above, we recorded a net loss of $9,694,000 in 2012 compared to net income of $60,000 in 2011.

Net loss available for common stockholders' for 2012 was $(11,175,000) or ($0.79) per share and for 2011 was $(1,954,000), or ($0.24) per share. Net income (loss) available for common stockholders' is a function of net income
(loss), less actual dividends paid on preferred stock, less "deemed dividends to preferred stockholders'" (or the "embedded beneficial conversion feature")." Deemed dividends to preferred stockholders' is the result of the FASB ASC 470-20-25, whereby the proceeds from the issuance convertible preferred stock, issued with detachable warrants, must be allocated between the convertible preferred stock and the value assigned to the warrants (either the "Black-Scholes" or the "Binomial" value, as appropriate). Then, the residual amount allocated to the convertible preferred stock is divided by the number of common shares into which the preferred stock is convertible, developing an "effective conversion price". This "effective conversion price" is then compared to the market price of the Company's stock on the date of the transaction, and the "differential", multiplied by the number of shares into which the preferred stock is convertible, yields the theoretical "deemed dividend", a non-cash event/charge. This calculated amount is recorded on the books and records as an "intra-equity" entry only, charging retained earnings/accumulated deficit and simultaneously increasing additional paid in capital. Again, it is a non-cash accounting entry only and has no effect on the actual Statement of Operations. However, FASB ASC Accounting Standards (ASC 470-20-25) require that this amount be shown on the Statement of Operations below Net Income (Loss) as though it were a cash charge, as a deduction below Net Income (Loss), just as if it were dividends actually paid, thereby, reducing Net Income (Loss) Available for Common Stockholders'; hence, also reducing reported Net Income (Loss) per Common Share.

Results of Operations - 2011 As Compared to 2010

Total revenue for the fiscal year ended December 31, 2011 was $17,946,000 compared to $17,117,000 for the fiscal year ended December 31, 2010, a net increase of $829,000, or 4.8%. This net increase is the result of several factors. We acquired Intronics in April 2010 and Q5 in August 2010 and 2011 was the first year of full revenues for each of these reporting units. Q5, based in California, contributed $1,200,000 of the increase in revenue in 2012. Intronics generated $3,200,000 in revenue for the period April 2010 through December 2010; however, in March and May of 2011, Intronics lost three large customers due to the customers taking their IT operations offshore and in-house, respectively, with these customers accounting for $2,500,000 in annual revenue. Accordingly, Intronics contributed $2,800,000 in revenue for entire year of 2011 compared to $3,200,000 for the eight months ended December 31, 2010, a decrease of $400,000. On an annualized basis for 2010, Intronics revenue would be $4,300,000, compared to $2,800,000 in 2011, or a decrease of $1,500,000 on an annualized to annualized basis. This decrease was more than offset by other sources, including the ERMS acquisition made January 1, 2011, which contributed $909,000 for the fiscal year ended December 31, 2011. All other markets remained stable generating improved gross and operating margins.

Gross margin (defined as revenue less cost of revenues - defined as all costs for billable staff) increased from $4,142,000 in the fiscal year ended December 31, 2010 to $4,688,000 in the fiscal year ended December 31, 2011, and improved as a percentage of revenue, growing from 24.2 % to 26.1% on a Company wide basis. This improvement reflects increased penetration in the advisory and consulting business, which produces higher gross margins. Our legacy business (excluding the Intronics and Q5 acquisitions) also produced improved gross margins, to 26.1% in 2011 versus 24.2 % in 2010, and from a market net operating margin perspective, a contribution of 19.6% versus 18.0% in 2011 over 2010, respectively.

Selling, general and administrative expenses increased $2,027,000 in the fiscal year ended December 31, 2011, from $3,818,000 to $5,845,000. This increase is attributable to two general factors. The first is the impact of the selling, general and administrative expense of Q5 and Intronics being incurred for a full year in 2011 versus a part year in 2010. This accounts for $486,000 for Intronics (acquired April 2010) and $ 442,000 for Q5 (acquired August 2010). The remainder of the increase of $1,099,000 is directly attributable to expenses incurred at the corporate level, many either first time charges, non-cash charges for stock option and warrant issuances or non-recurring items as the Company was building the platform for its future growth plans, including active acquisition efforts (see GHH acquisition described in detail above).


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These first time and/or non-recurring items included the following: i) $152,000 in costs associated with legal fees and warrant issuance expenses incurred in conjunction with our issuance of the Series C Preferred Stock in March 2011, ii) $58,000 in special accounting fees incurred in conjunction with both the Series C Preferred Stock issuance in March 2011 and the GHH acquisition that were not capitalizable under accounting rules, iii) $100,000 paid for consulting services directly related to pre-acquisition due diligence on the GHH acquisition (and other potential acquisition targets, prior to our hiring of a Chief Financial Officer in late October 2011), iv) $70,000 paid to an M&A search consulting firm as a search retainer for potential acquisition opportunities, v) $227,000 onetime cash payments to former acquirees under incentive arrangements, vi) during 2011, as part of our short and long term growth strategy, we committed to building a strong, well versed and recognized independent Board of Directors; accordingly, we instituted a standard program of compensating each Board of Directors member $2,500 for each Board of Directors meeting, and providing warrants to purchase shares of our common stock as incentives. During 2011, we were successful in building an independent Board of Directors and paid $40,000 in cash for directors' attendance at Board of Directors meetings, and incurred non-cash charges of $80,000 for warrants to purchase shares of our common stock issued to our Directors, vii) incidental to the aforementioned process, we engaged a consulting firm to assist us in our search for qualified independent Directors, and compensated that firm in warrants valued at $21,000 to purchase shares of our common stock, viii) pursuant to our acquisition of Q5, we incurred . . .

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