Get Started for Free Contexxia identifies hard-to-find pieces of information in SEC filings. No more highlighters, no more redlining, no more poring over huge documents. ZANETT INC (1133872) 10-Q published on Jun 08, 2011 at 5:28 pm
Reporting Period: Mar 30, 2011
In January 2011, the Company borrowed approximately $565,000 from Rockport Investments Ltd. (“Rockport”) to pay taxes, interest, and penalties to the Internal Revenue Service (“IRS”) in order to settle the IRS tax lien discussed further in Note 5. On May 20, 2011, the Company issued Rockport an unsecured promissory note payable to Rockport in the principal amount of approximately $1,212,128 which includes the approximately $565,000 loan from Rockport used to settle the IRS tax lien, approximately $566,993 in accrued capitalized interest under the Rockport convertible debt issued on March 31, 2010, as discussed in Note 7, and approximately $80,135 in penalties for non-payment of interest due under the Rockport convertible debt. Interest on this note accrues daily at the rate of 1.5% per month and the note matures on February 1, 2014.
The December 31, 2010 financial statements have been restated to properly reflect transactions with a related party (as more fully described in Note 5). The Company failed to withhold taxes on interest payments made to a related party for the period from 2005 through 2009 and was therefore assessed approximately $558,000 (including $225,000 of interest and penalties) by the IRS in January 2011. The Company and the related party agreed that the Company would be reimbursed for the portion of the taxes paid on behalf of the related party and received a promissory note in the amount of $333,000 due January 2012. Had these related party transactions been timely accounted for during the 2005 through 2010 fiscal years, the Company would have recorded a receivable from the related party of $333,000, a payable of $558,000, and expense for the related interest and penalties in the aggregate amount of $225,000. The interest and penalties attributable to each of the years in the period from 2005 through 2010 was immaterial, quarterly or annually, to the financial statements of the Company; however, the cumulative impact of recording the entire amount of the $225,000 interest and penalties in 2011 (the date of the lien release) would have been material to the quarter ended March 31, 2011. Accordingly, the Company has restated the 2010 financial statements included herein to properly include the impact of this oversight.
In the three months ended March 31, 2010, the Company incurred approximately $164,000 of interest expense attributed to various promissory notes and a line of credit with Bruno Guazzoni, the uncle of Zanett’s Chief Executive Officer, Claudio Guazzoni and a holder of 26.2% of the Company’s outstanding common stock. Mr. Guazzoni sold the line of credit and promissory notes to Rockport in a private transaction on February 28, 2010 (see Note 7).
The IRS commenced an audit of the Company’s tax return for the fiscal year ended December 31, 2007, and the audit was concluded in January 2011. As a result of the audit, the IRS instituted a tax lien on the Company for the non-payment of individual withholding taxes that, per IRS regulations, should have been withheld on interest payments to Bruno Guazzoni. As described in Note 1, the Company borrowed $565,000 from Rockport and paid the taxes, interest and penalties due to the IRS and the tax lien was released. The Company and Bruno Guazzoni agreed that the Company would be reimbursed for the taxes paid on behalf of Bruno Guazzoni, and on May 31, 2011, Bruno Guazzoni issued a promissory note (effective January 25, 2011) to the Company in the amount of $333,849. The promissory note bears interest at 4.5% per annum, and is payable on January 24, 2012, including accrued interest. As collateral, Mr. Guazzoni has agreed to pledge 292,118 of his personal shares of common stock in the Company which were valued at $1.20 per share, the closing price of our common stock on the Nasdaq Capital Market on January 25, 2011, the effective date of the note. On March 31, 2011, the end of our first fiscal quarter, the closing price of our common stock on the Nasdaq Capital Market was $1.26 per share. On June 7, 2011, the last complete day of trading immediately preceding the filing of this Quarterly Report on Form 10-Q, shares of our common stock on the Nasdaq Capital Market closed at $0.62.
On May 20, 2011, the Company and Rockport entered into an amendment to the Rockport convertible note (the “Note Amendment”). Under the Note Amendment, interest and penalties payable under the Rockport convertible note in the amount of approximately $647,128 were consolidated in the unsecured promissory note described in Note 1 for the period of March 31, 2010 to and including March 31, 2011. Other than the capitalization of the interest described above, the Rockport convertible note remains an outstanding obligation of the Company.
In connection with the preparation of its Annual Report on Form 10-K for the year ended December 31, 2010, the Company noted that the conversion feature embedded in the Rockport convertible debt should have been bifurcated and accounted for separately as a derivative liability. This embedded derivative had an estimated fair value of $160,467 on March 31, 2010, the inception date, and should have been reflected as a liability and then re-measured at fair value at each subsequent reporting date with the change in fair value reported in the statement of operations. Hence, the initial carrying value assigned to the Rockport convertible debt should have been $6,971,516 calculated as the difference between the principal amount of the debt and the fair value of the bifurcated embedded derivative. This resulted in additional debt discount interest expense of approximately $24,069 for the year ended December 31, 2010 and an unamortized balance of the convertible note debt discount of $128,374 and $136,398 at March 31, 2011 and December 31, 2010, respectively. The fair value of the embedded derivative liability was $151,744 and $149,577 at March 31, 2011 and December 31, 2010, respectively. The cumulative change in fair value has been recorded in the statement of operations.
Net interest expense increased $176,825, or 51%, to $525,518 in the quarter ended March 31, 2011 from $348,693 in the quarter ended March 31, 2010. In addition to interest on our working capital debt, in the first quarter of 2011 we accrued interest on the $500,000 promissory note we issued to Rockport in May of 2010, and we did not have this interest expense for that same period in 2010. In addition, we recorded interest of approximately $80,000 on the accrued interest from the unpaid interest on the Rockport convertible debt. We recorded an expense of $2,167 in three months ended March 31, 2011 in connection with the increase in fair value of the derivative liability recorded pursuant to the Rockport convertible debt. No such items existed in same period of 2010. In addition we recorded interest expense of $3,031, which represents the portion attributable to the quarter ended March 31, 2011 for the payment made to the IRS in connection with the settlement and release of a tax lien instituted by the IRS following an audit of our tax return for the fiscal year ended December 31, 2007 (see note 5).