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GBS ENTERPRISES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and the notes to those financial statements that are included elsewhere in this Annual Report on Form 10-K. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the "Risk Factors", "Cautionary Notice Regarding Forward-Looking Statements" and "Description of Business" sections and elsewhere in this annual report. We use words such as "anticipate," "estimate," "plan," "project," "continuing," "ongoing," "expect," "believe," "intend," "may," "will," "should," "could," "predict," and similar expressions to identify forward-looking statements. Although we believe the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bound of our knowledge of our business, our actual results could differ materially from those discussed in these statements. Factors that could contribute to such differences include, but are not limited to, those discussed in the Risk Factors" section of this annual report. We undertake no obligation to update publicly any forward-looking statements for any reason even if new information becomes available or other events occur in the future. Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this annual report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations, and prospects. Overview GBS Enterprises Incorporated, a Nevada corporation (the "Company," "GBS," "GBSX," "we," "us," "our" or similar expressions), conducts its primary business through its 50.1% owned subsidiary, GROUP Business Software AG ("GROUP"), a German-based public-company whose stock trades on the Frankfurt Exchange under the stock symbol INW. GROUP's software and consulting business is focused on serving IBM's Lotus Notes and Domino market. GROUP caters primarily to mid-market and enterprise-size organizations with over 3,500 customers in thirty-eight countries spanning four continents, representing more than 5,000,000 active users of its products. GROUP's customers include Abbot, Ernst & Young, Deutsche Bank, Bayer, HBSC, Merck and Toyota. GROUP provides IBM Lotus Notes/Domino Application and Transformation technology. Headquartered in Eisenach, Germany, the Company has offices throughout Europe and North America. The Company maintains a website at www.gbsx.us. GROUP maintains a website at www.gbs.com. The information contained in the Company's and GROUP's websites is not incorporated by reference herein. The Company's Common Stock is quoted on the OTC Bulletin Board under the ticker symbol "GBSX." Products and Services GBS has grown by consolidating the fragmented Lotus Software market through the acquisition of companies with complementary product, technology or services offerings. GBS has continuously developed its software and service business to service and support GBS's expanding Lotus customer base. Historically, GROUP has achieved growth by acquiring underperforming companies with complimentary operations and leveraging GROUP's expertise to turnaround and integrate these companies. Key success factors for this strategy are: enhanced portfolio, positioning GROUP as the 'one-stop-shop' for Lotus applications and services, expanded customer support, fast code migration, and cloud enablement/XPages conversion of acquired applications. Going forward, the Company intends focus on potential acquisition targets in the following areas of software and services: Applications and Application Modernizations, Professional Services, Hosting/Outsourcing Services, Administration and IT services, and XPages expertise. Messaging and Business Applications Software & Solutions GBS Messaging and Business Application Software & Solutions product lines include software and advisory services for email and Instant Messaging (IM) Management, Security, Compliance, Archiving and Productivity, CRM Applications, Governance, Risk & Compliance (GRC) Management software, Workflow and Business Process Management software, ePDF Archiving & Document Management. GBS develops, sells and installs well-known business process and management software suites based on Lotus Notes / Domino and IBM Portal technology, mainly for major international companies and medium-sized customers. 27 Through GBS's comprehensive messaging software product lines and associated services, Lotus Notes, Microsoft Exchange or SMTP-based-email customers, as well as Lotus Sametime, customers are able to provide their users with secure, efficient and centrally administered use of e-mail and IM while maintaining control over their compliance with current legal requirements and corporate guidelines. Consulting Services GBS develops, sells and orchestrates customer-specific Lotus Domino strategy and consulting services, such as CIO and IT department leader Strategic Advisory Services, Managed Services, Outsourcing, Administration, Assessments and Implementations, Performance Improvements, Custom Application Development, Governance and Security, Technical Support, and Training, as well as Email Migration Services. Based on GBS's unique concentration of industry talent and expertise, mainly in the areas inside and around IBM Lotus Notes/Domino, inside and around corporate messaging (IBM, Microsoft, SMTP) and inside and around IT environmental and application assessment, analysis and reporting, commercial and governmental customers, as well as Software Integrators (SI) and channel partners, are able to rely on the company's strategic and tactical advisory services for evaluating, planning, staffing and execution of any customer project. GBS Consulting Services' global teams of consultants use modern project management techniques, proprietary methodologies and GBS accelerator technologies to complete client projects on time and with reduced risk. We believe that our focus on recruiting and retaining top Lotus expertise positions our team to offer leading-edge Lotus Notes / Domino subject matter knowledge to our customers. GBS consultants have an average of over 12 years' experience each in Lotus Notes/Domino and its related products and are routinely asked to present at IBM Lotus events including Lotusphere (Connect), an annual conference hosted by IBM Lotus Software. As a Premier IBM Business Partner, GBS is one of the few partners that can sell and support licenses for all five IBM software brands: Lotus, WebSphere, Rational, Tivoli, and DB2. Market Trends As IT departments face continuous budget reductions and constant pressure for higher performance and efficiency, CIOs are focusing on modern technologies to support their need for increased scalability, flexibility and lower costs. GBS has identified this demand as a strategic growth opportunity for the company and has placed a significant focus on expanding its Modernizing/Migrating technology. GBS Lotus Application Modernization and Migration GBS Lotus Application Modernization and Migration activities are focused on the IBM Lotus / Domino applications market and the offering spans from expert services and accelerator technologies to modernized, web enabled (also named "cloud" or "cloud computing") and migrated Lotus applications; and thus ultimately take the Lotus applications from legacy to the future. The foundation of the Modernizing/Migrating Suite Software offering is GBS's significant R&D investment in a set of methodologies and key technology accelerators to automate the conversion of traditional Notes based client-server applications, into the IBM XPages framework which enables Domino applications to be run and accessed via the Lotus client, a web browser or on a mobile device. The patent-pending software that underpins Modernizing/Migrating was developed by GBS with assistance and guidance from IBM Corporation's Software Group to ensure alignment with future releases of the IBM Lotus / Domino and XPages technology. Revenue Model GBS generates its revenue from the sale of internally created software, third-party developed software and the delivery of related services, including IT systems planning, administration, support, hosting, implementation and integration. Strategy and Focus Areas Based on current market demands for modern, Cloud-based and mobile-device capable business applications, we have acquired and developed a set of unique technologies that help organizations reduce the time, cost, resources and risks associated with modernizing or migrating their existing applications. 28 We generate revenue from subscription and usage fees and related services, including support and strategic consulting services. The subscription period is typically based on a yearly or multi-year contract with our customers. Another sector of our strategic portfolio is a suite of tools and methodologies we have developed to rapidly convert Lotus Notes applications into web and modern mobile applications. This portfolio includes a set of powerful analysis tools known as Insights that identify all of the Lotus Notes applications within an organization and provide metrics about the uses and users of those applications. Because of the nature of Lotus Notes and Domino, the applications within a customer environment tend to be highly distributed and number in the thousands. For many organizations, this fact alone makes it extremely difficult to plan for projects that involve modernizing these applications for use in a browser and on mobile devices or migrating them to another platform. Our technologies help them to dramatically reduce the cost, risk, time and resources associated with these highly complex projects. We generate revenue with our analysis tools by charging a fee for the use of our technology and for the associated cost of the services to produce a report and set of recommendations for the customer. Additional revenues come from consulting services that result from helping our customers to implement those recommendations. For use of our conversion tools, referred to as Modernizing/Migrating, we charge a flat fee for the conversion and additional hourly rates to perform additional supporting development or testing as needed. We also believe there is significant revenue opportunity in licensing these tools to a network of global partners who also have existing presence and expertise in the Lotus Notes and Domino market. We have established partner agreements for the use of the analysis and conversion tools with partners in several countries and directly with IBM. Results of Operations Fiscal year ended December 31, 2012 compared to fiscal year ended December 31, 2011 Assets Total Assets decreased from $68,703,394 at December 31, 2011 to $56,802,492 at December 31, 2012. Total Assets consists of Total Current Assets and Total Non-Current Assets. Total Current Assets At December 31, 2012, our Total Current Assets were $6,444,192 compared to $9,982,991 at December 31, 2011. Total Current Assets consist of: Cash and Cash Equivalents; Accounts Receivable; Inventories; Prepaid Expenses; Other Receivables and Assets held for Sale. n Cash and Cash Equivalents decreased from $3,250,821 at December 31, 2011 to $1,154,602 at December 31, 2012 as a result of our investments in the strategic technology areas such as application migration and modernization, cloud technology and the associated costs necessary to build and implement the go to market strategy. n Accounts Receivable decreased from $5,007,194 at December 31, 2011 to $4,143,448 at December 31, 2012. n Inventories decreased from $236,712 at December 31, 2011 to $ nil at December 31, 2012. n Prepaid Expenses decreased from $444,147 at December 31, 2011 to $84,304 at December 31, 2012 due to the reclassification of prepaid license payments to a vendor into Intangible Assets. n Other Receivablesdecreased from $1,020,010 at December 31, 2011 to $676,976 at December 31, 2012. Other Receivables consist primarily of derivatives used for hedging held by one business entity, warrants sold with related funding in escrow, and installment payments due from the sale of GROUP Business Software Holding OY together with their Subsidiary GEDYS IntraWare GmbH on February 28, 2010. The decrease was primarily due to an insurance claim of approximately $1,900,000 which was included in the previous year. n Assets held for Sale were increased from $24,107 at December 31, 2011 to $384,862 at December 31, 2012. Total Non-Current Assets At December 31, 2012, our Total Non-Current Assets were $50,358,300, compared to $58,720,403 at December 31, 2011. Total Non-Current Assets consist of: Property (plant and equipment), Financial Assets, Investments in Related Company, Deferred Tax Assets, Goodwill, Software and Other Assets. n Property (plant and equipment) decreased from $1,604,994 at December 31, 2011 to $332,839 at December 31, 2012 due primarily to the sale of IDC Global, Inc. and their heavy concentration of fixed assets. 29 n Financial Assets decreased from $548,909 at December 31, 2011 to $428,422 at December 31, 2012, which includes long term loans of $427,232 and the non-current portion of the aforementioned sale of GEDYS IntraWare GmbH on February 28, 2010. n Deferred Tax Assets decreased from $2,748,800 at December 31, 2011 to $1,132,103 at December 31, 2012 and consisted of Deferred Tax Assets derived from Financial Assets and Losses carried forward. n Goodwill decreased from $39,221,603 at December 31, 2011 to $34,254,881 at December 31, 2012 and consisted of the goodwill associated with nine business entities. During the year ended December 31, 2012, the Company sold SD Holdings, Ltd. and dissolved Pavone Ltd., the effect of which was to reduce the goodwill associated with these subsidiaries. The reduction in goodwill attributed to GROUP Business Software AG ("GROUP") resulted when the Company purchased additional shares of GROUP as disclosed in Note 2 of the Company's financial statements. n Software decreased from $14,258,610 at December 31, 2011 to $12,207,031 at December 31, 2012 and consists of capitalized development costs, product rights and licenses. Our capitalized Software includes our expert business developments of $3,779,418, legacy business improvements/developments of $7,545,163, strategic business developments/other of $2,714,568. The decrease from 2011 to 2012 resulted from impairment testing write-downs. The decrease is again primarily based on the business decision to focus on the new CRM product and functional loss of the obsolete CRM. n Other Assets increased from $93,268 at December 31, 2011 to $156,379 at December 31, 2012. This includes reinsurance claims, tax credits, and other deposits. n Assets held for Sale were increased from $nil at December 31, 2011 to $1,846,645 at December 31, 2012. Liabilities Total Liabilities decreased from $24,946,246 at December 31, 2011 to $22,269,060 at December 31, 2012. Total Liabilities consists of Total Current Liabilities and Total Non-Current Liabilities. Total Current Liabilities At December 31, 2012 our Total Current Liabilities were $18,227,184, compared to $19,058,394 at December 31, 2011. Total Current Liabilities consist of: Notes Payable, Liabilities to Banks, Accounts Payable and Accrued Liabilities, Deferred Income, Other Liabilities and Amounts Due to Related Parties. n Notes Payable increased from $1,381,821 at December 31, 2011 to $2,313,572 at December 31, 2012 and consisted of the exercise of capital components of a convertible bond issue. n Liabilities to Banks decreased from $19,595 at December 31, 2011 to $6,774 at December 31, 2012 on payments of a line of credit held by a subsidiary. n Accounts Payable and Accrued Liabilities decreased from $6,491,565 at December 31, 2011 to $6,241,733 at December 31, 2012. This includes Trade payables, Tax Accruals and Other Accruals. n Deferred Income decreased from $6,476,582 at December 31, 2011 to $6,099,570 at December 31, 2012. n Other Liabilities of $4,256,410 at December 31, 2011 decreased to $860,032 at December 31, 2012. As a result of a reclassification of long term to short term liabilities due on the purchase of Permessa Corporation. These payments derived from the purchase of Permessa in 2010 and are now due in the short term. n Amounts Due to Related Parties increased from $432,421 at December 31, 2011 to $2,115,869 at December 31, 2012. n Liabilities held for Sale were increased from $nil at December 31, 2011 to $589,634 at December 31, 2012. 30 Total Non-Current Liabilities At December 31, 2012, our Total Non-Current Liabilities were $4,041,876, compared to $5,887,852 at December 31, 2011. Total Non-Current Liabilities consist of: Liabilities to Banks, Deferred Tax Liabilities, Retirement Benefit Obligation, Other Liabilities. n Liabilities to Banks increased from $3,463,483 at December 31, 2011 to $3,716,102 at December 31, 2012 and consisted of long-term business line of credit due to the Baden-Württembergische Bank. The increase from 2011 to 2012 in notes payable is due to the funding of expenditures consistent with the advancement of our technology and overall business plan. n Retirement Benefit Obligation increased from $150,632 at December 31, 2011 to $165,876 at December 31, 2012. n Other Liabilities decreased from $2,273,737 at December 31, 2011 to $nil at December 31, 2012. As a result of a reclassification of long term to short term liabilities due on the purchase of Permessa Corporation. Within the non-current liabilities, an amount of $2,270,000 has been converted into equity of the corresponding subsidiary in February, 2012. In adherence to Regulation S-X Rule 3A-02 this transaction and the resulting reduction of the liabilities will be presented in the Company's financials as per June 30, 2012. n Liabilities held for Sale were increased from $nil at December 31, 2011 to $159,898 at December 31, 2012. Revenues The Company generates revenue from product Licenses, Maintenance, Third-Party Products, Services and Other Revenue. For the fiscal year ended December 31, 2012, total revenue decreased $2,537,308 from $28,273,092 at December 31, 2011 to $25,735,784 at December 31, 2012. The decline mainly resulted from a $1,944,833 decrease in Service revenues, as a result of the sale of IDC, combined with a net decrease of $592,475 in product and other revenues. The Company operates across 4 primary regions United States, Germany, United Kingdom, and Other. For the fiscal year ended December 31, 2012 revenue across all regions decreased as presented in detail in the Company's Notes to the Annual Consolidated Financial Statements. Cost of Goods Sold For the fiscal year ended December 31, 2012, our Cost of Goods Sold decreased to $14,615,074 from $15,898,182. Cost of Goods Sold consists of Cost for Services, Cost for Third-Party Products and Cost for Software Licenses. Within Cost of Goods Sold the associated costs within the product division of revenue increased $62,481, from $5,575,747 at December 31, 2011, to $5,638,228 at December, 31 2012. The associated costs within the services division of revenue decreased $1,345,589, from $10,322,435 at December 31, 2011, to $8,975,846 at December 31, 2012. The gross profit margin remains with 43% (2012) and 44% (2011) on thesame level. Operating Expenses For the fiscal year ended December 31, 2012, our Operating Expenses decreased to $19,565,495 from $22,513,690 for the fiscal year ended December 31, 2011. Operating Expenses consist of Selling Expenses, Administrative Expenses and General Expenses. For the fiscal year ended December 31, 2012, our Selling Expenses decreased to $12,102,534 from $15,426,600 for the fiscal year ended December 31, 2011. Selling Expenses consist of costs for the Sales, Marketing and Service units and decreased primarily due to the sale and consolidation of subsidiary companies. For the fiscal year ended December 31, 2012, our Administrative Expenses decreased to $5,962,875 from $6,160,961 for the fiscal year ended December 31, 2011. Administrative Expenses consist of costs for the management and administration units and decreased primarily due to the sale and consolidation of subsidiary companies. For the fiscal year ended December 31, 2012, our General Expenses increased to $1,500,086 from $926,129 for the fiscal year ended December 31, 2011. 31 Other Income (Expense) For the fiscal year ended December 31, 2012, Other expense of $1,531,793 compared to Other Expense of $16,267,197 for the fiscal year ended December 31, 2011. Bad debts changes in this category increased for the write off of receivables primarily in our entities no longer functioning due to obsolete technology. Income from a settlement received in the previous fiscal year also was a contributing factor to the change. Income taxes (Expense) As a result of the change in the majority ownership of GROUP Business Software in 2011 and based on the current legal situation, management has determined it is more likely than not that the tax losses carried forward for the fiscal year ended December 31, 2011 will not be available as a deduction to determine taxable income. Therefore, the deferred tax assets from the losses carried forward for GROUP Business Software AG in an amount of $3,691,000 were written off in the fiscal year ended December 31, 2011 and included in income tax expense. For the fiscal year ended December 31, 2012 a statutory tax range from 23% to 34% has been applied resulting in an expected income tax recovery of $7,986,000. Reduced by Price Allocations from Consolidation of $2,798,000, permanent differences of $533,000 and other items as mentioned in Note 27. The total amount of income tax expense has been $1,054,734. Liquidity & Capital Resources At December 31, 2012, we had $1,154,602 in cash and cash equivalents, compared to $3,250,821 at December 31, 2011. At December 31, 2012, our accumulated stockholders' deficit was $18,974,582 compared to $12,147,666 at December 31, 2011. In principal, the Company's cash flow depends on the timely and successful market entry of its strategic offerings. The dependency accounts for revenue generated from direct customers engagements, as well as for revenue generated through the partner channel network. Especially for strategic offerings for paradigm shifting technologies, the management's budget plan is based on a series of assumptions regarding market acceptance, readiness and pricing. While management's assumptions are based on market research and customer surveys, assumptions bear the risk of being incorrect and may result in a delay in customer projects and consequently a delay or a reduction in the related strategic offering invoicing. In case these delays have an impact on the Company's liquidity and therefore its ability to support its operations with the necessary cash flow, the Company depends on its ability to generate cash flow from other resources, such as debt financing from related or independent resources or as equity financing from existing shareholders or through the stock market. During the entire fiscal year 2012 and for the first five months of 2013, the Company was in constant contact with internal and external sources for financing. These sources provided the necessary funds to support the working capital needs of the Company; mainly to finance the Company's strategic offering. There can be no assurances, however, that the Company will be able to obtain additional funds from these or any other sources or that such funds will be sufficient to permit the Company to implement its intended business strategy. In the event, the Company is not able to generate additional funds, management will postpone any strategic investment until the financing will be sufficient. However, management believes as a result of the assets purchased to date, in accordance with the above-mentioned statement, the Company will be able to provide sufficient cash flow to support its standard operations for the next 12 months. To date, we have funded our operations from private financings and operations. In March 2010, we consummated a private placement of Units for $1.25 per Unit for total gross proceeds of $7,555,000 (the "Private Placement"). The net proceeds of this offering were $6,839,327.25. Each Unit consisted of one share of common stock and one warrant exercisable to purchase one share of common stock from the date of grant until the third anniversary of the date of grant for $1.50 per share (the "Private Placement Warrants"). As of December 31, 2012, warrant holders exercised an aggregate of 2,025,000 Private Placement Warrants for gross proceeds to the Company of $3,037,500. If the remaining 4,019,000 Private Placement Warrants were exercised, of which there can be no assurance, the Company would receive $6,028,000 in additional gross proceeds. In March 2012, the Company entered into a Securities Purchase Agreement (the "Securities Purchase Agreement") with each of five "accredited investors" (as that term is defined by Rule 501(a) of Regulation D promulgated under the Securities Act), one of whom was Stephen D. Baksa, a member of the Board of Directors of the Company, and all of whom were investors in the Private Placement. Pursuant to the Securities Purchase Agreements entered into by the Company and the accredited investors, the Company sold the accredited investors an aggregate of 2,020,000 warrants (the "Investor Warrants") in consideration for $10.00 per investor. Each Investor Warrant is exercisable to purchase one share of common stock of the Company for a purchase price of $0.50 per share from the date of issuance to the third anniversary date of the date of issuance. As of December 31, 2012, warrant holders exercised an aggregate 905,000 Investor Warrants for gross proceeds to the Company of $457,500. If the remaining 1,120,000 Investor Warrants were exercised, of which there can be no assurance, the Company would receive $560,000 in additional gross proceeds. 32 In addition to the foregoing, during the fiscal year ended December 31, 2012, we raised capital by consummating the following transactions: n On April 16, 2012, the Company sold 120,000 Units to Joerg Ott, the Chairman of the Board of Directors and then Chief Executive Officer of the Company, for a price of $1.50 per Unit, for a total purchase price of $180,000. Each Unit consisted of one share of Common Stock of the Company and one warrant to purchase one share of Common Stock of the Company from the date of issuance until the third anniversary date of the date of issuance for $1.50 per share. The Company sold the Units and underlying securities to Mr. Ott in reliance on Section 4(2) of the Securities Act due to the fact that the issuance was isolated and did not involve a public offering of securities. n On May 10, 2012, the Company sold 30,000 Units to Markus R. Ernst, the Chief Financial Officer of the Company, for a purchase price of $1.50 per unit, for a total purchase price of $45,000. Each unit consists of one share of common stock of the Company and one warrant, allowing the holder to purchase one share of common stock of the Company from the date of issuance until the third anniversary date of the date of issuance for $1.50 per share. The Company sold the units and underlying securities to Mr. Ernst in reliance on Section 4(2) of the Securities Act due to the fact that the issuance was isolated and did not involve a public offering of securities. n On July 5, 2012, the Company entered into a convertible promissory note agreement (the "Loan Agreement") with Mohammad A. Shihadah, a member of the Board. Pursuant to the Loan Agreement, the Company issued a convertible promissory note, dated July 5, 2012 (the "Note"), to Mr. Shihadah for the principal amount of $50,000, bearing interest at a rate of 8% per year and maturing on the earlier of the first anniversary date of the date of issuance or such other time as described in more detail in the Note. The Note was convertible in full at $0.50 per share into common stock of the Company, if the conversion was not exercised on or before September 30, 2012. If not exercised Mr. Shihadah will receive a 3-year warrant to purchase shares at 50,000 shares of common stock at $0.50 per share. The conversion was not exercised by September 30, 2012, as per the terms of the Loan Agreement Mr. Shihadah was issued a 3-year warrant to purchase shares at 50,000 shares of common stock at $0.50 per share. o As of May 17, 2013, _______________ is outstanding under the Note. No principal or interest payments have been made on the Note. n On July 5, 2012, the Company entered into a convertible promissory note agreement (the "Loan Agreement") with K Group Ltd. Pursuant to the Loan Agreement, the Company issued a convertible promissory note, dated July 5, 2012 (the "Note"), to K Group Ltd. for the principal amount of $250,000, bearing interest at a rate of 8.5% per year and maturing on the earlier of the first anniversary date of the date of issuance or such other time as described in more detail in the Note. The Note was convertible in full at $0.50 per share into common stock of the Company, if this conversion if not exercised on or before September 30, 2012. (Did they exercise- if not, change the wording herein) If not exercised K Group Ltd. will receive a 3-year warrant to purchase shares at 250,000 shares of common stock at $1.00 per share. The conversion was not exercised by September 30, 2012, as per the terms of the Loan Agreement K Group Ltd. was issued a 3-year warrant to purchase shares at 250,000 shares of common stock at $1.00 per share. o As of May 17, 2013, _______________ is outstanding under the Note. No principal or interest payments have been made on the Note. n On July 5, 2012, the Company entered into a convertible promissory note agreement (the "Loan Agreement") with Vitamin B Venture GmbH. Pursuant to the Loan Agreement, the Company issued a convertible promissory note, dated July 5, 2012 (the "Note"), to Vitamin B Venture GmbH for the principal amount of $252,500, bearing interest at a rate of 8.5% per year and maturing on the earlier of the first anniversary date of the date of issuance or such other time as described in more detail in the Note. The Note was convertible in full at $0.50 per share into common stock of the Company, if this conversion if not exercised on or before September 30, 2012. If not exercised K Group Ltd. will receive a 3-year warrant to purchase shares at 250,000 shares of common stock at $1.00 per share. The conversion was not exercised by September 30, 2012, as per the terms of the Loan Agreement Vitamin B Venture GmbH. was issued a 3-year warrant to purchase shares at 250,000 shares of common stock at $1.00 per share. 33 o As of May 17, 2013, _______________ is outstanding under the Note. No principal or interest payments have been made on the Note. n On August 13, 2012, the Company entered into a note purchase and security agreement (the "Loan Agreement") with John A. Moore, a member of the Board. Pursuant to the Loan Agreement, the Company issued a secured promissory note, dated October 26, 2012 (the "Note"), to Mr. Moore for the principal amount of $1,000,000, bearing interest at a rate of 20% per year and maturing on the earlier of the first anniversary date of the date of issuance or such other time as described in more detail in the Note, without any penalty for prepayment. To secure the obligations of the Company under the Note, the Company granted Mr. Moore a secured priority security interest in the Company's Accounts Receivable and its subsidiaries located in the United States of America, as more fully described in the full text of the document. o In connection with the execution of the Loan Agreement, on October 26, 2012, the Company issued the Lender a common stock purchase warrant (the "Warrant"), pursuant to which the Lender is entitled to purchase 100,000 shares of common stock at an exercise price of $0.35 until the third anniversary date of the date of issuance. The Warrant was issued in a private transaction between the Company and the Lender and was exempt from registration under the Securities and Exchange Act of 1933, as amended, pursuant to Section 4(2) thereof. o In connection with the Loan Agreement, on February 22, 2013, the Company and Mr. Moore amended the Note pursuant to which Mr. Moore agreed to convert the interest due under the Note into shares of GBSX common stock at a rate of $0.30 per share. Pursuant to the amendment, the Company issued 450,960 shares of Common Stock to Mr. Moore. The Company issued the shares in reliance on Section 4(2) of the Securities Act due to the fact that the issuance was isolated and did not involve a public offering of securities. o As of May 17, 2013, _______________ is outstanding under the Note. No principal or interest payments have been made on the Note. n On October 26, 2012, the Company entered into a note purchase and security agreement (the "Loan Agreement") with Stephen D. Baksa, a member of the Board. Pursuant to the Loan Agreement, the Company issued a secured promissory note, dated October 26, 2012 (the "Note"), to Mr. Baksa for the principal amount of $1,000,000, bearing interest at a rate of 20% per year and maturing on the earlier of the first anniversary date of the date of issuance or such other time as described in more detail in the Note, without any penalty for prepayment. To secure the obligations of the Company under the Note, the Company granted the Baksa a first priority security interest in all of the Company's right, title and interest in and to the shares of IDC Global, Inc. then owned by the Company. The Note contains customary provisions upon an Event of Default, as more fully described in the full text of the document. o In connection with the execution of the Loan Agreement, on October 26, 2012, the Company issued the Lender a common stock purchase warrant (the "Warrant"), pursuant to which the Lender is entitled to purchase 500,000 shares of common stock at an exercise price of $0.20 until the third anniversary date of the date of issuance. The Warrant was issued in a private transaction between the Company and the Lender and was exempt from registration under the Securities and Exchange Act of 1933, as amended, pursuant to Section 4(2) thereof. On February 12, 2013, Mr. Baksa exercised the right to purchase 250,000 shares of common stock at the exercise price of $0.20. o In connection with the Loan Agreement, on February 22, 2013, the Company and Mr. Baksa amended the Note pursuant to which Mr. Baksa agreed to convert the interest due under the Note into shares of GBSX common stock at a rate of $0.30 per share. Pursuant to the amendment, the Company issued 200,000 shares of Common Stock to Mr. Baksa. The Company issued the shares in reliance on Section 4(2) of the Securities Act due to the fact that the issuance was isolated and did not involve a public offering of securities. o As of May 17, 2013, _______________ is outstanding under the Note. No principal or interest payments have been made on the Note. 34 n On November 30, 2012, the Company entered into a note purchase and security agreement (the "Loan Agreement") with an accredited investor (the "Lender"). Pursuant to the Loan Agreement, the Company issued a secured promissory note, dated November 30, 2012 (the "Note"), to the Lender in the aggregate principal amount of $500,000, bearing an annual interest rate of 20% and maturing on the earlier of the first anniversary date of the date of issuance or such other time as described in more detail in the Note, without any penalty for prepayment. To secure the obligations of the Company under the Note, the Company granted the Lender a first priority security interest in all of the Company's right, title and interest in and to the shares of IDC Global, Inc. owned by the Company. The Note contains customary provisions upon an Event of Default, as more fully described in the full text of the document. o In connection with the execution of the Loan Agreement, on November 30, 2012, the Company issued the Lender a common stock purchase warrant (the "Warrant"), pursuant to which the Lender is entitled to purchase 250,000 shares of common stock at an exercise price of $0.20 until the third anniversary date of the date of issuance. The Warrant was issued in a private transaction between the Company and the Lender and was exempt from registration under the Securities and Exchange Act of 1933, as amended, pursuant to Section 4(2) thereof. o On February 12, 2013, the Lender exercised the right to purchase 250,000 shares of common stock at the exercise price of $0.20. o As of May 17, 2013, _______________ is outstanding under Note. No principal or interest payments have been made on the Note. n On November 30, 2012, the Company entered into a note purchase and security agreement (the "Loan Agreement") with an accredited investor (the "Lender"). Pursuant to the Loan Agreement, the Company issued a secured promissory note, dated November 30, 2012 (the "Note"), to the Lender in the aggregate principal amount of $500,000, bearing an annual interest rate of 20% and maturing on the earlier of the first anniversary date of the date of issuance or such other time as described in more detail in the Note, without any penalty for prepayment. To secure the obligations of the Company under the Note, the Company granted the Lender a first priority security interest in all of the Company's right, title and interest in and to the shares of IDC Global, Inc. owned by the Company. The Note contains customary provisions upon an Event of Default, as more fully described in the full text of the document. o In connection with the execution of the Loan Agreement, on November 30, 2012, the Company issued the Lender a common stock purchase warrant (the "Warrant"), pursuant to which the Lender is entitled to purchase 250,000 shares of common stock at an exercise price of $0.20 until the third anniversary date of the date of issuance. The Warrant was issued in a private transaction between the Company and the Lender and was exempt from registration under the Securities and Exchange Act of 1933, as amended, pursuant to Section 4(2) thereof. o On February 12, 2013 the Lender exercised the right to purchase 250,000 shares of common stock at the exercise price of $0.20. o As of May 17, 2013, _______________ is outstanding under Note. No principal or interest payments have been made on the Note. Cash Flows Fiscal Year Ended Fiscal Year Ended December 31, 2012 December 31, 2011 Net cash provided (used in) Operating Activities $ 1,484,997 $ (7,957,372 ) Net cash provided (used in) Investing Activities $ (795,922 ) $ 1,733,943 Net cash provided (used in) Financing Activities $ 215,720 $ 7,484,947 Effect of exchange rate changes on cash $ (84,689 ) $ (144,058 ) Net increase (decrease) in cash and cash equivalents during the period $ (2,096,220 ) $ 1,505,856 Cash and cash equivalents, beginning of period $ 3,250,821 $ 1,744,965 Cash and cash equivalents, end of period $ 1,154,602 $ 3,250,821 35 Cash provided by operating activities was $1,484,997, an increase of $9,442,369 from the previous year's cash used in operating activities of $7,957,372. This change is primarily due to a decrease in deferred income taxes of $7,353,661, a decrease in accounts payable and other liabilities of $4,574,569, a decrease in net losses of $19,573,469, and an increase in accounts receivable of $2,675,208. Cash used in investing activities was $795,922, an increase of $2,529,865 from the previous year's cash provided by investing activities of $1,733,943. This change is primarily due to the purchase of intangible assets increasing $1,374,981, and proceeds from sale of subsidiaries decreasing $1,216,820 over the year ended December 31, 2012. Cash provided by financing activities was $215,720, a decrease of $7,269,227 from the previous year's cash provided by financing activities of $7,484,947. This change is primarily due to a $2,246,800 increase in borrowings and loans from related parties, and a net decrease in capital paid-in of $8,744,642 over the year ended December 31, 2012. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The areas where critical estimates were made that have significant importance to the financial statements are as follows: i. Allowance for doubtful accounts. The company provides for potential bad debts on an account-by-account basis. Bad debts have not been significant and our allowance has been accurate. Non-trade receivables are also scrutinized and allowed for based on expected recovery. ii. Allocation of the price paid when acquiring subsidiaries. When the Company acquires subsidiary companies an allocation of the purchase is required. The allocation is based on management's analysis of the value of the net assets, and is based on estimated future cash flows that each component will produce. Such components might include software, customer lists and other intangible assets that are not readily determinable. The allocation has a significant impact on the future earnings of the Company as certain assets, customer lists for example, must be amortized and charged to operations over time, while other assets, notably goodwill, does not. iii. Impairment testing on intangibles and goodwill. As noted in more detail below, these areas involve numerous estimates as to expected cash flows, expected rates of return and other factors that are difficult to determine and are often out of the Company's direct control. iv. Valuation of deferred tax credits. The Company provides an allowance for tax recoveries arising from the application of losses carried forward. An allowance is provided where management has determined that it is less than likely that the loss will be applied and income taxes recovered. Comprehensive Income (Loss) The Company adopted FASB Codification topic ("ASC") 220, Reporting Comprehensive Income, which establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Comprehensive income consists of net income and other gains and losses affecting stockholder's equity that are excluded from net income, such as unrealized gains and losses on investments available for sale, foreign currency translation gains and losses and minimum pension liability. Since inception, the Company's other comprehensive income represents foreign currency translation adjustments and small net actuarial losses on pension plans. 36 Net Income per Common Share FASB Codification topic ("ASC") 260, Earnings per share, requires dual presentation of basic and diluted earnings per share (EPS) with a reconciliation of the numerator and denominator of the EPS computations. Basic earnings per share amounts are based on the weighted average shares of common stock outstanding. If applicable, diluted earnings per share would assume the conversion, exercise or issuance of all potential common stock instruments such as options, warrants and convertible securities, unless the effect is to reduce a loss or increase earnings per share. Diluted net income (loss) per share on the potential exercise of the equity-based financial instruments is not presented where anti-dilutive. Accordingly, although the diluted weighted average number of common stock outstanding is disclosed on the statements of operation, the calculated net loss per share is the same for bother basic and diluted as both are based on the basic weighted average of common stock outstanding. There were no adjustments required to net income for the period presented in the computation of diluted earnings per share. Financial Instruments Financial instruments consist of cash and cash equivalents, accounts receivable, financial assets, notes payable, liabilities to banks, accounts payable and accrued liabilities and other liabilities. As of the financial statement date, the Company does not hold any derivate financial instruments. Financial assets and liabilities are measured upon first recognition and reviewed at the financial statement date. Changes in fair value are recognized through profit and loss. Unless otherwise noted, it is management's opinion that the Company is not exposed to significant interest or credit risks arising from these financial instruments. Currency Risk We use the US dollar as our reporting currency. The functional currencies of our significant foreign subsidiaries are the local currency, which includes the Euro, the British pound, the Bulgarian lev and the Indian rupee. Accordingly, some assets and liabilities are incurred in those currencies and we are subject to foreign currency risks. Fair Value Measurements The Company follows FASB Codification topic (ASC") 820, Fair Value Measurements and Disclosures, for all financial instruments and non-financial instruments accounted for at fair value on a recurring basis. This new accounting standard establishes a single definition of fair value and a framework for measuring fair value, sets out a fair value hierarchy to be used to classify the source of information used in fair value measurement and expands disclosures about fair value measurements required under other accounting pronouncements. It does not change existing guidance as to whether or not an instrument is carried at fair value. The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk. The Company has adopted (ASC") 825, Financial Instruments, which allows companies to choose to measure eligible financial instruments and certain other items at fair value that are not required to be measured at fair value. The Company has not elected the fair value option for any eligible financial instruments. Cash and Cash Equivalents The Company considers all highly liquid instruments with a maturity of three months or less at the time of issuance to be cash equivalents. Inventories Pursuant to ASC 330 (Inventories), inventories held for sale are recognized under inventories. Inventories were measured at the lower of cost or market. Cost is determined on a first-in-first out basis, without any overhead component. Goodwill and other Intangible Assets Intangible assets predominately include goodwill, acquired software and capitalized software development. Intangible assets acquired in exchange for payment are reflected at acquisition costs. If the development costs can be capitalized per ASC 985-20-25, these are reflected as ascribable personneland overhead costs. 37 Company created software can be intended for sale to third parties or used by the Company itself. If the conditions for capitalization are not met, the expenses are recorded with their effect on profit in the year in which theywere incurred. The Company amortizes intangible assets with a limited useful life to the estimated residual book value in accordance with ASC regulations. In addition, in special circumstances according to ASC 350-30, a recoverability test is performed and, if applicable, unscheduled amortization is considered. The useful life of acquired software is between three and five years and three years for Company-designed software. Intangible assets obtained as part of an acquisition which do not meet the criteria for a separate entry are identified as goodwill. Goodwill is reviewed once a year during an impairment test, whereby the appraised fair value of the invested capital of the reporting unit, is compared with the carrying (book) value of its invested capital amount (including goodwill.) Use value is generally applied in order to determine the recoverability of goodwill and intangible assets with an indefinite useful life. The projected financial plan prepared by the management serves as the basis for this determination of use value and the planning assumptions are each adjusted for the current state of knowledge. Reasonable assumptions regarding macroeconomic trends and historical developments are taken into account in making these adjustments. Future estimated cash flows are determined based on the expected growth rates of the markets in question. If the carrying amount of the reporting unit exceeds the appraised fair value, the impairment based on use value measures the amount of loss, if any, and an unscheduled amortization expense is recorded. If the appraised value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired. Property, Plant and Equipment Property, plant and equipment are valued at acquisition or manufacturing costs, reduced by scheduled and, if necessary, unscheduled depreciation. Fixed assets are depreciated on a straight-line basis, prorated over their expected useful life. Scheduled depreciation is mainly based on useful lives of 3 to 10 years. Leasehold improvements are depreciated up to 40 years. If fixed assets are sold, retired or scrapped, the profit or loss arising from the difference between the net sales proceeds and the residual book value are included under other operating earnings and expenses. Impairment or Disposal of Long-Lived Assets The Company evaluates the recoverability of its fixed assets and other assets in accordance with ASC topic, 360.10. This guidance requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds its' expected cash flows or appraised value In this instance, the asset is considered to be impaired and is written down to fair value. Revenue Recognition License Revenues Our license revenues consist of revenues earned from the licensing of our software products. These products are generally licensed on a perpetual basis. Pricing models have generally been based either upon the physical infrastructure, such as the number of physical desktop computers or servers, on which our software runs or on a per user basis. License revenues are recognized when the elements of revenue recognition for the licensed software are complete, generally upon electronic shipment of the software and the software key to provide full access to all functionalities for our customers. In general our invoices reflect license, service and maintenance components. In the case of multi element contracts, the revenues allocated to the software license in most cases represent the residual amount of the contract after the fair value of the other elements has been determined. Certain products of our software offering are licensed on a subscription basis. Software Maintenance Revenues Software maintenance revenues are recognized ratably on a pro-rata basis over the range of the contract period. Our contract periods typically range from one to five years. Vendor-specific objective evidence ("VSOE") of fair value for software maintenance services is established by the rates charged in stand-alone sales of software maintenance contracts or the stated renewal rate for software maintenance. Customers who are party to software maintenance agreements with us are entitled to receive support, product updates and upgrades on a when-and-if-available basis. 38 Professional Services Revenues Professional services include pre-project consulting, software design, customization, project management, implementation and training. Professional services are not considered essential to the functionality of our products, as these services do not alter the product capabilities and may be performed by our customers or by other vendors. Professional services engagements performed for a fixed fee, for which we are able to make reasonably dependable estimates of progress toward completion, are recognized on a proportional performance basis based on hours incurred and estimated hours of completion. Professional services engagements that are on a time and materials basis are recognized based on hours incurred. Revenues on all other professional services engagements are recognized upon completion. Our professional services may be sold with software products or on a stand-alone basis. Vendor Specific Objective Evidence (VSOE) of fair value for professional services is based upon the standard rates we charge for such services when sold separately. Foreign Currency Translation The functional currency of the Company is US dollars. For financial reporting purposes, the financial statements of GROUP were translated into US dollars. Assets and liabilities were translated at the exchange rates at the balance sheet dates and revenue and expenses were translated at the average exchange rates and stockholders' equity was translated at historical exchange rates. Any translation adjustments resulting are not included in determining net income but are included in foreign exchange adjustment to other comprehensive income, a component of stockholders' equity. Other Provisions According to FASB ASC 450 Contingencies, provisions are made whenever there is a current obligation to third parties resulting from a past event which is likely in the future to lead to an outflow of resources and of which the amount can be reliably estimated. Provisions not already resulting in an outflow of resources in the following year are recognized at their discounted settlement amount on the financial statement date. The discount taken is based on market interest rates. The settlement amount also includes the expected cost increases. Provisions are not set off against contribution claims. If the amended estimate leads to a reduction of the obligatory amount, the provision is proportionally reversed and the earnings are recognized in other operating earnings. Deferred Taxes Income taxes are provided in accordance with FASB Codification topic 740, Accounting for Income Taxes. A deferred tax asset or liability is recorded for all temporary differences between financial and tax reporting and net operating loss-carry forwards. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that, some portion or all of the deferred tax asset will not be realized. Deferred tax assets and liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment. Recent Accounting Pronouncements In July 2012, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment. With the objective of reducing the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-loved asset categories. The amendments permit an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Subtopic 350-30, Intangibles - Goodwill and Other - General Intangibles Other than Goodwill. The more-likely-than-not threshold is defined as having the likelihood of more than 50 percent. The amendments are effective for annual and interim impairment tests performed beginning April 1, 2013. Adoption of this new standard is not expected to have significant impact to the Company's financial statement. Principles of Consolidation and Reverse Acquisition As previously disclosed, the Company originally exchanged a total of 5,405,411 shares of common stock in exchange for 50.1% of the outstanding common shares of GROUP (and retained its 50.1% shareholding by acquiring an additional 883,765 shares of GROUP on February 27, 2012). Although the Company was the legal acquirer, the transaction was accounted for as a recapitalization of GROUP in the form of a reverse merger, whereby GROUP became the accounting acquirer and was deemed to have retroactively adopted the capital structure of the Corporation. Accordingly, the accompanying consolidated financial statements reflect the historical consolidated financial statements of GROUP for all periods presented, and do not include the historical financial statements of the Company. All costs associated with the reverse merger transaction were expensed as incurred. Those expenses totaled approximately $300,000 and were included in professional fees in administrative expenses. 39 The Company has based its financial reporting for the consolidation with GROUP in accordance with FASB Accounting Standard Codification (ASC) 805-40 as it relates to reverse acquisitions. Goodwill has been measured as the excess of the fair value of the consideration effectively transferred by the Company, the acquiree, for financial reporting purposes, over the net amount of the Company's recognized identifiable assets and liabilities. We have recorded the acquired assets and liabilities of GBSX on the acquisition date of January 6, 2011, at their fair value and the operations of GBSX have been included in the consolidated financial statements since the acquisition date. The assets and liabilities of GROUP, the acquirer for financial reporting purposes, are measured and recognized in the consolidated financial statements at their precombination carrying amounts in accordance with ASC 805-40-45-2(a). Therefore, in a reverse acquisition, the non-controlling interest reflects the non-controlling shareholders' proportionate interest in the pre-combination carrying amounts of GROUP's net assets even though the non-controlling interests in other acquisitions are measured at their fair values at the acquisition date. OFF-BALANCE SHEET ARRANGEMENTS We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder's equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us. |