We strategically built our business to deliver a wide range of IT services and solutions that address challenges common to many U.S. Government agencies, state and local governments and commercial companies. We believe that our core strengths position us to respond to the long-term trends and changing demands of our market. Our key focus areas are:

 

Enterprise Architecture. Our approach to developing architecture for our clients’ IT needs begins with the business model. Business drives the need for solutions, and technology facilitates the solution. By understanding the business drivers, we establish the architectural framework to build or extend the computing environment with right sized technology solutions that maximize business processes while minimizing the costs and risks to the client. We developed and continue to support the implementation of business processes for a new operation of the U.S. Department of Homeland Security (DHS) where we have successfully integrated technology into the business layer of the existing architectural framework.

 

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Software Development. We follow a systematic approach to developing software for specific client projects. Whether it is a full systems development lifecycle or portions of one, we approach our development tasks with process discipline to ensure tasks are defined, objectives established and progress measured. We developed a Human Resource PeopleSoft-based solution for the DHS to manage the entry and exit of personnel. We developed a software application called SmartForms and have converted standard paper forms to electronic forms to greatly enhance the simplicity and efficiency of processing personnel actions. We also created software to automate routine functions performed under a Network Services contract to enhance and speed-up productivity, as well as reduce the client’s operating expenses.

 

IT Infrastructure Management.   We operate one of the nation’s largest wide area networks for a major establishment of the U.S. Government. We provide this support under a subcontract we entered into in 2004 with a large systems integrator. Referred to as Advanced Server Management (ASM), our team of server experts supports approximately 2,000 servers and some 140,000 client stations from two large data centers in Maryland and Colorado. Operating around the clock, we consistently exceed the requirements of our service level agreements.

 

Systems Engineering.   We provide critical systems engineering support to the ASM Program and on projects for the DHS. Our engineers design and build systems supporting a mix of business activities. We both manage and execute engineering projects supporting complex wide area networks and local area networks in Windows and UNIX environments, and we provided engineering support for a nationwide wireless operation. Our engineers follow proven methodologies to transition systems from concept to operations.

 

Server Virtualization. Virtualization is the process of presenting a logical grouping of computing resources so they can be accessed in ways that give benefits over the original configuration. A good example of virtualization is multiprocessing computer architectures. This is the practice of partitioning or splitting up one server to appear as multiple servers. Using virtualization software provided by third party vendors such as VMWare, a client can run multiple operating systems on one physical machine and therefore a broader, richer set of business applications.

 

During 2006 and 2007, we executed the first phase of a nationwide physical to virtual server consolidation project for a major establishment of the U.S. Government. We began by architecting, designing and migrating approximately 800 servers. Early successes led the client to expand to an additional 1,600 servers. We led the client’s Advanced Computing Environment (ACE) virtual server project utilizing VMware’s ESX 3.0.1 to virtualize everything from application and print servers to terminal servers and domain controllers. The migration was transparent to the end user - there was no server downtime and no lost data.

 

Beginning in late 2007, we began providing consultant support to a Fortune 500 client in performing a global data center consolidation effort. Moreover, we are working on the initial stage of a major server virtualization program for one of the constituent agencies of DHS.

 

Program Management.   Our program managers are subject matter experts who are skilled in managing complex programs dealing with leading edge technologies. Our engagements span a broad range of tasks such as feasibility studies, concept and strategy planning, business process development and reengineering, and project execution. Our staff has a thorough understanding of the technical bases for management and therefore provides clients with expertise connecting technical delivery with sound project management using earned value management processes. We have provided program, portfolio and project management, risk management, master scheduling and acquisition management services to the DHS’s Wireless Management Office. In fact we supported the creation, deployment and maintenance of the multi-billion dollar Integrated Wireless Network (IWN) program.

 

Portfolio Management. We define, implement, and manage portfolios as an integral part of program management. We have proven experience in establishing portfolios as an effective strategy to assess the overall performance of a program through the projects that the program manages. Using performance measures that are defined for the program, the project portfolio can be better evaluated. In addition to overall program performance management, financial performance is supported through portfolio management by capturing planned and actual investments and their associated business cases. Through the use of industry standard software, such as ProSight, we ensure that the originator of the business case focuses on the accuracy and completeness of program and project information and that the program management office focuses on program management best practices.

 

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Project Management. Managing technology-driven projects is a complex process requiring skilled personnel to deliver on the actual work, as well as requiring expert project managers who can plan and execute the work. We have a proven methodology for project management, which includes standards for Earned Value Management that can be applied to any project type. We have created web-based project management environments to integrate the entire process of delivery with project management standards to optimize performance. A Portal provides a mechanism to engage the entire stakeholder community in the delivery process and enable team personnel to plan, perform, measure, and report on delivery. We developed a comprehensive project management system and have implemented earned value management-based project management standards for the DHS Wireless Management Office.

During 2007, we derived approximately 57% of our sales from our Advanced Server Management subcontract. During that same period, we derived approximately 9% of our sales from a prime contract with the DHS. We also entered into several subcontracts under which we provided IT services to various programs and divisions of DHS and other U.S. Government agencies. These subcontracts provided the balance of our 2007 sales.

Our Contract and Sales Vehicles

The acquisition of the following contract vehicles allows us additional opportunities to bid on new projects.

Federal Supply Schedule Contract. We were awarded a Federal Supply Schedule Contract by the U.S. General Services Administration (GSA) for IT consulting services (Schedule 70). Having a Schedule 70 allows us to compete for and secure prime contracts with all executive agencies of the U.S. Government, as well as other national and international organizations. Our Schedule 70 was expanded and extended in June 2006 to encompass 85 different labor categories for a three year term. During 2007 and 2006, we had one prime contract under our Schedule 70 with sales of approximately $756,000 in 2007 and $825,000 in 2006. Beginning in 2008, this contract was revised such that we are now a subcontractor to a major prime contractor for DHS for these same services. We have used the Schedule 70 as a basis for pricing our current and proposed work. We intend to continue using our Schedule 70 to facilitate the sale of IT consulting services to the U.S. Government.

Navy’s SeaPort-Enhanced (SeaPort-e) Program. In June 2006, we were awarded a prime contract under the Department of the Navy’s SeaPort-Enhanced (SeaPort-e) program. This contract allows us to compete for and perform service requirements solicited by various Navy commands, the Marine Corps, other organizations within the Department of Defense (DoD), non-DoD agencies, and certain joint agency organizations for work that is integrally related to the scope and mission of the contract. This work involves professional services in all phases of naval ship and weapon systems acquisition and life-cycle support, including research and development support, prototyping, technology analysis, acquisition logistics, project management support, modeling, test and evaluation trials, crisis and consequence management, and engineering support.

VMware Authorized Consultant (VAC). During 2007, we were approved as a VMware Authorized Consultant (VAC) by VMware, Inc. (NYSE:VMW) a subsidiary of EMC Corporation (NYSE:EMC). VMware is recognized as the industry leader in virtualization technology. As a VAC, we are trained and certified to deliver consulting services and solutions leveraging VMware technology. We are also certified as a VMware Enterprise VIP Reseller authorized to resell VMware’s full product line. We are actively working with a number of potential customers in that regard. These certifications are examples of our concerted effort to grow and expand our virtualization practice. Virtualization involves the creation, allocation, and management of “virtual machines,” which entails the virtual representation of hardware by a software system. What this means is that traditional “physical servers,” which typically run at only 5% to 15% of their capacity, can now be consolidated with the use of specialized software such as VMware to increase server utilization by a factor of ten to one or even greater. Reducing the number of physical machines required in a typical environment provides numerous and obvious benefits, including equipment cost savings, reduced operational maintenance costs, easier backup, improved availability, and better security.  Due to the substantial energy savings resulting from reduced infrastructure, virtualization is also a “green” technology.

 

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Hewlett Packard Developer and Solutions Partner Program (DSPP). In July 2007, we were accepted into the Hewlett Packard (NYSE:HPQ) Developer and Solutions Partner Program (DSPP). DSPP provides us with a mechanism to work with HP and our joint customers and prospects to provide solutions and services that complement HP's broad portfolio of products and services. HP has many tools and resources to help us generate new sales streams, and improve our mutual profitability, while at the same time adding unique value for our joint customers. The program comprises practical tools and services that we hope will help us in the key areas of marketing and selling our solutions, optimizing the technology, and collaborating with other organizations within our industry.

Navy Enterprise Maintenance Automated Information System (NEMAIS). We are a member of a team led by CACI International Inc. that was awarded a $36 million task order by the U.S. Navy in October 2007 to support its Navy Enterprise Maintenance Automated Information System (NEMAIS) data center operations. The task order, awarded under the Seaport II Enhanced contract vehicle (Seaport-e), provides for one base year and three one-year options. The CACI team will perform the work at the Naval Sea Systems Command (NAVSEA) site in Norfolk, Virginia and the Puget Sound Naval Shipyard in Washington State. As a result of the award CACI was able to maintain the same level of support it has been providing to the Navy for the NEMAIS data center which in turn enhances CACI’s and our core lines of business in engineering services, network services and business systems integration. In 2008, we began working with CACI on a portion of this project under the terms of our subcontract.

Competition

We compete mainly with other IT professional services firms operating in the federal, state and local government marketplace. We obtain much of our business on the basis of proposals submitted in response to requests from potential and current customers, who typically also receive proposals from other firms. Many of our proposed services are included with proposals of large prime contractors, where a specific area for our participation has been identified based on our expertise and experience. Certain large prime contractors are required to allocate a portion of their contract to small businesses and we are able to fill that role. We also face indirect competition from certain government agencies that perform services for themselves similar to those we market.

We have entered into subcontracts with systems integrators holding multi-year, multi-million dollar contracts with the U.S. Government. In such cases, our competition is mainly with other IT services companies classified as small business entities by government standards. For prime contracts with the U.S. Government, we anticipate that our competition will range from small business set aside contractors to full and open competition with large firms such as Northrop Grumman Information Technologies, Science Applications International Corp., EDS Corp., Computer Sciences Corp., Unisys, SRA International, and SI International, Inc.

Our competitors in general have substantially greater capital resources, research and development staffs, manufacturing capabilities, sales and marketing resources, facilities and experience than we do.

 

Because of the diverse requirements of U.S. Government customers and the highly competitive nature of large procurements, corporations frequently form teams to pursue contract opportunities. The same companies listed as competitors will often team with us or subcontract to us in the pursuit of new business. We believe that the major competitive factors in our market are distinctive technical competencies, successful past contract performance, price of services, reputation for quality and key management with domain expertise.

 

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Recent Capital Raising Activities

During May 2007, we converted $54,500 of principal on certain of our outstanding notes payable into 1,090,000 unregistered shares of common stock in accordance with the terms of the notes.

The following agreements have been accounted for in accordance with EITF 96-18 “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” whereby the fair value of the warrant will be recorded as the performance criteria are met. Warrant values were determined using the Black-Scholes option pricing model.

 

On April 4, 2007, we engaged the services of a consultant, an accredited investor, to assist us with business development for a term of one year through April 4, 2008 and issued the consultant (i) 100,000 restricted shares of our common stock having a fair value of $50,000 and (ii) a warrant to acquire 100,000 shares of our common stock, exercisable at $.50 per share, which expires on April 4, 2012 having a fair value of $24,380. During 2007, we recorded $55,785 of expense for these services.

On March 3, 2006, we engaged the services of a consultant and issued it a warrant to acquire 500,000 shares of our common stock, exercisable at $.30 per share, which expires on March 2, 2011. The warrant vests in increments of 100,000 common shares upon our realizing aggregate sales of $200,000, $1,200,000, $2,200,000, $3,200,000, and $4,200,000 from the consultant’s efforts on our behalf. During 2007, the consultant vested in 100,000 shares of our common stock and as a result we recorded $37,799 of expense for these services.

These transactions were exempt from registration, as they were nonpublic offerings made pursuant to Sections 4(2) and 4(6) of the Securities Act of 1933, as amended (the Act). All shares issued in the transactions described hereinabove bore an appropriate restrictive legend. No underwriter was involved in these transactions.

Employees

As of December 31, 2007 we had 85 full-time employees, including 72 in information technology services, two in executive management, two in finance and administration, one in employee recruiting, and eight in marketing and sales. We are not subject to any collective bargaining agreements and we believe that our relations with our employees are good. We believe that we are currently staffed at an appropriate level to implement and carry out our business plan for the next 12 months.

Our ability to develop and market our services, and to establish and maintain a competitive position in our businesses will depend, in large part, upon our ability to attract and retain qualified technical, marketing and managerial personnel, of which there can be no assurance.

General Information

We were incorporated under the laws of the state of Delaware on October 14, 1986. On January 7, 1998, we changed our name from Infinite Machines Corp. to Infinite Group, Inc. Our principal corporate headquarters are located at 60 Office Park Way, Pittsford, NY 14534. Our business is exclusively in the field of IT services. We maintain a website at www.IGIus.com. The content of our website shall not be deemed part of this report.

 

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Risk Factors

 

In addition to the other information provided in our reports, you should consider the following factors carefully in evaluating our business and us. Additional risks and uncertainties not presently known to us, which we currently deem immaterial or that are similar to those faced by other companies in our industry or business in general, such as competitive conditions, may also impair our business operations. If any of the following risks occur, our business, financial condition, or results of operations could be materially adversely affected.

Risks Related to our Industry

We depend on prime contracts or subcontracts with the U.S. Government for substantially all of our sales, and our business would be seriously harmed if the government ceased doing business with us or our prime contractors or significantly decreased the amount of business it does with us or our prime contractors.

We derived approximately 99% of our sales in 2007 from U.S. Government contracts as either a prime contractor or a subcontractor. We expect that we will continue to derive a substantial portion of our sales for the foreseeable future from work performed under U.S. Government contracts, as we have in the past, and from new marketing efforts focused on state and local governments. If we or our prime contractors were suspended or prohibited from contracting with federal, state or local governments, or if our reputation or relationship with the federal, state or local governments were impaired, or if any of the foregoing otherwise ceased doing business with us or our prime contractors or significantly decreased the amount of business it does with us or our prime contractors, our business, prospects, financial condition and operating results would be materially adversely affected.

Our business could be adversely affected by changes in budgetary priorities of the U.S. Government.

Because we derive a significant portion of our sales from contracts with the U.S. Government, we believe that the success and development of our business will continue to depend on our successful participation in U.S. Government contract programs. Changes in U.S. Government budgetary priorities could directly affect our financial performance. A significant decline in government expenditures, a shift of expenditures away from programs which call for the types of services that we provide or a change in U.S. Government contracting policies, could cause U.S. Governmental agencies to reduce their expenditures under contracts, to exercise their right to terminate contracts at any time without penalty, not to exercise options to renew contracts or to delay or not enter into new contracts. Any of those actions could seriously harm our business, prospects, financial condition or operating results. Moreover, although our contracts with governmental agencies often contemplate that our services will be performed over a period of several years, Congress usually must approve funds for a given program each government fiscal year and may significantly reduce or eliminate funding for a program. Significant reductions in these appropriations by Congress could have a material adverse effect on our business. Additional factors that could have a serious adverse effect on our U.S. Government contracting business include:

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changes in U.S. Government programs or requirements;

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budgetary priorities limiting or delaying U.S. Government spending generally, or by specific departments or agencies in particular, and changes in fiscal policies or available funding, including potential governmental shutdowns;

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reduction in the U.S. Government's use of technology solutions firms; and

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a decrease in the number of contracts reserved for small businesses, or small business set asides, which could result in our inability to compete directly for these prime contracts.

·

curtailment of the U.S. Government’s use of IT or related professional services.

 

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Our profitability will suffer if we are not able to maintain our pricing and utilization rates and control our costs.

Our profit margin, and therefore our profitability, is largely a function of the rates we charge for our IT Services and the utilization rate, or chargeability, of our employees. Accordingly, if we are not able to maintain the rates we charge for our services or an appropriate utilization rate for our employees, we will not be able to sustain our profit margin and our profitability will suffer. The rates we charge for our IT Services are affected by a number of factors, including:

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our clients' perception of our ability to add value through our services;

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competition;

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introduction of new services or products by us or our competitors;

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pricing policies of our competitors; and

·

general economic conditions.

Our utilization rates are also affected by a number of factors, including:

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seasonal trends, primarily as a result of holidays, vacations, and slow downs by our clients, which may have a more significant effect in the fourth quarter;

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our ability to transition employees from completed engagements to new engagements;

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our ability to forecast demand for our services and thereby maintain an appropriately balanced and sized workforce; and

·

our ability to manage employee turnover.

 

We have implemented cost-management programs to manage our costs, including personnel costs, support and other overhead costs. Some of our costs, like office rents, are fixed in the short term, which limits our ability to reduce costs in periods of declining sales. Our current and future cost-management initiatives may not be sufficient to maintain our margins as our level of sales varies.

If we fail to meet our contractual obligations to our clients, our ability to compete for future work and our financial condition may be adversely affected.

If we fail to meet our contractual obligations, we could be subject to legal liability, which could adversely affect our business, operating results and financial condition. The provisions we typically include in our contracts which are designed to limit our exposure to legal claims relating to our services may not protect us or may not be enforceable under some circumstances or under the laws of some jurisdictions. It is possible, because of the nature of our business, that we may be exposed to legal claims in the future. Effective January 1, 2007, we have acquired errors and omissions insurance with coverage limits of $1,000,000 and a deductible payable by us of $50,000. The policy limits may not be adequate to provide protection against all potential liabilities. As a consulting firm, we depend to a large extent on our relationships with our clients and our reputation for high-quality services to retain and attract clients and employees. As a result, claims made against us may damage our reputation, which in turn, could impact our ability to compete for new business.

Unfavorable government audits could require us to refund payments we have received, to forego anticipated sales and could subject us to penalties and sanctions.

The government agencies we work for generally have the authority to audit and review our contracts with them and/or our subcontracts with prime contractors. As part of that process, the government agency reviews our performance on the contract, our pricing practices, our cost structure and our compliance with applicable laws, regulations and standards. If the audit agency determines that we have improperly received payment or reimbursement, we would be required to refund any such amount. If a government audit uncovers improper or illegal activities by us, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeitures of profits, suspension of payments, fines and suspension or disqualification from doing business with the government. Any such unfavorable determination could adversely impact our ability to bid for new work which would have a negative impact on our business.

 

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The IT services industry is highly competitive, and we may not be able to compete effectively.

We operate in a highly competitive industry that includes a large number of participants. We believe that we currently compete principally with other IT professional services firms, technology vendors and the internal information systems groups of our clients. Many of the companies that provide services in our markets have significantly greater financial, technical and marketing resources than we do. Our marketplace is experiencing rapid changes in its competitive landscape. Some of our competitors have sought access to public and private capital and others have merged or consolidated with better-capitalized partners. These changes may create more or larger and better-capitalized competitors with enhanced abilities to compete for market share generally and our clients specifically, in some cases, through significant economic incentives to clients to secure contracts. These competitors may also be better able to compete for skilled professionals by offering them large compensation incentives. In addition, one or more of our competitors may develop and implement methodologies that result in superior productivity and price reductions without adversely affecting the competitors' profit margins. In addition, there are relatively few barriers to entry into our markets and we have faced, and expect to continue to face, competition from new entrants into our markets. As a result, we may be unable to continue to compete successfully with our existing or any new competitors.

Our future success depends on our ability to continue to retain and attract qualified employees.

We believe that our future success depends upon our ability to continue to train, retain, effectively manage and attract highly skilled technical, managerial, sales and marketing personnel. Employee turnover is generally high in the IT services industry. If our efforts in these areas are not successful, our costs may increase, our sales efforts may be hindered, and or our customer service may degrade. Although we invest significant resources in recruiting and retaining employees, there is often significant competition for certain personnel in the IT services industry. From time to time, we experience difficulties in locating enough highly qualified candidates in desired geographic locations, or with required specific expertise.

Our contracts with the U.S. Government may be terminated or adversely modified prior to completion, which could adversely affect our business.

U.S. Government contracts generally contain provisions, and are subject to laws and regulations, that give the U.S. Government rights and remedies not typically found in commercial contracts, including provisions permitting the U.S. Government to:

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terminate our existing contracts;

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reduce potential future income from our existing contracts;

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modify some of the terms and conditions in our existing contracts;

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suspend or permanently prohibit us from doing business with the U.S. Government or with any specific government agency;

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impose fines and penalties;

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subject us to criminal prosecution;

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subject the award of some contracts to protest or challenge by competitors, which may require the contracting U.S. agency or department to suspend our performance pending the outcome of the protest or challenge and which may also require the government to solicit new bids for the contract or result in the termination, reduction or modification of the awarded contract;

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suspend work under existing multiple year contracts and related task orders if the necessary funds are not appropriated by Congress;

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decline to exercise an option to extend an existing multiple year contract; and

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claim rights in technologies and systems invented, developed or produced by us.

 

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The U.S. Government may terminate a contract with us either "for convenience" (for instance, due to a change in its perceived needs or its desire to consolidate work under another contract) or if we default by failing to perform under the contract. If the U.S. Government terminates a contract with us for convenience, we generally would be entitled to recover only our incurred or committed costs, settlement expenses and profit on the work completed prior to termination. If the U.S. Government terminates a contract with us based upon our default, we generally would be denied any recovery for undelivered work, and instead may be liable for excess costs incurred by the U.S. Government in procuring undelivered items from an alternative source. We may in the future receive show-cause or cure notices under contracts that, if not addressed to the U.S. Government's satisfaction, could give the government the right to terminate those contracts for default or to cease procuring our services under those contracts.

Our U.S. Government contracts typically have terms of one or more base years and one or more option years. Many of the option periods cover more than half of the contract's potential term. U.S. Governmental agencies generally have the right not to exercise options to extend a contract. A decision to terminate or not to exercise options to extend our existing contracts could have a material adverse effect on our business, prospects, financial condition and results of operations.

Certain of our U.S. Government contracts also contain "organizational conflict of interest" clauses that could limit our ability to compete for certain related follow-on contracts. For example, when we work on the design of a particular solution, we may be precluded from competing for the contract to install that solution. While we actively monitor our contracts to avoid these conflicts, we cannot guarantee that we will be able to avoid all organizational conflict of interest issues.

In addition, U.S. Government contracts are frequently awarded only after formal competitive bidding processes, which have been and may continue to be protracted, and typically impose provisions that permit cancellation in the event that funds are unavailable to the public agency.

The competitive bidding process presents a number of risks, including the following:

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we expend substantial funds, managerial time and effort to prepare bids and proposals for contracts that we may not win;

·

we may be unable to estimate accurately the resources and cost that will be required to service any contract we win, which could result in substantial cost overruns; and

·

we may encounter expense and delay if our competitors protest or challenge awards of contracts to us in competitive bidding, and any such protest or challenge could result in a requirement to resubmit bids on modified specifications or in the termination, reduction or modification of the awarded contract.

If we fail to establish and maintain important relationships with government entities and agencies, our ability to successfully bid for new business may be adversely affected.

To develop new business opportunities, we rely on establishing and maintaining relationships with various government entities and agencies. We may be unable to successfully maintain our relationships with government entities and agencies, and any failure to do so could materially adversely affect our ability to compete successfully for new business.

Our business may suffer if our facilities or our employees are unable to obtain or retain the security clearances or other qualifications needed to perform services for our clients.

Many of our U.S. Government contracts require employees and facilities used in specific engagements to hold security clearances and to clear National Agency Checks and Defense Security Service checks. Some of our contracts require us to employ personnel with specified levels of education, work experience and security clearances. Depending on the level of clearance, security clearances can be difficult and time-consuming to obtain. If our employees or our facilities lose or are unable to obtain necessary security clearances or successfully clear necessary National Agency or Defense Security Service checks, we may not be able to win new business and our existing clients could terminate their contracts with us or decide not to renew them, and in each instance our operating results could be materially adversely affected. During 2007, we were granted a secret facilities clearance with the Defense Security Service.

 

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We must comply with a variety of laws, regulations and procedures and our failure to comply could harm our operating results.

We must observe laws and regulations relating to the formation, administration and performance of U.S. Government contracts which affect how we do business with our clients and impose added costs on our business. For example, the Federal Acquisition Regulation and the industrial security regulations of the Department of Defense and related laws include provisions that:

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allow our U.S. Government clients to terminate or not renew our contracts if we come under foreign ownership, control or influence;

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require us to disclose and certify cost and pricing data in connection with contract negotiations;

·

require us to prevent unauthorized access to classified information; and

·

require us to comply with laws and regulations intended to promote various social or economic goals.

We are subject to industrial security regulations of the Department of Homeland Security and other federal agencies that are designed to safeguard against foreigners' access to classified information. If we were to come under foreign ownership, control or influence, we could lose our facility security clearance, which could result in our U.S. Government customers terminating or deciding not to renew our contracts, and could impair our ability to obtain new contracts.

In addition, our employees often must comply with procedures required by the specific agency for which work is being performed, such as time recordation or prohibition on removal of materials from a location.

 

Our failure to comply with applicable laws, regulations or procedures, including federal procurement regulations and regulations regarding the protection of classified information, could result in contract termination, loss of security clearances, suspension or prohibition from contracting with the U.S. Government, civil fines and damages and criminal prosecution and penalties, any of which could materially adversely affect our business.

 

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The U.S. Government may revise its procurement or other practices in a manner adverse to us.

The U.S. Government may revise its procurement practices or adopt new contracting rules and regulations, such as cost accounting standards. It could also adopt new contracting methods relating to GSA contracts, government-wide contracts, or adopt new standards for contract awards intended to achieve certain social or other policy objectives, such as establishing new set-aside programs for small or minority-owned businesses. In addition, the U.S. Government may face restrictions from new legislation or regulations, as well as pressure from government employees and their unions, on the nature and amount of services the U.S. Government may obtain from private contractors. These changes could impair our ability to obtain new contracts or contracts under which we currently perform when those contracts are put up for recompetition bids. Any new contracting methods could be costly or administratively difficult for us to implement, and, as a result, could harm our operating results. For example, the Truthfulness, Responsibility and Accountability in Contracting Act, proposed in 2001, would have limited and severely delayed the U.S. Government's ability to use private service contractors. Although this proposal was not enacted, it or similar legislation could be proposed at any time. Any reduction in the U.S. Government's use of private contractors to provide federal information technology services could materially adversely impact our business.

Failure to maintain strong relationships with other government contractors could result in a decline in our sales.

We derived approximately 91% of our total sales in 2007 from contracts under which we acted as a subcontractor. Our subcontracts with prime contractors contain many of the same provisions as the prime contacts and therefore carry many of the same risks previously identified in these Risk Factors. As a subcontractor, we often lack control over fulfillment of a contract, and poor performance on the contract by others could tarnish our reputation, even when we perform as required. We expect to continue to depend on relationships with other contractors for a significant portion of our sales in the foreseeable future. Moreover, our sales and operating results could be materially adversely affected if any prime contractor chooses to offer services of the type that we provide or if any prime contractor teams with other companies to independently provide those services.

Risks Related to our Business

We experienced an operating loss and a net loss in 2007 and 2006.

During 2007 and 2006, we generated an operating loss of approximately $474,000 and $1.9 million, respectively, and a net loss of approximately $750,000 and $1.6 million, respectively. As of December 31, 2007, we had an accumulated deficit of approximately $31.0 million. Although we began to operate the IT business profitably beginning in the second quarter of 2004, we decided to increase our expenses for marketing and selling efforts beginning in 2005. Until we close new contracts and earn additional sales or curtail our marketing and selling efforts, we cannot assure you when we will be profitable on a consistent basis, or at all.

We are highly leveraged, which increases our operating deficit and makes it difficult for us to grow.

At December 31, 2007, we had current liabilities, including trade payables, of approximately $3.2 million and long-term liabilities of $1.5 million. We had working capital deficit of approximately $2.4 million and a current ratio of .24. Our objective is to improve our working capital position from profitable operations. We may continue to experience working capital shortages that impair our business operations and growth strategy if we continue to incur operating losses or net losses and as a result, our business, operations and financial condition will be materially adversely affected.

 

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We have significant liabilities related to the O&W pension plan. 

At December 31, 2007, the Osley & Whitney, Inc. (O&W) defined benefit pension plan had an accrued pension obligation liability of $2,404,189 and an accumulated other comprehensive loss of $2,227,689 which we recorded as a reduction of stockholders’ equity.

As plan sponsor, we may have been required to contribute amounts in 2004, 2005, 2006, and 2007 and may be required to make contributions in future years to fund the deficiency. We did not make a contribution in 2004, 2006 or 2007. During 2005, we did not make all required contributions. We currently do not have the funds available to make required contributions which currently approximate $1.8 million. We recorded defined benefit pension expense of approximately $351,000 in 2007 and $411,000 in 2006, including excise taxes of $213,000 in 2006 for failing to make plan contributions. We may be required to pay interest on these excise taxes and potentially could incur additional excise taxes up to 100% of required plan contributions that were not made. If we were to incur additional excise taxes, we could lose the ability to generate cash using our secured accounts receivable financing line or from other financing sources.

We have been dependent on a limited number of high net worth individuals to fund our working capital needs.

From 2003 through 2007, we raised approximately $2.5 million in a combination of equity, debt conversion and debt transactions from a limited number of high net worth investors. We cannot provide assurance that we will be able to continue to raise additional capital from this group of investors, or that we will be able to secure funding from additional sources. Certain debt holders have agreed to extensions of the maturity dates of their notes, most recently to January 2009. We cannot provide assurance that we will be able to obtain further extensions of maturity dates or that we will be able to repay or otherwise refinance the notes at their scheduled maturities.

We may require additional financing in the future, which may not be available on acceptable terms.

We may require additional funds for working capital and general corporate purposes. We cannot provide assurance that adequate additional financing will be available or, if available, will be offered on acceptable terms.

Moreover, our IT Services billings generate accounts receivable that are generally paid within 30 to 60 days from the invoice date. The cost of those sales generally consists of employee salaries and benefits that we must pay prior to our receipt of the accounts receivable to which these costs relate. We therefore need sufficient cash resources to cover such employee-related costs which, in many cases, require us to borrow funds on disadvantageous terms.

We have secured an accounts receivable financing line of credit in the amount of $800,000 from an independent finance organization that provides us with the cash needed to cover such employee-related costs. At December 31, 2007, we had only $20,000 of borrowing availability under this line. As we grow, additional working capital may be required to support this difference in the timing of cash receipts versus payroll disbursements. Moreover, our accounts receivable financing lender may decide to cease subsequent advances at any time in its discretion, upon our failure to meet certain contractual requirements or upon the occurrence of certain events or contingencies that are out of our control. In such event, our short-term cash requirements would exceed available cash on hand resulting in material adverse consequences to our business.

Finally, any additional equity financing and conversions by the holders of existing notes payable to common stock will be dilutive to stockholders. Debt financings, if available, may involve restrictive covenants that further limit our ability to make decisions that we believe will be in our best interests. In the event we cannot obtain additional financing on terms acceptable to us when required, our operations will be materially adversely affected and we may have to cease or substantially reduce operations.

 

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If we do not successfully integrate the businesses that we acquire, our results of operations could be adversely affected.

We may grow our business by acquiring companies and businesses that we feel have synergy and will complement our business plan. We regularly evaluate potential business combinations and pursue attractive transactions. We may be unable to profitably manage businesses that we may acquire or we may fail to integrate them successfully without incurring substantial expenses, delays or other problems that could negatively impact our results of operations.

Acquisitions involve additional risks, including:

·

diversion of management's attention;

·

difficulty in integration of the acquired business;

·

loss of significant clients acquired;

·

loss of key management and technical personnel acquired;

·

assumption of unanticipated legal or other financial liabilities;

·

becoming significantly leveraged as a result of debt incurred to finance acquisitions;

·

unanticipated operating, accounting or management difficulties in connection with the acquired entities;

·

costs of our personnel’s time, travel, legal services and accounting services in connection with a proposed acquisition; that may not be recovered;

·

impairment charges for acquired intangible assets, including goodwill that decline in value; and

·

dilution to our earnings per share as a result of issuing shares of our stock to finance acquisitions.

Also, client dissatisfaction or performance problems with an acquired firm could materially and adversely affect our reputation as a whole. Further, the acquired businesses may not achieve the sales and earnings we anticipated. We will continue to evaluate from time to time, on a selective basis, other strategic acquisitions if we believe they will help us obtain well-trained, high-quality employees, new product or service offerings, additional industry expertise, a broader client base or an expanded geographic presence. There can be no assurance that we will be successful in identifying candidates or consummating acquisitions on terms that are acceptable or favorable to us. In addition, there can be no assurance that financing for acquisitions will be available on terms that are acceptable or favorable. We may issue shares of our common stock as part of the purchase price for some or all of these acquisitions. Future issuances of our common stock in connection with acquisitions may dilute our earnings per share.

If we fail to adequately manage the size of our business, it could have a severe negative impact on our financial results or stock price.

Our management believes that in order to be successful we must appropriately manage the size of our business. This may mean reducing costs and overhead in certain economic periods, and selectively growing in periods of economic expansion. In addition, we will be required to implement operational, financial and management information procedures and controls that are efficient and appropriate for the size and scope of our operations. The management skills and systems currently in place may not be adequate and we may not be able to manage any significant reductions or growth effectively.

We may have difficulties in managing our growth.

Our future growth depends, in part, on our ability to implement and expand our financial control systems and to expand, train and manage our employee base and provide support to an expanded customer base. If we cannot manage growth effectively, it could have a material adverse effect on our results of operations, business and financial condition. In addition, acquisitions and expansion involve substantial infrastructure costs and working capital. We cannot provide assurance that we will be able to integrate acquisitions, if any, and expansions efficiently. Similarly, we cannot provide assurance that we will continue to expand or that any expansion will enhance our profitability. If we do not achieve sufficient sales growth to offset increased expenses associated with our expansion, our results will be adversely affected.

 

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We depend on the continued services of our key personnel.

Our future success depends, in part, on the continuing efforts of our senior executive officers, Michael S. Smith and James D. Frost. The loss of either of these key employees may materially adversely affect our business. Presently, we only have term "key man" life insurance on the life of Michael Smith in the amount of $500,000.

 

Our business depends upon obtaining and maintaining required security clearances.

 

Our U.S Government contracts require our employees to maintain various levels of security clearances. Obtaining and maintaining security clearances for employees involves a lengthy process, and it is difficult to identify, recruit and retain employees who already hold security clearances. If our employees are unable to obtain or retain security clearances or if our employees who hold security clearances terminate employment with us, the client whose work requires cleared employees could terminate the contract or decide not to renew it upon its expiration. To the extent we are not able to engage employees with the required security clearances for a particular contract, we may not be able to bid on or win new contracts, or effectively rebid on expiring contracts.

 

Our employees or subcontractors may engage in misconduct or other improper activities, which could cause us to lose contracts.

 

While we have ethics and compliance programs in place, we are exposed to the risk that employee fraud or other misconduct could occur. We enter into arrangements with prime contractors and joint venture partners to bid on and execute particular contracts or programs; as a result, we are exposed to the risk that fraud or other misconduct or improper activities by such persons may occur. Misconduct by employees, prime contractors or joint venture partners could include intentional failures to comply with federal laws including; U.S. Government procurement regulations; proper handling of sensitive or classified information; compliance with the terms of our contracts that we receive; falsifying time records or failures to disclose unauthorized or unsuccessful activities to us. These actions could lead to civil, criminal, and/or administrative penalties (including fines, imprisonment, suspension and/or bars from performing U.S. Government contracts) and harm our reputation. The precautions we take to prevent and detect such activity may not be effective in controlling unknown or unmanaged risks or losses, and such misconduct by employees, prime contractors or joint venture partners could result in serious civil or criminal penalties or sanctions or harm to our reputation, which could cause us to lose contracts or cause a reduction in revenue.

Risks Related to our Common Stock

Five stockholders own a significant portion of our stock and may delay or prevent a change in control or adversely affect the stock price through sales in the open market.

As of March 31, 2008, five individuals or their affiliates owned approximately 19.3%, 6.3%, 4.2%, 2.1%, and 2.0%, respectively, (33.9% in the aggregate) of our outstanding common stock (excluding stock options, warrants and convertible notes).

Two holders have the right to convert notes payable and accrued interest into shares of common stock at $.05 per share. If both parties converted all of the principal and accrued interest into common stock, these two individuals, including their current holdings, would own approximately 23% and 20.4%, respectively, of our then outstanding common stock. However, the shares of common stock issuable upon the proposed conversions may not result in a change in control which would limit the use of our net operating loss carryforwards. We estimate at March 31, 2008, that substantially all convertible notes payable and accrued interest could be converted to shares of common stock, (representing 40.9% of the then outstanding common stock) without affecting a change of control that would limit the use of our net operating loss carryforwards. If the two holders converted all of their notes payable and accrued interest into shares of common stock, then five individuals or their affiliates would own approximately 60.9% in the aggregate of our then outstanding common stock (excluding stock options and warrants).

 

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The concentration of large percentages of ownership by a single stockholder may delay or prevent a change in control. Additionally, the sale of a significant number of our shares in the open market by a single stockholder or otherwise could adversely affect our stock price.

The price of our common stock may be adversely affected by the possible issuance of shares as a result of the conversion of notes payable and exercise of outstanding warrants and options.

 

The sale of substantial amounts of our common stock could also adversely impact its price. As of December 31, 2007, we had outstanding approximately 23.6 million shares of our common stock and convertible notes payable and exercisable common stock options and warrants to purchase approximately 21.4 million shares of our common stock. The sale or the availability for sale of a large number of shares of our common stock in the public market could cause the price of our common stock to decline.

Our stock price is volatile and could be further affected by events not within our control.

The trading price of our common stock has been volatile and will continue to be subject to:

·

volatility in the trading markets generally;

 

·

significant fluctuations in our quarterly operating results;

 

·

announcements regarding our business or the business of our competitors;

 

·

changes in prices of our or our competitors' products and services;

 

·

changes in product mix; and

 

·

changes in sales and sales growth rates for us as a whole or for geographic areas, and other events or factors.

Statements or changes in opinions, ratings or earnings estimates made by brokerage firms or industry analysts relating to the markets in which we operate or expect to operate could also have an adverse effect on the market price of our common stock. In addition, the stock market as a whole has from time to time experienced extreme price and volume fluctuations which have particularly affected the market price for the securities of many small cap companies and which often have been unrelated to the operating performance of these companies. Finally, the market on which our stock trades may have a significant impact on the price and liquidity or our shares.

 

During 2007, the market price for our common stock varied between a high of $0.80 in December 2007 and a low of $0.42 in September 2007. This volatility may affect the price at which a stockholder could sell its shares of common stock, and the sale of substantial amounts of our common stock could adversely affect the price of our common stock. Our stock price is likely to continue to be volatile and subject to significant price and volume fluctuations in response to market and other factors, including variations in our quarterly operating results; and announcement by us or our competitors of significant acquisitions, strategic partnerships, joint ventures, or capital commitments.

 

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Our common stock is currently traded on the OTC Bulletin Board.  Because there is a limited public market for our common stock, a stockholder may not be able to sell shares when it wants. We cannot assure you that an active trading market for our common stock will ever develop.

There is limited trading in our common stock and we cannot assure you that an active public market for our common stock will ever develop.  The lack of an active public trading market means that a stockholder may not be able to sell its shares of common stock when it wants, thereby increasing its market risk.  Until our common stock is listed on an exchange, we expect that the shares will continue to be listed on the OTC Bulletin Board.  However, an investor may find it difficult to obtain accurate quotations regarding the common stock’s market value.  In addition, if we failed to meet the criteria set forth in SEC regulations, various requirements would be imposed by law on broker-dealers who sell our securities to persons other than established customers and accredited investors.  Consequently, such regulations may deter broker-dealers from recommending or selling our common stock, which may further affect the shares liquidity. Moreover our ability to obtain future financing may be adversely affected by the consequences of our common stock trading on the Over the Counter Bulletin Board.

Our quarterly sales, operating results and profitability will vary from quarter to quarter and other factors may result in increased volatility of our share price.

Our quarterly sales, operating results and profitability have varied in the past and are likely to vary significantly from quarter to quarter, making them difficult to predict. This may lead to volatility in our share price. The changes in the market price of our common stock may also be for reasons unrelated to our operating performance. Some other factors that may cause the market price of our common stock to fluctuate substantially include:

·

the failure to be awarded a significant contract on which we have bid;

·

the termination by a client of a material contract;

·

announcement of new services by us or our competitors;

·

announcement of acquisitions or other significant transactions by us or our competitors;

·

sales of common stock by IGI or existing stockholders, or the perception that such sales may occur;

·

adverse judgments or settlements obligating us to pay liabilities;

·

unforeseen legal expenses, including litigation costs;

·

changes in the value of the defined pension plan assets, required cash contributions and related pension expense as well as the impact of regulatory oversight of pension plans in general;

·

changes in management;

·

general economic conditions and overall stock market volatility;

·

changes in or the application of accounting principles generally accepted in the U.S.;

·

reduced demand for products and services caused, for example, by competitors;

·

the lack of availability or increase in cost of key components and subassemblies;

·

the inability to timely and successfully complete development of complex designs and components, or manufacture in volume and install certain of our products;

·

changes in the mix of products and services we or our distributors sell;

·

cancellations, delays or contract amendments by government agency customers;

·

expenses related to acquisitions or mergers; and

·

impairment charges arising out of our assessments of goodwill and intangibles.

 

ITEM 2. PROPERTIES

The table below lists our facility locations and square feet owned or leased. The Pittsford, New York lease includes an escalation provision for property taxes. The Vienna, Virginia rent includes utilities. The Vienna, Virginia lease includes escalation provisions for operating expenses and property taxes.

		Owned			Leased			Annual Rent			Termination Date
At December 31, 2007:
Pittsford, New York			-			2,942		$	28,576			2009
Vienna, Virginia			-			2,930		$	76,180			2008

 

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We believe all properties are in good operating condition. We do not own or intend to invest in any real property and currently have no policy with respect to investments or interests in real estate, real estate mortgage loans or securities of, or interests in, persons primarily engaged in real estate activities.

ITEM 3. LEGAL PROCEEDINGS

We are not presently involved in any material legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock trades on Nasdaq’s Over the Counter Bulletin Board (“OTCBB”) under the symbol IMCI.OB. The following table sets forth, for the periods indicated, the high and low closing bid quotations per share for our common stock. Quotations represent interdealer prices without an adjustment for retail markups, markdowns or commissions and may not represent actual transactions:

Year Ended December 31, 2007		High			Low
First Quarter		$	0.52		$	0.45
Second Quarter		$	0.62		$	0.48
Third Quarter		$	0.60		$	0.42
Fourth Quarter		$	0.80		$	0.45

 

Year Ended December 31, 2006		High			Low
First Quarter		$	0.45		$	0.20
Second Quarter		$	0.66		$	0.30
Third Quarter		$	0.62		$	0.29
Fourth Quarter		$	0.65		$	0.36

At December 31, 2007, we had approximately 1,500 beneficial stockholders.

Recent Sales of Unregistered Securities

In May 2007, we issued an aggregate of 1,090,000 unregistered shares of common stock to four accredited investors upon their conversion of $54,500 of principal on certain of our outstanding notes payable in accordance with the terms of the notes.

On February 21, 2008, we issued 250,000 unregistered shares of our common stock to an accredited investor upon its conversion of $12,500 of accrued interest payable on certain of our outstanding notes payable in accordance with the terms of the notes.

 

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These transactions were exempt from registration, as they were nonpublic offerings made pursuant to Sections 4(2) and 4(6) of the Act. All shares issued in the transactions described hereinabove bore an appropriate restrictive legend. No underwriter was involved in these transactions.

On January 24, 2008, upon the exercise of an outstanding stock option under our stock option plan, we issued 66,667 unregistered shares of our common stock and received aggregate proceeds of $16,667. The issuance of the shares was made in reliance upon exemption from registration set forth in Section 4(2) of the Act.

Dividend Policy

We have never declared or paid a cash dividend on our common stock. It has been the policy of our board of directors to retain all available funds to finance the development and growth of our business. The payment of cash dividends in the future will be dependent upon our earnings and financial requirements and other factors deemed relevant by our board of directors.

ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

Cautionary statement identifying important factors that could cause our actual results to differ from those projected in forward looking statements.

Readers of this report are advised that this document contains both statements of historical facts and forward looking statements. Forward looking statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those indicated by the forward looking statements. Examples of forward looking statements include, but are not limited to (i) projections of sales, income or loss, earnings per share, capital expenditures, dividends, capital structure and other financial items, (ii) statements of our plans and objectives with respect to business transactions and enhancement of stockholder value, (iii) statements of future economic performance, and (iv) statements of assumptions underlying other statements and statements about our business prospects.

This report also identifies important factors, which could cause actual results to differ materially from those indicated by the forward looking statements. These risks and uncertainties include the factors discussed under the heading “Risk Factors” beginning at page 10 of this report.

The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our financial statements and the notes thereto appearing elsewhere in this report.

Overview

Beginning in the second quarter of 2003 we commenced operations in the field of information technology (IT) consulting services and biometric technology, and we opened an office in the Washington, D.C. metropolitan area. We now provide business and technology integration and systems support primarily to U.S. Government clients. We focus on aligning business processes with technology for delivery of solutions to meet our clients’ exact needs and providing expert management services to the lifecycle of technology-based projects.

As of December 31, 2004, we sold or closed all of our prior businesses. Currently, our sole business is the provision of IT consulting services.

The following discussion relates to the businesses that were sold or closed and the current effect on our operations and financial position.

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Osley & Whitney, Inc. Retirement Plan

 

Since our sale of all of the common stock of Osley & Whitney, Inc. (O&W) on December 30, 2002, we have continued to act as the sponsor of the O&W Retirement Plan although we may not have had a legal obligation to do so.

At December 31, 2007, the O&W defined benefit pension plan had an accrued pension obligation liability of $2,404,189 and an accumulated other comprehensive loss of $2,227,689 which we have recorded as a reduction of stockholders’ equity. The market value of plan assets decreased from $3,457,115 at December 31, 2006 to $3,387,749 at December 31, 2007. The decrease was comprised of investment returns of $372,619 which were offset by benefit payments of $451,162 and expenses paid of $30,823. The benefit obligation decreased during 2007 by $239,250 to $5,379,889 at December 31, 2007 as a result of benefits paid of $451,162 which were offset by an actuarial loss of $85,078 and interest cost of $296,990.

At December 31, 2006, the O&W defined benefit pension plan had an accrued pension obligation liability of $2,471,391 and an accumulated other comprehensive loss of $2,578,639 which we have recorded as a reduction of stockholders’ equity. The market value of plan assets increased from $3,315,526 at December 31, 2005 to $3,457,115 at December 31, 2006. The increase was comprised of investment returns of $653,308 which were offset by benefit payments of $406,300 and expenses paid of $65,419. The benefit obligation decreased during 2006 by $101,997 to $5,619,139 at December 31, 2006 as a result of benefits paid of $406,300 and an actuarial gain of $814 which were offset by interest cost of $303,489.

We may have been required to contribute amounts in 2004, 2005, 2006, and 2007 and may be required to make contributions in future years to fund the deficiency. We did not make a contribution in 2004, 2006 or 2007. During 2005, we made contributions of $6,439 and 500,000 shares of our common stock, which were valued on the contribution date at $175,000 using the closing market price. We currently do not have the funds available to make required contributions which currently approximate $1.8 million. We recorded defined benefit pension expense of approximately $351,000 in 2007 and $411,000 in 2006, including excise taxes of $213,000 in 2006 for failing to make plan contributions. We may be required to pay interest on these excise taxes and potentially could incur additional excise taxes up to 100% of required plan contributions that were not made. If we were to incur additional excise taxes, we could lose the ability to generate cash using our secured accounts receivable financing line or from other financing sources.

In March 2005, we filed a funding waiver application requesting waivers of the minimum funding standard for the 2005 plan year of $513,551 and for the 2004 plan year of $979,328 (which includes quarterly cash disbursements aggregating approximately $455,000 for the year ended December 31, 2004 and unfunded prior year amounts). In August 2006, we received a reply from the Department of the Treasury denying our request for waivers of the minimum funding standard for the 2005 and 2004 plan years.

Although we have acted as the sponsor of the Plan since we acquired O&W, recently it was determined that we may not have had, or currently have, a legal obligation to do so from December 30, 2002 when we sold all of the common stock of O&W to a third party. We are presently advocating this position with the appropriate regulatory authorities to ascertain whether they concur or disagree with this determination. If our current efforts do not result in a concurrence with our position, we intend to pursue all appropriate further avenues to prevail in our position. Depending upon the ultimate outcome regarding our obligations as sponsor of the Plan, adjustments to our financial statements may be necessary.

Express Pattern (EP) Note Receivable

On March 14, 2002, we sold the net assets of EP. The remaining balance of the note receivable at December 31, 2005 after the offset and write-off was approximately $74,000. The interest earned on this note through December 31, 2005 in the amount of $27,545 was fully reserved because we believed that collection of the interest was doubtful at that time. In December 2006, we collected the principal balance of $74,000 and recorded interest income of $22,103 upon collection, in full satisfaction for all amounts owned.

 

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Liquidity and Capital Resources

At December 31, 2007, we had cash of $28,281 available for our working capital needs and planned capital asset expenditures. Our primary liquidity needs are the financing of working capital and capital expenditures. Our primary source of liquidity is cash provided by operations and our $800,000 credit facility. As of December 31, 2007, we were near the maximum borrowing level under our credit facility, due to the increase in accounts receivable as a result of a growth in our sales and the need to generate cash to fund our expenses, principally our increase in Cost of services, incurred as a result of our sales growth. During 2007, cash used by operating activities was $5,842, a near break even result.

At December 31, 2007, we had a working capital deficit of approximately $2.4 million and a current ratio of .24. Our objective is to improve our working capital position from profitable operations. The O&W Plan current liabilities have a significant impact on our working capital. Without the current liabilities of the O&W Plan of approximately $2 million, working capital would be a deficit of approximately $419,000. If we continue to incur operating losses or net losses, we may continue to experience working capital shortages that impair our business operations and growth strategy. Presently, we have sufficient cash flow and short-term financing sources, through sales with recourse of accounts receivable, to pay our payrolls and recurring invoices on a timely basis.

We have financed the activity of our new IT Services Group through the issuance of notes payable to third parties, including related parties, private placements of common stock, and financing through sales with recourse of our accounts receivable.

We have used our common stock to provide compensation to certain employees and consultants and to fund liabilities.

Cash Flows from Operating Activities

During 2007, cash used by operations was $5,842 compared with cash used by operations $259,925 in 2006. Our operating cash flow is primarily affected by the overall profitability of our contracts, our ability to invoice and collect from our clients in a timely manner, and our ability to manage our vendor payments. We bill our clients weekly or monthly after services are performed, depending on the contract terms. The improvement in cash used in 2007 was primarily due to our improved operations results which reduced our operating loss from approximately $1.9 million in 2006 to approximately $474,000 in 2007, which was further reduced by non-cash stock based compensation expense of $338,856 in 2007 including common stock, common stock options and warrants to service providers. Our accounts receivable increased principally due to the growth of sales in 2007. The increase in liabilities is primarily due to increased accounts payable, accrued interest payable for related party notes payable and accrued pension and retirement expenses.

Cash Flows from Investing Activities

Cash used in investing activities in 2007 was $20,717 compared with cash provided by investing activities of $63,562 in 2006. In 2006, we collected a note of $78,217 due from the sale of a former business. Cash used in investing activities was primarily for capital expenditures for computer hardware and software in 2007 and 2006.

Cash Flows from Financing Activities

Cash used in financing activities in 2007 was $18,946 and mainly due to principal payments of outstanding notes payable. In comparison, in 2006 we generated net cash from financing activities of $135,639 principally from borrowings from related parties and $25,420 from sales of common stock.

 

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Credit Agreement

We have a line of credit of up to $800,000 with a financial institution that allows us to sell selected accounts receivable invoices to the financial institution with full recourse against us. We pay fees based on the length of time that the invoice remains unpaid. At December 31, 2007, we had approximately $20,000 of availability under this line and could finance up to another approximately $20,000 based on eligible accounts receivable at December 31, 2007.

We believe the capital resources available to us under our line of credit and cash from our operations are adequate to fund our ongoing operations and to support the internal growth we expect to achieve for at least the next 12 months. However, if we experience significant growth in our sales, we believe that this would require increasing our financing line or obtaining additional working capital from other sources to support our sales growth by financing our growth in accounts receivable. We anticipate financing our external growth from acquisitions and our longer-term internal growth through one or more of the following sources: cash from operations; additional borrowing; issuance of equity; use of the existing revolving credit facility; or a refinancing of our credit facilities.

 

IT Consulting Services

Successes in our 2006 and 2007 initiatives are evident in the preferred relationships we have earned with several large systems integrators and one major product house. In addition, we are a member of a team that won the U.S. State Department’s recent Hybrid Information Technology Support Services (HITSS) contract and a member of a team that won a $36 million contract in October 2007 to support the U.S. Navy’s Enterprise Maintenance Automated Information System (NEMAIS) data center operations in Norfolk, Virginia and Puget Sound, Washington. In June 2006, we were awarded a prime contract under the Department of the Navy’s SeaPort-Enhanced (SeaPort-e) program. This contract allows us to compete for and perform service requirements solicited by various Navy commands, the Marine Corps, other organizations within the Department of Defense (DoD), non-DoD agencies, and certain joint agency organizations for work that is integrally related to the scope and mission of the contract. This work involves professional services in all phases of naval ship and weapon systems acquisition and life-cycle support, including research and development support, prototyping, technology analysis, acquisition logistics, project management support, modeling, test and evaluation trials, crisis and consequence management, and engineering support. (The NEMAIS Data Center contract referenced above was procured using the SeaPort-e contract vehicle of the prime contractor.)

During 2007, we were approved as a VMware Authorized Consultant (VAC) by VMware, Inc. (NYSE:VMW), a subsidiary of EMC Corporation (NYSE:EMC). VMware is recognized as the industry leader in virtualization technology. As a VAC, we are trained and certified to deliver consulting services and solutions leveraging VMware technology. We are also certified as a VMware Enterprise VIP Reseller authorized to resell VMware’s full product line. We are actively working with a number of potential customers in that regard. These certifications are examples of our concerted effort to grow and expand our server virtualization practice. Server virtualization involves the creation, allocation, and management of “virtual machines,” which entails the virtual representation of hardware by a software system. What this means is that traditional “physical servers,” which typically run at only 5% to 15% of their capacity, can now be consolidated with the use of specialized software such as VMware to increase server utilization by a factor of ten to one or even greater. Reducing the number of physical machines required in a typical environment provides numerous and obvious benefits, including equipment cost savings, reduced operational maintenance costs, easier backup, improved availability, and better security.  Due to the substantial energy savings resulting from reduced infrastructure, virtualization is also a “green” technology.

 

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In July 2007, we were accepted into the Hewlett Packard (NYSE:HPQ) Developer and Solutions Partner Program (DSPP). DSPP provides us with a mechanism to work with HP and our joint customers and prospects to provide solutions and services that complement HP's broad portfolio of products and services. HP has many tools and resources to help us generate new revenue streams, and improve our mutual profitability, while at the same time adding unique value for our joint customers. The program comprises practical tools and services that we hope will help us in the key areas of marketing and selling our solutions, optimizing the technology, and collaborating with other organizations within our industry.

The acquisition of these contract vehicles allows us additional opportunities to bid on new projects.

Although our future prospects appear promising, the lengthy government financing and procurement processes may result in continuing operating losses until sales increase to support our infrastructure.

In the future, we may issue additional debt or equity securities to satisfy our cash needs. Any debt incurred or issued may be secured or unsecured, at a fixed or variable interest rates and may contain other terms and conditions that our board of directors deems prudent. Any sales of equity securities may be at or below current market prices. We cannot assure you that we will be successful in generating sufficient capital to adequately fund our working capital needs.

 

Future Trends

We believe that our operations, as currently structured, together with our current financial resources, will result in improved financial performance in future years.

 

There is no assurance, that our current resources will be adequate to fund the liabilities for the O&W retirement plan or our current operations and business expansion or that we will be successful in raising additional working capital. Our failure to raise necessary working capital could force us to curtail operations, which would have a material adverse effect on our financial condition and results of operations.

 

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Results of Operations

 

Comparison of the years ended December 31, 2007 and 2006

The trends suggested by the following tables are not indicative of future operating results due to the relatively short track record that we have in focusing on providing IT consulting services.

The following table compares our statements of operations data for the years ended December 31, 2007 and 2006.

 

		Year Ended December 31,
														2007 vs. 2006
					As a % of						As a % of			Amount of			% Increase
		2007			Sales			2006			Sales			Change			(Decrease)
Sales		$	8,454,515			100.0	%	$	6,444,706			100.0	%	$	2,009,809			31.2	%
Cost of services			6,028,970			71.3			4,814,826			74.7			1,214,144			25.2
Gross profit			2,425,545			28.7			1,629,880			25.3			795,665			48.8
General and administrative			864,631			10.2			908,073			14.1			(43,442	)		(4.8	)
Defined benefit pension plan			351,460			4.2			410,777			6.4			(59,317	)		(14.4	)
Selling			1,560,315			18.5			1,595,221			24.8			(34,906	)		(2.2	)
Research and development			87,997			1.0			256,113			4.0			(168,116	)		(65.6	)
Impairment loss			-			.0			261,100			4.1			(261,100	)
Depreciation			35,075			.4			97,488			1.5			(62,413	)		(64.0	)
Total costs and expenses			2,899,478			34.3			3,528,772			54.8			(629,294	)		(17.8	)
Operating loss			(473,933	)		(5.6	)		(1,898,892	)		(29.5	)		1,424,959
Interest expense, net			(279,824	)		(3.3	)		(194,270	)		(3.0	)		(85,554	)		44.0
Other income			4,957			.1			498,088			7.7			(493,131	)		(99.0	)
Income tax expense			(1,000	)		(.0	)		(7,300	)		(.1	)		6,300			(86.3)	%
Net loss		$	(749,800	)		(8.9	)	$	(1,602,374	)		(24.9	)	$	852,574
Net loss per share - basic and diluted		$	(.03	)				$	(.08	)				$	.05

 

Sales

Sales for the year ended December 31, 2007 increased by $2,009,809 or 31.2% to $8,454,515 as compared to sales for the year ended December 31, 2006 of $6,444,706. A significant portion of this increase was a result of sales from new projects including significant server virtualization projects for a major establishment of the U.S. Government.

Server virtualization involves the creation, allocation, and management of “virtual machines,” which entails the virtual representation of hardware by a software system. Traditional “physical servers,” which typically run at only 5% to 15% of their capacity, can now be consolidated with the use of specialized software such as VMware to increase server utilization by a factor of ten to one or even greater. Reducing the number of physical machines required in a typical environment provides numerous and obvious benefits, including equipment cost savings, reduced operational maintenance costs, easier backup, improved availability, and better security. Due to the substantial energy savings resulting from reduced infrastructure, virtualization is also a “green” technology. We continue to devote substantial resources to support our expanding server and desktop virtualization practice.

In March 2006, one of our subcontracts for services to the U.S. Department of Homeland Security ended when the project ended. Contracts end naturally when projects are completed or when appropriations of funds have been fully depleted and new appropriations have not been approved. Our ongoing business development efforts entail the submission of numerous contract proposals and the identification of opportunities for other new contracts to replace sales that do not continue in the ordinary course of business and to increase our sales.

 

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We are pursuing opportunities to develop additional sales from new and existing target markets. In March 2006, we opened a regional office in Jackson, Mississippi, and hired a new business development employee and retained a lobbying firm to pursue state and local government business opportunities within the Gulf Coast region. Since the sales cycle has been longer than we anticipated, in December 2007, we closed our Jackson, Mississippi office and renewed our agreement with a locally based lobbying firm to identify and monitor new business opportunities for us. We remain committed to developing the state and local government market and are optimistic about our long-term prospects in Mississippi and several other states. Moreover, we are also channeling energies towards forming alliances with large systems integrators, who are mandated by federal policy to direct defined percentages of their work to small business subcontractors. In addition, we are currently working on proposals for contract awards that we believe will enhance our position as a government contractor.

Early successes in our recent initiatives are evident in the preferred relationships we have earned with several large systems integrators and one major product house. We are a member of a team that won the U.S. State Department’s recent Hybrid Information Technology Support Services (HITSS) contract and a member of a team that won a $36 million contract to support the Navy’s Enterprise Maintenance Automated Information System (NEMAIS) data center operations in Norfolk, Virginia and Puget Sound, Washington State. The acquisition of these contract vehicles allows us additional opportunities to bid on new projects. Although we believe our future prospects are robust, the lengthy government financing and procurement processes may result in continuing operating losses until sales increase to support our infrastructure.

 Cost of Services and Gross Profit

Cost of services represents the cost of employee services related to the IT Services Group. Cost of services for the year ended December 31, 2007 was $6,028,970 or 71.3% of sales as compared to $4,814,826 or 74.7% of sales for 2006. Gross profit was $2,424,545 or 28.7% of sales for 2007 compared to $1,629,880 or 25.3% of sales for 2006.

The increase in gross profit in 2007 is due to a change in the mix of our business resulting from new projects, including server virtualization projects, at improved profit margins. Additionally the increase is due to a reduction in the costs of employees who did not generate billable sales after contract reductions.

Although our objective is to maintain an overall gross margin of approximately 30%, in the future we may submit bids on new work with lower gross profit margins to generate opportunities for long-term, larger volume contracts and more stable sales.

General and Administrative Expenses

General and administrative expenses include corporate overhead such as compensation and benefits for executive, administrative and finance personnel, rent, insurance, professional fees, travel, and office expenses. General and administrative expenses for the year ended December 31, 2007 decreased by $43,442 or 4.8% to $864,631 from $908,073 for the same prior year period.

As a percentage of sales, general and administrative expenses were 10.2% for the year ended December 31, 2007 and 14.1 % for the year ended December 31, 2006. We anticipate that general and administrative expenses will continue at levels experienced in 2007 and will grow as we grow our business and incur travel and other expenses associated with managing a larger business. In 2007, we experienced a decrease in compensation expense of $41,200 from consolidating certain administrative functions, which were offset by the expenses associated with the reassignment of an independent consultant from research and development when the TouchThru™ development activities ended. In addition, we incurred certain non-recurring expenses in 2006 including legal fees of $25,000 related to administering our contracts and annual stockholder meeting proxy expenses of approximately $18,400.

 

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Defined Benefit Pension Plan Expenses

Defined benefit pension plan expenses are expenses (including pension expense, excise taxes, professional services, and interest costs) associated with the O&W Plan. These expenses were $351,460 for the year ended December 31, 2007 and $410,777 for the year ended December 31, 2006, a decrease of $59,317. The decrease in expense is due to recording excise taxes of $213,000 during 2006 which are offset by accruing additional interest on unfunded contributions and increases in legal and professional fees during 2007.

During 2006, the Pension Benefit Guarantee Corporation placed a lien on all of our assets to secure pension payments alleged to be due under the O&W Plan. This lien is subordinate to liens that secure accounts receivable financing and certain notes payable.

Although we have acted as the sponsor of the O&W Plan since we acquired O&W, recently it was determined that we may not have had, or currently have, a legal obligation to do so since December 30, 2002 when we sold all of the common stock of O&W to a third party. During, 2007, we incurred additional legal and professional fees in connection with advocating this position with the appropriate regulatory authorities to ascertain whether they concur or disagree with this determination. We are seeking the concurrence of the Department of Treasury and have recently provided to them the information related to our determination. They are presently reviewing this information.

If our current efforts do not result in a concurrence with our position, we intend to pursue all appropriate further avenues to prevail in our position. Depending upon the ultimate outcome regarding our obligations as sponsor of the O&W Plan, adjustments to our financial statements may be necessary.

Selling Expenses

For the year ended December 31, 2007, we incurred selling expenses of $1,560,315 associated with the growth of business in our IT Services Group, compared to $1,595,221 for the year ended December 31, 2006, a slight decrease of $34,906 or 2.2%.

Selling expenses consist of our business development staff including salaries, benefits, sales consultants, travel expenses, and occupancy expenses. During the second quarter of 2007, we hired new business development personnel. In June 2007, we hired a new business development employee to focus efforts toward increasing sales of physical to virtual server consolidation projects. In August 2007, we hired two additional employees to focus more effort in generating business opportunity leads and writing proposals for new projects.

We experienced a decrease in consulting expense of approximately $90,000 for the year ended December 31, 2007 as compared to 2006 due primarily to our hiring of a former consultant as an employee in the third quarter of 2006 and our reduction of the use and rate of compensation to other independent consultants.

As a result of implementing SFAS 123R, we recorded $141,506 and $205,059 of expense for the years ended December 31, 2007 and 2006, respectively, a decrease of $63,553.

We continued to incur expenses during 2007 associated with our business development efforts in the Gulf Coast region, although at a reduced rate of expense by December 31, 2007.

 

Research and Development; Impairment Loss and Inventory Obsolescence

For the year ended December 31, 2007, we recorded $87,997 of research and development expenses, a decrease of $168,116 compared to $256,113 for the year ended December 31, 2006. During the three months ended September 30, 2007, we ended development activities and related expenses for TouchThru™ and reassigned an independent consultant from these development efforts to other business activities. TouchThru™ is a self-contained terminal enabling physical access control using biometric identification. It incorporates fingerprint matching technology licensed from Ultra-Scan Corporation, a private technology company headquartered in Buffalo, New York.

 

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During the year ended December 31, 2006, we recorded an impairment loss of approximately $235,000 related to the carrying costs of TouchThru™ capitalized software development costs, tooling costs and approximately $26,000 of inventory obsolescence related to inventory we determined to be obsolete. Our TouchThru™ unit was designed around Ultra-Scan’s unique ultrasonic scanner. We anticipate that Ultra-Scan will improve the technology by designing a next generation scanner that will be smaller, lighter and less costly. We expect this will result in a substantial reduction in the costs of components to build our TouchThru™ unit and accordingly a substantial reduction in our sales price.  As a result of the evolution of our business strategy, during the three months ended September 30, 2006, we recorded an impairment loss for a portion of capitalized software development costs, all of the capitalized tooling costs and the related inventory.

We believe that significant resources will be required to market and sell a newly designed TouchThru™ product that is based on Ultra-Scan’s next generation scanner. Given our limited financial resources at this time and other business priorities, this has been deferred until the market is better established and we have the necessary working capital to support this product. We will continue to monitor the market and to determine when to enter this market in the future at the appropriate time and with sufficient resources.

Depreciation

Depreciation expense was $35,075 for the year ended December, 31 2007 compared to $97,488 for the year ended December 31, 2006. The decrease is due to less depreciation of assets related to the TouchThru™ product, which were considered impaired and written off during the last two quarters of 2006.

Operating Loss

For the year ended December 31, 2007 our operating loss was $(473,933) compared to an operating loss of $(1,898,892) for 2006; an improvement of $852,574. The improvement of $1,424,959 is principally attributable to:

·

our sales increased by $2,009,809 from $6,444,706 in 2006 to $8,454,115 in 2007;

·

our gross profit increased by $795,665 from $1,629,880 in 2006 to $2,425,545 in 2007 as a result of recording an impairment loss and inventory obsolescence of $261,100 related to the carrying values of TouchThru™ assets in 2006, with no such impairment or obsolescence in 2007;

·

our recording non-recurring write offs in 2006 of approximately $235,000 related to the carrying costs of TouchThru™ capitalized software development costs, tooling costs and approximately $26,000 of inventory obsolescence related to inventory we determined to be obsolete; and

·

realizing a decrease in total operating expenses of $629,294 from $3,528,772 in 2006 to $2,899,478 in 2007.

Included in the above are non-cash expenses of $245,272 and $243,050 for the years ended December 31, 2007 and 2006, respectively, as a result of implementing SFAS 123R and $93,584 and $21,785 as a result of warrants and stock options issued to consultants for the years ended December 31, 2007 and 2006, respectively.

Net Interest Expense

Net interest expense consists of interest income offset by interest expense on indebtedness and fees for financing accounts receivable invoices. Net interest expense was $279,824 for the year ended December 31, 2007 compared to $194,270 for the year ended December 31, 2006. The increase in net interest expense of $85,554 was principally due to an increase in the length of term and volume of accounts receivable invoices that were financed in 2007. We also recorded interest income of $22,103 in 2006 upon collection of the balance of the note due from Express Pattern.

 

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Other Income

Other income for the year ended December 31, 2007 was $4,957 compared to other income of $498,088 recorded in the year ended December 31, 2006.

In 2006, we received and recorded other income of $498,088, net of legal fees and expenses of $164,412. We were the plaintiff in a lawsuit filed in the Superior Court, State of Rhode Island on August 13, 1999 captioned Infinite Group, Inc. vs. Spectra Science Corporation and Nabil Lawandy. In the action, we asserted that by fraud and in breach of fiduciary duties owed, Spectra and its president, Nabil Lawandy, caused us to sell to Spectra shares of Spectra’s Series A Preferred stock at a substantial discount to fair market value. We alleged that in entering into the transaction it relied on various representations made by Spectra and Mr. Lawandy, which were untrue at the time they were made. The trial was completed in February 2005, and the jury returned a verdict in our favor in the amount of approximately $600,000. We appealed the amount of the verdict and entered into a settlement with the defendants in January 2006 and recorded other income of $498,088.

Income Taxes

Income tax expense was $1,000 and $7,300 for the years ended December 31, 2007 and 2006, respectively, consisting of state taxes.

 

Net Loss

For the year ended December 31, 2007, we recorded a net loss of $(749,800), or $(.03) per share. This compares to a net loss of $(1,602,374) or $(.08) per share for the year ended December 31, 2006.

Stock-Based Compensation

In the following table, we present adjustments and pro forma amounts to reflect the impact that the adoption of SFAS 123R related to employee stock options had on our financial statements including net loss for the years ended December 31, 2007 and 2006. Such expenses are allocated in the same manner as employee salary expense. We believe that these non-generally accepted accounting principles (GAAP) financial measures provide investors useful information to facilitate the comparison of current performance to prior performance. These non-GAAP measures should not be considered in isolation or as a substitute for performance measures in accordance with GAAP.

 

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		Year Ended December 31,
		2007			2007			2007			2006			2006			2006
		As Reported			Adjustments			Pro Forma			As Reported			Adjustments			Pro Forma
Sales		$	8,454,515		$	-		$	8,454,515		$	6,444,706		$	-		$	6,444,706
Cost of services			6,028,970			(87,950	)		5,941,020			4,814,826			(28,184	)		4,786,642
Gross profit			2,425,545			87,950			2,513,495			1,629,880			28,184			1,658,064
General and administrative			864,631			(15,817	)		848,814			908,073			(9,807	)		898,266
Defined benefit pension plan			351,460			-			351,460			410,777			-			410,777
Selling			1,560,315			(141,505	)		1,418,810			1,595,221			(205,059	)		1,390,162
Research and development			87,997			-			87,997			256,113			-			256,113
Impairment loss			-			-			-			261,100			-			261,100
Depreciation			35,075			-			35,075			97,488			-			97,488
Total costs and expenses			2,899,478			(157,322	)		2,742,156			3,528,772			(214,866	)		3,313,906
Operating loss			(473,933	)		245,272			(228,661	)		(1,898,892	)		243,050			(1,655,842	)
Interest expense, net			(279,824	)		-			(279,824	)		(194,270	)		-			(194,270	)
Other income			4,957			-			4,957			498,088			-			498,088
Income tax expense			(1,000	)		-			(1,000	)		(7,300	)		-			(7,300	)
Net loss		$	(749,800	)	$	245,272		$	(504,528	)	$	(1,602,374	)	$	243,050		$	(1,359,324	)
Net loss per share - basic and diluted		$	(.03	)	$	.01		$	(.02	)	$	(.08	)	$	.02		$	(.06	)

 

Critical Accounting Policies and Estimates 

There are several accounting policies that we believe are significant to the presentation of our consolidated financial statements. These policies require management to make complex or subjective judgments about matters that are inherently uncertain. Note 3 to our consolidated financial statements presents a summary of significant accounting policies. The most critical accounting policies follow.

Revenue Recognition

Consulting sales are recognized as the consulting services are provided. Client deposits received in advance are recorded as liabilities until associated services are completed. During 2007 sales to one client accounted for 85.1% of total sales (75.3% - 2006) and 83.6% of accounts receivable (81.6% - 2006) at December 31, 2007. In addition, during 2006 another client accounted for 12.8% of total sales and 4.7% of accounts receivable. Sales with this client were less than 10% of total sales during 2007.

Accounts Receivable Provisions

As part of the financial reporting process, management estimates and establishes reserves for potential credit losses relating to the collection of certain receivables. This analysis involves a degree of judgment regarding customers’ ability and willingness to satisfy its obligations to us. These estimates are based on past history with customers and current circumstances. Management’s estimates of doubtful accounts historically have been within reasonable limits of actual bad debts. Management’s failure to identify all factors involved in determining the collectibility of an account receivable could result in bad debts in excess of reserves established.

Deferred Tax Asset Valuation and Income Taxes

Management calculates the future tax benefit relating to certain tax timing differences and available net operating losses and credits available to offset future taxable income. This deferred tax asset is then reduced by a valuation allowance if management believes it is more likely than not that all or some portion of the asset will not be realized. This estimate is based on historical profitability results, expected future performance and the expiration of certain tax attributes which give rise to the deferred tax asset. As of the balance sheet date, a reserve has been established for the entire amount of the deferred tax asset. In the event, we generate future taxable income we will be able to utilize the net operating loss carry forwards subject to any utilization limitations. This will result in the realization of the deferred tax asset, which has been fully reserved. As a result, we would have to revise estimates of future profitability and determine if its valuation reserve requires downward adjustment.

 

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At December 31, 2007, we had federal net operating loss (NOL) carry forwards of approximately $20.8 million that expire in years 2009 through 2027. Our ability to utilize the federal NOL carry forwards may be impaired if we continue to incur operating losses and may be limited by the change of control provisions if we issue substantial numbers of new shares or stock options.

Defined Benefit Plan Assumptions

We have acted as sponsor of a defined benefit plan, under which participants earned a retirement benefit based upon a formula set forth in the plan. We record income or expense related to the plan using actuarially determined amounts that are calculated under the provisions of SFAS No. 87, "Employers' Accounting for Pensions." Key assumptions used in the actuarial valuations include the discount rate and the anticipated rate of return on plan assets. These rates are based on market interest rates, and therefore fluctuations in market interest rates could impact the amount of pension income or expense recorded for these plans. Despite our belief that these estimates are reasonable for these key actuarial assumptions, future actual results will likely differ from our estimates, and these differences could materially affect our future financial statements either unfavorably or favorably.

The discount rate enables a company to state expected future cash flows at a present value on the measurement date. We have little latitude in selecting this rate since it is based on the yield on high-quality fixed income investments at the measurement date. A lower discount rate increases the present value of benefit obligations and increases pension expense.

To determine the expected long-term rate of return on pension plan assets, management considers a variety of factors including historical returns and asset class return expectations based on the plan's current asset allocation.

Although we have acted as the sponsor of the Plan since we acquired O&W, recently it was determined that we may not have had, or currently have, a legal obligation to do so from December 30, 2002 when we sold all of the common stock of O&W to a third party. We are presently advocating this position with the appropriate regulatory authorities to ascertain whether they concur or disagree with this determination. If our current efforts do not result in a concurrence with our position, we intend to pursue all appropriate further avenues to prevail our position. Depending upon the ultimate outcome regarding our obligations as sponsor of the Plan, adjustments to our financial statements may be necessary.

Impairment of Long-Lived Assets

We evaluate at each balance sheet date the continued appropriateness of the carrying value of our long-lived assets including our long-term receivables and property, plant and equipment in accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposals of Long Lived Assets." We review long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of any such assets may not be recoverable. If indicators of impairment are present, management would evaluate the undiscounted cash flows estimated to be generated by those assets compared to the carrying amount of those items. The net carrying value of assets not recoverable is reduced to fair value. We consider continued operating losses, or significant and long-term changes in business conditions, to be the primary indicators of potential impairment. In measuring impairment, we look to quoted market prices, if available, or the best information available in the circumstances.

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Stock Option Awards

Prior to January 1, 2006, we accounted for stock option awards granted under our stock option plan in accordance with the recognition and measurement provisions of Accounting Principles Board Option No. 25, “Accounting for Stock Issued to Employees”, (“APB 25”) and related interpretations, as permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”, (SFAS 123”). Share-based employee compensation expense was not recognized in our consolidated statements of operations prior to January 1, 2006, as all stock option awards granted had an exercise price equal to or greater than the market value of the common stock on the date of grant. As permitted by SFAS 123, we reported pro-forma disclosures presenting operating results and net income (loss) per share as if we had used the fair value recognition provisions of SFAS 123 in the notes to the consolidated financial statements. Stock-based compensation related to non-employees was accounted for based on the fair value of the related stock options in accordance with SFAS 123 and its interpretations.

Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”, (SFAS 123R) using the modified prospective transition method. For further detail, see note 8 to the consolidated financial statements.

The compensation cost that has been charged against income for options granted to employees under the plans was $245,272 and $243,050 for the years ended December 31, 2007 and 2006, respectively. The impact of this expense was to increase basic and diluted net loss per share from $(.02) to $(.03) and from $(.06) to $(.08) for the years ended December 31, 2007 and 2006, respectively. The adoption of SFAS 123R did not have an impact on cash flows from operating or financing activities. For stock options issued as non-ISO’s, a tax deduction is not allowed for income tax purposes until the options are exercised. The amount of this deduction will be the difference between the fair value of our common stock and the exercise price at the date of exercise. Accordingly, there is a deferred tax asset recorded for the tax effect of the financial statement expense recorded. The tax effect of the income tax deduction in excess of the financial statement expense will be recorded as an increase to additional paid-in capital. Due to the uncertainty of the our ability to generate sufficient taxable income in the future to utilize the tax benefits of the options granted, we have recorded a valuation allowance to reduce its gross deferred tax asset to zero. As a result, for the years ended December 31, 2007 and 2006, there is no income tax expense impact from recording the fair value of options granted. No tax deduction is allowed for stock options issued as ISO’s.

We used volatility of 50% when computing the value of stock options and warrants during the year ended December 31, 2007, 71% when computing the value of stock options and warrants issued during the nine months ended December 31, 2006 and 100% for options issued during the three months ended March 31, 2006. This is based on historical volatility with consideration given to activity subsequent to July 2005, when we became current in its 1934 Act filings with the SEC, and the increase in the volume of trading in the Company’s common stock in 2006 and 2007. The Company believes the increase in the volume of trading has provided more liquidity and less volatility than was previously experienced. Each option awarded in 2007 and 2006 has a ten year exercise term and a holding period of ten years was assumed. The expected dividend yield is zero percent and the expected life of the options is ten years. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant and ranged from 4.1% to 4.76% for the year ended December 31, 2007 and 4.42% to 5.1% for the year ended December 31, 2006. We recorded expense for options, warrants and common stock issued to employees and independent service providers for the years ended December 31, 2007 and 2006 as follows:

		2007			2006
Employee stock options - SFAS 123R		$	245,272		$	243,050
Consultant - common stock warrants			56,084			16,770
Consultant - common stock			37,500			-
Consultant stock options			-			5,015
Total expense		$	338,856		$	264,835

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Equity Instruments Issued to Consultants and Vendors in Exchange for Goods and Services

Our accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of EITF 96-18 “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” and EITF 00-18, “Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees.” The measurement date for the fair value award of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. We use the Black-Scholes option-pricing model to determine the fair value of the awards. The fair value of the equity instrument is recognized over the term of the consulting agreement. We periodically evaluate the likelihood of reaching the performance requirements and recognize consulting expense associated with these performance based awards when it becomes probable the consultants will achieve their performance criteria and the awards become vested.

Recent Accounting Pronouncements

FASB Interpretation No. 48 (FIN 48), an Interpretation of SFAS 109

In June 2006, The FASB issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109” (“FIN 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company adopted the provisions of FIN 48 in the first quarter of fiscal 2008. See footnote 9 for additional information regarding the impact of adopting the provisions of FIN 48 and the related disclosures. 

Statement of Financial Accounting Standards No. 157, Fair Value Measurements