Iveda Solutions, Inc. - Quarter Report: 2011 September (Form 10-Q)

You should not rely on forward-looking statements as predictions of future events or results. Any or all of our forward-looking statements may turn out to be wrong. They can be affected by inaccurate assumptions, risks and uncertainties, and other factors, which could cause actual events or results to be materially different from those expressed or implied in the forward-looking statements. These factors may cause our actual results to differ materially from any forward-looking statement. In addition, new factors emerge from time to time and it is not possible for us to predict all factors that may cause actual results to differ materially from those contained in any forward-looking statements. We disclaim any obligation to publicly update any forward-looking statements to reflect events or circumstances after the date of this report, except as required by applicable law.

Except as otherwise indicated by the context, references in this Quarterly Report on Form 10-Q to “we,” “our,” “us,” “Iveda,” and “the Company” refer to the business of Iveda Solutions, Inc.  

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Conditions and Results of Operations is based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires the Company’s management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. A description of our critical accounting policies and related judgments and estimates that affect the preparation of our financial statements is set forth in Item 7, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations,” of our Annual Report on Form 10-K for the year ended December 31, 2010. Such policies are unchanged.

Overview

Iveda Solutions, Inc. began operations on January 24, 2005, under the name IntelaSight, Inc., a Washington corporation doing business as Iveda Solutions (“IntelaSight”).  On October 15, 2009,

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IntelaSight became a wholly-owned operating subsidiary of Iveda Corporation (formerly known as Charmed Homes, Inc.), a Nevada corporation, through a merger.  All Company operations were conducted through IntelaSight until December 31, 2010, at which time IntelaSight merged with and into Iveda Corporation, which changed its name to Iveda Solutions, Inc.  On April 30, 2011, the Company completed its acquisition of Sole-Vision Technologies, Inc. (doing business as MegaSys), a corporation organized under the laws of the Republic of China (“MegaSys”).  As of April 30, 2011, MegaSys is a wholly owned subsidiary of the Company.

The Company installs video surveillance equipment, primarily for security purposes, and provides video hosting, archiving, and real-time remote surveillance services with a proprietary reporting system, DSR™ (Daily Surveillance Report), to a variety of businesses and organizations. By consolidating computer power into a single location at the server level, the Company creates efficiencies due to economies of scale leveraging cloud computing, which offers more features and flexibility compared to traditional box systems. The Company has a SAFETY Act Designation by the Department of Homeland Security as an anti-terrorism technology provider. The Company’s principal sources of revenue are derived from our video hosting real-time surveillance and equipment sales and installation.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. Since our inception, we have accumulated net losses in the approximate amount of $9 million. For the nine months ended September 30, 2011, we used approximately $1.9 million in cash from operations, which significantly limits our ability to absorb continuing operating losses in the future. As a result, our ability to continue as a going concern is uncertain.  

Results of Operations

Revenue. We recorded revenue of $588,339 for the three months ended September 30, 2011, compared to $182,416 for the three months ended September 30, 2010, an increase of $405,923 or 222%. In the third fiscal quarter of 2011, our recurring service revenue was $219,333 or 37% of revenue, and our equipment sales and installation revenue was $369,006 or 63% of revenue, compared to recurring service revenue of $138,061 or 76% of revenue, and equipment sales and installation revenue of $44,355 or 24% of revenue for the same period in 2010. The increase in revenue was due to a $104,880 or 57% increase of U.S. revenue and the inclusion of revenue from MegaSys for a full quarter.     

 We recorded revenue of $1,447,410 for the nine months ended September 30, 2011, compared to $488,600 for the nine months ended September 30, 2010, an increase of $958,810 or 196%. In the first nine months of 2011, our recurring service revenue was $454,863 or 31% of revenue, and our equipment sales and installation revenue was $992,547 or 69% of revenue, compared to recurring service revenue of $348,652 or 71% of revenue, and equipment sales and installation revenue of $139,948 or 29% of revenue for the same fiscal period in 2010. The increase in revenue was due to a $276,704 or 57% increase of U.S. revenue and the inclusion of revenue from MegaSys for five months.    

Cost of Revenue. Total cost of revenue was $472,211  (80% of revenues; gross margin of 20%) for the three months ended September 30, 2011, compared to $115,817 (63% of revenue; gross margin of 37%) for the three months ended September 30, 2010, an increase of $356,394 or 308%.  The increase of cost of revenue and decrease of gross margin was primarily due to the increase of equipment sales and installation, which normally garner lower gross margin. Approximately $285,000 of MegaSys’ revenue with lower gross margin was derived from equipment sales and installation.

Total cost of revenue was $1,110,875 (77% of revenues; gross margin of 23%) for the nine months ended September 30, 2011, compared to $337,425  (69% of revenues; gross margin of 31%) for the nine months ended September 30, 2010, an increase of  $773,449 or 229%. There was only a slight decrease in gross margin for the nine months ended September 30, 2011, because only five months of MegaSys’ equipment sales and installation revenue, with normally lower gross margin, were included in

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the consolidated revenue. Thus, it has very low impact on the gross margin for the nine-month period ended September 30, 2011.

Operating Expenses. Operating expenses were $778,287 for the three months ended September 30, 2011, compared to $604,597 for the three months ended September 30, 2010, an increase of $173,690 or 29%.  The increase in operating expenses was primarily related to professional expenses incurred in the acquisition of MegaSys and the recording of non-cash stock compensation expense for options issued to employees.  

Operating expenses were $2,611,916 for the nine months ended September 30, 2011, compared to $1,630,024 for the nine months ended September 30, 2010, an increase of $981,892 or 60%. The increase in operating expenses was primarily related to expenses incurred in the acquisition of MegaSys and the recording of non-cash stock compensation expense issued to employees.

Loss from Operations. As a result of the increases in revenues and related gross profit, but a greater increase in operating expenses, the loss from operations increased to $662,159 for the three months ended September 30, 2011, compared to $537,998 for the three months ended September 30, 2010, an increase in loss of $124,161 or 23%.  The majority of the current period loss, $524,013, was from our U.S. operations and the remaining $138,146 from our operations in Taiwan.

As a result of the overall increase in operating expenses, loss from operations increased to $2,275,381 for the nine months ended September 30, 2011, compared to $1,478,849 for the nine months ended September 30, 2010, an increase in loss of $796,532 or 54%.

Other Expense-Net. Other expense-net was $495 for the three months ended September 30, 2011, compared to $1,458 for the three months ended September 30, 2010, a decrease of $963 or 66%.

Other expense-net was $19,668 for the nine months ended September 30, 2011, compared to $12,070 for the nine months ended September 30, 2011, an increase of $7,598 or 63%.

Net Loss. The increase of $123,198 or 23% in the net loss to $662,654 for the three months ended September 30, 2011, from $539,456 for the three months ended September 30, 2010, was primarily the effect of reduced gross profit and increase in operating expenses.  

The increase of $799,243 or 54% in the net loss to $2,290,162 for the nine months ended September 30, 2011, from $1,490,919 for the nine months ended September 30, 2010, was primarily the effect of reduced gross profit and increase in operating expenses.  

Liquidity and Capital Resources

We had cash and cash equivalents of $207,170 on September 30, 2011 in our domestic business and $259,796 in our foreign business.  The increase in cash from $355,343 as of December 31, 2010 was due to capital raised during the period and the inclusion of MegaSys.

Net cash used in operating activities during the nine months ended September 30, 2011, and for the nine months ended September 30, 2010, was $1,878,531 and $1,566,932, respectively. Cash used in operating activities for those periods consisted primarily of the net loss from operations.   

Net cash used (received) by investing activities for the nine months ended September 30, 2011, and the nine months ended September 30, 2010, was $(688,692) and $91,583, respectively.  The large source of cash in investing activities in 2011 was due to the MegaSys acquisition.

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We have experienced significant operating losses since our inception.  At December 31, 2010, we had approximately $4.4 million in net operating loss carry forwards available for federal and state income tax purposes. We did not recognize any benefit from these operating loss carry forwards for the year ended 2010 or through the first quarter of 2011. Our operating loss carry forwards expire starting in 2010 and continuing through 2028.

Our capital expenditures and working capital requirements could increase depending on our operating results and other adjustments to our operating plan as may be needed to respond to competition or unexpected events.  We believe that our cash on hand as of September 30, 2011 is insufficient to meet our anticipated cash needs for working capital and capital expenditures for the short term.  We continually evaluate our working capital needs, and we are seeking to obtain additional working capital through debt and equity offerings. There can be no assurance that additional funds will be available on acceptable terms. In the event that additional funds are not available on acceptable terms, we may be required to reduce the scope of, or cease, operations.

If we are unable to quickly increase our sales, we will need to raise additional capital during the year and may be required to reduce labor expenses to maintain our existing operations.

On September 15, 2010, the Company, as borrower, issued a Line of Credit Promissory Note (the “Note”) to Gregory Omi, a director of the Company, as lender, in the principal sum of up to Three Hundred Fifty Thousand Dollars ($350,000).  The line of credit was used for the purpose of purchasing equipment, software, and other infrastructure-related items to fulfill commitments to a government agency in Mexico.  The note balance of $197,000 plus accrued interest was repaid in full in April 2011.  The Note is accessible to Iveda for future draws for large projects that require infrastructure funding up front.   The unpaid principal of the line of credit bears simple interest at the rate of 1.5% per month or 18% per annum.  Any principal balance of the line of credit is due and payable no later than six months after each disbursement.  As of September 30, 2011, there was zero balance under the line of credit.

Two customers represented greater than 10% (25% and 17%) of total revenue for the nine months ended September 30, 2011. No other customers represented greater than 10% of total revenues in the nine months ended September 30, 2011.  There are some customer receivables that have aged over 120 days.  These customers have been identified and an adequate allowance for doubtful accounts has been set up to offset the risk of uncollectibility.

Substantially all cash is deposited in one financial institution. At times, amounts on deposit may be in excess of the FDIC insurance limit.  

Recent Developments

Completion of $2.5 Million Private Placement.  After the reporting period, in October 2011, the Company completed its private placement of $2.5 million pursuant to its private placement memorandum by issuing 847,500 shares of Common Stock at $1.00 per share in thirteen private placement transactions with a mix of investors including eight individuals, three trusts and two corporations.

These issuances were made pursuant to Section 4(2) of the Securities Act of 1933, as amended, Regulation D, and Rule 506 promulgated thereunder.  The facts relied upon by the Company to use this exemption were the following:  (a) the Company did not use general solicitation or advertising to market the securities; (b) the issuances were only made to accredited investors; and (c) the Company informed the investors that they would receive only “restricted” securities.

Agreement with Telmex, U.S.A., LLC.  On October 28, 2011, the Company entered into a Non-Exclusive Strategic Collaboration Agreement (the “Agreement”) with Telmex, U.S.A. LLC (“Telmex”). Telmex will resell products and services by and on behalf of the Company, subject to the terms and

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conditions of the Agreement.  The term of the Agreement is one year and will automatically renew for additional one-year increments. The Agreement will always be interpreted as a fixed-term agreement. Either party may terminate the Agreement at any time for any or no reason in such party’s sole discretion upon thirty days’ written notice to the other party. The Company will continue to provide services to end users, per the terms of the End-User Service Agreement, provided that the end users have the means to continuously pay Company for services rendered.  The Agreement is attached hereto as Exhibit 10.12.

Promissory Note.  On September 26, 2011, the Company entered into a $45,000 promissory note agreement with one of its shareholders.  Interest on the note will be payable in 45,000 warrants at a $1.10 exercise price, exercisable within three years of issuance.  On October 24, 2011, the Board of Directors approved the issuance of the warrants.

Warrants.  On October 24, 2011 the Company authorized the issuance of warrants to purchase 47,500 shares of Common Stock at an exercise price of $1.10 per share, exercisable within three years of grant date, to one of its Board Members for his help in raising funds without compensation.

As a smaller reporting company, the Company is not required to provide Part I, Item 3 disclosures in this Quarterly Report.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the design and operation of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of September 30, 2011.  Based on our evaluation, our principal executive officer and our principal financial officer concluded that the design and operation of our disclosure controls and procedures were not effective as of September 30, 2011.

Changes in Internal Control over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting for our U.S. operations.  We are in the process of evaluating our internal controls over financial reporting for MegaSys.

Limitations on the Effectiveness of Controls

Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the

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fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Iveda have been detected.  These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management or Board override of the control.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Identified Material Weakness

As of September 30, 2011, the Company had only one employee knowledgeable in SEC accounting and reporting.  As a result, there is a lack of proper segregation of duties necessary to insure that all transactions are accounted for accurately and in a timely manner.

 Management's Remediation Initiatives

As our resources allow, we plan to add financial personnel to our management team in order to properly segregate the duties necessary for accurate and timely financial reporting.

PART II. OTHER INFORMATION

See Part II, Item 1 of the Company’s Quarterly Report on Form 10-Q filed on August 15, 2011, which is incorporated herein by reference.

As a smaller reporting company, the Company is not required to provide Part II, Item 1A disclosures in this Quarterly Report.

In addition to issuances of equity securities previously reported on Form 8-K, during the reporting period, pursuant to a $2.5 million private placement memorandum, the Company received a total of $390,000 and issued 390,000 shares of Common Stock in thirteen private placement transactions with a mix of investors including six individuals, five trusts and two corporations. All issuances were at $1 per share.

These issuances were made pursuant to Section 4(2) of the Securities Act of 1933, as amended, Regulation D, and Rule 506 promulgated thereunder.  The facts relied upon by the Company to use this exemption were the following:  (a) the Company did not use general solicitation or advertising to market

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the securities; (b) the issuances were only made to accredited investors; and (c) the Company informed the investors that they would receive only “restricted” securities.

None.

None.

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* Filed herewith

** Furnished herewith

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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