Zerify, Inc. - Annual Report: 2008 (Form 10-K)
UNITED STATES
SECURITIES EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X .
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 2008
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TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
STRIKEFORCE TECHNOLOGIES, INC.
(Name of Small Business Issuer in its Charter)
NEW JERSEY | 333-122113 | 22-3827597 |
(State or other jurisdiction of incorporation or organization) | (Commission file number) | (I.R.S. Employer Identification No.) |
1090 King Georges Post Road, Suite 108
Edison, NJ 08837
(Address of Principal Executive Offices)
(732) 661-9641
(Issuer’s telephone number)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class | Name of each exchange on which registered |
N/A | N/A |
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common stock, $0.0001 par value
Title of Class
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. . Yes No X .
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. . Yes No X .
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No .
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K X .
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | . | Accelerated filer | . |
Non-accelerated filer | . | Small Business Issuer | X . |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act. Yes . No X .
The aggregate market value of voting stock held by non-affiliates of the registrant on March 16, 2009 was approximately $443,309. Solely for purposes of the foregoing calculation, all of the registrant’s directors and officers as of March 16, 2009, are deemed to be affiliates. This determination of affiliate status for this purpose does not reflect a determination that any persons are affiliates for any other purposes.
State the number of shares outstanding of each of the issuer’s classes of equity securities, as of the latest practicable date: As at March 16, 2009, there were 18,359,124 shares of Common Stock, $0.0001 par value per share issued and outstanding
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Documents Incorporated By Reference
None
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STRIKEFORCE TECHNOLOGIES, INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEARS ENDED DECEMBER 31, 2008 and 2007
TABLE OF CONTENTS
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CAUTION REGARDING FORWARD-LOOKING INFORMATION
Included in this annual report are "forward-looking" statements, as well as historical information. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that the expectations reflected in these forward-looking statements will prove to be correct. Our actual results could differ materially from those anticipated in forward-looking statements as a result of certain factors, including matters described in the section titled "Risk Factors." Forward-looking statements include those that use forward-looking terminology, such as the words "anticipate," "believe," "estimate," "expect," "intend," "may," "project," "plan," "will," "shall," "should," and similar expressions, including when used in the negative. Although we believe that the expectations reflected in these forward-looking statements are reasonable and achievable, these statements involve risks and uncertainties and we cannot assure you that actual results will be consistent with these forward-looking statements.
Such risks include, among others, the following: demand for payment of our convertible notes outstanding under which we are currently in default, our inability to obtain adequate financing to repay the convertible notes, our ability to continue financing the operations either through debt or equity offerings, international, national and local general economic and market conditions: our ability to sustain, manage or forecast our growth; material costs and availability; new product development and introduction; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; the loss of significant customers or suppliers; fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other factors referenced in this filing.
Consequently, all of the forward-looking statements made in this Form 10-K are qualified by these cautionary statements and there can be no assurance that the actual results anticipated by management will be realized or, even if substantially realized, that they will have the expected consequences to or effects on our business operations. We undertake no obligation to update or revise these forward-looking statements, whether to reflect events or circumstances after the date initially filed or published, to reflect the occurrence of unanticipated events or otherwise.
Unless otherwise noted, references in this Form 10-K to “StrikeForce” “we”, “us”, “our”, “SFT”, and the “Company” means StrikeForce Technologies, Inc., a New Jersey corporation.
PART I
ITEM 1. BUSINESS
StrikeForce Technologies, Inc. is a software development and services company that offers a suite of integrated computer network security products using proprietary technology. We were organized in August 2001 under New Jersey law as Strike Force Technical Services, Inc. We initially conducted operations as an integrator and reseller of computer hardware and telecommunications equipment and services. In December 2002, and formally memorialized by an agreement in September 2003, we acquired certain intellectual property rights and patent pending technology from NetLabs.com including the rights to further develop and sell their principal technology and certain officers of NetLabs.com joined StrikeForce as officers and directors of our Company. We subsequently changed our name to StrikeForce Technologies, Inc., under which we had conducted our business since August 2001. Our strategy is to develop and exploit our suite of network security products for customers in the corporate, financial, government, insurance, e-commerce and consumer sectors. We plan to grow our business primarily through this channel and also from internally generated sales, rather than by acquisitions. We have no subsidiaries and we conduct our operations from our corporate office in Edison, New Jersey.
The Company owns the exclusive right to license and develop various identification protection software products to protect computer networks from unauthorized access and to protect network owners and users from identity theft. The Company has developed a suite of products partly based upon the exclusive license and the Company is seeking to commercially exploit the products in the areas of financial services, e-commerce, corporate, government and consumer sectors. We are a development stage business and have had nominal revenues since our formation. On August 3, 2005 the Company’s registration statement on Form SB-2 was declared effective by the Securities and Exchange Commission and on December 14, 2005 the Company received its clearance for quotation on the Over-The-Counter Bulletin Board. On November 2, 2006, the Company filed a Post-Effective Amendment to its Form SB-2 Registration Statement with the SEC. The SEC declared the Company’s Post-effective Amendment effective on November 8, 2006.
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We began our operations in 2001 as a reseller and integrator of computer hardware and iris biometric technology. We derived the majority of our revenues as an integrator from the time we started our operations through the first half of 2003. In December 2002, upon the acquisition of the licensing rights to certain intellectual property and patent pending technology from NetLabs.com, we shifted the focus of our business to developing and marketing our own suite of security products. Based upon the acquired licensing rights and additional research and development, the Company has now developed various identification protection software products to protect computer networks from unauthorized access and to protect network owners and users from identity theft. The Company is seeking to commercially exploit the products in the areas of financial services, e-commerce, corporate, government, insurance and consumer sectors. We have had increasing nominal revenues since our formation. We have maintained our relationship with Panasonic and LG as a reseller, primarily for the resale of biometric identification equipment, such as iris scanners, that can be used with our software products.
We completed the development of our ProtectID® platform at the end of June 2006 and we completed the core development of our keyboard encryption and anti-keylogger product, GuardedID®, in December 2006, which is currently being sold and distributed. We seek to locate customers in a variety of ways. These include contracts primarily with value added resellers and distributors (both inside the United States and globally), direct sales calls initiated by our internal staff, exhibitions at security and technology trade shows, through the media, consulting agreements and through our own and agent relationships. Our sales generate revenue either as an Original Equipment Manufacturer (OEM) model, through a Hosting/License agreement, bundled with other company’s products or through direct purchase by customers. We price our products for hosted consumer transactions based on the number of transactions in which our software products are utilized. We also price our products for business applications based on the number of users. These pricing models provide the Company with one-time, monthly, quarterly and yearly recurring revenues. We are also generating revenues from annual maintenance contracts, renewal fees and project an increase in revenues based upon the execution of various agreements that we have recently closed and are being implemented.
We generated all of our 2008 and 2007 revenues of $287,035 and $661,580, respectively from the sales of our security products. $485,274 of our 2007 revenues was deemed uncollectible and was charged off in the third and fourth quarters of 2007. We market our products to financial service firms, e-commerce companies, government agencies and the enterprise market in general and with virtual private networks, as well as technology service companies that service all the above markets. We seek such sales through our own direct efforts and primarily through distributors, resellers and third party agents. We are also seeking to license the technology as original equipment with computer hardware and software manufacturers. We are engaged in production installations and pilot projects with various distributors, resellers and direct customers, as well as having reached additional reseller agreements with strategic vendors globally. Our GuardedID® product is also being sold directly to consumers, primarily through the Internet as well as distributors, resellers, third party agents and potential Original Equipment Manufacturer ("OEM") agreements by bundling GuardedID® with their products, which provides a value-add to their own products and offerings.
We have incurred substantial losses since our inception. We believe that our products provide a cost-effective and technologically competitive solution to address the problems of network security and identity theft in general. There can be no assurance, however, that our products will continue to gain acceptance in the commercial marketplace or that one of our competitors will not introduce technically superior products.
Our executive offices are located at 1090 King Georges Post Road, Suite 108, Edison, NJ 08837. Our telephone number is (732) 661-9641. We have 11 employees. Our Company’s website is www.strikeforcetech.com.
Our Products
StrikeForce is a software development and services company. We own and are seeking to commercially exploit various identification protection software products that were developed to protect computer networks from unauthorized access and to protect network owners and users from identity theft. Our principal products ProtectID® and GuardedID®, inclusive of our unique CryptoColor® technology, are proprietary authentication and keystroke encryption technologies that are intended to eliminate unauthorized access to computer networks and to prevent unauthorized individuals from copying (logging) keystrokes. We are seeking to develop a market for our suite of products in the financial services, e-commerce, corporate, government and consumer sectors. Our products are the subject of two pending patent applications. The products are as follows:
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ProtectID® is an authentication platform that uses “Out-of-Band” technology to authenticate computer network users by a variety of methods including traditional passwords combined with a telephone, PDA or multiple computer secure sessions, biometric identification or encrypted devices such as tokens or smartcards as examples. The authentication procedure separates authentication information such as usernames and passwords or biometric information, which are then provided to the network’s host server on separate channels. The platform provides the client choices and evolves with them over time.
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ValidateID® is a software application that validates the identity of an end user or applicant by asking a series of questions based on private and publicly available information, e.g., prior addresses or motor vehicles that are unlikely to be known by anyone other than the “correct” user.
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GuardedID® creates a 128-bit encrypted separate pathway for information delivery from a keyboard to a targeted application on a local computer, preventing the use of spyware/malware to collect user information. This product provides keyboard encryption and thwarts keylogging, which helps prevent the number one threat to consumers and businesses in today’s market: keylogging software, which is stealth software embedded in web sites, emails, pictures, MP3 files, videos or other software that, once unknowingly launched, secretly monitors and records all of a user's keystrokes on the computer and sends the data to the identity thief without the user’s awareness.
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ResetID™ provides user authenticated “Out-of-Band” remote technology to reset user credentials through a self-service method. ResetID™ provides a secure means of resetting a user’s password into Active Directory and LDAP databases. This product solves the problem and cost of numerous calls to a help desk to reset ones password.
A number of the above products include software and hardware that we contractually license from other vendors. We also distribute and resell related technology software and hardware products. These products include VASCO tokens and LG iris cameras, as well as additional authentication and telecommunication software and hardware devices. We have a reseller services agreement with a major credit bureau that we utilize in our ValidateID® application.
The ValidateID® product requires access to our hosted service provider. The ProtectID® product can either be hosted by our service provider (we have a strategic arrangement with a third party hosting service) or not hosted and internally installed into a customer’s infrastructure. With the exception of our licenses with Microsoft and our reseller agreement with VASCO, none of our contracts for hardware or software are with a sole supplier of that product.
Factors that are considered important to our success include, but are not limited to, the following:
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ProtectID® addresses the needs of a broad variety of customers for authentication security. One of the biggest problems facing the world is Identity Theft, the effects of which total an estimated $221 billion per year in business losses per The Aberdeen Group (source: Identity Theft Statistics Continue to Rise article on www.ezinearticles.com).
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The U.S. Federal Government increased it’s budget for cyber solutions to fight Identity Theft by 1,000%, from approximately $1.7 billion in 2007 to $17 billion in 2008.
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In June 2007, the Sibername forum (www.sibername.com) reported that gangs infected 10,000 web sites with keyloggers in order to steal site users’ bank details from Eastern Europe targeting Italy and other areas around the world. The heist was nicknamed the Italian Job.
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According to the Identity Theft Resource Center, more than 35 million data records were breached in 2008 in the U.S. and the majority of the lost data was neither encrypted nor protected by a password (source: Data Breaches Rose Sharply in 2008 article in ComputerWorld Security).
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According to a 2007 Ponemon Institute study, the total average cost of a data breach per reporting company was more than $6.3 million per breach and ranged from $225,000 to almost $35 million. Additionally, since January 2005, the Privacy Rights Clearinghouse has identified more than 215 million records of U.S. residents that have been exposed due to security breaches (source: 2007 Annual Study: U.S. Cost of a Data Breach).
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In respect to the latest version of our keyboard encryption and anti-keylogger Product, GuardedID®, a recent report from a government security group known as CERT states that minimally 80% of the malicious keylogging programs are undetected by the major anti-virus software suites. However, GuardedID® helps render the malicious programs useless, in real time.
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The Effectiveness of Our Products: Our products have been designed to provide the highest available level of security for computer networks and individual users. In particular, we believe that the “Out-of-Band” authentication process is an innovative technology that will greatly prevent unauthorized access to computer networks. We also believe that our products will substantially reduce or often eliminate unauthorized access to the computer networks of our customers and will provide effective security products to drastically reduce the incidence of identity fraud for our customers. We have not, however, implemented our products on a large scale and there can be no assurance that they will function in all aspects as intended. Likewise, a high level of innovation characterizes the software industry and there can be no assurance that our competitors will not develop and introduce a superior product. The effective functioning of our products once deployed is an important factor in our future success.
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Ability to Integrate our Software with Customer Environments: There are numerous operating systems that are used by computer networks. The ability of a software product to integrate with multiple operating systems is likely to be a significant factor in customer acceptance of particular products. StrikeForce’s ProtectID® operates on an independent platform and is able to integrate with multiple operating systems and user interfaces. ProtectID® has been designed to use multiple authentication devices on the market (including, but not limited to, biometrics, key-fob tokens, PDA’s, smart cards and telephones). Our ability to integrate our products with multiple existing and future technologies is likely to be a key factor in the acceptance of our product. Our GuardedID® product currently operates with Windows Internet Explorer (IE) and Firefox web browsers and under development for new features and versions.
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Relative Cost: We have attempted to design our products to provide a cost-effective suite of products for financial services, e-commerce, commercial, governmental and direct-consumer customers. Our ability to offer our products at a competitive price and to add to existing installations is likely to be a key factor in the acceptance of our product.
The technology developed by the Company and used in the Company’s ProtectID® and GuardedID® products is the subject of two pending patent applications. The Company’s firewall product is no longer being developed and the provisional patent application was allowed to expire. A fourth patent application relating to the Company’s ProtectID® product was combined into the first ProtectID® pending patent application and the fourth application was allowed to lapse.
We intend to market our products to financial service firms, e-commerce companies, government agencies and the enterprise market in general and with virtual private networks, as well as technology service companies that service all the above markets. We intend to seek such sales through our own direct efforts and primarily through distributors, resellers and third party agents. We are also seeking to license the technology as original equipment with computer hardware and software manufacturers. We are engaged in production installations and pilot projects with various resellers and direct customers, as well as having reached reseller agreements with strategic vendors globally. Our GuardedID® product is also being sold directly to consumers, primarily through the Internet as well as distributors, resellers, third party agents and potential Original Equipment Manufacturer ("OEM") agreements by bundling GuardedID® which could provide a value-add to their own products and offerings.
Business Model
We operate primarily as a software development company, providing security software products and services, to be sold to enterprises, Internet consumer businesses and consumers, both directly and through sales channels comprised of distributors, resellers, agents and OEM relationships, globally. We are focusing primarily on developing sales through “channel” relationships in which our products are offered by other manufacturers, distributors, value-added resellers and agents, globally. We also sell our suite of security products directly from our Edison, NJ office, which also augments our channel partner relationships. It is our strategy that these “channel” relationships will provide the greater percentage of our revenues ongoing. Examples of the channel relationships that we are pursuing include our attempts to establish OEM relationships with other security technology and software providers that would integrate or bundle the enhanced security capabilities of ProtectID® and or GuardedID® into their own product lines. These would include providers of networking software and manufacturers of computer and telecommunications hardware and software that provide managed services, as well as all markets interested in increasing the value of their products and packages, such as financial services software, anti-virus and identity theft product companies.
Our primary target markets include financial services such as banks, insurance companies and savings institutions, e-commerce based services companies, telecommunications and cellular carriers, technology software companies, government agencies and consumers. For the near term, we are narrowly focusing our concentration on short sales-cycle customers and strategic problem areas, such as where compliance with government regulations are key, stolen passwords used to acquire private information illegally, as well as remote users for medium to large size companies. Because we anticipate growing market demand, we are developing a sizeable global reseller and distribution channel as a strategy to generate, manage and fulfill demand for our products across market segments, minimizing the requirement for an increase in our staff. We intend to minimize the concentration on our initial direct sales efforts in the future as our distribution and reseller channels develop globally.
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We intend to generate revenue through fees for ProtectID® and ValidateID®, based on consumer volumes of usage in the e-commerce and financial services markets, one time per person fees in the enterprise markets, set-up and recurring transaction fees when the product is hosted, yearly maintenance fees and other one-time fees. GuardedID® pricing is for an annual license and we discount for volume purchases. GuardedID® pricing models, especially when bundling through OEM contracts, include monthly and quarterly recurring revenues. We also provide our clients a choice of operating our software internally by licensing or through our hosting service. GuardedID® requires a download on each and every computer it protects, whether for employees or consumers.
Marketing
Our multi-channel marketing strategy includes:
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Direct sales to enterprise and commercial customers (being minimized over time).
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Resellers, Agents & Distributors, (our strategic sales channel) who distribute and resell our products and services to enterprise and commercial customers (technology and software product distributors, systems integrators, other security technology and software vendors, telecom companies, identity theft related product companies, etc.).
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Application Service Provider (ASP) Partners: Our third party service provides a hosting platform that facilitates faster implementations with choices at competitive pricing.
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Original Equipment Manufacturers (OEM): SFT products are sold to other security technology vendors that integrate ProtectID® and GuardedID® into their products (bundling) and services.
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Internet sites in selling GuardedID® to consumers and small enterprises.
We had a strategic partnership with Panasonic in which Panasonic functioned as an Application Service Provider for our ProtectID® and ValidateID® products, which requires a secondary server used for the “Out-of-Band” authentication technology. As an authorized ASP provider, Panasonic operated our products in their data center for the benefit of clients who contract with us for our security products. In December 2007, we switched from Panasonic to a premier data center and co-location services provider that should maintain a comparable uptime. We believe that the new relationship improves the implementation time and reduces the cost and training requirements. The new hosting site is also SAS 70 certified, which is critical to providing a secure compliant service. Our agreement with the new services provider was for a one-year (1) term ending in December, 2008 and was renewed for an automatic one-year (1) renewal term. The relationship can be terminated by either party on sixty days notice. The hosting service is compensated by StrikeForce based on a flat monthly fee per the terms of the contract.
Intellectual Property
In December 2002, and formally memorialized by an agreement in September 2003, we acquired certain intellectual property rights and patent pending technology from NetLabs.com including the rights to further develop and sell their principal technology and certain officers of NetLabs.com joined StrikeForce as officers and directors of our company.
The technology developed by the Company and used in the Company’s ProtectID® and GuardedID® products are the subject of two pending patent applications. The Company’s firewall product, which was in the research and design phase is no longer being developed, therefore, the pending provisional patent application was allowed to expire. A fourth patent application relating to the Company’s ProtectID® product was combined into the first ProtectID® pending patent application and the fourth application was allowed to lapse.
We have one copyright pending. Also, four trademarks have been approved and registered: ProtectID®, ValidateID®, GuardedID® and CryptoColor®.
A portion of our software is licensed from third parties and the remainder is developed by our own team of developers. We rely upon confidentiality agreements signed by our employees, consultants and third parties to protect the intellectual property rights.
We license technology from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. We anticipate that we will continue to license technology from third parties in the future. Although we are not substantially dependent on any individual licensed technology, some of the software that we license from third parties could be difficult for us to replace. The effective implementation of our products depends upon the successful operation of third-party licensed products in conjunction with our suite of products, and therefore any undetected errors in these licensed products could create delays in the implementation of our products, impair the functionality of our products, delay new product introductions, damage our reputation, and/or cause us to provide substitute products.
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Business Strategy
We intend to incur significant additional costs before we become profitable. We anticipate that most of the costs that we incur will be related to salaries, professional fees, marketing, sales and research & design. We anticipate that we will increase our sales force by approximately two full-time employees and our technology staff by approximately three employees during the next 12 months. At the present time, our monthly burn rate is approximately $110,000 per month. We expect that our monthly cash usage for operations will increase in the future due to anticipated increased volumes and the preceding additions. We anticipate that the area in which we will experience the greatest increase in operating expenses is in marketing, selling, advertising, payroll related to sales and product support, technology and global strategic business consultants.
Our primary strategy over the next 12 months is to have our internal sales force focus on developing channel partners, including distributors, resellers and original equipment manufacturers (OEMs). Secondly, our internal sales team will target potential direct sales to network customers and in industries that management believes provides the greatest potential for near-term sales. These include small to medium sized financial institutions, government agencies, e-commerce and enterprise businesses. We are also executing agreements with strategic resellers and distributors for marketing, selling and supporting our products globally. It is our intention to ultimately utilize distributors, resellers and Company agents to generate the bulk of our sales. There can be no assurance, however, that we will succeed in implementing our sales strategy. Although management believes that there is an increasingly strong market for our products, we have not generated substantial revenue from the sale of our principal products and there is no assurance we can secure a market sufficient to permit us to achieve profitability in the next twelve months.
We also plan to pursue strategic partnerships with larger companies. In August 2003 we executed such a strategic partnership agreement with Panasonic that provided a hosted service for our suite of products. In December 2007, we switched from Panasonic to another premier data center and co-location services provider that should maintain a comparable uptime at a reduced operating cost. We believe that this new relationship improves the implementation time and reduces the cost and training requirements. This permits our clients to access our products without having to leverage or develop their own infrastructure.
Competition
The software development and services market is characterized by innovation and competition. There are several well-established companies within this market that offer network security systems and newer companies with emerging technologies.
We believe that our patent-pending “Out-of-Band” identity authentication product is an innovative, secure, adaptable, competitively priced, integrated network authentication system. The main features of ProtectID® include: an open architecture “Out-of-Band” platform for user authentication; operating system independence; biometric layering; mobile authentication; secure website logon; VPN access; domain authentication and multi-level authentication. Unlike other techniques for increased network security, ProtectID® does not rely on a specific authentication device or method (e.g., phone, tokens, smart cards, digital certificates or biometrics, such as a retinal or fingerprint scan). Rather ProtectID® has been developed as an “open platform” that incorporates many authentication devices and methods. For example, once a user has been identified to a computer network, a system deploying our ProtectID® authentication system permits the “Out-of-Band” authentication of that user by a telephone, PDA, email, hard token, SSL client software, a biometric device such as a fingerprint scan, or others, before that user is permitted to access the network. By using “Out-of-Band” authentication methods, management believes that ProtectID® provides a competitive product for customers with security requirements greater than typical name and password schemes for virtual private networks and computer systems with multiple users at remote locations, as examples. We also believe that our other products (ValidateID®, GuardedID® and ResetID™) offer an additional competitive edge for network security and e-commerce applications that should provide greater levels of security along with choices and the ability to evolve over time based on newer technologies made available.
Although we believe that our suite of products offer competitive advantages, there is no assurance that any of these products will gain acceptance in the marketplace. Our competitors include established software and hardware companies that are likely to be better financed and to have established sales channels. Due to the high level of innovation in the software development industry, it is also possible that a competitor will introduce a product that provides a higher level of security than the ProtectID® products or which can be offered at prices that are more advantageous to the customer.
Employees
As of fiscal year end December 31, 2008 the Company had 11 employees. We believe relations with employees are generally good.
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WHERE YOU CAN FIND MORE INFORMATION
You are advised to read this Form 10-K in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K that we file from time to time. You may obtain copies of these reports directly from us or from the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E. Washington, D.C. 20549, and you may obtain information about obtaining access to the Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains information for electronic filers at its website http://www.sec.gov.
ITEM 1A. RISK FACTORS
WE HAVE A LIMITED OPERATING HISTORY WITH SIGNIFICANT LOSSES AND EXPECT LOSSES TO CONTINUE FOR THE FORESEEABLE FUTURE. SHOULD WE CONTINUE TO INCUR LOSSES FOR A SIGNIFICANT AMOUNT OF TIME, THE VALUE OF YOUR INVESTMENT IN OUR COMMON STOCK COULD BE ADVERSELY AFFECTED, AND YOU COULD EVEN LOSE YOUR ENTIRE INVESTMENT.
We have yet to establish any history of profitable operations as shown in our independent certified financial audit for 2008 and 2007, respectively. As of December 31, 2008, we had an accumulated deficit of $17,920,483. We have incurred annual operating losses of $3,998,402 for the year ended December 31, 2007 and $1,544,033 for the year ended December 31, 2008. We have financed our operations through loans from our officers, employees, and the issuance of debt and equity securities in private placement transactions. Our revenues have not been sufficient to sustain our operations. Our profitability will require the successful marketing and sale of our ProtectID®, ValidateID®, GuardedID® and ResetID™ products and services.
WE WILL NEED TO RAISE ADDITIONAL FUNDS THROUGH THE PUBLIC MARKET, PRIVATE DEBT OR PRIVATE SALES OF EQUITY TO ACHIEVE OUR CURRENT BUSINESS STRATEGY OF COMPLETING AND PROFITING FROM OUR SUITE OF TECHNOLOGY PRODUCTS. OUR NEED TO RAISE ADDITIONAL FUNDS IN THE FUTURE WILL LIKELY INVOLVE THE ISSUANCE OF ADDITIONAL SHARES OF STOCK, WHICH COULD DILUTE THE VALUE OF YOUR INVESTMENT. THERE IS NO ASSURANCE, HOWEVER, THAT WE WILL BE ABLE TO RAISE ADDITIONAL MONIES IN THE FUTURE.
We will require additional financing to sustain our operations, without which we may not be able to continue operations. In addition, the terms of the secured convertible debentures issued to certain investors require that we obtain the consent of such investors prior to our entering into subsequent financing arrangements. Our inability to raise additional working capital or to raise the required financing in a timely manner would negatively impact our ability to fund our operations, our ability to generate revenues and to otherwise execute our business plan. No assurance can be given that we will be able to obtain additional financing, that we will be able to obtain additional financing on terms that are favorable to us or that the holders of the secured debentures will provide their consent to permit us to enter into subsequent financing arrangements. This can lead to the reduction or suspension of our operations and ultimately our going out of business. Should this occur, the value of your investment in the common stock could be adversely affected, and you could lose your entire investment.
WE HAVE ISSUED SECURED CONVERTIBLE DEBENTURES THAT MAY RESTRICT OUR ABILITY TO OBTAIN ADDITIONAL FINANCING.
We have issued three-year and two-year secured debentures in 2004 and 2005 that are convertible into shares of our common stock to YA Global Investments, LP (“YA Global”), formerly Cornell Capital Partners, LP, and Highgate House Funds, Ltd. (“Highgate”) respectively. Under the terms of the secured debentures, we are restricted in our ability to issue additional securities as long as any portion of the principal or interest on the secured debentures remains outstanding. Specifically, we may not, without the prior consent of the holders of the secured debentures, issue any common stock or preferred stock at a discount to its fair market value or issue any derivative security, such as warrants or options, convertible into common stock at less than fair market value. We are also precluded under the terms of the secured debentures from granting any third party a security interest in our assets. Our inability, without the secured debenture holders’ consent, to provide a discount on our stock or to grant a security interest could make it difficult to find parties willing to make additional investments in us or to loan us money and therefore could adversely affect our ability to raise additional funds.
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SECURED CONVERTIBLE DEBENTURES ISSUED TO YA GLOBAL INVESTMENTS, LP, FORMERLY CORNELL CAPITAL PARTNERS, LP, AND HIGHGATE HOUSE FUNDS, LTD. COULD RESULT IN A CHANGE IN CONTROL.
We have issued an aggregate of $1,774,876 in secured convertible debentures, including an aggregate of $1,024,876 principal amount secured debentures issued to YA Global Investments, LP ($427,447 of which were outstanding on March 16, 2009) and an aggregate of $750,000 principal amount secured debentures issued to Highgate House Funds, Ltd. ($244,720 of which were outstanding on March 16, 2009), which are convertible into shares of our common stock at an amount equal to the lesser of: (i) 120% of the average closing bid price for the 5 trading days immediately preceding the closing date (the “YA Global Fixed Conversion Price” and, together with the Highgate Fixed Conversion Price, the “Fixed Conversion Price”); or (ii) 80% of the lowest closing bid price of the common stock during the five days preceding the conversion date. In July, 2006, the YA Global and Highgate Fixed Conversion Price was reduced to $0.085 in connection with an anti-dilution adjustment.
Although the terms of the secured debentures contain a limitation that precludes conversion when the amount of shares already owned by YA Global Investments, LP and Highgate House Funds, Ltd., plus the amount of shares still outstanding to be converted, would exceed 4.99 percent, the limit may be waived by YA Global Investments, LP on 61 days notice to us and by Highgate House Funds, Ltd on 65 days notice to us. In addition, after the third anniversary (at maturity) of the issuance date of the YA Global Investments, LP debenture and second anniversary (at maturity) of the issuance dates of the Highgate House Funds, Ltd. debentures, any outstanding principal or interest owed on the secured debentures may be continued to be converted, at the option of the Holder, into stock with the same limitation. Depending on the price of our stock, if YA Global Investments, LP waived the 4.99 percent limitation, YA Global Investments, LP or Highgate House Funds, Ltd. could acquire enough shares to establish control of our Company.
At December 31, 2008, we had an aggregate of $427,447 remaining in principal amount of secured convertible debentures outstanding issued to YA Global, after conversions, and an aggregate of $244,720 remaining in principal amount of secured convertible debentures outstanding issued to Highgate, after conversions, for a combined total of $672,167.
In January 2008, the Company executed a Forbearance Agreement with YA Global whereby YA Global and Highgate agreed to forbear from exercising their rights under the secured convertible debentures through February 27, 2008. The terms of the Forbearance Agreement record the amount due to YA Global and Highgate by the Company to be $1,214,093, which includes principal, interest and the redemption premium. The terms also include a reduction in the YA Global and Highgate Fixed Conversion Price to $0.065. In connection with this Agreement, the Company issued to YA Global 500,000 contingency warrants with an exercise price of $0.15 per share. The warrants are exercisable for a period of five (5) years from date of issuance. The warrants are held in escrow and will only be released to YA Global if the total amount due by the Company is not paid to YA Global by February 29, 2008. The total amount of our indebtedness to YA Global and Highgate in the amount of $1,214,093, as agreed to in the Forbearance Agreement, is further broken down as:
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$427,447 (YA Global secured convertible debenture)
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$204,775 (YA Global accrued and unpaid interest on debenture)
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$85,489 (YA Global 20% redemption premium)
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$244,720 (Highgate secured convertible debenture
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$86,937 (Highgate accrued and unpaid interest on debentures)
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$48,944 (Highgate 20% redemption premium)
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$100,000 (YA Global promissory note dated May 1, 2006)
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$15,781 (YA Global accrued and unpaid interest on note)
In February 2008, the Forbearance Agreement was amended and extended to May 15, 2008, including the terms of the contingency warrants. Per the terms of the amendment, YA Global and Highgate shall receive an additional 105 days of interest for a total amount of $28,328.84 additional interest. The additional interest plus a security deposit of $171,671.16 were paid to YA Global and Highgate per the terms of a debt assignment agreement executed with the StrikeForce Investor Group (“SIG”) in February 2008, for a total amount paid to YA Global of $200,000. The security deposit will be applied to the amount due YA Global and Highgate if the remaining balance is paid in full by May 15, 2008. Otherwise, the security deposit will be applied to YA Global as liquidated damages.
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In May 2008, the Company executed a Forbearance Agreement with YA Global that supersedes the January 2008 agreement and February 2008 amendment, whereby YA Global and Highgate have agreed to forbear from exercising their rights under the secured convertible debentures through October 15, 2008. Per the terms of the May 2008 Forbearance Agreement, the Company agreed to use its best efforts to make available sufficient authorized shares of its common stock to effect conversion of the entire amount outstanding, to YA Global and Highgate, by October 15, 2008. The terms of the contingency warrants became applicable to the terms of the May 2008 Forbearance Agreement. Additionally, per the terms of the agreement, the SIG paid $75,000 to YA Global in May 2008 which is further broken down as:
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$17,268 (additional prepaid interest to YA Global from May 15, 2008 to October 15, 2008)
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$7,181 (additional prepaid interest to Highgate from May 15, 2008 to October 15, 2008)
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$27,840 (accrued interest due on the Highgate debenture dated April 26, 2005)
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$22,711 (non-refundable extension payment that will be applied to the redemption amount if the remaining balance is paid in full by October 15, 2008)
The payment of the accrued interest of $27,840 for the Highgate April 26, 2005 debenture reduced the total amount of our indebtedness to YA Global and Highgate to $1,186,253 as agreed to in the May 2008 Forbearance Agreement.
The Company is in discussions with YA Global regarding an extension to the May 2008 Forbearance Agreement, which was in effect until October 15, 2008. The Company and YA Global are negotiating an extension which would extend and amend the Forbearance Agreement to the end of the second quarter of 2009, but a final agreement has not yet been executed.
THE CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR SECURED CONVERTIBLE DEBENTURES COULD REQUIRE US TO ISSUE A SUBSTANTIALLY GREATER NUMBER OF SHARES, WHICH COULD CAUSE DILUTION TO OUR EXISTING STOCKHOLDERS.
Our obligation to issue a combination of shares or deliver shares through the escrow agent upon conversion of our $672,167 principal amount secured convertible debentures is essentially limitless. The following is an example of the amount of shares of our common stock that are issuable upon conversion of our secured convertible debentures (excluding accrued interest), based on various market prices:
Price Per Share | With 20% Discount | Number of Shares | Percentage of Stock* Issuable |
$0.10 | $0.080 | 8,402,088 | 49.07% |
$0.07 | $0.056 | 12,002,982 | 70.11% |
$0.05 | $0.040 | 16,804,175 | 98.15% |
* Based on 17,121,124 shares of common stock outstanding as of December 31, 2008. As illustrated, the number of shares of common stock issuable upon conversion of our secured convertible debentures will increase if the market price of our stock declines, which will cause dilution to our existing stockholders.
THE SALES OF COMMON STOCK BY INVESTORS AFTER DELIVERY OF A CONVERSION NOTICE COULD HAVE A DEPRESSIVE EFFECT ON THE PRICE OF OUR COMMON STOCK. IN ADDITION, WE DO NOT INTEND TO DISCLOSE THE TIMING OF ANY CONVERSION NOTICES WHICH WE MAY RECEIVE FROM THE INVESTORS AND AS A RESULT, YOU WILL HAVE NO KNOWLEDGE OF WHEN THE INVESTORS ARE CONVERTING INTO SHARES OF OUR COMMON STOCK.
While the securities purchase agreements with YA Global and Highgate contain provisions prohibiting them from engaging in short sales, the investors may, nevertheless, engage in the sale of escrowed shares after delivering a conversion notice to us but before actual delivery of the shares. In the event that YA Global and/or Highgate were to engage in any such sales, this may create downward pressure on the price of our common stock and could result in higher levels of volatility. Further, any resulting decline in the price of our stock could result in increased dilution due to the fact that we could be required to issue greater numbers of shares upon receiving future conversion notices. In addition, not only the sale of shares issued upon conversion of secured debentures, but also the mere perception that these sales could occur, may adversely affect the market price of the common stock. In addition, we do not intend to disclose the timing of conversion notices which we may receive from YA Global and/or Highgate. As a result, you will have no knowledge of when the investors are converting. Further, you will not know that the investors have shares of our common stock that they may be imminently selling, or that the investors have sold such shares, all of which may have a depressive effect on the price of our common stock.
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THE ISSUANCE OF SHARES OF OUR COMMON STOCK UPON CONVERSION OF THE SECURED CONVERTIBLE DEBENTURES MAY CAUSE IMMEDIATE AND SUBSTANTIAL DILUTION TO OUR EXISTING STOCKHOLDERS.
The issuance of shares of our common stock upon conversion of the secured convertible debentures may result in substantial dilution to the interests of other stockholders since the selling stockholders may ultimately convert and sell the full amount issuable on conversion. There is no upper limit on the number of shares that may be issued which will have the effect of further diluting the proportionate equity interest and voting power of holders of our common stock, including investors in this offering.
WE WILL NEED TO FILE AN ADDITIONAL REGISTRATION STATEMENT TO REGISTER FOR SALE BY THE SECURED CONVERTIBLE DEBENTURE HOLDERS SHARES OF COMMON STOCK ISSUABLE UPON CONVERSION OF DEBENTURES THAT ARE NOT COVERED BY THIS PROSPECTUS.
The shares of common stock that have been registered for sale by YA Global and Highgate upon conversion of the secured convertible debentures do not include all of the shares of common stock that would be issuable if such debentures were converted in full. As a result, the Company will be required to file an additional registration statement to register such additional shares. We may incur substantial costs in connection with the preparation of filing of such registration statement and the failure to file such registration statement could result in a default under the secured convertible debentures.
IF WE ARE REQUIRED FOR ANY REASON TO REPAY OUR OUTSTANDING SECURED CONVERTIBLE DEBENTURES, WE WOULD BE REQUIRED TO DEPLETE OUR WORKING CAPITAL, IF AVAILABLE, OR RAISE ADDITIONAL FUNDS. OUR FAILURE TO REPAY THE SECURED CONVERTIBLE DEBENTURES, IF REQUIRED, COULD RESULT IN LEGAL ACTION AGAINST US, WHICH COULD REQUIRE THE SALE OF SUBSTANTIALLY ALL OF OUR ASSETS, CURRENTLY PLEDGED UNDER A UNIFORM COMMERICAL CODE (UCC) FILING IN THE STATE OF NEW JERSEY.
Any event of default in our obligations to the holders of the secured convertible debentures such as our failure to repay the principal or interest when due, our failure to issue shares of common stock upon conversion by the holder, our failure to timely file a registration statement or have such registration statement declared effective, breach of any covenant, representation or warranty in the securities purchase agreements for such secured convertible debentures or in the secured convertible debentures, the commencement of a bankruptcy, insolvency, reorganization or liquidation proceeding against us and the delisting of our common stock could require the early repayment of the secured convertible debentures if the default is not cured with the specified grace period. We anticipate that the full amount of the secured convertible debentures, together with accrued interest, will be converted into shares of our common stock, in accordance with the terms of the secured convertible debentures. If we were required to repay the secured convertible debentures, we would be required to use our limited working capital and raise additional funds. If we were unable to repay the secured debentures when required, the debenture holders could commence legal action against us and foreclose on all of our assets to recover the amounts due. Any such actions would require us to severely limit operations or to file for protection under United States Bankruptcy laws.
OUR SECURITY AGREEMENTS WITH YA GLOBAL INVESTMENTS, LP AND HIGHGATE HOUSE FUNDS LTD. CONTAIN NEGATIVE COVENANTS WHICH RESTRICT OUR ABILITY TO CREATE SECURITY INTERESTS, CHANGE MANAGEMENT, DECLARE DIVIDENDS, MAKE LOANS AND INCUR ADDITIONAL INDEBTEDNESS, WITHOUT YA GLOBAL AND HIGHGATE’S PRIOR WRITTEN CONSENT. SUCH RESTRICTIONS COULD IMPEDE OUR ABILITY TO OBTAIN ADDITIONAL FUNDING TO FINANCE OUR ONGOING OPERATIONS, WHICH WOULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR INVESTMENT.
In connection with the securities purchase agreements for our secured convertible debentures with both YA Global Investments, LP (dated December 20, 2004, January 18, 2005 and amended on April 27, 2005 into one debenture with interest to April 27, 2005) and Highgate House Funds Ltd. (dated April 27, 2005 and May 6, 2005) we granted both YA Global and Highgate a secured interest in all of our assets. In accordance with such agreement, we may not, without YA Global and Highgate’s written consent, directly or indirectly:
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permit to exist any assignment, transfer, pledge, mortgage, security interest or other lien or encumbrance in or against any part of the pledged property;
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materially change our ownership, executive staff or management, including Mark L. Kay and Mark Corrao;
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declare or pay any dividend of any kind, in cash or in property, on any class of our capital stock, or make any distribution of any kind in respect thereof;
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make any loan, advance or extension of credit to any person other than in the normal course of our business; or to create, incur, or assume any additional indebtedness of any description whatsoever in an aggregate amount in excess of $25,000.
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These restrictions could impede our ability to obtain additional funding to finance our ongoing operations, which would have a negative impact on our business and the value of your investment.
THE PATENT APPLICATIONS FOR THE TECHNOLOGY ARE PENDING AND THERE IS NO ASSURANCE THAT THESE APPLICATIONS WILL BE GRANTED. FAILURE TO OBTAIN THE PATENTS FOR THE APPLICATIONS COULD PREVENT US FROM SECURING ROYALTY PAYMENTS IN THE FUTURE.
The technology developed by the Company and used in the Company’s ProtectID® (exclusively licensed from NetLabs.com) and GuardedID® products is the subject of two patent pending applications. The Company’s firewall product, which was in the research and design phase is no longer being developed, therefore the pending provisional patent (acquired from NetLabs.com) application was allowed to expire. A fourth patent application relating to the Company’s ProtectID® product was combined into the first ProtectID® pending patent application and the fourth application was allowed to lapse. To date the two patent applications have not been granted. We cannot be certain that these patents will be granted nor can we be certain that other companies have not filed for patent protection for this technology. Even if the patents were granted for the technology, there is no assurance that we will be in a position to enforce the patent rights. Failure to be granted patent protection for the technology could result in greater competition or in limited royalty payments. This could result in inadequate revenue and cause us to cease operations.
WE WILL FACE INTENSE COMPETITION FROM COMPETITORS THAT HAVE GREATER FINANCIAL, TECHNICAL AND MARKETING RESOURCES. THESE COMPETITIVE FORCES MAY IMPACT OUR PROJECTED GROWTH AND ABILITY TO GENERATE REVENUES AND PROFITS, WHICH WOULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR INVESTMENT.
We likely will face competition from alternate security software programs and services. As is typical of a new industry, demand and market acceptance for recently introduced services are subject to a high level of uncertainty and risk. In addition, the software industry is characterized by frequent innovation. As the market for computer security products evolves, it will be necessary for us to continually modify and enhance our existing products and develop new products. We believe that our competitors will enhance existing product lines and introduce new products. If we are unable to update our software to compete or to meet announced schedules for improvements and enhancements, it is likely that our sales will suffer and that potential customers will be lost to a competing company’s product.
Because the market for our services is new and evolving, it is difficult to predict the future growth rate, if any, and the size of this market. Substantial marketing activities will be required to meet our revenue and profit goals. There can be no assurance we will be successful in such marketing efforts. There can be no assurance either that the market for our services will develop or become sustainable. Further, other companies may decide to provide services similar to ours. These companies may be better capitalized than us and we could face significant competition in pricing and services offered.
IF WE DO NOT ADEQUATELY PROTECT THE INTELLECTUAL PROPERTY RIGHTS, WE MAY EXPERIENCE A LOSS OF REVENUE AND OUR OPERATIONS MAY BE MATERIALLY IMPAIRED.
We rely upon confidentiality agreements signed by our employees, consultants and third parties to protect the intellectual property. We cannot assure that we can adequately protect the intellectual property or successfully prosecute potential infringement of the intellectual property rights. Also, we cannot assure that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve these types of conflicts to our satisfaction. Failure to protect the intellectual property rights would result in a loss of revenue and could adversely affect our operations and financial condition.
OUR INABILITY TO RETAIN OUR KEY EXECUTIVE OFFICERS WOULD IMPEDE OUR BUSINESS PLAN AND GROWTH STRATEGIES, WHICH COULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR INVESTMENT.
Our success depends, to a critical extent, on the continued efforts and services of our Chief Executive Officer, Mark L. Kay, our Chief Technical Officer, Ramarao Pemmaraju, our Chief Financial Officer, Mark Corrao and our Executive Vice President and Head of Marketing, George Waller. Were we to lose three or more of these key executive officers, we would be forced to expend significant time and money in the pursuit of a replacement, which would result in both a delay in the implementation of our business plan and the diversion of limited working capital. We can give you no assurance that we can find satisfactory replacements for these key executive officers at all, or on terms that are not unduly expensive or burdensome to our Company. Only one of our executive officers (CEO) had an employment agreement providing for his continued service to us, which is now expired. We do not currently carry a key-man life insurance policy on any of our employees, which would assist us in recouping our costs in the event of the loss of those officers.
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THE INABILITY TO MANAGE OUR GROWTH COULD IMPEDE OUR ABILITY TO GENERATE REVENUES AND PROFITS AND TO OTHERWISE IMPLEMENT OUR BUSINESS PLAN AND GROWTH STRATEGIES, WHICH WOULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR INVESTMENT.
We plan to grow rapidly, which will place strains on our management team and other Company resources to both implement more sophisticated managerial, operational and financial systems, procedures and controls and to hire, train and manage the personnel necessary to implement those functions. Our staff is currently comprised of 11 people and we believe that in order for us to achieve our goals, it will be necessary to further expand our personnel, particularly in the area of sales, support services, technology development and client support. As we grow, we also expect to increase detailed and pertinent internal and administrative controls and procedures, require further product enhancements and customization of our existing products for specific clients, as well as enter new geographic markets. We do not presently have in place the corporate infrastructure common to larger organizations. We do not, for example, have a separate human resources department or purchasing department designed for a larger organization. Some of our key personnel do not have experience managing large numbers of personnel. Substantial expansion of our organization will require the acquisition of additional information systems and equipment, a larger physical space and formal management of human resources. It will require that we expand the number of people within our organization providing additional administrative support (or consider outsourcing) and to develop and implement additional internal controls appropriate for a larger organization. Our experience to date in managing the minimal growth of our Company has been positive, without product failures or breakdowns of internal controls.
We plan to devote substantial resources to our ProtectID® and GuardedID® products, focusing on our marketing, sales, administrative, operational, financial and other systems to implement our longer-term business plan and growth strategies. We also are growing our distribution and reseller services through our channel strategy. This expansion requires us to significantly improve, replace and or acquire managers, operational and financial systems, procedures and controls, to improve the coordination between our various corporate functions, to manage, train, motivate and maintain a growing employee and marketing base. Our performance and profitability will depend on the ability of our officers and key employees to:
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manage our business as a cohesive global enterprise;
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manage expansion through the timely implementation and maintenance of appropriate administrative, operational, financial and management information systems, controls and procedures;
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add internal capacity, facilities and third-party sourcing arrangements when needed;
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maintain and continually improve service quality controls;
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attract, train, retain, motivate and manage effectively our employees.
The time and costs to effectuate this business development process may place a significant strain on our management personnel, systems and resources, particularly given the limited amount of financial resources and skilled employees that may be available at the time. There can be no assurance that we will integrate and manage successfully new systems, controls and procedures for our business, or that our systems, controls, procedures, facilities and personnel, even if successfully integrated, will be adequate to support our projected future operations. There can be no assurance that any expenditure incurred during this expansion will ever be recouped. Any failure to implement and maintain such changes could have a material adverse effect on our business, financial condition and results of operations.
OUR RESULTS OF OPERATIONS MAY HIGHLY FLUCTUATE FROM QUARTER TO QUARTER AS WE CONTINUE TO GROW. THEREFORE, THESE RESULTS CANNOT BE USED TO PREDICT HOW WE MAY PERFORM IN THE FUTURE.
As a result of our limited operating history, we have limited historical financial data in which to base our planned operating expenses. Our expense levels are expected to increase. It is anticipated that as we mature, our sales and operating results will fluctuate from quarter to quarter and from year to year due to a combination of factors, including, among other things:
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We Will Incur Large Expenses in Marketing Our Product
Our products are not widely recognized or distributed in the marketplace and in order to introduce them effectively, we will have to continue to develop and market them aggressively. We will compete in our marketing efforts with other competitors, many of which are well-established. We think it is likely that in order to compete effectively, we may need to spend more money on marketing our products relative to our sales volume than do the more established companies. These expenses may make it more difficult for us to become a profitable company and reduce our profitability in the short term and are likely to negatively affect our net income.
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Product Defects or Service Quality Problems Could Affect Our Sales
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Although we consider our principal products ready for commercial production and are actively marketing them to potential customers, we do not have significant experience with the use of our products on a large scale. We have not experienced any product defects that are material to the performance of our products, but there can be no assurance that there will not be product defects in the future. Likewise, we cannot be certain that the security provided by our products cannot be circumvented, now or in the future, although we are unaware of anyone having successfully defeating the technology. Our products are complex and may contain undetected errors or defects or may contain errors or defects in new versions that we attempt to release. Errors and defects that occur in the future could result in adverse product reviews and a loss of, or delay in, market acceptance of our products. We have, however, received a number of independent endorsements of GuardedID® and ProtectID® from recognized, well known third party security product lab testers and reviewers (PCMagazine.com for GuardedID® and SCMagazineUS.com for ProtectID®).
THE APPLICATION OF THE “PENNY STOCK” RULES COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK AND INCREASE YOUR TRANSACTION COSTS IN SELLING OUR COMMON STOCK.
The Securities and Exchange Commission (“SEC”) has adopted Rule 3a51-1 which establishes the definition of a “penny stock,” for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, Rule 15g-9 require:
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that a broker or dealer approve a person’s account for transactions in penny stocks; and
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the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.
In order to approve a person’s account for transactions in penny stocks, the broker or dealer must:
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obtain financial information and investment experience objectives of the person; and
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make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the SEC relating to the penny stock market, which, in highlight form:
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sets forth the basis on which the broker or dealer made the suitability determination; and
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that the broker or dealer received a signed, written agreement from the investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities subject to the “penny stock” rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.
VOLATILITY IN OUR STOCK PRICE MAY SUBJECT US TO SECURITIES LITIGATION, THEREBY DIVERTING OUR RESOURCES, WHICH MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS.
The market for our common stock is likely to be characterized by significant price volatility when compared to seasoned issuers, we expect that our share price will continue to be more volatile than a seasoned issuer for the indefinite future. In the past, plaintiffs have often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may in the future be the targets of similar litigation. Securities litigation could result in substantial costs and liabilities and could divert management’s attention and resources.
FAILURE TO ACHIEVE AND MAINTAIN EFFECTIVE INTERNAL CONTROLS IN ACCORDANCE WITH SECTION 404 OF THE SARBANES-OXLEY ACT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND OPERATING RESULTS.
It may be time consuming, difficult and costly for us to develop and implement the additional internal controls, processes and reporting procedures required by the Sarbanes-Oxley Act. We may need to hire additional financial reporting, internal auditing and other finance staff in order to develop and implement appropriate additional internal controls, processes and reporting procedures. If we are unable to comply with these requirements of the Sarbanes-Oxley Act, we may not be able to obtain the independent accountant certifications that the Sarbanes-Oxley Act requires of publicly traded companies.
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If we fail to comply in a timely manner with the requirements of Section 404 of the Sarbanes-Oxley Act regarding internal control over financial reporting or to remedy any material weaknesses in our internal controls that we may identify, such failure could result in material misstatements in our financial statements, cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our common stock.
Pursuant to Section 404 of the Sarbanes-Oxley Act and current SEC regulations, beginning with our annual report on Form 10-K for our fiscal period ending December 31, 2007, we will be required to prepare assessments regarding internal controls over financial reporting and beginning with our annual report on Form 10-K for our fiscal period ending December 31, 2008, furnish a report by our management on our internal control over financial reporting. We have begun the process of documenting and testing our internal control procedures in order to satisfy these requirements, which is likely to result in increased general and administrative expenses and may shift management time and attention from revenue-generating activities to compliance activities. While our management is expending significant resources in an effort to complete this important project, there can be no assurance that we will be able to achieve our objective on a timely basis. There also can be no assurance that our auditors will be able to issue an unqualified opinion on management’s assessment of the effectiveness of our internal control over financial reporting. Failure to achieve and maintain an effective internal control environment or complete our Section 404 certifications could have a material adverse effect on our stock price.
In addition, in connection with our on-going assessment of the effectiveness of our internal control over financial reporting, we may discover “material weaknesses” in our internal controls as defined in standards established by the Public Company Accounting Oversight Board, or the PCAOB. A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The PCAOB defines “significant deficiency” as a deficiency that results in more than a remote likelihood that a misstatement of the financial statements that is more than inconsequential will not be prevented or detected.
In the event that a material weakness is identified, we will employ qualified personnel and adopt and implement policies and procedures to address any material weaknesses that we identify. However, the process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. We cannot assure you that the measures we will take will remediate any material weaknesses that we may identify or that we will implement and maintain adequate controls over our financial process and reporting in the future.
Any failure to complete our assessment of our internal control over financial reporting, to remediate any material weaknesses that we may identify or to implement new or improved controls, or difficulties encountered in their implementation, could harm our operating results, cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of the periodic management evaluations of our internal controls and, in the case of a failure to remediate any material weaknesses that we may identify, would adversely affect the annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting that are required under Section 404 of the Sarbanes-Oxley Act. Inadequate internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
We operate from leased offices located at 1090 King Georges Post Road, Suite #108, Edison, New Jersey 08837. We do not hold any material investments in other real or personal property other than office equipment. We anticipate these facilities will be adequate for the immediate future but that if we are successful in introducing our products, we will need to seek larger or additional office quarters. We have a non-cancelable operating lease for office space that expires in February 2013 that includes a monthly base rent payment of $6,355.56. The lease does not contain a renewal option and requires us to pay all executory costs such as maintenance and insurance.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently a party to, nor is any of its property currently the subject of, any material legal proceeding. None of the Company’s directors, officers or affiliates is involved in a proceeding adverse to the Company’s business or has a material interest adverse to the Company’s business.
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In January 2008, a money judgment in the amount of sixty nine thousand nine hundred fifty two dollars, for past due payables, in favor of Lewis PR, a California corporation, against the Company was entered into the Superior Court of California, County of San Diego. In February 2008, a settlement agreement was reached between the parties whereby Lewis PR will receive a payment of thirteen thousand dollars by September 2008 as full settlement of the debt. A payment of $6,500 was made in October 2008. The Company is pursuing a revised settlement agreement with the debtor.
In February 2008, summonses were filed in the Superior Court of the State of New Jersey against the Company and its CEO demanding payment on a promissory note in the amount of forty five thousand dollars. In October 2008, a money judgment in the amount of forty nine thousand two hundred sixty three dollars, for the past due note, in favor of the note holder, against the Company was entered into the Superior Court of New Jersey, County of Middlesex. In January 2009, the Company and the note holder executed a Forbearance Agreement whereby the note holder agreed to forbear his rights under the terms of the promissory note until March 31, 2009. Per the terms of the agreement, the Company made a partial payment of $10,000 to the note holder, towards the note balance, in January 2009 and also placed 500,000 shares of its common stock in escrow with the note holder’s escrow agent. The shares will be returned to the Company upon its fulfillment of the terms of the Forbearance Agreement.
In April 2008, a summons was filed in the Superior Court of the State of New Jersey against the Company demanding payment on a convertible promissory note in the amount of one hundred thousand dollars. The Company and the note holder have agreed upon a settlement whereby the debt shall be assigned to the SIG by the Company and the SIG shall repay the agreed upon settlement amount to the note holder, in installments, through February 2009. The SIG made payments of $10,000 in July 2008, $5,000 in September 2008, $15,000 in October 2008, $5,000 in December 2008 and $10,000 in January 2009 to the note holder. In December 2008, the complaint was amended to include the SIG and James Solakian, the representative of the SIG, in the default judgment.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company’s annual meeting of shareholders was held on August 8, 2008. At the annual meeting, the Company's shareholders voted upon the following matters:
(1)
The election of five members to the Company's Board of Directors to hold office until the Company's next Annual Meeting of Stockholders in 2009 or until each Director’s successor is duly elected and qualified; and
(2)
The ratification of the appointment of Li & Company, PC, as the Company's independent certified public accountants; and
(3)
The enactment of a one for ten reverse stock split (1:10), to be effective as of the filing of an amendment to the Company's Articles of Incorporation with the New Jersey Secretary of State and upon the receipt of regulatory approval.
Per the results recorded on the Report of Inspector of Election, Mark L. Kay, Robert Denn, Mark Corrao, Ramarao Pemmaraju and George Waller were elected as the Company’s Board of Directors; Li & Company, PC was ratified as the Company’s independent certified public accountants; and a one for ten reverse stock split (1:10) was approved. On September 30, 2008, the New Jersey Secretary of State approved the Company’s Restated Certificate of Incorporation. On October 31, 2008, the Company received regulatory approval for the effectuation of the one for ten reverse stock split (1:10) at the open of business on November 3, 2008 at which time the Company’s new ticker symbol became SFOR.
All share and per share data in the Form 10-K, financial statements and related notes have been restated to give retroactive effect to the reverse stock split.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
(A) MARKET INFORMATION
The Company’s Small Business registration statement on Form SB-2 was declared effective by the SEC in August 2005 and the Company’s shares were approved for listing on the OTC Bulletin Board by the National Association of Securities Dealers, Inc. (“NASD”) in December 2005. Prior to December 2005, there was no public market for the common stock. The Company’s common stock is quoted on the OTC Electronic Bulletin Board maintained by the NASD under the symbol “SFOR.OB” (prior to November 3, 2008 the symbol was “SKFT.OB”). It has been traded in the over-the-counter market on a limited basis. The following sets forth high and low bid price quotations for each calendar quarter during the last fiscal years that trading occurred or quotations were available. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Quarter Ended: | High: | Low: |
December 31, 2007 | $0.022 | $0.017 |
March 31, 2008 | $0.220 | $0.180 |
June 30, 2008 | $0.150 | $0.150 |
September, 2008 | $0.140 | $0.110 |
December 31, 2008 | $0.080 | $0.080 |
The closing bid price for our shares of common stock on March 16, 2009 was $0.03.
Our common stock is considered a low priced security under the “Penny Stock” rules promulgated by the Securities and Exchange Commission. Under these rules, broker-dealers participating in transactions in these securities must first deliver a risk disclosure document which describes risks associated with these stocks, broker-dealers’ duties, customers’ rights and remedies, market and other information, and make suitability determinations approving the customers for these stock transactions based on financial situation, investment experience and objectives. Broker-dealers must also disclose these restrictions in writing, provide monthly account statements to customers, and obtain specific written consent of each customer. With these restrictions, the likely effect of designation as a low priced stock is to decrease the willingness of broker-dealers to make a market for the stock, to decrease the liquidity of the stock and increase the transaction cost of sales and purchases of these stocks compared to other securities.
(B) HOLDERS
As of March 16, 2009, there were approximately 216 holders of the common stock on record (several holders of record are brokerage firms, which handle accounts for individual investors).
(C) DIVIDENDS
We have not previously paid any cash dividends on common stock and do not anticipate or contemplate paying dividends on common stock in the foreseeable future. Our present intention is to utilize all available funds to develop and expand our business. The only restrictions that limit the ability to pay dividends on common equity, or that are likely to do so in the future, are those restrictions imposed by law and those restrictions imposed under contractual obligation. Under New Jersey corporate law, no dividends or other distributions may be made which would render a company insolvent or reduce assets to less than the sum of liabilities plus the amount needed to satisfy outstanding liquidation preferences.
Any future determination to pay cash dividends will be at the discretion of our board of directors, and will be dependent upon our financial condition, results of operations, capital requirements and other factors as our board may deem relevant at that time.
(D) RECENT ISSUANCES OF UNREGISTERED SECURITIES
In November 2008, the Company issued 3,000 shares of its common stock, 750 shares of which were recorded in December 2007 and 2,250 shares of which were recorded in 2008, and issuable to a law firm as compensation for general counsel legal services rendered.
In November 2008, the Company issued 20,467 shares of its common stock, which were recorded in December 2007, to a note holder relating to an amendment to a convertible promissory note as 5,000 extension shares. The remaining 15,467 shares were issued to the note holder for converted interest owed from October 1, 2007 to December 31, 2007 on the note.
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In November 2008, the Company issued 5,576,000 shares of its common stock, which were recorded in 2008, to 26 note holders relating to 68 units sold, per the terms of a term sheet executed with the SIG in January 2008 and amended in May 2008, with each unit consisting of a 10% promissory note of $25,000, maturing three years from the execution date and with a 10% discount rate, and 82,000 non-dilutable (for one year) restricted shares of the Company’s common stock.
In November 2008, the Company issued 100,000 shares of its common stock (of a total of 1,000,000 shares owed), which were recorded in January 2008, to a note holder relating to a promissory note executed in January 2008.
In December 2008, the Company issued 900,000 shares of its common stock (the balance of a total of 1,000,000 shares owed), which were recorded in January 2008, to a note holder relating to a promissory note executed in January 2008.
In December 2008, the Company issued 7,500 shares of its common stock, valued at $0.06 per share for 2,500 shares, $0.10 per share for 2,500 shares and $0.14 per share for 2,500 shares, and issuable to a law firm as compensation for general counsel legal services rendered.
In December 2008, the Company sold 2 units, per the terms of a term sheet executed with the SIG in January 2008 and amended in May 2008, with each unit consisting of a 10% promissory note of $25,000, maturing three years from the execution date, and 82,000 non-dilutable (for one year) restricted shares of the Company’s common stock. The Company issued 164,000 restricted shares of common stock, at $0.08 per share to two note holders.
In December 2008, the Company issued 290,695 shares of common stock, valued at $0.095 per share, issuable to five note holders and the placement agent per an amendment executed in November 2008 to the February 2007 unit purchase agreements. Per the amendment, the shares of common stock recorded but not yet issued to the note holders were cancelled. The 240,000 shares of common stock recorded from December 2007 through September 2008 were cancelled in December 2008.
In December 2008, the Company cancelled 60,000 shares of common stock, recorded but not yet issued, issuable to a note holder and the placement agent per an amendment executed in November 2008 to the April 2007 unit purchase agreement. Per the amendment, the shares of common stock recorded but not yet issued to the note holder were cancelled. The 60,000 shares of common stock recorded from December 2007 through September 2008 were cancelled in December 2008.
In December 2008, the Company issued 59,384 shares of common stock, valued at $0.095 per share, issuable to two remaining note holders per an amendment executed in November 2008 to the July 2006 unit purchase agreements. Per the amendment, the shares of common stock recorded but not yet issued to the note holder were cancelled. The 19,618 shares of common stock recorded from December 2007 through September 2008 were cancelled in December 2008.
In December 2008, the Company issued 320,928 warrants with an exercise price of $0.20 per share and expiring December 22, 2012 to five note holders per an amendment executed in November 2008 to the February 2007 unit purchase agreements.
In December 2008, the Company issued 79,179 warrants with an exercise price of $0.20 per share and expiring December 22, 2012 to two remaining note holders per an amendment executed in November 2008 to the July 2006 unit purchase agreements.
All of the above offerings and sales were made in reliance upon the exemption from registration under Rule 506 of Regulation D promulgated under the Securities Act and/or Section 4(2) of the Securities Act, based on the following: (a) the investors confirmed to us that they were “accredited investors,” as defined in Rule 501 of Regulation D promulgated under the Securities Act and had such background, education and experience in financial and business matters as to be able to evaluate the merits and risks of an investment in the securities; (b) there was no public offering or general solicitation with respect to the offering; (c) the investors were provided with certain disclosure materials and all other information requested with respect to our company; (d) the investors acknowledged that all securities being purchased were “restricted securities” for purposes of the Securities Act, and agreed to transfer such securities only in a transaction registered under the Securities Act or exempt from registration under the Securities Act; and (e) a legend was placed on the certificates representing each such security stating that it was restricted and could only be transferred if subsequent registered under the Securities Act or transferred in a transaction exempt from registration under the Securities Act.
ITEM 6. SELECTED FINANCIAL DATA.
The following information has been summarized from financial information included elsewhere and should be read in conjunction with such financial statements and notes thereto.
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Summary of Statements of Operations of Strikeforce
Years Ended December 31, 2008 and 2007
Statement of Operations Data: |
|
| For the Years Ended December 31, | ||
|
| ||||
|
| 2008 |
| 2007 | |
|
|
|
|
| |
Revenues | $ | 287,035 | $ | 661,580 | |
Cost of sales |
| 120,201 |
| 83,720 | |
Operating and Other Expenses |
| (1,710,867) |
| (4,576,262) | |
|
|
|
|
| |
Net loss | $ | (1,544,033) | $ | (3,998,402) | |
|
|
| |||
Balance Sheet Data: |
| December 31, | |||
|
| 2008 |
| 2007 | |
|
|
|
|
| |
Current Assets | $ | 489,110 | $ | 382,400 | |
Total Assets |
| 1,642,805 |
| 1,841,627 | |
Current Liabilities |
| 6,618,495 |
| 5,828,075 | |
Non Current Liabilities |
| 1,750,000 |
| 1,629,270 | |
Total Liabilities |
| 8,368,495 |
| 7,457,345 | |
Working Capital (Deficit) |
| (6,129,385) |
| (5,445,675) | |
Shareholders’ Equity (Deficit) | $ | (6,725,690) | $ | (5,615,718) | |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The information in this Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a “safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact made in this report are forward looking. In particular, the statements herein regarding industry prospects and future results of operations or financial position are forward looking statements. Forward-looking statements reflect management's current expectations and are inherently uncertain. Our actual results may differ significantly from management's expectations.
The following discussion and analysis should be read in conjunction with the financial statements of StrikeForce Technologies, Inc., included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management.
Background
StrikeForce Technologies, Inc. (hereinafter referred to as “we”, “us”, “our”, “SFT”, “StrikeForce” and “the Company”) is a software development and services company that offers a suite of integrated computer network security products using proprietary technology. We were organized in August 2001 under New Jersey law as Strike Force Technical Services, Inc. We initially conducted operations as an integrator and reseller of computer hardware and telecommunications equipment and services. In December 2002, and formally memorialized by an agreement in September 2003, we acquired certain intellectual property rights and patent pending technology from NetLabs.com including the rights to further develop and sell their principal technology and certain officers of NetLabs.com joined StrikeForce as officers and directors of our Company. We subsequently changed our name to StrikeForce Technologies, Inc., under which we had conducted our business since August 2001. Our strategy is to develop and exploit our suite of network security products for customers in the corporate, financial, government, insurance, e-commerce and consumer sectors. We plan to grow our business primarily through this channel and also from internally generated sales, rather than by acquisitions. We have no subsidiaries and we conduct our operations from our corporate office in Edison, New Jersey.
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The Company owns the exclusive right to license and develop various identification protection software products to protect computer networks from unauthorized access and to protect network owners and users from identity theft. The Company has developed a suite of products partly based upon the exclusive license and the Company is seeking to commercially exploit the products in the areas of financial services, e-commerce, corporate, government and consumer sectors. We are a development stage business and have had nominal revenues since our formation. On August 3, 2005 the Company’s registration statement on Form SB-2 was declared effective by the Securities and Exchange Commission and on December 14, 2005 the Company received its clearance for quotation on the Over-The-Counter Bulletin Board. On November 2 2006, the Company filed a Post-Effective Amendment to its Form SB-2 Registration Statement with the SEC. The SEC declared the Company’s Post-effective Amendment effective on November 8, 2006.
We began our operations in 2001 as a reseller and integrator of computer hardware and iris biometric technology. We derived the majority of our revenues as an integrator from the time we started our operations through the first half of 2003. In December 2002, upon the acquisition of the licensing rights to certain intellectual property and patent pending technology from NetLabs.com, we shifted the focus of our business to developing and marketing our own suite of security products. Based upon the acquired licensing rights and additional research and development, the Company has now developed various identification protection software products to protect computer networks from unauthorized access and to protect network owners and users from identity theft. The Company is seeking to commercially exploit the products in the areas of financial services, e-commerce, corporate, government, insurance and consumer sectors. We have had increasing nominal revenues since our formation. We have maintained our relationship with Panasonic and LG as a reseller, primarily for the resale of biometric identification equipment, such as iris scanners, that can be used with our software products. We generated nominal revenues from our activities as a reseller during 2008 and 2007.
We completed the development of our ProtectID® platform at the end of June 2006 and we completed the core development of our keyboard encryption and anti-keylogger product, GuardedID®, in December 2006, which is currently being sold and distributed. We seek to locate customers in a variety of ways. These include contracts primarily with value added resellers and distributors (both inside the United States and globally), direct sales calls initiated by our internal staff, exhibitions at security and technology trade shows, through the media, consulting agreements and through our own and agent relationships. Our sales generate revenue either as an Original Equipment Manufacturer (OEM) model, through a Hosting/License agreement, bundled with other company’s products or through direct purchase by customers. We price our products for hosted consumer transactions based on the number of transactions in which our software products are utilized. We also price our products for business applications based on the number of users. These pricing models provide the Company with one-time, monthly, quarterly and yearly recurring revenues. We are also generating revenues from annual maintenance contracts, renewal fees and project an increase in revenues based upon the execution of various agreements that we have recently closed and are being implemented.
We generated all of our 2008 and 2007 revenues of $287,035 and $661,580, respectively from the sales of our security products. $485,274 of our 2007 revenues was deemed uncollectible and was charged off in the third and fourth quarters of 2007. We market our products to financial service firms, e-commerce companies, government agencies and the enterprise market in general and with virtual private networks, as well as technology service companies that service all the above markets. We seek such sales through our own direct efforts and primarily through distributors, resellers and third party agents. We are also seeking to license the technology as original equipment with computer hardware and software manufacturers. We are engaged in production installations and pilot projects with various distributors, resellers and direct customers, as well as having reached additional reseller agreements with strategic vendors globally. Our GuardedID® product is also being sold directly to consumers, primarily through the Internet as well as distributors, resellers, third party agents and potential Original Equipment Manufacturer ("OEM") agreements by bundling GuardedID® with their products, which could provide a value-add to their own products and offerings.
We have incurred substantial losses since our inception. We believe that our products provide a cost-effective and technologically competitive solution to address the problems of network security and identity theft in general. There can be no assurance, however, that our products will continue to gain acceptance in the commercial marketplace or that one of our competitors will not introduce technically superior products.
We operate primarily as a software development company, providing security software products and services, to be sold to enterprises, Internet consumer businesses and consumers, both directly and through sales channels comprised of distributors, resellers, agents and OEM relationships, globally. We are focusing primarily on developing sales through “channel” relationships in which our products are offered by other manufacturers, distributors, value-added resellers and agents, globally. We also sell our suite of security products directly from our Edison, NJ office, which also augments our channel partner relationships. It is our strategy that these “channel” relationships will provide the greater percentage of our revenues ongoing. Examples of the channel relationships that we are pursuing include our attempts to establish OEM relationships with other security technology and software providers that would integrate or bundle the enhanced security capabilities of ProtectID® and or GuardedID® into their own product lines. These would include providers of networking software and manufacturers of computer and telecommunications hardware and software that provide managed services, as well as all markets interested in increasing the value of their products and packages, such as financial services software, anti-virus and identity theft product companies.
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Our primary target markets include financial services such as banks, insurance companies and savings institutions, e-commerce based services companies, telecommunications and cellular carriers, technology software companies, government agencies and consumers. For the near term, we are narrowly focusing our concentration on short sales-cycle customers and strategic problem areas, such as where compliance with government regulations are key, stolen passwords used to acquire private information illegally, as well as remote users for medium to large size companies. Because we anticipate growing market demand, we are developing a sizeable global reseller and distribution channel as a strategy to generate, manage and fulfill demand for our products across market segments, minimizing the requirement for an increase in our staff. We intend to minimize the concentration on our initial direct sales efforts in the future as our distribution and reseller channels develop globally.
We intend to generate revenue through fees for ProtectID® and ValidateID®, based on consumer volumes of usage in the e-commerce and financial services markets, one time per person fees in the enterprise markets, set-up and recurring transaction fees when the product is hosted, yearly maintenance fees and other one-time fees. GuardedID® pricing is for an annual license and we discount for volume purchases. GuardedID® pricing models, especially when bundling through OEM contracts, include monthly and quarterly recurring revenues. We also provide our clients a choice of operating our software internally by licensing or through our hosting service. GuardedID® requires a download on each and every computer it protects, whether for employees or consumers.
Use of Estimates
Management's Discussion and Analysis of Financial Condition is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. When preparing our financial statements, we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reporting amounts of revenues and expenses during the reported period. Significant estimates include, but are not limited to, the estimated useful lives of property and equipment and website development costs. Actual results could differ from those estimates.
Results of Operations
FOR THE YEAR ENDED DECEMBER 31, 2008 COMPARED TO THE YEAR ENDED DECEMBER 31, 2007
Revenues for the year ended December 31, 2008 were $287,035 compared to $661,580 for the year ended December 31, 2007, a decrease of $374,545 or 56.6%. The decrease in revenues was primarily due to the amount of a one-time sale of our newly developed GuardedID® keyboard encryption and anti-keylogger technology that occurred in the first quarter of 2007. Of the total sales for the year ended December 31, 2007, $485,274 (of the revenues) were deemed uncollectible and were charged off in the third and fourth quarters of 2007.
Revenues generated consisted of hardware and software sales, services and maintenance sales, revenue from sign on fees and recurring transaction revenues. Hardware sales for the year ended December 31, 2008 were $21,852 compared to $8,333 for the year ended December 31, 2007, an increase of $13,519. The increase in hardware revenues was primarily due to the increase in the Company’s sales of our one-time-password token key-fobs. Software, services and maintenance sales for the year ended December 31, 2008 were $104,450 compared to $535,308 for the year ended December 31, 2007, a decrease of $430,858. The decrease in software, services and maintenance revenues was primarily due to the amount of a one-time sale of our newly developed GuardedID® keyboard encryption and anti-keylogger technology that occurred in the first quarter of 2007 and was subsequently written off. Sign on fees for access to our hosted service provider to utilize our ASP transaction model amounted to $8,250 for the year ended December 31, 2008 compared to $2,000 for the year ended December 31, 2007, an increase of $6,250. The increase was due to the increase in signing up new e-commerce clients. Transaction revenues from the ASP hosting model were $152,483 for the year ended December 31, 2008 and $115,939 for the year ended December 31, 2007, an increase of $36,544. The increase was caused by an increased number of transactions being processed by our clients through the ASP hosting facility.
Cost of revenues for the year ended December 31, 2008 was $120,201 compared to $83,720 for the year ended December 31, 2007, an increase of $36,481, or 43.6%. The increase was primarily due to the processing fees incurred as a result of the increase in transactions relating to our ASP hosting service.
Gross profit for the year ended December 31, 2008 was $166,834 compared to $577,860 for the year ended December 31, 2007, a decrease of $411,026, or 71.1%. The decrease in gross profit was primarily due to the amount of a one-time sale of our newly developed GuardedID® keyboard encryption and anti-keylogger technology that occurred in the first quarter of 2007 and was subsequently written off. Gross profit as a percentage of sales decreased to 58.1% from 87.4% due to the decrease in software sales and the increased number of transactions being processed by our clients through the ASP hosting facility due to the addition of new e-commerce clients which result in a lower profit margin than our other products and services.
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Research and development expenses for the year ended December 31, 2008 were $422,753 compared to $375,030 for the year ended December 31, 2007, an increase of $47,723, or 12.7%. The increase is primarily attributable to the increase in engineering resources relating to the enhancements in Version 2.0 (in production) of our GuardedID® keyboard encryption and anti-keylogger technology and the development of version 3.0 (now in beta for all Windows applications). The salaries, benefits and overhead costs of personnel conducting research and development of our software products comprise research and development expenses.
Selling, general and administrative (“SGA”) expenses for the year ended December 31, 2008 were $1,716,081 compared to $2,772,138 for the year ended December 31, 2007, a decrease of $1,056,057 or 38.1%. The net decrease was due primarily to decreases in our promotional, marketing and professional fees which occurred in the year ended December 31, 2008. Selling, general and administrative expenses consist primarily of salaries, benefits and overhead costs for executive and administrative personnel, insurance, fees for professional services, including consulting, legal, and accounting fees, travel costs, non-cash stock compensation expense for the issuance of stock to non-employees and other general corporate expenses.
Other (income) expense for the year ended December 31, 2008 was ($427,967) as compared to $1,429,094 for the year ended December 31, 2007, representing a decrease in other expense of $1,857,061, or 130%. The decrease was primarily due to the forgiveness of certain debt and to net mark to market changes of ($957,575) in the fair value of derivative financial instruments relating to the convertible secured promissory notes.
Our net loss for the year ended December 31, 2008 was $1,544,033 compared to a net loss of $3,998,402 for the year ended December 31, 2007, a decrease of $2,454,369, or 61.4%. The decrease in our net loss was primarily due to the decrease in SGA expenses, the forgiveness of certain debt and to net mark to market changes in the fair value of derivative financial instruments relating to the convertible secured promissory notes.
Liquidity and Capital Resources
Our total current assets at December 31, 2008 were $489,110, including $43,030 in cash and $80,737 in restricted cash as compared with $382,400 in total current assets at December 31, 2007, which included cash of $16,307 and $0 in restricted cash. Additionally, we had a stockholders’ deficiency in the amount of $6,725,690 at December 31, 2008 as compared to a stockholders’ deficiency of $5,615,718 at December 31, 2007. The increase in the deficiency is a result of the Company’s net losses and funding through an increased debt position from convertible debentures and promissory notes rather than the sale of stock. We have historically incurred recurring losses and have financed our operations through loans, principally from affiliated parties such as our directors, and from the proceeds of debt and equity financing. The liabilities include a computed liability for the fair value of derivatives of $510,689, which will only be realized on the conversion of the derivatives, or settlement of the debentures.
We financed our operations during the year ended December 31, 2008 through debt and equity financing, recurring revenues from our ProtectID® and ValidateID® hosting platforms and sales of our GuardedID® keystroke encryption technology. We expect that we will rely, at least in the near future, on a substantial percentage of the sales of our GuardedID® product and a limited number of customers for our other products revenues and may continue to have customer concentrations. Inherently, as time progresses and corporate exposure in the market grows, we hope to attain greater numbers of customers and the concentrations would then diminish. Until this is accomplished, we will continue to attempt to secure additional financing through both the public and private market sectors to meet our continuing commitments of capital expenditures and until our sales revenue can provide greater liquidity.
The number of common shares outstanding increased from 9,999,999 shares at the year ended December 31, 2007 to 17,121,124 at the year ended December 31, 2008, an increase of 71.2%. The increase in the number of common shares outstanding was primarily due to the shares issued in 2008 related to financing.
We do not expect to resell a significant amount of biometric iris equipment over the next twelve months as we concentrate more on our core authentication and keyboard encryption and anti-keylogger software products
We have historically incurred losses and we anticipate that we will not generate any significant revenues until the second half of 2009. Our operations presently require funding of approximately $110,000 per month. Management believes, but cannot provide assurances, that we will be profitable over the next 12 months based on some potential clients contracting with the Company in the financial industry, technology, insurance, enterprise, government, insurance and consumer sectors in the United States, Latin America, Europe and Asia. There can be no assurance, however, that the sales anticipated will materialize or that we will achieve the profitability we have forecasted.
At December 31, 2008, $427,447 in aggregate principal amount of the YA Global debentures was issued and outstanding.
At December 31, 2008, $244,720 in aggregate principal amount of the Highgate debentures remained outstanding.
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Prior to the maturity date of both convertible secured promissory notes, the Company notified YA Global and Highgate that it is currently evaluating available maturity options regarding the convertible notes. YA Global and Highgate have agreed to extend the maturity date until the options afforded the company have been concluded.
In January 2008, the Company executed a Forbearance Agreement with YA Global whereby YA Global and Highgate have agreed to forbear from exercising their rights under the secured convertible debentures through February 27, 2008. The terms of the Forbearance Agreement record the amount due to YA Global and Highgate by the Company to be $1,214,093, which includes principal, interest and the redemption premium. The terms also include a reduction in the YA Global and Highgate Fixed Conversion Price to $0.065. In connection with this Agreement, the Company issued to YA Global 500,000 contingency warrants with an exercise price of $0.15 per share. The warrants are exercisable for a period of five (5) years from date of issuance. The warrants are held in escrow and will only be released to YA Global if the total amount due by the Company is not paid to YA Global by February 29, 2008. The total amount of our indebtedness to YA Global and Highgate in the amount of $1,214,093, as agreed to in the Forbearance Agreement, is further broken down as:
·
$427,447 (YA Global secured convertible debenture)
·
$204,775 (YA Global accrued and unpaid interest on debenture)
·
$85,489 (YA Global 20% redemption premium)
·
$244,720 (Highgate secured convertible debenture)
·
$86,937 (Highgate accrued and unpaid interest on debentures)
·
$48,944 (Highgate 20% redemption premium)
·
$100,000 (YA Global promissory note dated May 1, 2006)
·
$15,781 (YA Global accrued and unpaid interest on note)
In February 2008, the Forbearance Agreement was amended and extended to May 15, 2008, including the terms of the contingency warrants. Per the terms of the amendment, YA Global and Highgate shall receive an additional 105 days of interest for a total amount of $28,328.84 additional interest. The additional interest plus a security deposit of $171,671.16 were paid to YA Global and Highgate per the terms of a debt assignment agreement executed with an investor group in February 2008, for a total amount paid to YA Global of $200,000. The security deposit will be applied to the amount due YA Global and Highgate if the remaining balance due of $1,042,421.84 is paid in full by May 15, 2008. Otherwise, the security deposit will be applied to YA Global as liquidated damages.
In May 2008, the Company executed a Forbearance Agreement with YA Global that supersedes the January 2008 agreement and February 2008 amendment, whereby YA Global and Highgate have agreed to forbear from exercising their rights under the secured convertible debentures through October 15, 2008. Per the terms of the May 2008 Forbearance Agreement, the Company agreed to use its best efforts to make available sufficient authorized shares of its common stock to effect conversion of the entire amount outstanding, to YA Global and Highgate, by October 15, 2008. The terms of the contingency warrants became applicable to the terms of the May 2008 Forbearance Agreement. Additionally, per the terms of the agreement, the SIG paid $75,000 to YA Global in May 2008 which is further broken down as:
·
$17,268 (additional prepaid interest to YA Global from May 15, 2008 to October 15, 2008)
·
$7,181 (additional prepaid interest to Highgate from May 15, 2008 to October 15, 2008)
·
$27,840 (accrued interest due on the Highgate debenture dated April 26, 2005)
·
$22,711 (non-refundable extension payment that will be applied to the redemption amount if the remaining balance is paid in full by October 15, 2008)
The payment of the accrued interest of $27,840 for the Highgate April 26, 2005 debenture reduced the total amount of our indebtedness to YA Global and Highgate to $1,186,253 as agreed to in the May 2008 Forbearance Agreement.
The Company is in discussions with YA Global regarding an extension to the May 2008 Forbearance Agreement, which was in effect until October 15, 2008. The Company and YA Global are negotiating an extension which would extend and amend the Forbearance Agreement to the end of the second quarter of 2009, but a final agreement has not yet been completed.
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During the year ended December 31, 2008, the Company repaid a total of $90,711 of unsecured convertible notes to eleven unrelated parties. Additionally, during the year ended December 31, 2008, the Company reached settlement agreements and assigned to the SIG a total of $263,777 of unsecured convertible notes with nine unrelated parties.
During the year ended December 31, 2008, the Company repaid a total of $54,937 of unsecured convertible notes to two related parties.
The Company issued unsecured notes during the year ended December 31, 2008 in an aggregate total of $150,000 to one unrelated party and an aggregate total of $1,750,000 to twenty-eight unrelated parties per the term sheet executed with the SIG in January 2008 and amended in May 2008. Upon repayment of the Company’s open secured notes and receipt of a release of indebtedness from YA Global and Highgate, the intellectual property of the Company will be pledged to the twenty-eight unrelated parties in the SIG until such time that the unsecured notes and accrued interest of the SIG are repaid in full. Additionally, during the year ended December 31, 2008, the Company repaid a total of $199,581 of unsecured notes to three unrelated parties. Additionally, during the year ended December 31, 2008, the Company terminated a consulting agreement with a financial advisor thereby canceling and forgiving the unsecured note in the amount of $15,000 issued to the advisor for services to be rendered. Additionally, during the year ended December 31, 2008, the Company reached settlement agreements and assigned to the SIG a total of $16,461 of unsecured notes with two unrelated parties.
The Company issued unsecured notes during the year ended December 31, 2008 in an aggregate total of $100,000 to two related parties. Additionally, during the year ended December 31, 2008, the Company repaid a total of $55,000 of unsecured notes to two related parties.
Summary of Funded Debt
As of December 31, 2008 the Company’s open unsecured promissory note balance was $1,950,208, listed as follows:
·
$100,000 to YA Global (this note by its terms became convertible into shares of common stock as of September 17, 2006 at the lesser of $2.20 per share or 90% of VWAP thirty day average prior to the date of conversion) – current portion
·
$55,208 to an unrelated individual – current portion
·
$45,000 to an unrelated individual – current portion
·
$1,750,000 to twenty unrelated individuals through term sheet with the SIG
As of December 31, 2008 the Company’s open unsecured related party promissory note balances were $696,000, listed as follows:
·
$626,000 to our CEO – current portion
·
$70,000 to our former President, who remains a Director – current portion
As of December 31, 2008 the Company’s open convertible secured note balances were $672,167, listed as follows:
·
$427,447 to YA Global (04/05 amended secured debenture) – current portion
·
$244,720 to Highgate (05/05 secured debenture) – current portion
As of December 31, 2008 the Company’s open convertible note balances were $1,163,177, net of discount on convertible notes of $67,335, listed as follows:
·
$235,000 to an unrelated company (03/05 unsecured debenture) - current portion
·
$7,000 to an unrelated company (06/05 unsecured debenture) – current portion
·
$10,000 to an unrelated individual (06/05 unsecured debenture) - current portion
·
$140,000 to four unrelated individuals (07/05 unsecured debentures) - current portion
·
$65,000 to an unrelated individual (03/06 unsecured debenture) - current portion
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·
$200,000 to an unrelated individual (06/06 unsecured debenture) – current portion
·
$150,000 to an unrelated individual (09/06 unsecured debenture) – current portion
·
$3,512 to one unrelated individual (02/07 unsecured debenture) - current portion
·
$100,000 to an unrelated individual (05/07 unsecured debenture) – current portion
·
$100,000 to an unrelated individual (06/07 unsecured debentures) – current portion
·
$100,000 to an unrelated individual (07/07 unsecured debenture) – current portion
·
$120,000 to four unrelated individuals (08/07 unsecured debentures) – current portion
As of December 31, 2008 the Company’s open convertible note balances - related parties were $419,255, listed as follows:
·
$268,000 to our CEO – current portion
·
$57,500 to our VP of Technical Services – current portion
·
$30,000 to a relative of our CTO & one of our Software Developers – current portion
·
$5,000 to a relative of our CFO – current portion
·
$58,755 to our Office Manager – current portion
Based on present revenues and expenses, we are unable to generate sufficient funds internally to sustain our current operations. We must raise additional capital or other borrowing sources to continue our operations. It is management’s plan to seek additional funding through the sale of common stock and the issuance of notes and debentures, including notes and debentures convertible into common stock. If we issue additional shares of common stock, the value of shares of existing stockholders is likely to be diluted.
However, the terms of the convertible secured debentures issued to certain of the existing stockholders require that we obtain the consent of such stockholders prior to our entering into subsequent financing arrangements. No assurance can be given that we will be able to obtain additional financing, that we will be able to obtain additional financing on terms that are favorable to us or that the holders of the secured debentures will provide their consent to permit us to enter into subsequent financing arrangements.
Our future revenues and profits, if any, will primarily depend upon our ability to secure sales of our suite of network security and anti-malware products. We do not presently generate significant revenue from the sales of our products. Although management believes that our products are competitive for customers seeking a high level of network security, we cannot forecast with any reasonable certainty whether our products will gain acceptance in the marketplace and if so by when.
Except for the limitations imposed upon us respective to the convertible secured debentures of YA Global and Highgate, there are no material or known trends that will restrict either short term or long-term liquidity.
Off-Balance Sheet Arrangements
We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.
Going Concern
We are assuming that we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We have incurred net operating losses of $1,544,033 for the year ended December 31, 2008, compared to a net operating loss of $3,998,402 for the year ended December 31, 2007. At December 31, 2008, the Company's accumulated deficit was $17,920,483, its working capital deficiency was $6,129,385 and approximately 89% of its assets consist of deferred royalties. Additionally, for the year ended December 31, 2008, we had negative cash flows from operating activities of $1,318,579. Since our inception, we have incurred losses, had an accumulated deficit, and have experienced negative cash flows from operations. The expansion and development of our business may require additional capital. These conditions raise substantial doubt about our ability to continue as a going concern.
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We have issued three-year and two-year secured debentures in 2004 and 2005 that are convertible into shares of our common stock to YA Global Investments, LP and Highgate House Funds, Ltd., respectively. Under the terms of the secured debentures, we are restricted in our ability to issue additional securities as long as any portion of the principal or interest on the secured debentures remains outstanding.
Currently, the Company is attempting to generate sufficient revenues and improve gross margins by implementing a revised sales strategy. In principle, the Company is redirecting its sales focus from direct sales to international channel sales, where the Company is primarily selling through a channel of Distributors, Value Added Resellers, Strategic Partners and Original Equipment Manufacturers. The revenues from this approach are more lucrative than selling direct, due to the increase in sales volume of GuardedID® and ProtectID® through the channel partners. This strategy, if successful, should increase the Company’s sales and revenues allowing us to mitigate future losses. In addition, management has raised funds through convertible debt instruments and the sale of equity in order to alleviate the working capital deficiency. Through the utilization of the capital markets, the Company is seeking to locate the additional funding necessary to continue to expand and enhance its growth; however, there can be no assurance that we will be able to increase revenues or raise additional capital. The Company is currently in negotiations with other investors, but the success of such negotiations cannot be assured.
The accompanying consolidated financial statements do not include any adjustments that might be necessary should we be unable to continue as a going concern. If we fail to generate positive cash flows or obtain additional financing when required, we may have to modify, delay or abandon some or all of our business and expansion plans.
Critical Accounting Policies
In accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), we record certain assets at the lower of cost or fair market value. In determining the fair value of certain of our assets, we must make judgments, estimates and assumptions regarding circumstances or trends that could affect the value of theses assets, such as economic conditions. Those judgments, estimates and assumptions are based on information available to us at that time. Many of those conditions, trends and circumstances are outside our control and if changes were to occur in the events, trends or other circumstances on which our judgments or estimates were based, we may be required under U.S. GAAP to adjust those estimates that are affected by those changes. Changes in such estimates may require that we reduce the carrying value of the affected assets on our balance sheet (which are commonly referred to as “write downs” of the assets involved).
It is our practice to establish reserves or allowances to record adjustments or “write-downs” in the carrying value of assets, such as accounts receivable. Such write-downs are recorded as charges to income or increases in the expense in our Statement of Operations in the periods when such reserves or allowances are established or increased. As a result, our judgments, estimates and assumptions about future events can and will affect not only the amounts at which we record such assets on our balance sheet but also our results of operations.
In making our estimates and assumptions, we follow U.S. GAAP applicable to our business and those that we believe will enable us to make fair and consistent estimates of the fair value of assets and establish adequate reserves or allowances. Set forth below is a summary of the accounting policies that we believe are material to an understanding of our financial condition and results of operations.
Discount on Debt
The Company has allocated the proceeds received from convertible debt instruments between the underlying debt instruments and has recorded the conversion feature as a liability in accordance with Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) and related interpretations. The conversion feature and certain other features that are considered embedded derivative instruments, such as a conversion reset provision, a penalty provision and redemption option, have been recorded at their fair value within the terms of SFAS No. 133 as its fair value can be separated from the convertible note and its conversion is independent of the underlying note value. The conversion liability is marked to market each reporting period with the resulting gains or losses shown on the Statement of Operations. The Company has also recorded the resulting discount on debt related to the warrants and conversion feature and is amortizing the discount using the effective interest rate method over the life of the debt instruments.
Derivative Financial Instruments
We do not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.
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The Company evaluates its convertible debt, options, warrants or other contracts to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for under SFAS No. 133 and related interpretations including Emerging Issues Task Force (“EITF”) Issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock” (“EITF Issue No. 00-19”). The result of this accounting treatment is that the fair value of the embedded derivative is marked-to-market each balance sheet date and recorded as a liability. In the event that the fair value is recorded as a liability, the change in fair value is recorded in the Statement of Operations as other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity.
In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument.
The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. Equity instruments that are initially classified as equity that become subject to reclassification under SFAS No. 133 are reclassified to liability at the fair value of the instrument on the reclassification date. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument is expected within 12 months of the balance sheet date.
The fair value model utilized to value the various compound embedded derivatives in the secured convertible notes comprises multiple probability-weighted scenarios under various assumptions reflecting the economics of the secured convertible notes, such as the risk-free interest rate, expected Company stock price and volatility, likelihood of conversion and or redemption, and likelihood of default status and timely registration. At inception, the fair value of the single compound embedded derivative was bifurcated from the host debt contract and recorded as a derivative liability which resulted in a reduction of the initial notional carrying amount of the secured convertible notes (as unamortized discount which will be amortized over the term of the notes under the effective interest method).
The Company accounts for derivatives in accordance with SFAS No. 133 and the related interpretations. SFAS No. 133, as amended, requires companies to recognize all derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of a derivative instrument depends on: (i) whether the derivative has been designated and qualifies as part of a hedging relationship, and (ii) the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument based upon the exposure being hedged as either a fair value hedge, cash flow hedge or hedge of a net investment in a foreign operation.
The derivatives (convertible debentures) issued on December 20, 2004 and January 18, 2005 (amended April 27, 2005) and on April 27, 2005 and May 6, 2005 have been accounted for in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) and the related interpretations. SFAS No. 133, as amended and the Financial Accounting Standards Board Emerging Issues Task Force Issue “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (“EITF No. 00-19”).
The Company has identified the YA Global and Highgate debentures have compound embedded derivatives. These compound embedded derivatives have been bifurcated from their respective host debt contracts and accounted for as derivative liabilities in accordance with EITF 00-19. When multiple derivatives exist within the Convertible Notes, they have been bundled together as a single hybrid compound instrument in accordance with SFAS No. 133 Derivatives Implementation Group Implementation Issue No. B-15, Embedded Derivatives: Separate Accounting for Multiple Derivative Features Embedded in a Single Hybrid Instrument”.
The compound embedded derivatives within the Convertible Notes have been recorded at fair value at the date of issuance; and are marked-to-market each reporting period with changes in fair value recorded to the Company’s Statement of Operations as “Net change in fair value of derivative liabilities”. The Company has utilized a third party valuation consultant to fair value the embedded derivatives using layered discounted probability-weighted cash flow approach. We have developed a financial model to value the compound embedded derivatives analyzing the conversion features, redemption options and penalty provisions. Additionally, our model has been developed to incorporate management’s assessment of the various potential outcomes relating to the specific features and provisions contained in the convertible debt instruments.
The six primary events that can occur which will affect the value of the compound embedded derivatives are (a) payments made in cash, (b) payments made with stock, (c) the holder converts the note(s), (d) the company redeems the note(s), (e) the company fails to register the common shares related to the convertible debt and (f) the company defaults on the note (s).
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The primary factors driving the economic value of the embedded derivatives are the same as the Black-Scholes factors, except that they are incorporated intrinsically into the binomial calculations for this purpose. Those factors are stock price, stock volatility, trading volume, outstanding shares issued, beneficial shares owned by the holder, interest rate, whether or not a timely registration has been obtained, change in control, event of default, and the likelihood of obtaining alternative financing. We assigned probabilities to each of these potential scenarios over the initial term, and at each quarter, the remaining term of the underlying financial instrument. The financial model generates a quarterly cash flow over the remaining life of the underlying debentures and assigns a risk-weighted probability to the resultant cash flow. We then assigned a discounted weighted average cash flow over the potential scenarios which were compared to the discounted cash flow of the debentures without the subject embedded derivatives. The result is a value for the compound embedded derivatives at the point of issue and at subsequent quarters.
The fair value of the derivative liabilities are subject to the changes in the trading value of the Company’s common stock, as well as other factors. As a result, the Company’s financial statements may fluctuate from quarter-to-quarter based on factors, such as the price of the Company’s stock at the balance sheet date and the amount of shares converted by YA Global and Highgate. Consequently, our financial position and results of operations may vary from quarter-to-quarter based on conditions other than our operating revenues and expenses.
Software Development Costs
Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed” (“SFAS No. 86”) requires capitalization of software development costs incurred subsequent to establishment of technological feasibility and prior to the availability of the product for general release to customers. Systematic amortization of capitalized costs begins when a product is available for general release to customers and is computed on a product-by-product basis at a rate not less than straight-line basis over the product’s remaining estimated economic life. To date, all costs have been accounted for as research and development costs and no software development cost has been capitalized.
Management will evaluate the net realizable value of software costs capitalized by comparing estimated future gross revenues reduced by the estimated future costs of completing, disposing of and maintaining the software. These costs also include the costs of performing maintenance and customer support required by us.
Revenue Recognition
The Company’s revenues are derived principally from the sale and installation of its various identification protection software products and related hardware and services. The Company recognizes revenue when it is realized or realizable and earned less estimated future returns. The Company considers revenue realized or realizable and earned when it has persuasive evidence of an arrangement that the product has been shipped or the services have been rendered to the customer, the sales price is fixed or determinable, and collectability is reasonably assured. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue:
We recognize revenue from the sales of software licenses when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed and determinable and collection of the resulting receivable is reasonably assured. Delivery generally occurs when the product is delivered to a common carrier.
We assess collection based on a number of factors, including past transaction history with the customer and the creditworthiness of the customer. We do not request collateral from our customers. If we determine that collection of a fee is not reasonably assured, we defer the fee and recognize revenue at the time collection becomes reasonably assured, which is generally upon the receipt of cash.
For technology arrangements with multiple obligations (for example, undelivered software, maintenance and support), we allocate revenue to each component of the arrangement using the residual value method based on the fair value or the fixed agreement of the undelivered elements. Accordingly, we defer technology revenue in the amount equivalent to the fair value or the fixed agreement of the undelivered elements.
We recognize revenue for maintenance services ratably over the contract term. Our training and consulting services are billed at hourly rates and we generally recognize revenue as these services are performed. However, upon execution of a contract, we determine whether any services included within the arrangement require us to perform significant work either to alter the underlying software or to build additional complex interfaces so that the software performs as the customer requests. If these services are included as part of an arrangement, we recognize the fee using the percentage of completion method. We determine the percentage of completion based on our estimate of costs incurred to date compared with the total costs budgeted to complete the project.
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Impairment of Long-lived Assets
Long-lived assets, which include property and equipment, deferred royalties, website development cost and patents are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable or the useful life is shorter than originally estimated.
The Company assesses the recoverability of its assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. If assets are determined to be recoverable, but the useful lives are shorter than originally estimated, the net book value of the assets is depreciated over the newly determined remaining useful lives.
Stock Based Transactions
We have concluded various transactions where we paid the consideration in shares of our common stock and/or warrants or options to purchase shares of our common stock. These transactions include:
·
Acquiring the services of various professionals who provided us with a range of corporate consultancy services, including developing business and financial models, financial advisory services, strategic planning, development of business plans, investor presentations and advice and assistance with investment funding;
·
Retaining the services of our Advisory Board to promote the business of the Company;
·
Settlement of our indebtedness; and
·
Providing incentives to attract, retain and motivate employees who are important to our success.
When our stock is used, the transactions are valued using the price of the shares on the date they are issued or if the value of the asset or service being acquired is available and is believed to fairly represent its market value, the transaction is valued using the value of the asset or service being provided.
When options or warrants to purchase our stock are used in transactions with third parties or our employees, the transaction is valued using the Black-Scholes valuation method. The Black-Scholes valuation method is widely used and accepted as providing the fair market value of an option or warrant to purchase stock at a fixed price for a specified period of time. Black-Scholes uses five (5) variables to establish market value of stock options or warrants:
·
strike price (the price to be paid for a share of our stock);
·
price of our stock on the day options or warrants are granted;
·
number of days that the options or warrants can be exercised before they expire;
·
trading volatility of our stock; and
·
annual interest rate on the day the option or warrant is granted.
The determination of expected volatility requires management to make an estimate and the actual volatility may vary significantly from that estimate. Accordingly, the determination of the resulting expense is based on a management estimate.
Recent Accounting Pronouncements
On June 5, 2003, the United States Securities and Exchange Commission (“SEC”) adopted final rules under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), as amended by SEC Release No. 33-8934 on June 26, 2008. Commencing with its annual report for the fiscal year ending December 31, 2009, the Company will be required to include a report of management on its internal control over financial reporting. The internal control report must include a statement:
·
Of management’s responsibility for establishing and maintaining adequate internal control over its financial reporting;
·
Of management’s assessment of the effectiveness of its internal control over financial reporting as of year end; and
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·
Of the framework used by management to evaluate the effectiveness of the Company’s internal control over financial reporting.
Furthermore, in the following fiscal year, it is required to file the auditor’s attestation report separately on the Company’s internal control over financial reporting on whether it believes that the Company has maintained, in all material respects, effective internal control over financial reporting.
In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007) “Business Combinations” (“SFAS No. 141(R)”), which requires the Company to record fair value estimates of contingent consideration and certain other potential liabilities during the original purchase price allocation, expense acquisition costs as incurred and does not permit certain restructuring activities previously allowed under Emerging Issues Task Force Issue No. 95-3 to be recorded as a component of purchase accounting. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. The Company has not determined the effect that the adoption of SFAS No. 141(R) will have on the financial results of the Company.
In December 2007, the FASB issued FASB Statement No. 160 “Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51” (“SFAS No. 160”), which causes noncontrolling interests in subsidiaries to be included in the equity section of the balance sheet. SFAS No. 160 applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. The Company has not determined the effect that the adoption of SFAS No. 160 will have on the financial results of the Company.
In March 2008, the FASB issued FASB Statement No. 161 “Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133” (“SFAS No. 161”), which changes the disclosure requirements for derivative instruments and hedging activities. Pursuant to SFAS No.161, Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 with early application encouraged. SFAS No. 161 encourages but does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In years after initial adoption, this Statement requires comparative disclosures only for periods subsequent to initial adoption. The Company does not expect the adoption of SFAS No. 161 to have a material impact on the financial results of the Company.
Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not hold any derivative instruments and do not engage in any hedging activities
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Please see pages F-1 through F-30.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On October 3, 2006, we engaged Most & Company, LLP as our independent certified public accounting firm.
On January 9, 2007, we dismissed our independent registered public accounting firm, Most & Company, LLP (“Mostco”). Mostco has performed no audit services for the Company, but has performed the review of Form 10-QSB for the interim period ended September 30, 2006. The decision to change independent registered public accounting firms was approved by the members of our Board of Directors.
On January 9, 2007, we engaged Li & Company, PC as our independent certified public accounting firm.
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ITEM 9A. CONTROLS AND PROCEDURES
Our management team, under the supervision and with the participation of our principal executive officer and our principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (Exchange Act), as of the last day of the fiscal period covered by this report, December 31, 2008. The term disclosure controls and procedures means our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our principal executive and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2008.
Our principal executive officer and our principal financial officer, are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Management is required to base its assessment of the effectiveness of our internal control over financial reporting on a suitable, recognized control framework, such as the framework developed by the Committee of Sponsoring Organizations (COSO). The COSO framework, published in Internal Control-Integrated Framework, is known as the COSO Report. Our principal executive officer and our principal financial officer, have has chosen the COSO framework on which to base its assessment. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.
This annual report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report on Form 10-K.
There were no changes in our internal control over financial reporting that occurred during the last quarter of 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Our principal executive officer and our principal financial officer, report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
It should be noted that any system of controls, however well designed and operated, can provide only reasonable and not absolute assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of certain events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Changes in Internal Control Over Financial Reporting
During the fiscal year ended December 31, 2008, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
LACK OF INDEPENDENT BOARD OF DIRECTORS AND AUDIT COMMITTEE
Management is aware that an audit committee composed of the requisite number of independent members along with a qualified financial expert has not yet been established. Considering the costs associated with procuring and providing the infrastructure to support an independent audit committee and the limited number of transactions, Management has concluded that the risks associated with the lack of an independent audit committee are not justified. Management will periodically reevaluate this situation.
LACK OF SEGREGATION OF DUTIES
Management is aware that there is a lack of segregation of duties at the Company due to the small number of employees dealing with general administrative and financial matters. However, at this time management has decided that considering the abilities of the employees now involved and the control procedures in place, the risks associated with such lack of segregation are low and the potential benefits of adding employees to clearly segregate duties do not justify the substantial expenses associated with such increases. Management will periodically reevaluate this situation
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ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
DIRECTORS AND EXECUTIVE OFFICERS.
The following sets forth the executive officers and/or Directors of the Company, their ages, and all offices and positions with the Company.
Name | Age | Position |
Mark L. Kay | 60 | Chief Executive Officer and Chairman of the Board of Directors |
Mark Corrao | 51 | Chief Financial Officer and Director |
Ramarao Pemmaraju | 48 | Chief Technical Officer and Director |
Robert Denn | 51 | Director |
George Waller | 51 | Executive Vice President and Head of Marketing and Director |
All of our directors serve until their successors are elected and qualified by our shareholders, or until their earlier death, retirement, resignation or removal. Officers are appointed by the Board of Directors and their terms of office are, except to the extent governed by the YA Global Investments, LP and Highgate House Funds, Ltd. agreements, at the direction of the Board of Directors. The following is a brief description of the business experience of our executive officers who are also the Directors and significant employees:
Mark L. Kay, Chief Executive Officer and Chairman of the Board of Directors
Mr. Mark Kay joined StrikeForce as our CEO in May 2003 following his retirement at JPMorganChase & Co. In December 2008, a majority of the Board of Directors, by written consent, eliminated the position of President of the Company, with those responsibilities being assumed by Mr. Kay. A majority of the Board of Directors also appointed Mr. Kay as the Chairman of the Board in December 2008. Prior to joining StrikeForce Mr. Kay was employed by JPMorganChase & Co. from August of 1977 until his retirement in December 2002, at which time he was a Managing Director of the firm. During his tenure with JPMorganChase & Co. Mr. Kay led strategic and corporate business groups with global teams up to approximately 1,000 people. His responsibilities also included Chief Operations Officer, Chief Information Officer, and Global Technology Auditor. Mr. Kay’s business concentrations were in securities (fixed income and equities), proprietary trading and treasury, global custody services, audit, cash management, corporate business services and web services. Prior to his employment with JPMorganChase & Co., Mr. Kay was a systems engineer at Electronic Data Services (EDS) for approximately five years from September 1972 through to August 1977. He holds a B.A. in Mathematics from CUNY.
Mark Corrao, Chief Financial Officer
Mr. Corrao is one of our original founders in August 2001. Mr. Corrao brings to StrikeForce Technologies over twenty-five years of experience in the financial and accounting areas. Mr. Corrao has spent numerous years in the public accounting arena specializing in certified auditing, SEC accounting, corporate taxation and financial planning. His tenure in accounting included being a partner in a Connecticut CPA firm for several years. Mr. Corrao’s background also includes numerous years on Wall Street with such prestigious firms as Merrill Lynch, Spear Leeds & Kellogg and Greenfield Arbitrage Partners. While on Wall Street Mr. Corrao was involved in several IPO’s and has been a guiding influence in several start up companies. Prior to joining StrikeForce, he was the Director of Sales at Applied Digital Solutions from December 2000 through December 2001. Mr. Corrao was the Vice President of Sales at Advanced Communications Sciences from March 1997 though December 2000. Mark has a B.S. from CUNY.
34
Robert Denn, Director
Mr. Robert Denn joined StrikeForce in July 2002 as a consultant assisting us with a private placement. He joined us as President in December 2002. In December 2008, the Board of Directors eliminated the position of President. As a result, Robert Denn is no longer an officer or employee of the Company, but he remains on the Board of Directors. In December 2008, a majority of the Board of Directors, by written consent, eliminated the position of President of the Company, which was held by Mr. Denn, with those responsibilities being assumed by Mark L. Kay, the Chief Executive Officer of the Company. Also in December 2008, a majority of the Board of Directors also appointed Mark L. Kay as the Chairman of the Board to replace Mr. Denn in that capacity. A former registered representative of Essex Securities, Mr. Denn was a co-founder of Netlabs.com, Inc., a company formed to develop security software products, in May 1999. In February 2001, Mr. Denn left the retail securities industry and joined NetLabs.com as its President. The intellectual property asset rights of Netlabs.com were subsequently acquired by StrikeForce in December 2002. In addition, Mr. Denn has over twenty years of sales and management experience in the financial services industry inclusive of such prestigious firms as Citibank, Fleet and Bank of New York. Mr. Denn has a B.A. in Business Administration from William Paterson University.
Ramarao Pemmaraju, Chief Technology Officer
Mr. Ramarao Pemmaraju Joined StrikeForce in July 2002 as our Chief Technology Officer (CTO) and the inventor of the ProtectID® product. In May 1999 Mr. Pemmaraju co-founded Netlabs.com, which developed security software products. Mr. Pemmaraju concentrated his time on Netlabs from July 2001 through to July 2002. From June 2000 to July 2001 Mr. Pemmaraju was a systems architect and project leader for Coreon, an operations service provider in telecommunications. From October 1998 through May 2000, Mr. Pemmaraju was a systems engineer with Nexgen systems, an engineering consulting firm. Mr. Pemmaraju has over eighteen years experience in systems engineering and telecommunications. His specific expertise is in systems architecture, design and product development. Mr. Pemmaraju holds a M.S.E.E. from Rutgers University and a B.E. from Stevens Tech.
George Waller, Executive Vice President and Head of Marketing
Mr. Waller joined StrikeForce in June 2002 as a Vice President in charge of sales and marketing. In July 2002, Mr. Waller became the CEO of StrikeForce, a position he held until Mr. Kay joined us in May 2003. Since May 2003, Mr. Waller has been the Executive Vice President overseeing Sales, Marketing, Business Development and product development. From 2000 through June 2002, Mr. Waller was Vice President of business development for Infopro, an outsourcing software development firm. From 1999 to 2001, Mr. Waller was Vice President of sales and Marketing for Teachmeit.com-Incubation systems, Inc., a multifaceted computer company and sister company to Infopro. From 1997 through 1999, Mr. Waller was the Vice President of Internet Marketing for RX Remedy, an aggregator of medical content for online services. Previously, Mr. Waller was a Vice President of Connexus Corporation, a software integrator.
Family Relationships
There are no family relationships between any two or more of our directors or executive officers. There is no arrangement or understanding between any of our directors or executive officers and any other person pursuant to which any director or officer was or is to be selected as a director or officer, and there is no arrangement, plan or understanding as to whether non-management shareholders will exercise their voting rights to continue to elect the current board of directors. There are also no arrangements, agreements or understandings to our knowledge between non-management shareholders that may directly or indirectly participate in or influence the management of our affairs.
Involvement in Certain Legal Proceedings
To the best of our knowledge, during the past five years, none of the following occurred with respect to a present or former director or executive officer of our Company: (1) any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time; (2) any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); (3) being subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of any competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; and (4) being found by a court of competent jurisdiction (in a civil action), the SEC or the commodities futures trading commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
Board of Directors
Our By-laws provide that there must be no less than one and no more than seven directors, as determined by the Board of Directors. Our Board of Directors currently consists of five directors.
35
Directors need not be stockholders of the Company or residents of the State of New Jersey. Directors are elected for an annual term and generally hold office until the next Directors have been duly elected and qualified. A vacancy on the Board may be filled by the remaining Directors even though less than a quorum remains. A Director appointed to fill a vacancy remains a Director until his successor is elected by the Stockholders at the next annual meeting of Shareholder or until a special meeting is called to elect Directors.
The executive officers of the Company are appointed by the Board of Directors.
During fiscal 2008, our Board of Directors met seven times. The Board of Directors also uses resolutions in writing to deal with certain matters and, during fiscal 2008, eleven written resolutions were signed by a majority of the Directors.
The Company encourages all Directors to attend the Annual Meeting of stockholders, either in person or by telephone. The Company’s Annual Meeting of Stockholders was held in August 2008.
Compensation of Directors
Our bylaws provide that, unless otherwise restricted by our certificate of incorporation, our Board of Directors has the authority to fix the compensation of directors. The directors may be paid their expenses, if any, related to attendance at each meeting of the board of directors and may be paid a fixed sum for attendance at each meeting of the board of directors or a stated salary as our director. Our bylaws further provide that no such payment will preclude any director from serving our company in any other capacity and receiving compensation therefore. Further, members of special or standing committees may be given compensation for attending committee meetings.
Committees
StrikeForce has two committees: the Audit Committee and the Compensation Committee. At this time, there are no members of either Committee and the Board of Directors performs the acts of the Committees. None of our current directors are deemed “independent” directors as that term is used by the national stock exchanges or have the requisite public company accounting background or expertise to be considered an “audit committee financial expert” as that term is defined under regulation S-B promulgated under the Securities Act of 1933, as amended.
It is anticipated that the principal functions of the Audit Committee will be to recommend the annual appointment of StrikeForce’s auditors, the scope of the audit and the results of their examination, to review and approve any material accounting policy changes affecting StrikeForce’s operating results and to review StrikeForce’s internal control procedures.
It is anticipated that the Compensation Committee will develop a Company-wide program covering all employees and that the goals of such program will be to attract, maintain, and motivate our employees. It is further anticipated that one of the aspects of the program will be to link an employee’s compensation to his or her performance, and that the grant of stock options or other awards related to the price of the common shares will be used in order to make an employee’s compensation consistent with shareholders’ gains. It is expected that salaries will be set competitively relative to the technology development industry and that individual experience and performance will be considered in setting salaries.
At present, executive and director compensation matters are determined by a majority vote of the board of directors.
We do not have a nominating committee. Historically our entire Board has selected nominees for election as directors. The Board believes this process has worked well thus far particularly since it has been the Board's practice to require unanimity of Board members with respect to the selection of director nominees. In determining whether to elect a director or to nominate any person for election by our stockholders, the Board assesses the appropriate size of the Board of Directors, consistent with our bylaws, and whether any vacancies on the Board are expected due to retirement or otherwise. If vacancies are anticipated, or otherwise arise, the Board will consider various potential candidates to fill each vacancy. Candidates may come to the attention of the Board through a variety of sources, including from current members of the Board, stockholders, or other persons. The Board of Directors has not yet had the occasion to, but will, consider properly submitted proposed nominations by stockholders who are not directors, officers, or employees of the Company on the same basis as candidates proposed by any other person.
Section 16(a) Beneficial Ownership Reporting Compliance
The Company does not have any class of equity securities registered pursuant to Section 12 of the Exchange Act. Therefore, our executive officers, directors and 10% beneficial owners are not required to file initial reports of ownership and reports of changes in ownership pursuant to Section 16(a) of the Exchange Act.
36
Code of Ethics.
The Company has adopted a code of ethics that applies to the Company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The Company’s code of ethics contains standards that are reasonably designed to deter wrongdoing and to promote:
·
Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
·
Full, fair, accurate, timely, and understandable disclosure in reports and documents that the Company files with, or submits to, the Commission and in other public communications made by the company;
·
Compliance with applicable governmental laws, rules and regulations;
·
The prompt internal reporting of violations of the code to the board of directors or another appropriate person or persons; and
·
Accountability for adherence to the code.
Indemnification of Officers and Directors
As permitted by New Jersey law, our Articles of Incorporation provide that we will indemnify its directors and officers against expenses and liabilities they incur to defend, settle, or satisfy any civil or criminal action brought against them on account of their being or having been Company directors or officers unless, in any such action, they are adjudged to have acted with gross negligence or willful misconduct.
Pursuant to the foregoing provisions, we have been informed that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in that Act and is, therefore, unenforceable.
Stockholder Communications with the Board
Stockholders who wish to communicate with the Board of Directors should send their communications to the Chairman of the Board at the address listed below. The Chairman of the Board is responsible for forwarding communications to the appropriate Board members.
StrikeForce Technologies, Inc.
1090 King George’s Post Road
Suite #108
Edison, NJ 08837
Attn: Mark L. Kay, Chairman
ITEM 11. EXECUTIVE COMPENSATION.
Summary Compensation Table
The following table sets forth certain compensation information for: (i) the person who served as the Chief Executive Officer of StrikeForce during the year ended December 31, 2008, regardless of the compensation level, and (ii) each of our other executive officers, serving as an executive officer at any time during 2008. The foregoing persons are collectively referred to in this Form 10-K as the “Named Executive Officers.” Compensation information is shown for the year ended December 31, 2008:
37
Name/ Principal Position |
| Year |
|
|
|
|
| Stock |
| Incentive Plan Option |
| Securities Underlying |
| Nonqualified Deferred Compensation |
| All Other |
|
| ||||||||||||||||||||
Salary | Bonus | Awards | Awards | Options/SARs | Earnings | Compensation | Total | |||||||||||||||||||||||||||||||
($) | ($) | ($) | ($) | ($) | ($) | ($) | ($) | |||||||||||||||||||||||||||||||
Mark L. Kay |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Chief Executive Officer |
| 2008 |
| 15,077 |
| — |
| — |
| (397,538) | 1 | — |
| 82,923 | 2 | — |
| (299,538) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Robert Denn |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Former President |
| 2008 |
| 15,077 |
| — |
| — |
| (49,348) | 1 | — |
| 82,923 | 2 | — |
| 48,652 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Mark Corrao |
| 2008 |
| 15,077 |
| — |
| — |
| (49,348) | 1 | — |
| 82,923 | 2 | — |
| 48,652 | ||||||||||||||||||||
Chief Financial Officer |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
George Waller |
| 2008 |
| 15,077 |
| — |
| — |
| (51,287) | 1 | — |
| 82,923 | 2 | — |
| 46,713 | ||||||||||||||||||||
Executive Vice President |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Ramarao Pemmaraju |
| 2008 |
| 15,077 |
| — |
| — |
| (49,348) | 1 | — |
| 82,923 | 2 | — |
| 48,652 | ||||||||||||||||||||
Chief Technical Officer |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
There are no employment agreements between StrikeForce and any executive officer or director.
(1)
Fair value of Incentive Plan options cancelled by executive officers and the Company in 2008.
(2)
Nonqualified deferred compensation earnings to executive officers have been accrued for 2008 as a result of missed salaries due to cash flow constraints.
Outstanding Option Awards at Year End
The following table provides certain information regarding unexercised options to purchase common stock, stock options that have not vested, and equity-incentive plan awards outstanding at December 31, 2008, for each Named Executive Officer and/or Director.
38
Outstanding Equity Awards At Fiscal Year-End Table |
| |||||||||||||||||||||||||||||
|
| Option Awards |
| Stock Awards |
| |||||||||||||||||||||||||
Name |
| Number of Securities Underlying Unexercised Options (#) Exercisable |
| Number of Securities Underlying Unexercised Options (#) Unexercisable |
| Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) |
| Option Exercise Price ($) |
| Option Expiration Date |
| Number of Shares or Units of Stock That Have Not Vested (#) |
| Market Value of Shares or Units of Stock That Have Not Vested ($) |
| Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested (#) |
| Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested ($) |
| |||||||||||
Mark L. Kay |
|
| 9,231 15,705 |
|
| - - |
|
| - - |
| $ $ | 0.375 0.240 |
|
| 03/02/17 03/16/17 |
|
| - - |
|
| - - |
|
| - - |
|
| - - |
| ||
|
|
| 16,388 |
|
| - |
|
| - |
| $ | 0.230 |
|
| 04/27/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 16,346 |
|
| - |
|
| - |
| $ | 0.200 |
|
| 05/25/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 25,128 |
|
| - |
|
| - |
| $ | 0.150 |
|
| 06/08/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 18,643 |
|
| - |
|
| - |
| $ | 0.170 |
|
| 06/22/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 47,115 |
|
| - |
|
| - |
| $ | 0.080 |
|
| 11/23/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 18,056 |
|
| 6,944 |
|
| - |
| $ | 0.200 |
|
| 12/12/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
Robert Denn |
|
| 16,346 25,128 |
|
| - - |
|
| - - |
| $ $ | 0.200 0.150 |
|
| 05/25/17 06/08/17 |
|
| - - |
|
| - - |
|
| - - |
|
| - - |
| ||
|
|
| 18,643 |
|
| - |
|
| - |
| $ | 0.170 |
|
| 06/22/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 47,115 |
|
| - |
|
| - |
| $ | 0.080 |
|
| 11/23/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 18,056 |
|
| 6,944 |
|
| - |
| $ | 0.200 |
|
| 12/12/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
Mark Corrao |
|
| 16,346 25,128 |
|
| - - |
|
| - - |
| $ $ | 0.200 0.150 |
|
| 05/25/17 06/08/17 |
|
| - - |
|
| - - |
|
| - - |
|
| - - |
| ||
|
|
| 18,643 |
|
| - |
|
| - |
| $ | 0.170 |
|
| 06/22/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 47,115 |
|
| - |
|
| - |
| $ | 0.080 |
|
| 11/23/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 18,056 |
|
| 6,944 |
|
| - |
| $ | 0.200 |
|
| 12/12/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
George Waller |
|
| 25,128 18,643 |
|
| - - |
|
| - - |
| $ $ | 0.150 0.170 |
|
| 06/08/17 06/22/17 |
|
| - - |
|
| - - |
|
| - - |
|
| - - | |||
|
|
| 47,115 |
|
| - |
|
| - |
| $ | 0.080 |
|
| 11/23/17 |
|
| - |
|
| - |
|
| - |
|
| - | |||
|
|
| 18,056 |
|
| 6,944 |
|
| - |
| $ | 0.200 |
|
| 12/12/17 |
|
| - |
|
| - |
|
| - |
|
| - | |||
Ramarao Pemmaraju |
|
| 16,346 25,128 |
|
| - - |
|
| - - |
| $ $ | 0.200 0.150 |
|
| 05/25/17 06/08/17 |
|
| - - |
|
| - - |
|
| - - |
|
| - - |
| ||
|
|
| 18,643 |
|
| - |
|
| - |
| $ | 0.170 |
|
| 06/22/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 47,115 |
|
| - |
|
| - |
| $ | 0.080 |
|
| 11/23/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
|
|
| 18,056 |
|
| 6,944 |
|
| - |
| $ | 0.200 |
|
| 12/12/17 |
|
| - |
|
| - |
|
| - |
|
| - |
| ||
Option Exercises And Stock Vested Table
None.
Pension Benefits Table
None.
39
Nonqualified Deferred Compensation Table
Name
| Executive Contributions in Last Fiscal Year ($)
| Registrant Contributions in Last Fiscal Year ($)
| Aggregate Earnings in Last Fiscal Year ($)
| Aggregate Withdrawals / Distributions ($)
| Aggregate Balance at Last Fiscal Year-End ($)
|
|
|
|
|
|
|
Mark L. Kay | - | - | 82,923 | - | 48,385 |
|
|
|
|
|
|
Robert Denn | - | - | 82,923 | - | 48,385 |
|
|
|
|
|
|
Mark Corrao | - | - | 82,923 | - | 48,385 |
|
|
|
|
|
|
George Waller | - | - | 82,923 | - | 45,231 |
|
|
|
|
|
|
Ramarao Pemmaraju | - | - | 82,923 | - | 48,385 |
All Other Compensation Table
None.
Perquisites Table
None.
Director Compensation
All of our directors were also executive officers of the Company through December 2008. In December 2008, the Board of Directors eliminated the position of President. As a result, the Company President is no longer an officer or employee of the Company, but he remains on the Board of Directors. Because he was an executive officer through December 2008, his compensation data is included above in the Executive Officer’s Summary Compensation Table. Our directors did not receive any separate compensation for serving as such during fiscal 2008.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Share Ownership of Certain Beneficial Owners
The following table sets forth certain information as of December 31, 2008, with respect to the shares of common stock beneficially owned by: (i) each director; (ii) each executive officer; (iii) all current executive officers (regardless of salary and bonus level) and directors as a group; and (iv) each person known by us to beneficially own more than 5% of our outstanding common stock. The address for each shareholder is 1090 King Georges Post Road, Suite 108, Edison, New Jersey 08837, with the exception of James R. Solakian whose address is 152 Mockingbird Court, Three Bridges, NJ 08887. Unless otherwise indicated, the shareholders listed in the table below have sole voting and investment powers with respect to the shares indicated:
This table is based upon information obtained from our stock records.
NAME OF BENEFICIAL OWNER | AMOUNT OF OWNERSHIP(1) | PERCENTAGE OF CLASS(2) |
|
|
|
Mark L. Kay | 304,159 (3) | 1.75% |
Mark Corrao | 256,109 (4) | 1.48% |
Robert Denn | 453,336 (5),(7) | 2.63% |
Ramarao Pemmaraju | 539,103 (6),(7) | 3.11% |
George Waller | 221,297 (8),(9) | 1.28% |
All directors and executive officers as a group (5 persons) | 1,774,004 (10) | 9.90% |
NetLabs.com, Inc. | 874,000 (11),(12) | 4.89% |
James R. Solakian | 2,660,500 (13) | 15.39% |
40
(1)
A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from the date hereof.
(2)
Based on 17,121,124 shares of common stock outstanding as of December 31, 2008; also including 30,900 shares of common stock available to beneficial owners upon the conversion of certain convertible loans, 1,495,319 shares of common stock underlying options and 200,120 shares of common stock underlying warrants.
(3)
Includes 27,733 shares of common stock available upon the conversion of certain convertible loans valued at $10.00 per share for $240,000 of convertibles and $7.50 per share for $28,000 of convertibles, 166,612 shares of common stock underlying vested ten-year options valued from $0.08 to $0.375 per share and 33,980 shares of common stock underlying warrants, consisting of 5,180 ten-year warrants exercisable at $10.00, 20,000 five-year warrants exercisable at $1.20, 8,800 five-year warrants exercisable at $0.50.
(4)
Includes 125,288 shares of common stock underlying vested ten-year options valued from $0.08 to $0.20 per share.
(5)
Includes 125,288 shares of common stock underlying vested ten-year options valued from $0.08 to $0.20 per share and 840 shares of common stock underlying ten-year warrants exercisable at $10.00.
(6)
Includes 3,167 shares of common stock available upon the conversion of certain convertible loans valued at $10.00 per share for $25,000 of convertibles and $7.50 per share for $5,000 of convertibles, 209,189 shares of common stock underlying vested ten-year options valued from $0.08 to $0.20 per share and 300 shares of common stock underlying ten-year warrants exercisable at $10.00. Of the total shares, 87,368 shares, consisting of 3,167 shares of common stock available upon the conversion of certain convertible loans valued at $10.00 per share for $25,000 of convertibles and $7.50 per share for $5,000 of convertibles, 83,901 shares of common stock underlying vested ten-year options valued from $0.08 to $0.20 per share and 300 shares of common stock underlying ten-year warrants exercisable at $10.00, are in the name of Sunita Pemmaraju who is a family member of Ramarao Pemmaraju.
(7)
Excludes shares owned by NetLabs.com, Inc. which is controlled by Robert Denn and Ramarao Pemmaraju.
(8)
Shares are listed in the name of Katherine LaRosa who is a family member of George Waller.
(9)
Includes 108,942 shares of common stock underlying vested ten-year options valued from $0.08 to $0.20 per share.
(10)
Includes 30,900 shares of common stock available upon the conversion of certain convertible loans valued at $10.00 per share for $265,000 of convertibles and $7.50 per share for $33,000 of convertibles, 735,319 shares of common stock underlying vested ten-year options valued from $0.08 to $0.375 per share and 35,120 shares of common stock underlying warrants, consisting of 6,320 ten-year warrants exercisable at $10.00, 20,000 five-year warrants exercisable at $1.20, 8,800 five-year warrants exercisable at $0.50.
(11)
Robert Denn and Ramarao Pemmaraju control NetLabs.com, Inc.
(12)
Includes 760,000 shares of common stock underlying vested ten-year options valued at $3.60 per share.
(13)
Includes 165,000 shares of common stock underlying warrants, consisting of 15,000 five-year warrants exercisable at $0.25 and 150,000 five-year warrants exercisable at $0.40.
DESCRIPTION OF SECURITIES
Equity Incentive Plan Information
The following table sets forth as of December 31, 2008, the total number of shares of our common stock which may be issued upon the exercise of outstanding stock options and other rights under compensation plans approved by the shareholders, and under compensation plans not approved by the shareholders. The table also sets forth the weighted average purchase price per share of the shares subject to those options, and the number of shares available for future issuance under those plans.
41
Plan Category |
| Number of securities to be issued upon exercise of outstanding options |
| Weighted-average exercise price of outstanding options |
| Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||
Equity compensation plans approved by security holders |
|
| 1,427,297 |
| $ | 0.448 |
|
| 98,572,703 |
Equity compensation plans not approved by security holders |
|
| N/A |
| $ | N/A |
|
| N/A |
Total |
|
| 1,427,297 |
| $ | 0.448 |
|
| 98,572,703 |
Options for 1,427,297 shares have been granted under StrikeForce’s 2004 Equity Incentive Plan which was approved by unanimous consent of the Board of Directors. The option shares were granted at various times from May 2003 through December 2007 and are exercisable at a range of $0.08 to $10.00 per share. In August 2008, the Company repurchased, at no cost, employee stock options totaling 1,111,791 shares of common stock from twelve employees as a result of a voluntary tender by the employees. The exercise price of the cancelled options ranged from $0.15 per share to $10.00 per share.
General
Our authorized capital stock consists of 100,000,000 shares of common stock, par value $0.0001, and 10,000,000 shares of preferred A stock, $0.10 par value (none of which are issued and outstanding).
Common Stock
The shares of our common stock presently outstanding, and any shares of our common stock issues upon exercise of stock options and/or warrants, will be fully paid and non-assessable. Each holder of common stock is entitled to one vote for each share owned on all matters voted upon by shareholders, and a majority vote is required for all actions to be taken by shareholders. In the event we liquidate, dissolve or wind-up our operations, the holders of the common stock are entitled to share equally and ratably in our assets, if any, remaining after the payment of all our debts and liabilities and the liquidation preference of any shares of preferred stock that may then be outstanding. The common stock has no preemptive rights, no cumulative voting rights, and no redemption, sinking fund, or conversion provisions. Since the holders of common stock do not have cumulative voting rights, holders of more than 50% of the outstanding shares can elect all of our Directors, and the holders of the remaining shares by themselves cannot elect any Directors. Holders of common stock are entitled to receive dividends, if and when declared by the Board of Directors, out of funds legally available for such purpose, subject to the dividend and liquidation rights of any preferred stock that may then be outstanding.
Voting Rights
Each holder of Common Stock is entitled to one vote for each share of Common Stock held on all matters submitted to a vote of stockholders.
Dividends
Subject to preferences that may be applicable to any then-outstanding shares of Preferred Stock, if any, and any other restrictions, holders of Common Stock are entitled to receive ratably those dividends, if any, as may be declared from time to time by the Company’s board of directors out of legally available funds. The Company and its predecessors have not declared any dividends in the past. Further, the Company does not presently contemplate that there will be any future payment of any dividends on Common Stock.
Amendment of our Bylaws
Our bylaws may be adopted, amended or repealed by the affirmative vote of a majority of our outstanding shares. Subject to applicable law, our bylaws also may be adopted, amended or repealed by our board of directors.
Transfer Agent
Our transfer agent is Worldwide Stock Transfer, LLC. Their address is 433 Hackensack Avenue, Level – L, Hackensack, NJ 07601.
42
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
None of the following parties has, since our date of incorporation, had any material interest, direct or indirect, in any transaction with us or in any presently proposed transaction that has or will materially affect us:
·
Any of our directors or officers, except as described below;
·
Any person proposed as a nominee for election as a director;
·
Any person who beneficially owns, directly or indirectly, shares carrying more than 5% of the voting rights attached to our outstanding shares of common stock;
·
Any of our promoters;
·
Any relative or spouse of any of the foregoing persons who has the same house address as such person.
RELATED PARTY CONVERTIBLE NOTES
Mark L. Kay, our Chief Executive Officer, loaned us an aggregate of $568,000 during 2004, 2005 and 2006, memorialized in the form of convertible loans. As of December 31, 2008 an aggregate amount of $268,000 remained outstanding. The details of these convertible notes are as follows:
In January 2004, we issued a principal amount $60,000 convertible note with warrants to purchase 600 shares of common stock to Mr. Mark L. Kay, our CEO. The note payable has a maturity date of December 31, 2004 and a variable interest rate payable equal to Mr. Mark L. Kay’s private account monthly lending rate. The conversion feature allows Mr. Mark L. Kay to convert the note into shares of our common stock at $10.00 per share. In November 2004, to reflect the current issue price of the stock, the conversion price was amended to $7.20. Mr. Kay, at his election, converted this note to stock on December 1, 2004 and received 8,333 shares of our common stock. The warrant exercise period ends in January 2014.
In February 2004, we issued a principal amount $60,000 convertible note with warrants to purchase 600 shares of common stock to Mr. Mark L. Kay, our CEO. The note payable has a maturity date of September 30, 2005 and an amended fixed interest rate of 8%. The conversion feature allows Mr. Mark L. Kay to convert the note into shares of our common stock at $10.00 per share. The warrant exercise period ends February 2014. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been extended to June 30, 2009.
In June 2004, we issued a principal amount $50,000 convertible note to Mr. Mark L. Kay, our CEO. The note payable has a maturity date of December 31, 2005 and an amended fixed interest rate of 8%. The conversion feature allows Mr. Mark L. Kay to convert the note into shares of our common stock at $10.00 per share. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been extended to June 30, 2009.
In September 2004, we issued a principal amount $30,000 convertible note with warrants to purchase 300 shares of common stock to Mr. Mark L. Kay, our CEO. The note has a maturity date of December 31, 2005 and an amended fixed interest rate of 8%. The conversion feature allows Mr. Mark L. Kay to convert the note into shares of our common stock at $10.00 per share. The warrant exercise period ends in September 2014. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been extended to June 30, 2009.
In August 2005, we issued a principal amount $90,000 convertible note with warrants to purchase 900 shares of common stock to Mr. Mark L. Kay, our CEO. The note payable has a maturity date of December 31, 2005 and an amended fixed interest rate of 8%. The conversion feature allows Mr. Mark L. Kay to convert the note into shares of our common stock at $10.00 per share. The warrant exercise period ends August 2015. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been extended to June 30, 2009.
In January 2006, we issued a principal amount $10,000 convertible note with warrants to purchase 100 shares of common stock to Mr. Mark L. Kay, our CEO. The note payable has a maturity date of December 31, 2006 and an amended fixed interest rate of 8%. The conversion feature allows Mr. Mark L. Kay to convert the note into shares of our common stock at $10.00 per share. The warrant exercise period ends January 2016. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been extended to June 30, 2009.
43
In February 2006, we issued a principal amount $28,000 convertible note with warrants to purchase 280 shares of common stock to Mr. Mark L. Kay, our CEO. The note payable has a maturity date of December 31, 2006 and an amended fixed interest rate of 8%. The conversion feature allows Mr. Mark L. Kay to convert the note into shares of our common stock at $7.50 per share. The warrant exercise period ends February 2016. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been extended to June 30, 2009.
For the seven months ended July 31, 2006, the variable interest rate of the six open notes ranged between 8.625% and 11.000% per annum. In September 2006, the interest rate of the six open notes was revised to a fixed rate of 8%, effective August 1, 2006.
In November 2003, we issued a principal amount $50,000 convertible note with warrants to purchase 500 shares of common stock to Mr. Michael Brenner, one of our Vice Presidents. The note payable has a maturity date of December 31, 2004 and an interest rate of prime plus two (2%) percent. The conversion feature allows Mr. Michael Brenner to convert the note into shares of our common stock at $10.00 per share. In November 2004, the maturity date of the convertible note was extended to June 30, 2005. In December 2004, we amended the conversion price on the convertible note to $.72 per share. The warrant exercise period ends November 2013. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been further extended to June 30, 2009.
In January 2004, we issued a principal amount $15,000 convertible note with warrants to purchase 150 shares of common stock to Mr. Michael Brenner, one of our Vice Presidents. The note payable has a maturity date of December 31, 2004 and an interest rate of prime plus four (4%) percent. The conversion feature allows Mr. Michael Brenner to convert the note into shares of our common stock at $10.00 per share. In November 2004, the maturity date of the convertible note was extended to June 30, 2005. In December 2004, we amended the conversion price on the convertible note to $7.20 per share. The warrant exercise period ends January 2014. In December 2004, Mr. Michael Brenner elected to convert half of the principal amount, $7,500, into common stock at a conversion price of $7.20 and received 1,0,42 shares of our common stock. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been further extended to March 31, 2009.
In November 2004, we issued in principal amounts, an aggregated total of $50,000 convertible promissory notes to three relatives of Mr. David Morris, our former Vice President of Sales. The three notes payable have a maturity date of April 30, 2006 and bear interest at prime plus two (2%) percent. Interest is due and payable at the maturity date, unless converted in full. The conversion feature allows the holder to convert into shares of our common stock at $10.00 per share. The notes were repaid, from May 2006 through September 2006, in accordance with their terms.
In August, September and December 2005 and March 2006, the Company executed 8% convertible promissory notes in the amounts of $10,000, $5,000, $10,000 and $5,000 with one of its Software Developers and a relative of the Chief Technology Officer. The principal due hereunder shall be payable in full in immediately available funds of one million dollars or more through any sales or investment by the end of December 31, 2005, for the 2005 notes, and December 31, 2006, for the 2006 note, or later if agreed upon by the individual and the Company. In December 2005, the maturity dates of the 2005 notes were extended to March 31, 2006. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity dates of all of the notes have since been extended to June 30, 2009.
In August and December 2005, the Company executed 8% convertible promissory notes in the amounts of $50,000 and $34,000 with its former President. The convertible promissory note for $34,000 was paid in full in December 2005. The principal due hereunder shall be payable in full in immediately available funds of one million dollars or more through any sales or investment by the end of December 31, 2005 or later if agreed upon by the President and the Company. In December 2005, the maturity date of the note was extended to March 31, 2006. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been further extended to December 31, 2007. The $50,000 note was repaid in February 2008.
In September 2005, the Company executed an 8% convertible promissory note in the amount of $5,000 with a relative of the Chief Financial Officer. The Principal due hereunder shall be payable in full in immediately available funds of one million dollars or more through any sales or investment by the end of December 31, 2005 or later if agreed upon by the individual and the Company. In December 2005, the maturity dates of the notes were extended to March 31, 2006. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been further extended to June 30, 2009.
In December 2005, the Company executed a 21.90% convertible promissory note in the amount of $3,000 with a relative of the Chief Financial Officer. The Principle due hereunder shall be payable in full in immediately available funds of one million dollars or more through any sales or investment by the end of March 31, 2006 or later if agreed upon by the individual and the Company. In December 2005, the convertible promissory note was paid in full.
44
In December 2005, the Company executed an 8% convertible promissory note in the amount of $10,000 with its Office Manager. The principal due hereunder shall be payable in full in immediately available funds of one million dollars or more through any sales or investment by the end of December 31, 2006 or later if agreed upon by the Office Manager and the Company. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been further extended to June 30, 2009.
In January 2006, the Company executed an 8% convertible promissory note in the amount of $70,000 with its Office Manager. The principal due hereunder shall be payable in full in immediately available funds of one million dollars or more through any sales or investment by the end of June 30, 2006 or later if agreed upon by the Office Manager and the Company. The note was partially repaid in the amounts of $10,000 in June 2006, $2,500 in August 2006, $200 in November 2007, $3,609 in December 2007, $2,937 in January 2008, $1,000 in February 2008 and $1,000 in March 2008. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. The maturity date of the note has been further extended to June 30, 2009.
In connection with several of the convertible notes payable, the Company issued warrants exercisable in the aggregate into 8,050 shares of the Company’s common stock at an exercise price of $10.00 per share to the note holders. The warrants were issued at the ratio of one warrant for each $100 of convertible notes payable. These warrants are exercisable for a period of ten years from issuance. The fair value of all the warrants issued using the Black-Scholes Option Pricing Model was $21,339. The financing expense related to the issuance of these warrants was recorded prior to 2007.
At December 31, 2008 and 2007, accrued interest due for the convertible notes – related parties was $120,948 and $86,021, respectively, and is included in accrued expenses in the Company’s balance sheet. Interest expense for convertible notes payable – related parties for the years ended December 31, 2008 and 2007 was $34,928 and $40,273, respectively.
RELATED PARTY PROMISSORY NOTES
At December 31, 2008, the Company had executed eleven notes payable with its CEO aggregating $626,000:
·
Three of the notes, aggregating $189,000, had maturity dates of December 31, 2005 with interest at a per annum rate equal to the CEO’s private account monthly lending rate. In December 2005, the maturity dates of the notes were extended to March 31, 2006. In September 2006, the maturity dates of the notes were extended to March 31, 2007 and the interest rate was revised to a fixed rate of 8%, effective August 1, 2006. The maturity dates of the notes have since been extended to June 30, 2009.
·
Two of the notes, aggregating $160,000 have maturity dates of May 13, 2006 for the $150,000 note and September 30, 2006 for the $10,000 note. Both notes bear interest at a rate equal to 8% per annum. In September 2006, the maturity dates of the notes were extended to March 31, 2007. The maturity dates of the notes have since been extended to June 30, 2009.
·
Three of the notes, in the amounts of $7,000, $5,000 and $150,000, were executed in April 2006 and bear interest at a per annum rate equal to the CEO’s private account monthly lending rate. The $7,000 note was repaid in April 2006. The $5,000 note has a maturity date of September 30, 2006. The $150,000 note has a maturity date of June 30, 2006. In September 2006, the maturity dates of the notes were extended to March 31, 2007 and the interest rate was revised to a fixed rate of 8%, effective August 1, 2006. The maturity dates of the notes have since been extended to June 30, 2009.
·
One of the notes, in the amount of $100,000, was executed in May 2006 and bears interest at a rate equal to 9% per annum with a maturity date of July 31, 2006. In September 2006, the maturity date of the $100,000 note was extended to March 31, 2007. The maturity date of the note has since been extended to June 30, 2009.
·
One of the notes, in the amount of $22,000, was executed in February 2007 and bears interest at a rate equal to 8% per annum with a maturity date of July 31, 2007. In September 2006, the maturity date of the $22,000 note was extended to March 31, 2007. The maturity date of the note has since been extended to June 30, 2009.
·
The remaining note in the amount of $30,000 was executed in July 2008 and bears interest at a rate equal to 4% per annum with a maturity date of September 30, 2008. The note was repaid in July 2008.
45
For the seven months ended July 31, 2006, the variable interest rate ranged between 8.625% and 11% per annum. In September 2006, the interest rate of the six open notes was revised to a fixed rate of 8%, effective August 1, 2006. In connection with the $100,000 note executed in May 2006, the Company issued warrants exercisable in the aggregate into 20,000 shares of the Company’s common stock at an exercise price of $1.30 per share to the CEO. The warrants were issued at the ratio of one warrant for each $5.00 of note payable. These warrants are exercisable for a period of five years from issuance. In connection with the $22,000 note executed in February 2007, the Company issued warrants exercisable in the aggregate into 8,800 shares of the Company’s common stock at an exercise price of $0.50 per share to the CEO. The warrants were issued at the ratio of four warrants for each $10.00 of note payable. These warrants are exercisable for a period of five years from issuance. The fair value of all the warrants issued using the Black-Scholes Option Pricing Model was $28,058. For the years ended December 31, 2008 and 2007, the Company recorded $0 and $3,758, respectively, in financing expense related to the issuance of these warrants.
At December 31, 2008, the Company had executed six notes payable with its former President aggregating $95,000. Notes totaling $10,000 are non-interest bearing. Notes totaling $85,000 bear interest at a rate equal to 8% percent per annum. In September 2006, the maturity date of four of the notes, aggregating $25,000 was extended to March 31, 2007. The maturity dates of the four notes have since been extended to December 31, 2007 and the four notes were repaid in February 2008. The remaining two notes were executed in February 2008 for $52,000 and $18,000, respectively, with maturity dates of February 28, 2009. The Company is pursuing note extensions.
Interest expense for notes payable - related parties for the years ended December 31, 2008 and 2007 was $56,395 and $52,280, respectively.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table shows the audit fees incurred for fiscal year 2008 and 2007:
|
| 2008 |
| 2007 |
| ||
Audit fees |
| $ | 49,500 |
| $ | 45,000 |
|
Audit related fees |
|
| 6,000 |
|
| 10,000 |
|
Tax fees |
|
| 3,000 |
|
| 3,000 |
|
Total |
| $ | 58,500 |
| $ | 58,000 |
|
The Board of Directors has reviewed and discussed with the Company's management and independent registered public accounting firm the audited consolidated financial statements of the Company contained in the Company's Annual Report on Form 10-K for the Company's 2008 fiscal year. The Board has also discussed with the auditors the matters required to be discussed pursuant to SAS No. 61 (Codification of Statements on Auditing Standards, AU Section 380), which includes, among other items, matters related to the conduct of the audit of the Company's consolidated financial statements.
The Board has received and reviewed the written disclosures and the letter from the independent registered public accounting firm required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees), and has discussed with its auditors its independence from the Company. The Board has considered whether the provision of services other than audit services is compatible with maintaining auditor independence.
Based on the review and discussions referred to above, the Board approved the inclusion of the audited consolidated financial statements be included in the Company's Annual Report on Form 10-K for its 2008 fiscal year for filing with the SEC.
Pre-Approval Policies
The Board's policy is now to pre-approve all audit services and all permitted non-audit services (including the fees and terms thereof) to be provided by the Company's independent registered public accounting firm; provided, however, pre-approval requirements for non-audit services are not required if all such services (1) do not aggregate to more than five percent of total revenues paid by the Company to its accountant in the fiscal year when services are provided; (2) were not recognized as non-audit services at the time of the engagement; and (3) are promptly brought to the attention of the Board and approved prior to the completion of the audit.
The Board pre-approved all fees described above.
46
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(1)
Filed as an exhibit to the Registrant’s Form SB-2 dated as of May 11, 2005 and incorporated herein by reference.
(2)
Filed as an exhibit to the Registrant’s Amendment No. 1 to Form SB-2 dated as of June 27, 2005 and incorporated herein by reference.
(3)
Filed herewith.
(4)
Filed as an exhibit to the Registrant’s Form 8-K dated August 1, 2006 and incorporated herein by reference.
47
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| STRIKEFORCE TECHNOLOGIES, INC. | ||
|
|
| |
Dated: March 31, 2009 | By: | /s/ Mark L. Kay |
|
| Mark L. Kay | ||
| Chief Executive Officer | ||
|
|
| |
|
| ||
Dated: March 31, 2009 | By: | /s/ Mark Joseph Corrao |
|
| Mark Joseph Corrao | ||
| Chief Financial Officer and Principal Accounting Officer | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.
48
STRIKEFORCE TECHNOLOGIES, INC.
INDEX TO FINANCIAL STATEMENTS
DECEMBER 31, 2008 AND 2007
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
StrikeForce Technologies, Inc.
Edison, New Jersey
We have audited the accompanying balance sheets of StrikeForce Technologies, Inc. (“StrikeForce” or the "Company") as of December 31, 2008 and 2007 and the related statements of operations, stockholders’ deficit and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, based on our audit, the financial statements referred to above present fairly, in all material respects, the financial position of StrikeForce as of December 31, 2008 and 2007, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the Unites States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company had an accumulated deficit and a working capital deficiency at December 31, 2008 and had a net loss and cash used in operations for the year ended December 31, 2008, respectively. These conditions raise substantial doubt about its ability to continue as a going concern. Management’s plans in regards to these matters are also described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/Li & Company, PC
Li & Company, PC
Skillman, New Jersey
March 27, 2009
F-2
STRIKEFORCE TECHNOLOGIES, INC.
BALANCE SHEETS
|
| December 31, |
| December 31, |
|
| 2008 |
| 2007 |
ASSETS |
|
|
|
|
Current Assets: |
|
|
|
|
Cash and cash equivalents | $ | 43,030 | $ | 16,307 |
Restricted cash |
| 80,737 |
| - |
Accounts receivable |
| 38,535 |
| 32,960 |
Current portion of deferred royalties |
| 326,808 |
| 326,808 |
Prepayments and other current assets |
| - |
| 6,325 |
Total current assets |
| 489,110 |
| 382,400 |
|
|
|
|
|
Property and equipment, net |
| 11,027 |
| 16,963 |
Deferred royalties, net of current portion |
| 1,127,935 |
| 1,424,563 |
Website development cost, net |
| 1,720 |
| 4,688 |
Patents |
| 4,329 |
| 4,329 |
Security deposit |
| 8,684 |
| 8,684 |
Total Assets | $ | 1,642,805 | $ | 1,841,627 |
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' DEFICIT |
| |||
|
|
|
|
|
Current Liabilities: |
|
|
|
|
Convertible secured notes payable | $ | 672,167 | $ | 672,167 |
Derivative financial instruments |
| 510,689 |
| 1,468,264 |
Current maturities of convertible notes payable, net of discount of $67,335 in 2008 |
| 1,163,177 |
| 800,000 |
Current maturities of convertible notes payable - related parties |
| 419,255 |
| 107,500 |
Current maturities of notes payable |
| 200,208 |
| 281,250 |
Current maturities of notes payable - related parties |
| 696,000 |
| 25,000 |
Capital leases payable |
| 5,532 |
| 5,532 |
Accounts payable |
| 899,387 |
| 961,552 |
Accrued expenses |
| 1,739,530 |
| 1,187,762 |
Payroll taxes payable |
| 53,481 |
| 53,375 |
Common stock to be issued |
| - |
| 8,155 |
Due to factor |
| 209,192 |
| 209,192 |
Due to employees |
| 49,877 |
| 48,326 |
Total current liabilities |
| 6,618,495 |
| 5,828,075 |
|
|
|
|
|
Convertible notes payable, net of current maturities, |
|
|
|
|
net of discount of $148,421 in 2007 |
| - |
| 636,579 |
Convertible notes payable - related parties, net of current maturities |
| - |
| 366,691 |
Notes payable, net of current maturities |
| 1,750,000 |
| - |
Notes payable - related parties, net of current maturities |
| - |
| 626,000 |
Total Liabilities |
| 8,368,495 |
| 7,457,345 |
|
|
|
|
|
Commitments and contingencies |
|
|
|
|
|
|
|
|
|
Stockholders' Deficit |
|
|
|
|
Preferred stock at $0.10 par value; 10,000,000 shares authorized; |
|
|
|
|
none issued or outstanding |
| - |
| - |
Common stock at $0.0001 par value; 100,000,000 shares authorized; |
|
|
|
|
17,121,124 and 9,999,999 shares issued and outstanding, respectively |
| 1,712 |
| 1,000 |
Additional paid-in capital |
| 11,193,081 |
| 10,759,732 |
Accumulated deficit |
| (17,920,483) |
| (16,376,450) |
Total Stockholders' Deficit |
| (6,725,690) |
| (5,615,718) |
Total Liabilities and Stockholders' Deficit | $ | 1,642,805 | $ | 1,841,627 |
F-3
STRIKEFORCE TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS
|
| For the Year |
| For the Year |
|
| Ended |
| Ended |
|
| December 31, |
| December 31, |
|
| 2008 |
| 2007 |
|
|
|
|
|
Revenues | $ | 287,035 | $ | 661,580 |
|
|
|
|
|
Cost of sales |
| 120,201 |
| 83,720 |
|
|
|
|
|
Gross profit |
| 166,834 |
| 577,860 |
|
|
|
|
|
Operating expenses: |
|
|
|
|
Selling, general and administrative expenses |
| 1,716,081 |
| 2,772,138 |
Research and development |
| 422,753 |
| 375,030 |
Total operating expenses |
| 2,138,834 |
| 3,147,168 |
|
|
|
|
|
Loss from operations |
| (1,972,000) |
| (2,569,308) |
|
|
|
|
|
Other (income) expense: |
|
|
|
|
Interest income |
| (10,867) |
| - |
Interest expense |
| 295,439 |
| 502,360 |
Financing expense |
| 762,248 |
| 159,625 |
Derivative instruments (income) expense, net |
| (957,575) |
| 1,267,466 |
Forgiveness of debt |
| (420,760) |
| - |
Other (income) expenses |
| 1,655 |
| (24,250) |
Total other (income) expense |
| (329,860) |
| 1,905,201 |
|
|
|
|
|
Loss before taxes |
| (1,642,140) |
| (4,474,509) |
|
|
|
|
|
Income income tax provision (benefit) |
|
|
|
|
Income tax provision |
| 1,560 |
| 1,500 |
Proceeds from sale of State Net Operating Loss Carry-forwards (“NOL”) |
| (99,667) |
| (477,607) |
Total income tax provision (benefit) |
| (98,107) |
| (476,107) |
|
|
|
|
|
Net loss | $ | (1,544,033) | $ | (3,998,402) |
|
|
|
|
|
Net loss per common share – basic and diluted | $ | (0.14) | $ | (0.87) |
|
|
|
|
|
Weighted average number of common shares outstanding – basic and diluted |
| 10,914,276 |
| 4,585,045 |
F-4
STRIKEFORCE TECHNOLOGIES, INC.
STATEMENT OF STOCKHOLDERS’ DEFICIT
FOR THE YEAR ENDED DECEMBER 31, 2007
| Common stock at $0.0001 par value |
| Additional |
|
|
| Total | ||
|
| Paid-in |
| Accumulated |
| Stockholders' | |||
| Shares |
| Amount |
| Capital |
| Deficit |
| Deficit |
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006 | 2,884,449 | $ | 288 | $ | 9,086,449 | $ | (12,378,048) | $ | (3,291,311) |
|
|
|
|
|
|
|
|
|
|
Sale of shares of common stock including warrants | 272,107 |
| 27 |
| 75,514 |
| - |
| 75,541 |
|
|
|
|
|
|
|
|
|
|
Issuance of shares of common stock for conversions of notes payable and accrued interest | 5,436,570 |
| 544 |
| 760,770 |
| - |
| 761,314 |
|
|
|
|
|
|
|
|
|
|
Issuance of shares of common stock for consulting services | 677,424 |
| 68 |
| 87,434 |
| - |
| 87,502 |
|
|
|
|
|
|
|
|
|
|
Issuance of shares of common stock for financing | 729,449 |
| 73 |
| 160,181 |
| - |
| 160,254 |
|
|
|
|
|
|
|
|
|
|
Issuance of warrants in connection with convertible notes payable | - |
| - |
| 153,192 |
| - |
| 153,192 |
|
|
|
|
|
|
|
|
|
|
Issuance of warrants in connection with consulting services | - |
| - |
| 9,817 |
| - |
| 9,817 |
|
|
|
|
|
|
|
|
|
|
Issuance of stock options for employee stock option compensation | - |
| - |
| 426,375 |
| - |
| 426,375 |
|
|
|
|
|
|
|
|
|
|
Net loss | - |
| - |
| - |
| (3,998,402) |
| (3,998,402) |
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2007 | 9,999,999 | $ | 1,000 | $ | 10,759,732 | $ | (16,376,450) | $ | (5,615,718) |
F-5
STRIKEFORCE TECHNOLOGIES, INC.
STATEMENT OF STOCKHOLDERS’ DEFICIT
FOR THE YEAR ENDED DECEMBER 31, 2008
| Common stock at $0.0001 par value |
| Additional Paid-in |
| Accumulated |
| Total Stockholders’ | ||
| Shares |
| Amount |
| Capital |
| Deficit |
| Deficit |
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2007 | 9,999,999 | $ | 1,000 | $ | 10,759,732 | $ | (16,376,450) | $ | (5,615,718) |
|
|
|
|
|
|
|
|
|
|
Issuance of shares of common stock for consulting services | 10,500 |
| 1 |
| 1,359 |
| - |
| 1,360 |
|
|
|
|
|
|
|
|
|
|
Issuance of shares of common stock for financing | 7,110,546 |
| 711 |
| 187,098 |
| - |
| 187,809 |
|
|
|
|
|
|
|
|
|
|
Issuance of warrants in connection with promissory notes payable | - |
| - |
| 44,321 |
| - |
| 44,321 |
|
|
|
|
|
|
|
|
|
|
Issuance of stock options for employee stock option compensation | - |
| - |
| 200,571 |
| - |
| 200,571 |
|
|
|
|
|
|
|
|
|
|
Net loss | - |
| - |
| - |
| (1,544,033) |
| (1,544,033) |
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2008 | 17,121,045 | $ | 1,712 | $ | 11,193,081 | $ | (17,920,483) | $ | (6,725,690) |
F-6
STRIKEFORCE TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS
|
| For the Year |
| For the Year |
|
| Ended |
| Ended |
|
| December 31, |
| December 31, |
|
| 2008 |
| 2007 |
Cash flows from operating activities: |
|
|
|
|
Net loss | $ | (1,544,033) | $ | (3,998,402) |
Adjustments to reconcile net loss to net cash |
|
|
|
|
used in operating activities: |
|
|
|
|
Depreciation and amortization |
| 12,637 |
| 19,012 |
Forgiveness of debt |
| (420,760) |
| - |
Discount on notes payable |
| 170,000 |
| - |
Amortization of discount on convertible notes |
| 85,436 |
| 198,819 |
Amortization of deferred royalties |
| 296,628 |
| 274,191 |
Mark to market on derivative financial instruments |
| (957,575) |
| 1,267,466 |
Issuance of stock options for employee stock option compensation |
| 200,571 |
| 426,375 |
Issuance of common stock, options and warrants for consulting services |
| 1,360 |
| 97,319 |
Issuance of common stock and warrants for financing expense |
| 227,780 |
| 160,254 |
Changes in operating assets and liabilities: |
|
|
|
|
Accounts receivable |
| (5,575) |
| (13,884) |
Prepaid expenses |
| 6,325 |
| 15,268 |
Accounts payable |
| (9,415) |
| 248,283 |
Accrued expenses |
| 624,540 |
| 501,390 |
Payroll taxes payable |
| 106 |
| 1 |
Common stock to be issued |
| (8,155) |
| 8,155 |
Due to factor |
| - |
| 209,192 |
Amount received from (paid to) employees |
| 1,551 |
| (11,031) |
Net cash used in operating activities |
| (1,318,579) |
| (597,592) |
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
Change in restricted cash |
| (80,737) |
| - |
Investment in website |
| - |
| (1,135) |
Purchases of property and equipment |
| (3,733) |
| (3,986) |
Net cash used in investing activities |
| (84,470) |
| (5,121) |
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
Proceeds from sale of common stock and warrants |
| - |
| 75,541 |
Proceeds from convertible notes payable |
| - |
| 763,952 |
Proceeds from convertible notes payable - related parties |
| - |
| - |
Proceeds from notes payable |
| 150,000 |
| 447,500 |
Proceeds from notes payable, net of discount of $170,000, in the form of restricted cash |
| 1,580,000 |
| - |
Proceeds from notes payable - related parties |
| 100,000 |
| 22,000 |
Payments of convertible notes payable - related parties |
| (54,936) |
| (3,809) |
Payments of notes payable |
| (199,581) |
| (416,250) |
Payments of convertible notes payable |
| (90,711) |
| (243,000) |
Payments of notes payable - related parties |
| (55,000) |
| - |
Principal payments on capital leases |
| - |
| (34,369) |
Net cash provided by financing activities |
| 1,429,772 |
| 611,565 |
Net increase in cash |
| 26,723 |
| 8,852 |
Cash and cash equivalents at beginning of year |
| 16,307 |
| 7,455 |
Cash and cash equivalents at end of year | $ | 43,030 | $ | 16,307 |
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
Cash paid for: |
|
|
|
|
Interest | $ | 293,788 | $ | 502,360 |
Income taxes | $ | 3,215 | $ | 2,448 |
Non-cash investing and financing activities: |
|
|
|
|
Conversion of convertible notes payable into common stock | $ | - | $ | 761,314 |
Issuance of promissory note for consulting services | $ | - | $ | 15,000 |
Issuance of warrants for convertible notes | $ | - | $ | 153,192 |
Issuance of warrants for promissory notes | $ | 4,350 | $ | - |
F-7
STRIKEFORCE TECHNOLOGIES, INC.
DECEMBER 31, 2008 and 2007
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS
StrikeForce Technical Services Corporation was incorporated in August 2001 under the laws of the State of New Jersey. On September 3, 2004, the stockholders approved an amendment to the Certificate of Incorporation to change the name to StrikeForce Technologies, Inc. (“StrikeForce” or the “Company”). Prior to December 2002, the Company was a reseller of computer hardware, software products, and telecommunications equipment and services. In December 2002, the Company began to acquire the rights to intangible technology, which upon the consummation changed the direction of the Company’s business. The Company is a software development and services company. The Company owns the exclusive right to license and develop various identification protection software products that were developed to protect computer networks from unauthorized access and to protect network owners and users from identity theft. The Company has developed a suite of products based upon the licenses and the Company is seeking to commercially exploit the products in the areas of financial services, eCommerce, corporate, government and consumer sectors. The technology developed by the Company and used in the Company’s ProtectID® and GuardedID® products is the subject of two pending patent applications. The Company’s firewall product is no longer being developed and the provisional patent application was allowed to expire. A fourth patent application relating to the Company’s ProtectID® product was combined into the first ProtectID® pending patent application and the fourth application was allowed to lapse. The Company’s operations are based in Edison, New Jersey.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
Reclassification
Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation. These reclassifications had no effect on reported losses.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reporting amounts of revenues and expenses during the reported period. Significant estimates include, but are not limited to, the estimated useful lives of property and equipment and website development costs. Actual results could differ from those estimates.
Cash equivalents
The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.
Accounts receivable
Trade accounts receivable are recorded at the invoiced amount, net of allowances for doubtful accounts and sales returns. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on historical write-off experience, customer specific facts and economic conditions. Bad debt expense is included in general and administrative expenses.
Outstanding account balances are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company recorded bad debt expense of $1,278 and $485,274 for the years ended December 31, 2008 and 2007, respectively. There were no allowances for doubtful accounts at December 31, 2008 or 2007.
F-8
Property and equipment
Property and equipment are recorded at cost. Expenditures for major additions and betterments are capitalized. Maintenance and repairs are charged to operations as incurred. Depreciation of property and equipment is computed by the straight-line method (after taking into account their respective estimated residual values) over the assets estimated useful lives. Leasehold improvements, if any, are amortized on a straight-line basis over the lease period or the estimated useful life, whichever is shorter. Upon sale or retirement of property and equipment, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in operations.
Leases
Lease agreements are evaluated to determine whether they are capital leases or operating leases in accordance with Statement of Financial Accounting Standards No. 13 “Accounting for Leases”, as amended (“SFAS No. 13”). When substantially all of the risks and benefits of property ownership have been transferred to the Company, as determined by the test criteria in SFAS No. 13, the lease then qualifies as a capital lease.
Capital lease assets are depreciated on an accelerated method, over the capital lease assets estimated useful lives consistent with the Company’s normal depreciation policy for tangible fixed assets, but generally not exceeding the lease term. Interest charges are expensed over the period of the lease in relation to the carrying value of the capital lease obligation.
Rent expense for operating leases, which may include free rent or fixed escalation amounts in addition to minimum lease payments, is recognized on a straight-line basis over the duration of each lease term.
Deferred royalties
Deferred royalties represent stock based compensation paid by the Company for certain licenses that have been capitalized. Such licenses are utilized in connection with the Company’s operations.
Website development cost
Website development cost is stated at cost less accumulated amortization. The cost of the website development is amortized on a straight-line basis over its estimated useful life of three years.
Patents
All costs incurred to the point when a patent application is to be filed are expensed as incurred as research and development cost. Patent application costs, generally legal costs, thereafter incurred are capitalized. Patents are amortized over the expected useful lives of the patents, which is generally 17 to 20 years for domestic patents and 5 to 20 years for foreign patents, once the patents are granted or are expensed if the patent application is rejected. The costs of defending and maintaining patents are expensed as incurred. As of December 31, 2008, the Company capitalized $4,329 in patent application costs as incurred with no amortization due to the fact that the patent applications are still pending.
Impairment of long-lived assets
Long-lived assets, which include property and equipment, deferred royalties, website development cost and patents are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable or the useful life is shorter than originally estimated.
The Company assesses the recoverability of its assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. If assets are determined to be recoverable, but the useful lives are shorter than originally estimated, the net book value of the assets is depreciated over the newly determined remaining useful lives. The Company determined that there was no impairment based on management’s evaluation at December 31, 2008 or 2007.
F-9
Fair value of financial instruments
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying amounts of financial assets and liabilities, such as cash, trade accounts receivable, prepayments, accounts payable, accrued expenses, payroll taxes payable, due to factor and due to employees, approximate their fair values because of the short maturity of these instruments. The Company’s notes payable and capital leases payable approximate the fair value of such instruments based upon management’s best estimate of interest rates that would be available to the Company for similar financial arrangements at December 31, 2008 and 2007.
Discount on debt
The Company has allocated the proceeds received from convertible debt instruments between the underlying debt instruments and has recorded the conversion feature as a liability in accordance with Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) and related interpretations. The conversion feature and certain other features that are considered embedded derivative instruments, such as a conversion reset provision, a penalty provision and redemption option, have been recorded at their fair value within the terms of SFAS No. 133 as its fair value can be separated from the convertible note and its conversion is independent of the underlying note value. The conversion liability is marked to market each reporting period with the resulting gains or losses shown on the Statement of Operations. The Company has also recorded the resulting discount on debt related to the warrants and conversion feature and is amortizing the discount using the effective interest rate method over the life of the debt instruments.
Derivatives
The Company accounts for derivatives in accordance with SFAS No. 133 and the related interpretations. SFAS No. 133, as amended, requires companies to recognize all derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of a derivative instrument depends on: (i) whether the derivative has been designated and qualifies as part of a hedging relationship, and (ii) the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument based upon the exposure being hedged as either a fair value hedge, cash flow hedge or hedge of a net investment in a foreign operation. At December 31, 2008, the Company had not entered into any transactions which were considered hedges under SFAS No. 133.
Financial instruments
The Company evaluates its convertible debt, options, warrants or other contracts to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for under SFAS No. 133 and related interpretations including Emerging Issues Task Force (“EITF”) Issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock” (“EITF Issue No. 00-19”). The result of this accounting treatment is that the fair value of the embedded derivative is marked-to-market each balance sheet date and recorded as a liability. In the event that the fair value is recorded as a liability, the change in fair value is recorded in the Statement of Operations as other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity.
In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument.
The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. Equity instruments that are initially classified as equity that become subject to reclassification under SFAS No. 133 are reclassified to liability at the fair value of the instrument on the reclassification date. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument is expected within 12 months of the balance sheet date.
F-10
The fair value model utilized to value the various compound embedded derivatives in the secured convertible notes comprises multiple probability-weighted scenarios under various assumptions reflecting the economics of the secured convertible notes, such as the risk-free interest rate, expected Company stock price and volatility, likelihood of conversion and or redemption, and likelihood of default status and timely registration. At inception, the fair value of the single compound embedded derivative was bifurcated from the host debt contract and recorded as a derivative liability which resulted in a reduction of the initial notional carrying amount of the secured convertible notes (as unamortized discount which will be amortized over the term of the notes under the effective interest method).
Revenue recognition
The Company’s revenues are derived principally from the sale and installation of its various identification protection software products and related hardware and services. The Company recognizes revenue when it is realized or realizable and earned less estimated future returns. The Company follows the guidance of the United States Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) No. 101 “Revenue Recognition” (“SAB No. 101”), as amended by SAB No. 104 (“SAB No. 104”) for revenue recognition. The Company recognizes revenue when it is realized or realizable and earned less estimated future doubtful accounts. The Company considers revenue realized or realizable and earned when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the product has been shipped or the services have been rendered to the customer, (iii) the sales price is fixed or determinable, and (iv) collectability is reasonably assured. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue:
Hardware – Revenue from hardware sales is recognized when the product is shipped to the customer and there are either no unfulfilled Company obligations or any obligations that will not affect the customer's final acceptance of the arrangement. All cost of these obligations is accrued when the corresponding revenue is recognized. There were no revenues from fixed price long-term contracts.
Software, Services and Maintenance – Revenue from time and service contracts is recognized as the services are provided. Revenue from delivered elements of one-time charge licensed software is recognized at the inception of the license term, provided the Company has vendor-specific objective evidence of the fair value of each delivered element. Revenue is deferred for undelivered elements. The Company recognizes revenue from the sale of software licenses, when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed and determinable, and collection of the resulting receivable is reasonably assured. Delivery generally occurs when the product is delivered to a common carrier. The Company assesses collection based on a number of factors, including past transaction history with the customer and the creditworthiness of the customer. The Company does not request collateral from customers. If the Company determines that collection of a fee is not reasonably assured, the Company defers the fee and recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash. Revenue from monthly software licenses is recognized on a subscription basis.
ASP Hosted Services – The Company offers an Application Service Provider hosted service whereby customer usage transactions are invoiced monthly on a cost per transaction basis. The service is sold via the execution of a Service Agreement between the Company and the customer. Initial set-up fees are recognized over the period in which the services are performed.
Revenue from fixed price long-term service contracts is recognized over the contract term based on the percentage of services that are provided during the period compared with the total estimated services to be provided over the entire contract. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent. Revenue from maintenance is recognized over the contractual period or as the services are performed. Revenue in excess of billings on service contracts is recorded as unbilled receivables and is included in trade accounts receivable. Billings in excess of revenue that is recognized on service contracts are recorded as deferred income until the aforementioned revenue recognition criteria are met.
Stock based compensation
Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004) “Share-Based Payment” (“SFAS No. 123R”) using the modified prospective method. Under this method, compensation cost in the first quarter of 2006 includes the portion vesting in the period for (1) all share-based payments granted prior to, but not vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 and (2) all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the revised provisions of SFAS No. 123R. The fair value of each option grant estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
F-11
| December 31, |
| December 31, |
| 2008 |
| 2007 |
Risk-free interest rate | 3.0% - 4.5% |
| 4.0% - 5.2% |
Dividend yield | 0.00% |
| 0.00% |
Expected volatility | 150% - 350% |
| 200% - 400% |
Expected option life | 5 - 10 years |
| 5 - 10 years |
The expected life of the options has been determined using the simplified method as prescribed in SEC Staff Accounting Bulletin No. 107 (“SAB No. 107”). Results of prior periods do not reflect any restated amounts and the Company had no cumulative effect adjustment upon adoption of SFAS No. 123R under the modified prospective method. The Company’s policy is to recognize compensation cost for awards with only service conditions and a graded vesting schedule on a straight-line basis over the requisite service period for the entire award. Additionally, the Company’s policy is to issue new shares of common stock to satisfy stock option exercises.
The adoption of SFAS No. 123R increased the Company’s reported operating loss and net loss by $200,571 and $426,375 for the years ended December 31, 2008 and 2007, respectively. The expense is classified as selling, general and administrative expense on the statement of operations.
The fair value of each option award is estimated on the date of grant using a Black-Scholes option-pricing valuation model. The ranges of assumptions for inputs shown in the table above for 2008 and 2007 are as follows:
·
The expected volatility is based on a combination of the historical volatility of the Company’s and comparable companies’ stock over the contractual life of the options.
·
The Company uses historical data to estimate employee termination behavior. The expected life of options granted is derived from SAB 107 and represents the period of time the options are expected to be outstanding.
·
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods within the contractual life of the option.
·
The expected dividend yield is based on the Company’s current dividend yield as the best estimate of projected dividend yield for periods within the contractual life of the option.
Software development costs
Statement of Financial Accounting Standards No. 86 “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed” (“SFAS No. 86”) requires capitalization of software development costs incurred subsequent to establishment of technological feasibility and prior to the availability of the product for general release to customers. Systematic amortization of capitalized costs begins when a product is available for general release to customers and is computed on a product-by-product basis at a rate not less than straight-line basis over the product’s remaining estimated economic life. To date, all costs have been accounted for as research and development costs and no software development cost has been capitalized. Total research and development costs for the years ended December 31, 2008 and 2007 were $422,753 and $375,030, respectively.
Income taxes
The Company follows Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes” (“SFAS No. 109”), which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of operations in the period that includes the enactment date.
F-12
Net loss per common share
Net loss per common share is computed pursuant to Statement of Financial Accounting Standards No. 128 “Earnings Per Share” (“SFAS No. 128”). Basic loss per share is computed by taking net loss divided by the weighted average number of common shares outstanding for the period. Diluted loss per share is computed by dividing net loss by the weighted average number of shares of common stock and potentially outstanding shares of common stock during each period to reflect the potential dilution that could occur from common shares issuable through stock options, warrants, and convertible debt, which excludes 1,427,297 shares of stock options, 1,561,692 shares of common stock issuable under warrants and 1,939,755 shares of common stock issuable under the conversion feature of the convertible notes payable for the year ended December 31, 2008, and 53,281 shares of common stock to be issued, 2,539,088 shares of stock options, 1,146,585 shares of common stock issuable under warrants and 2,815,369 shares of common stock issuable under the conversion feature of the convertible notes payable for the year ended December 31, 2007, respectively. These potential shares of common stock were not included as they were anti-dilutive.
Recently issued accounting pronouncements
On June 5, 2003, the United States Securities and Exchange Commission (“SEC”) adopted final rules under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), as amended by SEC Release No. 33-8934 on June 26, 2008. Commencing with its annual report for the fiscal year ending December 31, 2009, the Company will be required to include a report of management on its internal control over financial reporting. The internal control report must include a statement:
·
Of management’s responsibility for establishing and maintaining adequate internal control over its financial reporting;
·
Of management’s assessment of the effectiveness of its internal control over financial reporting as of year end; and
·
Of the framework used by management to evaluate the effectiveness of the Company’s internal control over financial reporting.
Furthermore, in the following fiscal year, it is required to file the auditor’s attestation report separately on the Company’s internal control over financial reporting on whether it believes that the Company has maintained, in all material respects, effective internal control over financial reporting.
In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007) “Business Combinations” (“SFAS No. 141(R)”), which requires the Company to record fair value estimates of contingent consideration and certain other potential liabilities during the original purchase price allocation, expense acquisition costs as incurred and does not permit certain restructuring activities previously allowed under Emerging Issues Task Force Issue No. 95-3 to be recorded as a component of purchase accounting. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. The Company has not determined the effect that the adoption of SFAS No. 141(R) will have on the financial results of the Company.
In December 2007, the FASB issued FASB Statement No. 160 “Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51” (“SFAS No. 160”), which causes noncontrolling interests in subsidiaries to be included in the equity section of the balance sheet. SFAS No. 160 applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. The Company has not determined the effect that the adoption of SFAS No. 160 will have on the financial results of the Company.
F-13
In March 2008, the FASB issued FASB Statement No. 161 “Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133” (“SFAS No. 161”), which changes the disclosure requirements for derivative instruments and hedging activities. Pursuant to SFAS No.161, Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 with early application encouraged. SFAS No. 161 encourages but does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In years after initial adoption, this Statement requires comparative disclosures only for periods subsequent to initial adoption. The Company does not expect the adoption of SFAS No. 161 to have a material impact on the financial results of the Company.
Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying consolidated financial statements.
NOTE 3 - GOING CONCERN
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As reflected in the accompanying financial statements, the Company had an accumulated deficit of $17,920,483 and a working capital deficiency of $6,129,385 at December 31, 2008 and had a net loss and cash used in operations of $1,544,033 and $1,318,579 for the year ended December 31, 2008, respectively.
Currently, the Company is attempting to increase revenues and improve gross margins by implementing a revised sales and marketing strategy. In principle, the Company is redirecting its sales focus from direct sales to companies using an internal sales force, to selling through a distribution channel of Value Added Resellers and Original Equipment Manufacturers. The profit margin from this approach is more lucrative than selling direct due to the increase in sales volume of GuardedID® through a distribution channel strategy. This strategy, if successful, should increase the Company’s sales and revenues allowing the Company to mitigate future losses. In addition, management has raised funds through convertible debt instruments and the sale of equity in order to help alleviate the working capital deficiency. Through the utilization of the public capital markets, the Company plans to raise the funds necessary to continue to expand and enhance its growth; however, there can be no assurance that they will be able to increase revenues or raise additional capital. The Company is currently in negotiations with investors to conclude the necessary working capital needs of the Company.
Management expects cash flows from operating activities to improve by the middle of 2009, primarily as a result of certain contracts, although there can be no assurance that such contracts will materialize in revenue sufficient to meet operating expenses and fund future operations. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. If it fails to generate positive cash flows or obtain additional financing when required, it may have to modify, delay or abandon some or all of its business and expansion plans.
NOTE 4 - PREPAYMENTS AND OTHER CURRENT ASSETS
Prepaid expenses at December 31, 2007 consist entirely of prepaid insurance.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2008 and 2007:
|
| December 31 | ||
|
| 2008 |
| 2007 |
Computer equipment | $ | 65,460 | $ | 65,460 |
Computer software |
| 15,545 |
| 11,812 |
Furniture and fixtures |
| 10,157 |
| 10,157 |
Office equipment |
| 15,906 |
| 15,906 |
Total |
| 107,068 |
| 103,335 |
Less: accumulated depreciation and amortization |
| (96,041) |
| (86,372) |
| $ | 11,027 | $ | 16,963 |
F-14
Depreciation and amortization expense for the years ended December 31, 2008 and 2007 amounted to $9,669 and $14,395, respectively.
NOTE 6 - DEFERRED ROYALTIES
On December 2, 2004, the Company issued NetLabs, as advance royalties, options to purchase 760,000 shares of the Company’s common stock at a price of $3.60 per share to vest as follows: 253,000 shares at issuance, 253,000 shares at September 11, 2005 and 254,000 shares at September 11, 2006 for the exclusive rights to the intellectual property related to the patents pending for its “Out-of-Band” technology and firewall solutions, while clarifying that NetLabs still retains ownership.
The fair values for these options were measured at the end of each reporting period and were fixed at each vesting date using the Black-Scholes Option Pricing Model.
As of December 31, 2008 the options to purchase 253,000 shares that vested at issuance are valued (as fixed) at $1,066,395, the options to purchase 253,000 shares that vested at September 11, 2005 are valued (as fixed) at $1,529,132, and the options to purchase the final 254,000 shares (which vested on September 11, 2006) are valued (as fixed) at $264,160. The deferred royalties are being amortized over the term of the original NetLabs Agreement of ten (10) years which will terminate on August 31, 2013. At December 31, 2008, the total value of the deferred royalties, net of accumulated amortization of $1,404,944, is $1,454,743. For the years ended December 31, 2008 and 2007, $296,628 and $274,191 of royalties were expensed, respectively.
The following table summarizes the annual amounts of deferred royalties that are amortized to general and administrative expenses over the next four (4) years and thereafter:
2009 | $ | 334,014 |
2010 |
| 303,834 |
2011 |
| 303,834 |
2012 |
| 303,834 |
2013 and beyond |
| 209,227 |
Total deferred royalties | $ | 1,454,743 |
Less current portion |
| (326,808) |
Deferred royalties, net of current portion | $ | 1,127,935 |
NOTE 7 - WEBSITE DEVELOPMENT COST
Website development cost, less accumulated amortization, consisted of the following at December 31, 2008 and 2007:
|
| December 31 | ||
|
| 2008 |
| 2007 |
Website development cost | $ | 22,331 | $ | 22,331 |
Less: accumulated amortization |
| (20,611) |
| (17,643) |
| $ | 1,720 | $ | 4,688 |
Amortization expense for the years ended December 31, 2008 and 2007 amounted to $2,968 and $4,617, respectively.
NOTE 8 - CONVERTIBLE NOTES PAYABLE
Convertible notes payable at December 31, 2008 and 2007 consisted of the following:
|
| December 31, 2008 |
| December 31, 2007 |
(1) Convertible note bearing interest at 8% per, with a conversion price of $9.00 per share, extended three times through March 31, 2008. In April 2008, the Company assigned the note to the Company’s investor group and the note holder agreed to an amount of $12,500 as full settlement of the note. The settlement amount was paid to the note holder by the Company in April 2008 (see Note 20). | $ | - | $ | 125,000 |
(2) Convertible note bearing interest at 8% per annum maturing on March 28, 2008, with a conversion price of $9.00 per share. As of December 31, 2008, the Company and the note holder are in discussions regarding a settlement of the note balance. |
| 235,000 |
| 235,000 |
F-15
(3) Convertible non-interest bearing note, having a conversion price of $9.00 per share and maturing on June 30, 2006. In January 2007, the Company agreed to make periodic payments in order to repay the note in full by March 31, 2009. |
| 7,000 |
| 15,000 |
(4) Convertible note bearing interest at 8% per annum maturing on June 20, 2008, with a conversion price of $9.00 per share. In December 2008 the note was extended to June 30, 2009. |
| 10,000 |
| 10,000 |
(5) Convertible note bearing interest at 8% per annum maturing on July 7, 2008, with a conversion price of $9.00 per share. In December 2008 the note was extended to June 30, 2009. |
| 15,000 |
| 15,000 |
(6) Convertible note bearing interest at 8% per annum maturing on July 11, 2008, with a conversion price of $9.00 per share. In December 2008 the note was extended to June 30, 2009. |
| 15,000 |
| 15,000 |
(7) Convertible note bearing interest at 8% per annum maturing on July 27, 2008, with a conversion price of $9.00 per share. In December 2008 the note was extended to June 30, 2009. |
| 10,000 |
| 10,000 |
(8) Convertible note bearing interest at 8% per annum maturing on July 27, 2008, with a conversion price of $9.00 per share. In December 2008 the note was extended to June 30, 2009. In January 2009, the note holder combined the note balance and accrued interest owed into a purchase of nine units, each unit consisting of a 10% promissory note of $25,000 for a total of $225,000, maturing January 23, 2012 and 82,000 shares of the Company’s common stock. An additional loan to the Company, in January 2009, of $100,000 by the note holder was included as part of the purchase of the nine units (see Note 23). |
| 100,000 |
| 100,000 |
(9) Convertible note bearing interest at 8% per annum maturing on March 15, 2008, with a conversion price of $9.00 per share. In July 2008, the Company, the note holder and the Company’s investor group agreed upon a settlement whereby the debt shall be assigned to the investor group by the Company and the investor group shall repay the agreed upon settlement amount to the note holder, in installments, through February 2009. The investor group made payments totaling $35,000 to the note holder from July 2008 to December 2008 (see Note 20). |
| 65,000 |
| 100,000 |
(10) Convertible note bearing interest at 9% per annum maturing on June 9, 2009, with a conversion price of $1.40 per share. |
| 200,000 |
| 200,000 |
(11) Convertible note bearing interest at 9% per annum maturing on September 29, 2009, with a conversion price of $0.80 per share. |
| 150,000 |
| 150,000 |
(12) Six units, sold in February 2007 to six individuals, each consisting of an 18% convertible note of $16,667 for a total of $100,000, maturing August 31, 2007, with a conversion price of $0.50 per share and 6,667 bonus shares of the Company’s common stock, per individual, valued at $0.3988, for a total of 40,000 shares of common stock. Six months of prorated interest of $8,729, was due at closing and paid to the note holders. In November 2007 the notes were extended to April 30, 2008. Per the terms of the extensions, the Company repaid 20% of the note balances in November 2007. Of the remaining balances, 20% was due by January 31, 2008 and 60% plus accrued interest was due by April 30, 2008. The payments have been extended by the Company. In conjunction with the November extensions, the note holders shall receive an aggregate total of 20,000 shares of the Company’s common stock per month (“extension shares”) with a value based on the closing market price of the stock on the 18th of each month. In June 2008, the Company paid $9,768 against the six notes. In November 2008, the Company and the six note holders agreed to an amendment to the unit purchase agreements whereby the open note balances, accrued interest and shares of common stock recorded but not yet issued were forgiven and cancelled. The Company also issued 320,928 warrants with an exercise price of $0.20 per share, expiring December 22, 2012 to five of the note holders. As of December 31, 2008, one note holder has not yet agreed to the final settlement balance and his note balance of $3,512 remains open. For the years ended December 31, 2008 and 2007, the Company expensed $27,616 and $20,489, respectively, of financing expenses related to the shares issued for the note extensions and settlement (see Note 16). |
| 3,512 |
| 80,000 |
(13) Convertible note executed in March 2007 bearing interest at 18% per annum maturing on January 31, 2008, with a conversion price of $0.25 per share, which has been extended three times through January 31, 2008. In March 2008, the Company assigned the note to the Company’s investor group and the note holder agreed to an amount of $15,000 as full settlement of the note. The settlement amount was paid to the note holder by the investor group in March 2008 (see Note 20). |
| - |
| 75,000 |
F-16
(14) One unit, sold in April 2007, consisting of an 18% convertible note payable of $25,000, maturing October 24, 2007, with a conversion price of $0.50 per share and 12,000 bonus shares of the Company’s common stock, at $0.19 per share. Six months of prorated interest of $2,250, due at closing was paid to the note holder. In November 2007 the note was extended to April 30, 2008. Per the terms of the extension, the Company repaid 20% of the note balance in November 2007. Of the remaining note balance, 20% was due by January 31, 2008 and 60% plus accrued interest was due by April 30, 2008. The payments have been extended by the Company. In November 2008, the Company and the note holder agreed to an amendment to the unit purchase agreement whereby the open note balance, accrued interest and shares of common stock recorded but not yet issued were forgiven and cancelled. Per the settlement agreement, the note holder agreed to a settlement payment of $5,000. The company made two payments of $2,500 each to the note holder in November 2008 and December 2008. For the years ended December 31, 2008 and 2007, the Company expensed $0 and $3,331, respectively, of financing expenses related to the shares issued for the note extensions (see Note 16). |
| - |
| 20,000 |
(15) Convertible note executed in May 2007 bearing interest at 9% per annum maturing on May 1, 2009, with a conversion price of $0.35 per share. The Company issued 57,143 warrants with an exercise price of $0.70 per share and an expiration date of May 1, 2009. |
| 100,000 |
| 100,000 |
(16) Convertible note for $15,000 executed in June 2007 bearing interest at 9% per annum maturing on June 21, 2009, with a conversion price of $0.15 per share. The Company issued 120,000 warrants with an exercise price of $0.30 per share and an expiration date of June 21, 2009. In February 2008, the Company assigned the note to the Company’s investor group and the note holder agreed to an amount of $3,000 as full settlement of the note. The settlement amount was paid to the note holder by the investor group in February 2008 (see Note 20). |
| - |
| 15,000 |
(17) Convertible notes executed in June 2007 bearing interest at 8% per annum maturing on June 29, 2009, with a conversion price of $0.20 per share. The Company issued 100,000 warrants with an exercise price of $0.40 per share and an expiration date of June 29, 2009. |
| 100,000 |
| 100,000 |
(18) Convertible note executed in July 2007 bearing interest at 8% per annum maturing on July 2, 2009, with a conversion price of $0.20 per share. The Company issued 100,000 warrants with an exercise price of $0.40 per share and an expiration date of July 2, 2009. |
| 100,000 |
| 100,000 |
(19) Convertible notes executed in August 2007 bearing interest at 9% per annum maturing on August 9, 2009, with a conversion price of $0.25 per share. The Company issued 96,000 warrants with an exercise price of $0.40 per share and an expiration date of August 9, 2010. |
| 120,000 |
| 120,000 |
|
| 1,230,512 |
| 1,585,000 |
Less current maturities | $ | - | $ | 85,000 |
Interest expense for the convertible notes payable for the years ended December 31, 2008 and 2007 was $123,655 and $132,929, respectively.
NOTE 9 - CONVERTIBLE NOTES PAYABLE – RELATED PARTIES
|
| December 31, 2008 |
| December 31, 2007 |
(1) Convertible note executed in November 2003 with the VP of Technology bearing interest at the prime rate plus 2% per annum with an extended maturity date of June 30, 2009, and a conversion price of $10.00 per share. The Company issued 500 warrants with an exercise price of $10.00 per share expiring November 10, 2013. | $ | 50,000 | $ | 50,000 |
(2) Convertible note executed in January 2004 with the VP of Technology bearing interest at the prime rate plus 4% per annum with an extended maturity date of March 31, 2009, and a conversion price of $10.00 per share. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. |
| 7,500 |
| 7,500 |
(3) Convertible notes executed in February, June, September 2004 and August 2005 with the CEO bearing interest at an amended rate of 8% per annum with an extended maturity date of June 30, 2009, and a conversion price of $10.00 per share. The Company issued 1,800 warrants with an exercise price of $10.00 per share and expiration dates of February 4, 2014, September 7, 2014 and August 16, 2015. |
| 230,000 |
| 230,000 |
(4) Convertible notes executed in August, and September 2005 with a Software Developer bearing interest at 8% per annum with an extended maturity date of June 30, 2009, and a conversion price of $10.00 per share. The Company issued 150 warrants with an exercise price of $10.00 per share and expiration dates of August 26, 2015 and September 29, 2015. |
| 15,000 |
| 15,000 |
F-17
(5) Convertible note executed in August 2005 with the former President bearing interest at 8% per annum with an extended maturity date of December 31, 2007, and a conversion price of $10.00 per share. The Company issued 500 warrants with an exercise price of $10.00 per share and an expiration date of August 26, 2015. The note was repaid in full in February 2008. |
| - |
| 50,000 |
(6) Convertible note executed in September 2005 with a relative of the Chief Financial Officer bearing interest at 8% per annum with an extended maturity date of June 30, 2009, and a conversion price of $10.00 per share. The Company issued 50 warrants with an exercise price of $10.00 per share and an expiration date of December 7, 2015. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. |
|
|
|
|
Convertible notes payable – related parties at December 31, 2008 and 2007 consisted of the following: |
|
|
|
|
(7) Convertible note executed in December 2005 with a Software Developer bearing interest at 8% per annum with an extended maturity date of June 30, 2009, and a conversion price of $10.00 per share. The Company issued 100 warrants with an exercise price of $10.00 per share and an expiration date of December 6, 2015. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. |
| 10,000 |
| 10,000 |
(8) Convertible notes executed in December 2005 and January 2006 with the Office Manager bearing interest at 8% per annum with an extended maturity date of June 30, 2009, and a conversion price of $10.00 per share. The Company issued 800 warrants with an exercise price of $10.00 per share and expiration dates of December 28, 2015 and January 9, 2016. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. |
| 58,755 |
| 63,691 |
(9) Convertible notes executed in January and February 2006 with the CEO bearing interest at an amended rate of 8% per annum with an extended maturity date of June 30, 2009, and a conversion price of $10.00 per share. The Company issued 380 warrants with an exercise price of $10.00 per share and expiration dates of January 18, 2016 and February 28, 2016. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. |
| 38,000 |
| 38,000 |
(10) Convertible note executed in March 2006 with a Software Developer bearing interest at 8% per annum with an extended maturity date of June 30, 2009, and a conversion price of $7.50 per share. The Company issued 50 warrants with an exercise price of $10.00 per share and an expiration date of March 6, 2016. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. |
| 5,000 |
| 5,000 |
|
| 419,255 |
| 474,191 |
Less current maturities |
| (419,255) |
| (107,500) |
| $ | - | $ | 366,691 |
At December 31, 2008 and 2007, accrued interest due for the convertible notes – related parties was $120,948 and $86,021, respectively, and is included in accrued expenses in the accompanying balance sheet. Interest expense for convertible notes payable – related parties for the years ended December 31, 2008 and 2007 was $34,928 and $40,273, respectively.
NOTE 10 - NOTES PAYABLE
Notes payable at December 31, 2008 and 2007 consisted of the following:
|
| December 31, 2008 |
| December 31, 2007 |
(1) One unit consisting of a $100,000 promissory note and 20,000 shares of the Company’s common stock, at $1.40, sold in May 2006. The note bears interest at 9% per annum and matured on August 28, 2006. Because the note was not fully repaid within a twenty (20) day grace period after the maturity date, the remaining outstanding principal and accrued and unpaid interest was convertible into shares of common stock of the Company at the sole option of the holder, at a conversion price equal to the lesser of (a) $2.20 or (b) ninety percent (90%) of the lowest VWAP, as defined, of the common stock during the thirty (30) trading days immediately preceding the date of conversion as quoted by Bloomberg, LP. The Company paid a placement agent fee of $7,000 relating to the promissory note. In January 2008, the Company executed a Forbearance Agreement with YA Global, the note holder, whereby YA Global has agreed to forbear from exercising its rights under the secured convertible debentures through February 27, 2008. The terms of the Forbearance Agreement also include a reduction in the YA Global Fixed Conversion Price to $0.065. In February 2008, the Forbearance Agreement was further extended to May 15, 2008. In May 2008, the Company executed a Forbearance Agreement with YA Global, the note holder, whereby YA Global has agreed to forbear from exercising its rights under the secured convertible debentures through October 15, 2008. The Company is pursuing an extension. | $ | 100,000 | $ | 100,000 |
F-18
(2) Six 12% promissory notes of $25,000, maturing January 10, 2007, for a total of $150,000. In January 2007, the Company extended the maturity date of five of the notes, totaling $100,000, to March 10, 2007 and increased the interest rate to 20% per annum. The remaining promissory note in the amount of $50,000 was paid in full in February 2007. In 2007, the Company paid $81,250 against the five remaining notes. In June 2008, the Company paid $2,289 against the two remaining notes. In November 2008, the Company and the two remaining note holders agreed to an amendment to the unit purchase agreements whereby the open note balances, accrued interest and shares of common stock recorded but not yet issued were forgiven and cancelled. In December 2008, the two note holders received a total of 59,384 shares of common stock, at $0.095 per share, relating to the settlement agreement. The Company also issued 79,179 warrants with an exercise price of $0.20 per share, expiring December 22, 2012 to the two note holders. For the years ended December 31, 2008 and 2007, the Company expensed $5,641 and $21,273, respectively, of financing expenses related to the shares issued for the note extensions, penalties and settlement (see Note 16). |
| - |
| 18,750 |
(3) Promissory note executed in June 2007, bearing interest at 9% per annum, maturing on December 14, 2007. In December 2007, the Company repaid $5,000 of the principal to the note holder and the note was extended to January 31, 2008. In January 2009, the note holder executed a forbearance agreement whereby he agreed to forbear his rights under the promissory note until March 31, 2009. Per the terms of the agreement, the Company made a $10,000 payment to the note holder in January 2009 and issued 500,000 shares of restricted common stock, at $0.07 per share, to be held in escrow with the note holder’s attorney. The escrow shares will be returned to the Company contingent upon the Company’s payment of the remaining note balance and accrued interest to the note holder by March 31, 2009 (see Note 23). |
| 45,000 |
| 45,000 |
(4) Promissory note for $15,000 executed in November 2007, bearing interest at 8% per annum, maturing on May 21, 2008. In March 2008, the agreement was terminated, the note was cancelled and the debt was forgiven. |
| - |
| 15,000 |
(5) Promissory note for $52,500 executed in December 2007, bearing interest at 12% per annum, maturing on September 6, 2008. The note was repaid in full in March 2008. |
| - |
| 52,500 |
(6) Promissory note for $50,000 executed in December 2007, bearing interest at 8% per annum, maturing on December 31, 2008. The note was repaid in full in March 2008. |
| - |
| 50,000 |
(7) Promissory note executed in January 2008, bearing interest at 8% per annum, maturing on December 31, 2008. In September 2008 the note was extended to December 31, 2008. The Company made a payment of $94,792 to the note holder in December 2008. In December 2008, the note was extended to June 30, 2009. |
| 5,208 |
| - |
(8) Promissory note executed in January 2008, bearing interest at 18% per annum, maturing on July 31, 2008. In July 2008 the note was extended to December 31, 2008. In December 2008, the note was extended to June 30, 2009. |
| 50,000 |
| - |
(9) Seventy units, sold in 2008, with each unit consisting of a 10% promissory note of $25,000, maturing three years from the execution date and with a 10% discount rate, and 62,000 non-dilutable (for one year) restricted shares of the Company’s common stock, at market price. |
| 1,750,000 |
| - |
|
| 1,950,208 |
| 281,250 |
Less current maturities |
| (200,208) |
| (281,250) |
| $ | 1,750,000 | $ | - |
Interest expense for notes payable for the years ended December 31, 2008 and 2007 was $176,833 and $34,347, respectively.
NOTE 11 -
NOTES PAYABLE – RELATED PARTIES
Notes payable – related parties at December 31, 2008 and 2007 consisted of the following:
|
| December 31, 2008 |
| December 31, 2007 |
(1) Promissory notes executed in March 2004 with the CEO bearing interest at an amended rate of 8% per annum with an extended maturity date of June 30, 2009. | $ | 105,000 | $ | 105,000 |
(2) Promissory note executed in November 2004 with the CEO bearing interest at an amended rate of 8% per annum with an extended maturity date of June 30, 2009. |
| 84,000 |
| 84,000 |
(3) Promissory notes executed in January 2006 with the former President, non-interest bearing, with an extended maturity date of December 31, 2007. The note was repaid in full in February 2008. |
| - |
| 10,000 |
F-19
(4) Promissory notes executed in February and April 2006 with the CEO bearing interest at 8% per annum with an extended maturity date of June 30, 2009. |
| 315,000 |
| 315,000 |
(5) Promissory notes executed in February and March 2006 with the former President bearing interest at 8% per annum with an extended maturity date of December 31, 2007. The notes were repaid in full in February 2008. |
| - |
| 15,000 |
(6) Promissory note executed in May 2006 with the CEO bearing interest at 9% per annum with an extended maturity date of June 30, 2009. The Company issued 20,000 warrants with an exercise price of $1.30 per share and an expiration date of May 25, 2011. The fair value of the warrants issued was $24,300. |
| 100,000 |
| 100,000 |
(7) Promissory note executed in February 2007 with the CEO bearing interest at 8% per annum with an extended maturity date of June 30, 2009. The Company issued 8,800 warrants with an exercise price of $0.50 per share and an expiration date of February 21, 2012. The fair value of the warrants issued was $3,758. For the years ended December 31, 2008 and 2007, the Company recorded $0 and $3,758, respectively, in financing expense related to the issuance of these warrants. 70,000 |
| 22,000 |
| 22,000 |
(8) Promissory notes executed in February 2008 with the former President bearing interest at 8% per annum with a maturity date of February 28, 2009. The Company is pursuing note extensions. |
| 70,000 |
| - |
| $ | 696,000 | $ | 651,000 |
Less current maturities |
| (696,000) |
| (25,000) |
| $ | - | $ | 626,000 |
Interest expense for notes payable - related parties for the years ended December 31, 2008 and 2007 was $56,395 and $52,280, respectively.
NOTE 12 - CAPITAL LEASE PAYABLE
The aggregate minimum remaining lease payments under capital leases consisted of the following at December 31, 2008:
|
| December 31, |
|
| 2008 |
Due period ending December 31, 2007 | $ | 5,532 |
Less: amount representing interest |
| - |
Net present value of capital lease obligations |
| 5,532 |
Current portion of capital lease payable |
| (5,532) |
Capital lease payable, net of current portion | $ | - |
The capital leases listed above relate to property and equipment with a book value of $11,830.
NOTE 13 -
ACCRUED EXPENSES
Accrued expenses consisted of the following at December 31, 2008 and 2007:
|
| December 31 | ||
|
| 2008 |
| 2007 |
Interest | $ | 805,919 | $ | 579,534 |
Commitment fees |
| 32,697 |
| 32,697 |
Professional fees |
| 153,146 |
| 153,146 |
Other |
| 747,768 |
| 422,385 |
Total Accrued Expenses | $ | 1,739,530 | $ | 1,187,762 |
NOTE 14 - CONVERTIBLE SECURED NOTES PAYABLE
Convertible secured notes payable consisted of the following at December 31, 2008 and 2007:
|
| December 31, 2008 |
| December 31, 2007 |
YA Global (formerly Cornell) | $ | 427,447 | $ | 427,447 |
Highgate House Funds, Ltd. |
| 244,720 |
| 244,720 |
Total convertible secured notes payable | $ | 672,167 | $ | 672,167 |
F-20
On April 27, 2005, the Company entered into an amended and restated 8% secured convertible debenture with YA Global Investments, LP, formerly Cornell Capital Partners, LP, (“Amended YA Global Debenture”) in the amount of $1,024,876, which terminated the two $500,000 debentures entered into with YA Global in December 2004 and January 2005. The new debenture entitles YA Global, at its option, to convert, the debenture, plus accrued interest, into shares of the Company’s common stock at a price per share equal to the lesser of (i) the greater of $2.50 or an amount equal to 120% of the initial bid price or (ii) an amount equal to 80% of the lowest Volume Weighted Average Price, as defined, of the Company’s common stock for the last five trading days immediately preceding the conversion date. If not converted, the entire principal amount and all accrued interest shall be due on the second year anniversary of the debenture. The Company, at its option, may redeem, with fifteen days advance written notice, a portion or all the outstanding convertible debentures. The redemption shall be 110% of the amount redeemed plus accrued interest remaining for the first six months of the executed debenture and after that time the redemption is 120% of the amount redeemed plus accrued interest remaining. The conversion feature and the Company’s optional early redemption right have been bundled together as a single compound embedded derivative liability, and fair valued using a layered probability-weighted cash flow approach.
On April 27, 2005, the Company entered into a Securities Purchase Agreement (“SPA”) with Highgate House Funds, Ltd. (“Highgate”) pursuant to which the Company received $750,000 in exchange for two 7% secured convertible debentures amounting to $750,000 that mature in two (2) years, and the issuance of 15,000 shares of the Company’s common stock. The first debenture funding occurred upon the signing of the SPA and the second debenture funding occurred upon the filing of the registration statement. The Company has agreed to reserve for issuance of 200,000 shares of the Company’s common stock, which may be adjusted as agreed upon by the parties, to be issued to the debenture holder upon conversion of accrued interest and liquidated damages and additional shares of common stock required to be issued to the debenture holder in accordance with the SPA. Additionally, in accordance with the SPA, the Company is required to maintain in escrow and register with the SEC five times the number of shares of common stock that would be needed to satisfy the full conversion of all such convertible debentures outstanding and to issue additional shares as needed if the number of shares in escrow becomes less than that required. Further, following a notice of conversion, the investors may sell escrowed shares in the registered distribution before they are actually delivered, but, the investors will not engage in short sales. The terms of the secured debentures contain a limitation that precludes conversion when the amount of shares already owned by YA Global and Highgate, plus the amount of shares still outstanding to be converted, would exceed 4.99%. The limitation may be waived by YA Global upon 61 days advance written notification to the Company. In addition, on the third anniversary of the issuance date of the YA Global debenture and second anniversary of the issuance dates of the Highgate debentures, any outstanding principal or interest owed on the secured debentures will be converted into stock without any applicable limitation on the number of shares that may be converted.
The aforementioned debentures bear interest at a rate of 7% per annum, compounded monthly, and expire 2 years after the date of issuance. The debentures are convertible into shares of common stock at a conversion price equal to the lesser of (i) 120% of the average closing bid price for the 5 trading days immediately preceding the closing date; or (ii) 80% of the lowest closing bid price for the 5 trading days immediately preceding the date of conversion. In addition, the Company has the right to redeem the debentures, at any time prior to its maturity, upon 3 business day’s prior written notice to the holder. The redemption price is equal to 120% of the face amount redeemed plus accrued interest. In the event that the Company redeems the debentures within 180 days after the date of issuance, the redemption price shall be 110% of the face amount redeemed plus accrued interest. The conversion feature and the Company’s optional early redemption right have been bundled together as a single compound embedded derivative liability, and fair valued using a layered probability-weighted cash flow approach.
In July 2006, the Company agreed to an anti-dilution adjustment with YA Global and Highgate whereby the conversion price of the secured convertible debentures was reduced to a fixed per share price equal to the lower of $0.85 or 80% of the lowest closing bid price during the five days preceding the conversion date.
The SPA contains certain negative covenants concerning assets, ownership, management and debt. The Company has paid $75,000 for structuring fees and expenses and $5,000 for commitment fees related to this SPA.
Interest expense for the convertible secured notes payable for the years ended December 31, 2008 and 2007 was $51,529 and $80,736, respectively.
F-21
In January 2008, the Company executed a Forbearance Agreement with YA Global whereby YA Global and Highgate have agreed to forbear from exercising their rights under the secured convertible debentures through February 27, 2008. The terms of the Forbearance Agreement record the amount due to YA Global and Highgate by the Company to be $1,214,093, which includes principal, interest and the redemption premium. The terms also include a reduction in the YA Global and Highgate Fixed Conversion Price to $0.065. In connection with this Agreement, the Company issued to YA Global 500,000 contingency warrants with an exercise price of $0.15 per share. The warrants are exercisable for a period of five (5) years from date of issuance. The warrants are held in escrow and will only be released to YA Global if the total amount due by the Company is not paid to YA Global by February 29, 2008.
In February 2008, the Forbearance Agreement was amended and extended to May 15, 2008, including the terms of the contingency warrants. Per the terms of the amendment, YA Global and Highgate shall receive an additional 105 days of interest for a total amount of $28,328.84 additional interest. The additional interest plus a security deposit of $171,671.16 were paid to YA Global and Highgate per the terms of a debt assignment agreement executed with an investor group in February 2008, for a total amount paid to YA Global of $200,000. The security deposit will be applied to the amount due YA Global and Highgate if the remaining balance due is paid in full by May 15, 2008. Otherwise, the security deposit will be applied to YA Global as liquidated damages.
In May 2008, the Company executed a Forbearance Agreement with YA Global that supersedes the January 2008 agreement and February 2008 amendment, whereby YA Global and Highgate have agreed to forbear from exercising their rights under the secured convertible debentures through October 15, 2008. Per the terms of the May 2008 Forbearance Agreement, the Company agreed to use its best efforts to make available sufficient authorized shares of its common stock to effect conversion of the entire amount outstanding, to YA Global and Highgate, by October 15, 2008. The terms of the contingency warrants became applicable to the terms of the May 2008 Forbearance Agreement. Additionally, per the terms of the agreement, the Company’s investor group paid $75,000 to YA Global in May 2008 which is further broken down as:
·
$17,268 (additional prepaid interest to YA Global from May 15, 2008 to October 15, 2008)
·
$7,181 (additional prepaid interest to Highgate from May 15, 2008 to October 15, 2008)
·
$27,840 (accrued interest due on the Highgate debenture dated April 26, 2005)
·
$22,711 (non-refundable extension payment that will be applied to the redemption amount if the remaining balance is paid in full by October 15, 2008)
The payment of the accrued interest of $27,840 for the Highgate April 26, 2005 debenture reduced the total amount of our indebtedness to YA Global and Highgate to $1,186,253 as agreed to in the May 2008 Forbearance Agreement.
The Company is in discussions with YA Global regarding an extension to the May 2008 Forbearance Agreement, which was in effect until October 15, 2008. The Company and YA Global are negotiating an extension which would extend and amend the Forbearance Agreement to the end of the second quarter of 2009, but a final agreement has not yet been completed.
Conversions to Common Stock
For the year ended December 31, 2008, YA Global had no conversions.
For the year ended December 31, 2007, YA Global converted $597,429.56 of the April 27, 2005 debenture into 5,376,225 shares of the Company’s common stock, pursuant to the terms of the Securities Purchase Agreement. The conversion price ranged from $0.037 to $0.34 per share.
For the year ended December 31, 2008, Highgate had no conversions.
For the year ended December 31, 2007, Highgate converted $20,279.64 of the May 6, 2005 debenture into 59,046 shares of the Company’s common stock, pursuant to the terms of the Securities Purchase Agreement. The conversion price was $0.34 per share.
F-22
NOTE 15 - FINANCIAL INSTRUMENTS
The secured convertible notes payable are hybrid instruments which contain an embedded derivative feature which would individually warrant separate accounting as a derivative instrument under SFAS No. 133. The embedded derivative feature has been bifurcated from the debt host contract, referred to as the "Compound Embedded Derivative Liability". The embedded derivative feature includes the conversion feature within the note and an early redemption option. The value of the embedded derivative liability was bifurcated from the debt host contract and recorded as a derivative liability, which resulted in a reduction of the initial carrying amount (as unamortized discount) of the notes. The unamortized discount is amortized to interest expense using the effective interest method over the life of the notes, or 12 months.
The secured convertible debentures issued to YA Global and Highgate have been accounted for in accordance with SFAS No. 133 and EITF 00-19. The Company has identified the above instruments having derivatives that require evaluation and accounting under the relevant guidance applicable to financial derivatives. These compound embedded derivatives have been bifurcated from their respective host debt contracts and accounted for as derivative liabilities in accordance with EITF 00-19. When multiple derivatives exist within convertible notes, they have been bundled together as a single hybrid compound instrument in accordance with SFAS No. 133 Derivatives Implementation Group Implementation Issue No. B-15, “Embedded Derivatives: Separate Accounting for Multiple Derivative Features Embedded in a Single Hybrid Instrument”. The compound embedded derivatives within the secured convertible notes have been recorded at fair value at the date of issuance; and are marked-to-market each reporting period with changes in fair value recorded to the Company’s statement of operations as “Derivative instrument expense, net”. The Company has utilized a third party valuation consultant to fair value the compound embedded derivatives using a layered discounted probability-weighted cash flow approach. The fair value of the derivative liabilities are subject to the changes in the trading value of the Company’s common stock, as well as other factors. As a result, the Company’s financial statements may fluctuate from quarter-to-quarter based on factors, such as the price of the Company’s stock at the balance sheet date and the amount of shares converted by note holders. Consequently, the financial position and results of operations may vary from quarter-to-quarter based on conditions other than operating revenues and expenses.
NOTE 16 - STOCKHOLDERS’ DEFICIT
Common Stock
On August 8, 2008, the shareholders of the Company authorized a 1 for 10 reverse stock split. All share and per share data in the financial statements and related notes have been restated to give retroactive effect to the reverse stock split.
Issuance of Stock for Services
In August 2005, the Company entered into a retainer agreement with an attorney, whereas the attorney will act as in house counsel for the Company with respect to all general corporate matters. The agreement is at will and required a payment of 1,000 shares of common stock, valued at $9.00 per share, due upon execution. The certificate for the 1,000 shares of common stock was issued in October 2005. Commencing on September 1, 2005, the fee structure also includes a monthly cash fee of $1,000 and the monthly issuance of 2,500 shares of common stock, valued at market. For the year ended December 31, 2008, the Company issued 10,500 shares of common stock, valued at $1,360, all of which has been expensed as legal fees, related to the agreement. 750 shares of the common stock issued in 2008 were recorded and expensed, at $125, in 2007.
In December 2007, the Company executed a consulting agreement with a financial advisor whereby the consultant will provide introduction of potential investors to the Company. As compensation for the services, the consultant shall receive a monthly fee in the amount of $5,000. The agreement can be terminated by either party by providing the other party with thirty days advance written notice. The consultant received 500,000 shares of the Company’s common stock, valued at $0.065 per share. The shares are restricted and have piggyback registration rights upon the next registration statement filed by the Company.
Issuance of Stock for Financing
In January 2008, the Company recorded 1,000,000 shares of common stock, valued at $0.0092 per share, issuable to an individual as consideration for a promissory note executed in January 2008 (see Note 10). The shares have Rule 144 piggyback registration rights. For the year ended December 31, 2008, the Company expensed $9,200 of financing expenses related to the shares. The shares were issued in November 2008.
F-23
In accordance with a term sheet executed with an investment firm in January 2008, the Company sold 59 units to twenty-two investors. In January 2008, the Company recorded 2,294,000 shares of common stock, valued at $0.023 to $0.025 per share, issuable to twelve investors per the terms of the agreement. In February 2008, the Company recorded 1,054,000 shares of common stock, valued at $0.028 to $0.038 per share, issuable to seven investors per the terms of the agreement. In March 2008, the Company recorded 248,000 shares of common stock, valued at $0.025 per share, issuable to one investor per the terms of the agreement. In April 2008, the Company recorded 62,000 shares of common stock, valued at $0.017 to $0.018 per share, issuable to two investors per the terms of the agreement. In May 2008, in accordance with an amendment to the term sheet the Company signed with the investor firm, the Company recorded 1,180,000 shares of the Company’s common stock, valued at $0.02 per share, to reflect the retroactive increase in the shares to be issued to the investors who purchased units as of the date of the amendment. The increase recorded was 20,000 shares for each unit sold (see Note 20). In July 2008, the Company recorded 82,000 shares of common stock, valued at $0.023 per share, issuable to one investor per the terms of the agreement. In August 2008, the Company recorded 492,000 shares of common stock, valued at $0.011 to $0.019 per share, issuable to two investors per the terms of the agreement. In September 2008, the Company recorded 164,000 shares of common stock, valued at $0.017 per share, issuable to one investor per the terms of the agreement. The 5,576,000 shares recorded from January to September 2008 were issued in November 2008. In December 2008, the Company issued 164,000 shares of common stock, valued at $0.08 per share, issuable to two investors per the terms of the agreement (see Note 20). All of the shares recorded relating to the term sheet are non-dilutable and have Rule 144 piggyback registration rights. For the year ended December 31, 2008, the Company expensed $140,849 of financing expenses related to the shares.
In December 2008, the Company issued 290,695 shares of common stock, valued at $0.095 per share, issuable to five note holders and the placement agent per an amendment executed in November 2008 to the February 2007 unit purchase agreements (see Note 8). Per the amendment, the shares of common stock recorded but not yet issued were forgiven and cancelled. The 240,000 shares of common stock recorded from December 2007 through September 2008 were cancelled in December 2008 and $46,800 in financing expense was reversed. For the years ended December 31, 2008 and 2007, the Company expensed $27,616 and $20,489, respectively, of financing expenses related to the shares issued for the note extensions and settlement.
In December 2008, the Company cancelled 60,000 shares of common stock, recorded but not yet issued, issuable to a note holder and the placement agent per an amendment executed in November 2008 to the April 2007 unit purchase agreement (see Note 8). Per the amendment, the shares of common stock recorded but not yet issued were forgiven and cancelled. The 60,000 shares of common stock recorded from December 2007 through September 2008 were cancelled in December 2008 and $11,700 in financing expense was reversed. For the years ended December 31, 2008 and 2007, the Company expensed $0 and $3,331, respectively, of financing expenses related to the shares issued for the note extensions.
In December 2008, the Company issued 59,384 shares of common stock, valued at $0.095 per share, issuable to two remaining note holders per an amendment executed in November 2008 to the July 2006 unit purchase agreements (see Note 10). Per the amendment, the shares of common stock recorded but not yet issued were forgiven and cancelled. The 19,618 shares of common stock recorded from December 2007 through September 2008 were cancelled in December 2008 and $3,836 in financing expense was reversed. For the years ended December 31, 2008 and 2007, the Company expensed $5,641 and $21,273, respectively, of financing expenses related to the shares issued for the note extensions and settlement.
Issuance of Warrants for Financing
In December 2008, the Company issued 320,928 warrants with an exercise price of $0.20 per share and expiring December 22, 2012 to five note holders per an amendment executed in November 2008 to the February 2007 unit purchase agreements (see Note 8). The fair value of the warrants was $32,061. For the years ended December 31, 2008 and 2007, the Company recorded $32,061 and $0, respectively, in financing expense related to the issuance of these warrants.
In December 2008, the Company issued 79,179 warrants with an exercise price of $0.20 per share and expiring December 22, 2012 to two remaining note holders per an amendment executed in November 2008 to the July 2006 unit purchase agreements (see Note 10). The fair value of the warrants was $7,910. For the years ended December 31, 2008 and 2007, the Company recorded $7,910 and $0, respectively, in financing expense related to the issuance of these warrants.
F-24
Warrants
At December 31, 2008, the Company issued warrants related to its convertible notes payable. The warrants entitle the note holders to purchase the Company’s common stock at: 6,667 warrants with an exercise price of $5.50 per share, 40,000 warrants with an exercise price of $2.50 per share, 4,500 warrants with an exercise price of $2.00 per share, 56,250 warrants with an exercise price of $1.60 per share, 57,143 warrants with an exercise price of $0.70 per share, 446,000 warrants with an exercise price of $0.40 per share and 120,000 warrants with an exercise price of $0.30 per share. 383,810 warrants have a two year exercise term, 100,500 warrants have a three year exercise term and 246,250 warrants have a five year exercise term.
At December 31, 2008, the Company issued warrants related to its convertible notes payable – related parties. The warrants entitle the note holders to purchase the Company’s common stock at $10.00 per share and have an exercise term of ten years. At December 31, 2008, 3,100 warrants will expire in the year 2013, 1,650 warrants expire in the year 2014, 2,170 warrants in the year 2015 and 1,130 warrants in the year 2016.
At December 31, 2008, the Company issued warrants related to its notes payable. The warrants entitle the note holder to purchase the Company’s common stock at $0.25 per share for 15,000 warrants and $0.50 per share for 10,000 warrants with an exercise term of five years.
At December 31, 2008, the Company issued warrants related to its notes payable – related parties. The warrants entitle the note holder to purchase the Company’s common stock at $0.50 per share for 8,800 warrants and $1.30 per share for a 20,000 warrants with an exercise term of five years.
NOTE 17 - STOCK BASED COMPENSATION
In September 2004, the stockholders approved the Equity Incentive Plan for its employees (“Incentive Plan”), effective April 1, 2004. Of the total authorized for issuance at December 31, 2008, 98,572,703 shares were available for future issuance.
2004 Equity Incentive Plan
The number of shares authorized for issuance under the Incentive Plan was increased to 10,000,000 in September 2006, 15,000,000 in March 2007, 20,000,000 in June 2007 and 100,000,000 in December 2007, by unanimous consent of the Board of Directors. In August 2008, the Company repurchased, at no cost, employee stock options totaling 1,111,791 shares of common stock from twelve employees as a result of a voluntary tender by the employees. The exercise price of the cancelled options ranged from $0.15 per share to $10.00 per share.
Option shares totaling 142,500 vest equally over a three year period beginning one-year from the date of grant, option shares totaling 200,000 vest in one-third increments of six months each over an eighteen month period from the date of grant and option shares totaling 1,084,797 vest over a one-year period from the date of grant.
The table below summarizes the Company’s Incentive Plan stock option activity through December 31, 2008:
| Number of Option Shares |
| Exercise Price Range Per Share |
| Weighted Average Exercise Price |
| Weighted Average Remaining (in years) |
| Aggregate Intrinsic Value (in thousands) |
Balance, January 1, 2007 | 634,455 | $ | 0.70 - $ 1.00 | $ | 3.540 |
|
| $ | --- |
Granted | 1,904,633 | $ | 0.08 - $ 5.00 | $ | 0.221 |
|
| $ | --- |
Balance, |
|
|
|
|
|
|
|
|
|
December 31, 2007 | 2,539,088 | $ | 0.08 - $ 10.00 | $ | 1.050 |
|
| $ | --- |
Cancelled | 1,111,791 | $ | 0.15 - $ 10.00 | $ | 1.823 |
|
| $ | --- |
Balance, |
|
|
|
|
|
|
|
|
|
December 31, 2008 | 1,427,297 | $ | 0.08 - $ 10.00 | $ | 0.448 |
|
| $ | --- |
Vested and Exercisable, December 31, 2008 | 1,357,852 |
|
| $ | 0.448 |
|
| $ | --- |
F-25
As of December 31, 2008, an aggregate of 1,427,297 options were outstanding under the incentive plan. The exercise price for 37,500 options is $10.00, for 105,000 options is $1.00, for 9,231 is $0.375, for 15,705 is $0.24, for 16,388 options is $0.23, for 325,577 options is $0.20, for 171,131 options is $0.17, for 259,743 options is $0.15 and 487,022 options is $0.08. As of December 31, 2007, an aggregate of 2,539,088 options were outstanding under the incentive plan. The exercise price for 183,000 options was $10.00, for 10,000 options was $5.00, for 277,500 options was $1.00, for 34,810 options was $0.99, for 40,543 options was $0.85, for 49,231 options was $0.70, for 49,372 options was $0.698, for 202,308 was $0.50, for 55,812 was $0.45, for 91,898 was $0.375, for 78,526 was $0.24, for 155,184 options was $0.23, for 377,308 options was $0.20, for 186,832 options was $0.17, for 259,743 options was $0.15 and for 487,021 options was $0.08. At December 31, 2008, there were 1,357,852 vested incentive plan stock options outstanding of which 487,019 options are exercisable at $0.08, 259,744 options are exercisable at $0.15, 171,132 options are exercisable at $0.17, 273,494 options are exercisable at $0.20, 16,388 options are exercisable at $0.23, 15,705 options are exercisable at $0.24, 9,231 options are exercisable at $0.375, 87,500 options are exercisable at $1.00 and 37,639 options are exercisable at $10.00.
As of December 31, 2008, there was $20,086 of total unrecognized compensation cost related to unvested share-based compensation arrangements that is expected to be recognized over a weighted-average period of 12 months.
The following table summarizes information concerning outstanding and exercisable Incentive Plan options as of December 31, 2008:
|
| Options Outstanding |
| Options Exercisable |
| |||||||||||
Range of Exercise Prices |
| Number Outstanding |
| Average Remaining Contractual Life (in years) |
| Weighted-Average Exercise Price |
| Number Exercisable |
| Weighted-Average Exercise Price |
| |||||
$10.000 |
|
| 37,500 |
|
| 7.00 |
| $ | 10.000 |
|
| 37,639 |
| $ | 10.000 |
|
$1.000 |
|
| 105,000 |
|
| 9.00 |
|
| 1.000 |
|
| 87,500 |
|
| 1.000 |
|
$0.080 - $0.375 |
|
| 1,284,797 |
|
| 10.00 |
|
| 0.143 |
|
| 1,232,713 |
|
| 0.143 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 1,427,297 |
|
| 8.67 |
| $ | 0.448 |
|
| 1,357,852 |
| $ | 0.448 |
|
Non-Incentive Plan Stock Option Grants
Since December 31, 2005, the Company has outstanding an aggregate of 761,889 non-plan, non-qualified options for non-employees with 760,000 exercisable at $3.60 and 1,889 exercisable at $9.00 yielding a weighted average exercise price of $3.613 and no outstanding incentive options outside of the Plan.
NOTE 18 - INCOME TAXES
As of December 31, 2008, the Company had deferred tax assets of approximately $3,874,000, resulting from certain temporary and permanent differences and net operating loss (“NOL”) carry-forwards of approximately $11,395,000, which are available to offset future taxable income, if any, through 2028. As utilization of the net operating loss carry-forwards and temporary difference is not considered more likely than not and accordingly, the deferred tax asset has been fully offset by a valuation allowance.
Deferred tax assets consist primarily of the tax effect of NOL carry-forwards. The Company has provided a full valuation allowance on the deferred tax assets because of the uncertainty regarding its realizability. The valuation allowance increased approximately $232,000 and $443,000 for the year ended December 31, 2008 and 2007, respectively.
Components of deferred tax assets as of December 31, 2008 and 2007 are as follows:
F-26
|
| December 31 | ||
|
| 2008 |
| 2007 |
Net deferred tax assets – Non-current: |
|
|
|
|
Expected Federal income tax benefit from NOL carry-forwards | $ | 3,874,000 | $ | 3,642,000 |
Less valuation allowance |
| (3,874,000) |
| (3,642,000) |
Deferred tax assets, net of valuation allowance | $ | - | $ | - |
|
|
|
|
|
The reconciliation of the effective income tax rate to the federal statutory rate |
|
|
|
|
Federal income tax rate |
| 34.0% |
| 34.0% |
Change in valuation allowance on net operating loss carry-forwards |
| (34.0)% |
| (34.0)% |
Effective income tax rate |
| 0.0% |
| 0.0% |
NOTE 19 - COMMITMENTS AND CONTINGENCIES
Payroll Taxes
As of December 31, 2008, the Company owes $53,481 of payroll taxes, of which approximately $45,000 are delinquent from the year ended December 31, 2003. The Company has also recorded $32,462 of related estimated penalties and interest on the delinquent payroll taxes. Although the Company has not entered into any formal repayment agreements with the respective tax authorities, management plans to make payment as funds become available.
Lease Agreements
In January 2008, the Company executed a lease renewal agreement with its landlord. The term of the renewal is from February 1, 2008 through January 31, 2013. Per the terms of the renewal, the Company shall pay a monthly base rent of $6,356 with no rent payments due for the months of February 2008, February 2009 and February 2010. In September 2008, the Company commenced discussions with the landlord to reduce the rent by 50%, effective September 2008, for a period of six months. In November 2008, the Company executed a lease amendment with its landlord whereby the Company made reduced base rent payments of $3,049 per month for the months of September 2008 through February 2009. The base rent payments for the months of March through May 2009 shall be $6,356 per month. The base rent payments for the months of June through November 2009 shall be $9,996 per month. The base rent payments from December 2009 through the remainder of the lease term shall be $6,356 per month. The landlord agreed to waive late fees owed prior to November 2008 of $4,904 provided the Company does not default on the lease through November 30, 2009.
In October 2008, the Company executed a lease termination agreement for certain office equipment. The Company and the leasing company executed a new one-year lease effective November 2008 for the equipment. Per the terms of the new lease, the Company shall make twelve monthly payments of $93.95 plus tax including a $1 purchase option upon lease termination.
Consulting Agreements
In January 2008, the Company executed a representation letter with an attorney whereby the attorney shall serve as general counsel to the Company. As compensation for the services, the attorney shall receive a monthly fee in the amount of $3,500, commencing in February 2008. The agreement can be terminated by either party by providing the other party with thirty days advance written notice. The Company terminated the agreement in April 2008.
In February 2008, the Company executed a representation letter with an attorney whereby the attorney shall serve as patent attorney to the Company. As compensation for the services, the attorney shall invoice the Company on an hourly basis. The Company paid a retainer of $5,000 to the attorney which was applied to the Company’s first invoice. The agreement can be terminated by the Company at any time by providing the attorney with written notice.
In November 2008, the Company executed a consulting agreement with a marketing firm whereby the firm shall provide the Company with a marketing and advertising strategy and also design the Company’s new web site and improve its internet presence. In November 2008, the Company’s investor group paid a retainer of $18,000 to the firm. In December 2008, the Company’s investor group paid the agreement Phase 1 fee of $17,500 to the firm (see Note 20 below). Phase 2 of the agreement is in progress and, upon its completion, the fee shall be $12,900. If the Company elects to proceed with the marketing firm once Phase 2 is completed, the monthly fee shall be $8,000. The Company has also agreed to pay a Success Fee to the firm in the amount of 5% of gross sales generated above the first $100,000 of gross sales of the Company’s GuardedID® product between November 2008 and December 2009. Either party may terminate the agreement by providing sixty days written notice to the other party.
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Investor Group
In January 2008, the Company executed a term sheet with an investor group whereby the group will assist the Company on an ongoing best efforts basis in order for the Company to obtain financing of up to $2,500,000 in the form of up to 100 units, each unit containing a $25,000 promissory note and 62,000 non-dilutable (for one year), restricted shares of the Company’s common stock. The promissory notes shall have a three year term, bearing interest at 10% per annum, with a 10% discount rate. All funds received as a result of the sale of the units shall be held in an escrow account that shall be managed by the investor group’s assigned representative. Upon repayment of the Company’s open secured notes and receipt of a release of indebtedness from YA Global and Highgate, the intellectual property of the Company will be pledged to the note holders in the investor group until such time that the unsecured notes and accrued interest of the investor group are repaid in full. In January 2008, the Company sold 37 units to the investor group for a total of $925,000 in promissory notes with a discount of $92,500. In November 2008, the Company issued 2,294,000 shares of common stock in relation to the units sold. In February 2008, the Company sold 17 units to the investor group for a total of $425,000 in promissory notes with a discount of $42,500. In November 2008, the Company issued 1,054,000 shares of common stock in relation to the units sold. In March 2008, the Company sold 4 units to the investor group for a total of $100,000 in promissory notes with a discount of $10,000. In November 2008, the Company issued 248,000 shares of common stock in relation to the units sold. In April 2008, the Company sold 1 unit to the investor group for a total of $25,000 in promissory notes with a discount of $2,500. In November 2008, the Company issued 62,000 shares of common stock in relation to the unit sold. In May 2008, the Company executed an amendment to the term sheet whereby the number of restricted and non-dilutable shares of the Company’s common stock to be issued per unit sold was increased from 62,000 shares to 82,000 shares. The increase was applied retroactively to those investors who purchased units as of the date of the amendment. In November 2008, in accordance with the amendment, the Company issued 1,180,000 shares of the Company’s common stock, valued at $0.02 per share, and computed as 20,000 shares multiplied by 59 units to reflect the retroactive increase in the shares to be issued to the investors who purchased units as of the date of the amendment (see Note 16). In July 2008, the Company sold 1 unit to the investor group for a total of $25,000 in promissory notes with a discount of $2,500. In November 2008, the Company issued 82,000 shares of common stock in relation to the unit sold. In August 2008, the Company sold 6 units to the investor group for a total of $150,000 in promissory notes with a discount of $15,000. In November 2008, the Company issued 492,000 shares of common stock in relation to the units sold. In September 2008, the Company sold 2 units to the investor group for a total of $50,000 in promissory notes with a discount of $5,000. In November 2008, the Company issued 164,000 shares of common stock in relation to the units sold. In December 2008, the Company sold 2 units to the investor group for a total of $50,000 in promissory notes, with no discount, and the Company issued 164,000 shares of common stock in relation to the units sold (see Note 16). The investor group advanced funds totaling $50,000 in February 2008, $280,000 in March 2008, $74,070 in April 2008, $80,000 in May 2008, $95,000 in June 2008, $125,000 in July 2008, $71,000 in August 2008, $77,000 in September 2008, $73,000 in October 2008, $86,000 in November 2008 and $118,000 in December 2008, respectively, to the Company. The funds being held in escrow are classified as restricted cash on the Company’s balance sheets.
In February 2008, the Company executed a Debt Assignment and Security Designation Agreement with the investor group whereby the Company has assigned the debt owed as convertible secured notes payable to YA Global and Highgate to the investor group. The investor group paid a total of $200,000 to YA Global and Highgate in February 2008 for additional interest and the security deposit owed in relation to the extended and amended forbearance agreement the Company and YA Global executed in February 2008 and $75,000 in May 2008 for additional interest, partial accrued interest and an extension fee owed in relation to the new forbearance agreement the Company and YA Global executed in May 2008 (see Note 14).
In February 2008, the Company executed an Assignment and Settlement Agreement with a trade vendor whereby the Company has assigned the debt owed to the vendor, in the amount of $48,750, to the investor group. Per the terms of the Settlement Agreement, the Company remitted $12,500 to the vendor as full settlement of its indebtedness to the vendor.
In February 2008, the Company assigned a convertible promissory note in the amount of $15,000 to the investor group and the note holder agreed to an amount of $3,000 as full settlement of the note. The settlement amount was paid to the note holder by the investor group in February 2008 (see Note 8).
In March 2008, the Company assigned a convertible promissory note in the amount of $75,000 to the investor group and the note holder agreed to an amount of $15,000 as full settlement of the note. The settlement amount was paid to the note holder by the investor group in March 2008 (see Note 8).
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In April 2008, the Company assigned a convertible promissory note in the amount of $125,000 to the investor group and the note holder agreed to an amount of $12,500 as full settlement of the note. The settlement amount was paid to the note holder by the Company in April 2008 (see Note 8).
In April 2008, the Company executed an Assignment Agreement with the investor group whereby the Company has transferred ownership of a March 2008 receivable, in the amount of $22,520, to the investor group. The receivable was paid in May 2008.
In July 2008, the Company and a note holder agreed upon a settlement whereby a convertible promissory note in the amount of $100,000 shall be assigned to the investor group by the Company and the investor group shall repay the agreed upon settlement amount of $45,000 to the note holder, in installments, through February 2009. The investor group made payments of $10,000 in July 2008, $5,000 in September 2008, $15,000 in October 2008, $5,000 in December 2008 and $10,000 in January 2009 to the note holder (see Note 8).
In September 2008, the Company executed an Assignment and Settlement Agreement with a trade vendor whereby the Company has assigned the debt owed to the vendor, in the amount of $21,400, to the investor group. Per the terms of the Settlement Agreement, the investor group remitted $5,000 to the vendor as full settlement of its indebtedness to the vendor.
In November 2008, the investor group paid a retainer of $18,000 to a marketing firm in relation to a consulting agreement the Company executed with the firm in November 2008 (see Note 20 above).
In December 2008, the investor group paid a fee of $17,500 to a marketing firm in relation to a consulting agreement the Company executed with the firm in November 2008 (see Note 20 above).
Due to Factor
In March 2007, the Company entered into a sale and subordination agreement with a factoring firm whereby the Company sold its rights to two invoices, from February 2007 and March 2007, totaling $470,200 to the factor. Upon signing the agreement and providing the required disclosures, the factor remitted 65%, or $144,440, of the February 2007 invoice and a certain percentage of $53,010 of the March 2007 invoice to the Company. The Company paid a $500 credit review fee to the factor relating to the agreement. Per the terms of the agreement, once the Company’s client remits the invoice amount to the factor, the factor deducts a discount fee from the remaining balance of the factored invoices and forwards the net proceeds to the Company. The discount fee is computed as a percentage of the face amount of the invoice as follows: 2.25% fee for invoices paid within 30 days of the down payment date with an additional 1.125% for each 15 day period thereafter. In September 2007, the February 2007 factored invoice was deemed uncollectible and was written off as bad debt expense. In December 2007, the March 2007 factored invoice was deemed uncollectible and was written off as bad debt expense. In February 2008, the Company and the factor have agreed to a total settlement amount of $75,000 to be paid by the Company to the factor in September 2008 unless both parties mutually agree to extend the due date. In September 2008, the Company and the factor reached a verbal agreement to extend the due date to December 31, 2008. The Company is pursuing an extension. As of December 31, 2008, the balance due to the factor by the Company was $209,192 including interest.
NOTE 20 - CONCENTRATION OF CREDIT RISK
(i) Customers and Credit Concentrations
Five (5) customers accounted for 33.0%, 16.5%, 11.3%, 8.2% and 7.0% of net sales for the year ended December 31, 2008 and four (4) customers accounted for 38.8%, 20.7%, 12.9% and 11.7% of the total accounts receivable as of December 31, 2008, respectively. Three (3) customers accounted for 71.1%, 11.7% and 3.8% of net sales for the year ended December 31, 2007 and three (3) different customers accounted for 83.1%, 5.4% and 5.1% of the total accounts receivable as of December 31, 2007, respectively.
A reduction in sales from or loss of such customers would have a material adverse effect on the Company’s results of operations and financial condition.
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NOTE 21 - SUBSEQUENT EVENTS
Notes Payable
In January 2009, the Company executed a forbearance agreement with a note holder whereby the note holder agrees to forbear his rights under the promissory note until March 31, 2009. Per the terms of the agreement, the Company made a $10,000 payment to the note holder in January 2009 and issued 500,000 shares of restricted common stock, at $0.07 per share, to the note holder to be held in escrow with the note holder’s attorney. The escrow shares will be returned to the Company contingent upon the payment of the remaining note balance and accrued interest to the note holder by the Company by March 31, 2009 (see Note 10).
In January 2009, the Company executed a promissory note for $225,000, bearing interest at 10% per annum, maturing on January 23, 2012. Per the terms of the promissory note, a note holder of a $100,000 convertible note, executed in July 2008, rolled the convertible note balance and accrued interest owed into a purchase of nine units with each unit consisting of a 10% promissory note of $25,000 for a total of $225,000 and 82,000 shares of the Company’s common stock, valued at $0.06, for a total of 738,000 shares of common stock. An additional loan to the Company, in January 2009, of $100,000 by the note holder was included as part of the purchase of the nine units (see Note 8). The shares were issued in February 2009.
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