UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: September 30, 2007
o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to ___________
Commission file number 000-27465
INNOVATIVE SOFTWARE
TECHNOLOGIES, INC.
(Exact name of small business issuer as specified in its charter)
California | 95-4691878 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
911 Ranch Road 620 N., Suite 204 Austin, TX 78734 (Address of principal executive offices) |
(512) 266-2000
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act: None |
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $0.001 par Value |
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 time period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for past 90 days.
YES x NO o
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act):
YES o NO x
State the number of shares outstanding of each of the issuer's classes of common equity as of the latest practicable date: As of November 14, 2007, the registrant had 97,602,885 shares of common stock, par value $0.001, outstanding.
Transitional Small Business Issuer Disclosure Format: YES o NO ý
Index
Page Number | |||
PART I. | FINANCIAL INFORMATION | ||
Item 1. | Financial Statements | ||
Consolidated Balance Sheet as of September 30, 2007 (unaudited) | 4 | ||
Consolidated Statements of Operations for the three months | |||
Ended September 30, 2007 and 2006 and for the period from inception | |||
(January 12, 2005) through September 30, 2007 (unaudited) | 5 | ||
Consolidated Statements of Cash Flows for the three months | |||
Ended September 30, 2007 and 2006 and for the period from inception | |||
(January 12, 2005) through September 30, 2007 (unaudited) | 6 | ||
Notes to Consolidated Financial Statements (unaudited) | 7 | ||
Item 2. | Management's Discussion and Analysis or Plan of Operation | 16 | |
Item 3. | Controls and Procedures | 19 | |
PART II. | OTHER INFORMATION | ||
Item 1. | Legal Proceedings | 20 | |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 20 | |
Item 3. | Defaults Upon Senior Securities | 20 | |
Item 4. | Submission of Matters to a Vote of Security Holders | 20 | |
Item 5. | Other Information | 21 | |
Item 6. | Exhibits | 21 | |
SIGNATURES |
2
INTRODUCTORY NOTE
This Report on Form 10-QSB for Innovative Software Technologies, Inc., (the “Company”) may contain forward-looking statements. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,” “believe,” “estimate,” and “continue” or similar words. Forward-looking statements include information concerning possible or assumed future business success or financial results. You should read statements that contain these words carefully because they discuss future expectations and plans, which contain projections of future results of operations or financial condition or state other forward-looking information. We believe that it is important to communicate future expectations to investors. However, there may be events in the future that we are not able to accurately predict or control. Accordingly, we do not undertake any obligation to update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties set forth under “Risk Factors” in this report and in our Form 10-KSB and any other periodic reports filed with the SEC. Accordingly, to the extent that this Quarterly Report contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of the Company, please be advised that the Company’s actual financial condition, operating results and business performance may differ materially from that projected or estimated by the Company in forward-looking statements.
3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INNOVATIVE SOFTWARE TECHNOLOGIES, INC. | ||
CONSOLIDATED BALANCE SHEET | ||
(A DEVELOPMENT STAGE COMPANY) | ||
as of September 30, 2007 | ||
(UNAUDITED) | ||
ASSETS |
CURRENT ASSETS | ||||
Cash | $ | 127,118 | ||
Accounts receivable | 3,345 | |||
Inventory | 3,362 | |||
Prepaid expenses and other current assets | 9,340 | |||
Total current assets | 143,165 | |||
Property and equipment, net | 153,979 | |||
Deferred financing costs | 103,256 | |||
Deposits | 15,700 | |||
Total assets | $ | 416,100 | ||
LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||
CURRENT LIABILITIES | ||||
Accounts payable and accrued expenses | $ | 796,611 | ||
Accrued officer salary and expenses | 60,500 | |||
Customer deposits | 110,554 | |||
Deferred gain on sale of fixed assets | 7,975 | |||
Current portion of capital lease obligation | 51,927 | |||
Convertible notes and debentures | 934,971 | |||
Derivative financial instruments | 1,652,617 | |||
Total current liabilities | 3,615,155 | |||
Capital lease obligation, less current portion | 23,182 | |||
Total liabilities | 3,638,337 | |||
STOCKHOLDERS’ DEFICIT | ||||
Preferred stock, 25,000,000 shares authorized, no par value | ||||
Series A, 1,500,000 shares authorized, 450,000 shares outstanding | 450,000 | |||
Common stock - authorized, 300,000,000 shares of $0.001 par | ||||
value; issued and outstanding, 81,184,496 shares | 81,184 | |||
Additional paid-in capital | 208,620 | |||
Deficit accumulated during the development stage | (3,962,041 | ) | ||
Total stockholders' deficit | (3,222,237 | ) | ||
Total liabilities and stockholders' deficit | $ | 416,100 |
See accompanying notes to financial statements
4
INNOVATIVE SOFTWARE TECHNOLOGIES, INC. | ||||||||||||
(A DEVELOPMENT STAGE COMPANY) | ||||||||||||
CONSOLIDATED STATEMENTS OF EARNINGS | ||||||||||||
(UNAUDITED) |
For the Three Months Ended September 30, | For the Six Months Ended September 30, | From Inception (January 12, 2005) Through September 30, | ||||||||||||||
2007 | 2006 | 2007 | 2006 | 2007 | ||||||||||||
REVENUE | ||||||||||||||||
High availability | $ | 35,900 | $ | 35,100 | $ | 67,545 | $ | 35,100 | $ | 184,363 | ||||||
Business continuity | 3,180 | 1,995 | 3,675 | 3,567 | 11,432 | |||||||||||
Total Revenue | 39,080 | 37,095 | 71,220 | 38,667 | 195,795 | |||||||||||
COST OF REVENUE | ||||||||||||||||
High availability | 11,311 | 22,338 | 33,023 | 33,197 | 118,779 | |||||||||||
Business continuity | 6,884 | 1,267 | 6,884 | 3,368 | 6,884 | |||||||||||
Total cost of revenue, excluding depreciation below | 18,195 | 23,605 | 39,907 | 36,565 | 125,663 | |||||||||||
GROSS PROFIT | 20,885 | 13,490 | 31,313 | 2,102 | 70,132 | |||||||||||
OPERATING EXPENSES | ||||||||||||||||
General and administrative | 188,780 | 1,095,318 | 517,165 | 1,235,504 | 2,945,282 | |||||||||||
Commissions and other selling expenses | - | - | - | - | 12,500 | |||||||||||
Depreciation and amortization | 31,309 | 13,353 | 33,424 | 19,230 | 79,266 | |||||||||||
Total operating expenses | 220,089 | 1,108,671 | 550,589 | 1,254,734 | 3,037,048 | |||||||||||
LOSS FROM OPERATIONS | (199,204 | ) | (1,095,180 | ) | (519,276 | ) | (1,252,632 | ) | (2,966,917 | ) | ||||||
OTHER INCOME (EXPENSE) NET | ||||||||||||||||
Change in fair value of derivative liabilities | (349,244 | ) | (10,623 | ) | 270,919 | (10,579 | ) | 169,241 | ||||||||
Interest expense | (62,814 | ) | (209,715 | ) | (308,691 | ) | (209,715 | ) | (1,225,723 | ) | ||||||
Interest income | 322 | 2,724 | 2,585 | 44 | 7,747 | |||||||||||
Other income | 5,463 | 43,685 | 3,673 | 8,980 | 53,610 | |||||||||||
OTHER INCOME (EXPENSE) NET | (406,273 | ) | (173,929 | ) | (31,514 | ) | (211,270 | ) | (995,125 | ) | ||||||
LOSS BEFORE INCOME TAXES | (605,477 | ) | (1,269,110 | ) | (550,790 | ) | (1,463,902 | ) | (3,962,041 | ) | ||||||
INCOME TAXES | - | - | - | - | - | |||||||||||
NET LOSS | $ | (605,477 | ) | $ | (1,269,110 | ) | $ | (550,790 | ) | $ | (1,463,902 | ) | $ | (3,962,041 | ) | |
UNDECLARED PREFERRED | ||||||||||||||||
STOCK DIVIDENDS | (4,500 | ) | - | (9,000 | ) | - | (22,500 | ) | ||||||||
LOSS APPLICABLE | ||||||||||||||||
TO COMMON STOCKHOLDERS | $ | (609,977 | ) | $ | (1,269,110 | ) | $ | (559,790 | ) | $ | (1,463,902 | ) | $ | (3,984,541 | ) | |
BASIC AND DILUTED | ||||||||||||||||
LOSS PER COMMON SHARE | $ | (0.01 | ) | $ | (0.02 | ) | $ | (0.01 | ) | $ | (0.02 | ) | ||||
WEIGHTED AVERAGE NUMBER OF | ||||||||||||||||
COMMON SHARES USED IN | ||||||||||||||||
BASIC PER SHARE CALCULATION | 76,973,527 | 71,950,397 | 75,126,586 | 64,646,805 |
See accompanying notes to financial statements.
5
INNOVATIVE SOFTWARE TECHNOLOGIES, INC. | |||||||
(A DEVELOPMENT STAGE COMPANY) | |||||||
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS | |||||||
(UNAUDITED) |
For the Six Months Ended September 30, | From Inception (January 12, 2005) Through September 30, | |||||||||
2007 | 2006* | 2007 | ||||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||
Net loss | $ | (550,790 | ) | $ | (1,463,902 | ) | $ | (3,962,041 | ) | |
Adjustments to reconcile net (loss) to net cash flows from operating activities | ||||||||||
Depreciation and amortization | 33,424 | 19,230 | 79,266 | |||||||
Common stock and stock option based compensation | - | 748,484 | 655,883 | |||||||
Notes payable issued for expenses paid by affiliates and third parties | - | - | 258,605 | |||||||
Amortization of deferred gain on sale of assets | (2,658 | ) | (2,658 | ) | ||||||
Services paid in common stock | 29,727 | - | 126,559 | |||||||
Amortization of convertible debt discount | 157,097 | 169,635 | 893,452 | |||||||
Change in fair value of derivative liabilities | (270,919 | ) | 10,579 | (169,241 | ) | |||||
Amortization of deferred financing costs | 24,966 | 37,400 | 120,943 | |||||||
Net change in operating assets and liabilities: | ||||||||||
Accounts receivable | 5,650 | (17,265 | ) | (3,345 | ) | |||||
Inventory | (3,362 | ) | - | (3,362 | ) | |||||
Prepaid expenses and other current assets | (2,195 | ) | (6,326 | ) | 1,460 | |||||
Deposits | 19,557 | 16,850 | (14,700 | ) | ||||||
Accounts payable and accrued expenses | 64,076 | (42,584 | ) | 40,580 | ||||||
Customer deposits | 110,554 | - | 110,554 | |||||||
Net cash flows from operating activities | (384,873 | ) | (527,899 | ) | (1,868,045 | ) | ||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||
Purchase of fixed assets | (33,058 | ) | (139,731 | ) | (206,385 | ) | ||||
Fixed assets exchanged for lease payments | 2,490 | - | 2,490 | |||||||
Cash acquired in the reverse acquisition of Innovative | - | 51,148 | 51,149 | |||||||
Net cash flows from investing activities | (30,568 | ) | (88,583 | ) | (152,746 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||
Proceeds from sale lease-back of property and equipment | - | - | 125,000 | |||||||
Increase in deferred financing costs | - | - | (156,200 | ) | ||||||
Proceeds from notes payable | - | 372,114 | 427,969 | |||||||
Repayments of notes payable | - | - | (30,000 | ) | ||||||
Principal payments under capital lease | (15,917 | ) | - | (21,188 | ) | |||||
Proceeds from convertible debt | 17,828 | 275,000 | 1,681,328 | |||||||
Common stock issued for cash | 100,000 | - | 121,000 | |||||||
Net cash flows from financing activities | 101,911 | 647,114 | 2,147,909 | |||||||
Net increase (decrease) in cash | (313,530 | ) | 30,632 | 127,118 | ||||||
Cash at beginning of period | 440,648 | 6,270 | - | |||||||
Cash at end of period | $ | 127,118 | $ | 36,902 | $ | 127,118 | ||||
SUPPLEMENTAL CASH FLOW INFORMATION | ||||||||||
Non cash investing and financing activities | ||||||||||
Issuance of common stock to retire notes payable - affiliate | $ | - | $ | 22,337 | $ | 22,337 | ||||
Issuance of common stock for acquisition | $ | - | $ | - | $ | 440,000 | ||||
Assets acquired under capital lease | $ | - | $ | - | $ | 136,512 | ||||
Fixed assets exchanged for lease payment | ||||||||||
Issuance of common stock for debt repayment | $ | 283,633 | $ | - | $ | 458,748 | ||||
Convertible debt issued for financing costs | $ | 44,000 | $ | - | $ | 88,000 | ||||
Cash paid for interest | $ | 17,050 | $ | - | $ | 34,100 | ||||
Cash paid for taxes | $ | - | $ | - | $ | 17,050 |
* Reclassified to conform to the 2007 presentation. Certain items have been reclassified to conform to the current presentation. |
See accompanying notes to financial statements.
6
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) | Basis of Presentation and Reporting |
The accompanying unaudited consolidated financial statements have been prepared in accordance accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-QSB and Regulation S-B. Accordingly, they do not contain all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the Company’s financial condition as of September 30, 2007, and the results of its operations for the six months ended September 30, 2007, and September 30, 2006, and the cash flows for the six months ended September 30, 2007, and September 30, 2006. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited 2007 consolidated financial statements, including the notes thereto, and the other information set forth therein, included in the Company's Annual Report on Form 10-KSB for the year ended March 31, 2007. Operating results for the three-month period ended September 30, 2007, are not necessarily indicative of the operating results that may be expected for the year ending March 31, 2008.
On June 26, 2006, Innovative Software Technologies, Inc., a California corporation (“Innovative”), completed the acquisition of AcXess, Inc., a Florida corporation (“AcXess”), in a stock exchange transaction. As a result of the Transaction, AcXess became a wholly owned subsidiary of Innovative.
The accompanying unaudited consolidated financial statements present the accounts of Innovative and its wholly owned subsidiaries, AcXess, Inc., and EPMG, Inc. (collectively, the “Company”). All intercompany balances and significant transactions have been eliminated.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. However, the Company has incurred a loss of $3,962,041 from inception (January 12, 2005) through September 30, 2007, and has a working capital deficiency and stockholder deficit of $3,368,734 and $3,222,237, respectively, at September 30, 2007. The Company currently has minimal revenue generating operations and expects to incur substantial operating expenses in order to expand its business. The Company expects to incur operating losses for the foreseeable future. The Company is in default on its convertible notes and through September 30 and incurred liquidated damages of approximately $62,000 in connection with its convertible debentures (see Note 6). The accompanying financial statements do not include any adjustments that might become necessary should the Company be unable to continue as a going concern.
Management intends to continue to finance operations through fundraising activities as well as to seek potential acquisitions that have positive cash flows; however, there can be no assurance of successful fundraising or acquisition activity in the future.
(2) | Summary of Significant Accounting Policies |
(a) Loss per Common Share
The Company calculates net income (loss) per share as required by Statement of Financial Accounting Standards (SFAS) 128, "Earnings per Share." Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares and dilutive common stock equivalents outstanding during periods when anti-dilutive common stock equivalents are not considered in the computation.
Basic loss per share is based on the weighted effect of common shares issued and outstanding, and is calculated by dividing net loss by the weighted average shares outstanding during the period. Diluted loss per share is calculated by dividing net loss by the weighted average number of common shares used in the basic loss per share calculation plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares outstanding.
7
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(2) | Summary of Significant Accounting Policies (continued) |
(a) Loss per Common Share (continued)
Shown below are the incremental common shares attributable to the exercise of outstanding options and warrants that were excluded from the computation of diluted loss per share because the effect would be antidilutive.
2007 | 2006 | ||||||
Warrants and stock options | 34,180,205 | 11,678,349 |
(b) Customer Concentration
During the six months ended September 30, 2007 and 2006, two customers accounted for approximately 92% and 82% of revenues, respectively. The loss of these customers would have a material adverse effect on financial results.
(c) Deferred Financing Costs
The Company capitalizes financing costs as incurred and amortizes these costs to interest expense over the life of the underlying instruments.
(3) | Common Stock |
On June 5, 2007, the Company issued 459,778 shares of its common stock with a fair market value of $22,989 for legal expenses. On July 27, 2007, the Company issued 336,862 shares of its common stock with a fair market value of $6,737 for legal expenses. The shares of stock issued in the above transactions were valued at the closing market price on the date of issue.
On August 9, 2007, the Company sold 2,000,000 shares of its common stock to an accredited investor at a price of $0.05 per share. The Company also issued a warrant to the investor to purchase 2,000,000 shares of its common stock at an exercise price of $0.05 per share. The warrant has an expiration of 2 years from the date of issue.
On August 23, 2007, the Company issued an aggregate of 5,672,655 shares of common stock in exchange for the conversion of convertible promissory notes and accrued interest therein in the aggregate amount of $283,633, based on a conversion price of $0.05 per share.
(4) | Commitments, Concentrations and Contingencies |
(a) Leases:
In February 2007 the Company entered into a $500,000 Master Lease Line for Equipment Purchases (the “Master Lease Agreement”). At that time, the Company sold property and equipment for $125,000 and leased them back under the Master Lease Agreement. The Company recognized a gain on the sale of those assets of $10,633 which was deferred and will be recognized over the 24 month term of the lease.
The Master Lease Agreement calls for draws of a minimum of $100,000, a minimum term of 18 months and a maximum term of 36 monthsThe lease entered into in February 2007 has monthly payments of $6,363. The Company accounted for this lease as a capital lease.
In connection with the Master Lease Agreement, the Company agreed to issue five year warrants to the lender to purchase 1,350,000 shares of the Company’s common stock at an exercise price of $0.18 per share. Ten percent (135,000) of the warrants vested upon execution of the Master Lease Agreement. The remaining 90% of the warrants vest as on a pro rata basis as the lender provides funding under the Master Lease Agreement. As such 303,750 warrants vested upon execution of the sale lease-back described above. The total number of warrants, 438,750, was valued using the Black-Scholes method and applied to the capital lease obligation in accordance with Accounting Principles Board (“APB”) No. 14. This resulted in a decrease in capital lease obligation of $37,726 and a corresponding increase in additional paid-in capital.
Rent expense under all operating leases for the six month periods ended September 30, 2007, and 2006, was $21,243 and $25,310 respectively. As of July 1, 2007, our principal executive offices are located at 911 Ranch Road 620 North, Austin, Texas 78734. This office consists of approximately 340 square feet which we rent for $900 per month. The term of the lease is month to month with a 60 day notice period.
8
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(4) | Commitments, Concentrations and Contingencies (continued) |
(b) Litigation:
Kansas City Explorers
The Company is a defendant in a lawsuit in the Circuit Court of Platte County, Missouri, “Kansas City Explorers vs. Innovative Software” Case no. 04CV82050 in which the claimant is seeking money for advertising which it alleges is still due, and have alleged damages of $50,028. The claimant has been court ordered to produce answers to certain discovery requests of the Company which they have failed to produce. Management intends to aggressively defend the claim based upon the lack of contract between the parties, lack of proof of damages, as well as minimal proof of advertising services actually performed for Company products and services, and other legal and equitable defenses. The Company has not accrued any amount for the contingency.
Bernard F. Mathaisel
On June 14, 2007 the Company was served with a complaint from Bernard F. Mathaisel for breach of contract relating to an alleged consulting agreement with the Company and breach of contract alleging failure to repay a Note due him in the principal amount of $55,000. On October 11, 2007, Mr. Mathaisel and the Company executed a mutual release and the complaint was dismissed on October 25, 2007 following the purchase of the Mathaisel note by another investor.
(5) | Convertible Notes and Derivative Liabilities |
Derivative Financial Instruments
The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.
The Company reviews the terms of convertible debt and equity instruments issued to determine whether there are embedded derivative instruments, including the embedded conversion option, that are required to be bifurcated and accounted for separately as a derivative financial instrument. In circumstances where the convertible instrument contains more than one embedded derivative instrument, including the conversion option, that is required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. Also, in connection with the sale of convertible debt and equity instruments, the Company may issue freestanding options or warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity. The Company may also issue options or warrants to non-employees in connection with consulting or other services they provide.
Certain instruments, including convertible debt and equity instruments and the freestanding options and warrants issued in connection with those convertible instruments, may be subject to registration rights agreements, which impose penalties for failure to register the underlying common stock by a defined date. If the convertible debt or equity instruments are not considered to be "conventional", then the existence of the potential cash penalties under the related registration rights agreement requires that the embedded conversion option be accounted for as a derivative instrument liability. Similarly, the potential cash penalties under the related registration rights agreement may require us to account for the freestanding options and warrants as derivative instrument liabilities, rather than as equity. In addition, when the ability to physical or net-share settle the conversion option or the exercise of the freestanding options or warrants is deemed to be not within the control of the Company, the embedded conversion option or freestanding options or warrants may be required to be accounted for as a derivative instrument liability.
Derivative financial instruments are initially measured at their fair value. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income. For option-based derivative financial instruments, the Company uses the Black-Scholes option pricing model to value the derivative instruments.
When freestanding options or warrants are issued in connection with the issuance of convertible debt or equity instruments and will be accounted for as derivative instrument liabilities (rather than as equity), the total proceeds received are first allocated to the fair value of those freestanding instruments. When the freestanding options or warrants are to be accounted for as equity instruments, the proceeds are allocated between the convertible instrument and those derivative equity instruments, based on their relative fair values. When the convertible debt or equity instruments contain embedded derivative instruments that are to be bifurcated and accounted for as liabilities, the total proceeds allocated to the convertible host instruments are first allocated to the fair value of all the bifurcated derivative instruments. The remaining proceeds, if any, are then allocated to the convertible instruments themselves, usually resulting in those instruments being recorded at a discount from their face amount.
9
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(5) | Convertible Notes and Derivative Liabilities (continued) |
Derivative Financial Instruments (continued)
To the extent that the fair values of the freestanding and/or bifurcated derivative instrument liabilities exceed the total proceeds received, an immediate charge to income is recognized, in order to initially record the derivative instrument liabilities at their fair value.
The discount from the face value of the convertible debt, together with the stated interest on the instrument, is amortized over the life of the instrument through periodic charges to income, usually using the effective interest method. When the instrument is convertible preferred stock, the dividends payable are recognized as they accrue and, together with the periodic amortization of the discount, are charged directly to retained earnings.
The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed periodically, including at the end of each reporting period. If re-classification is required, the fair value of the derivative instrument, as of the determination date, is re-classified. Any previous charges or credits to income for changes in the fair value of the derivative instrument are not reversed. 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 could be required within twelve months of the balance sheet date. As of September 30, 2007 $1,652,617 of derivative financial instruments have been classified as current liabilities.
In January 2006 the Board of Directors of the Company approved the raising of up to $1,000,000 via the issuance of promissory notes (the “Notes”) to accredited investors. These notes have a term of six months, an interest rate of 12% per annum, and are convertible into shares of common stock of the Company at a 30% discount to a future Qualified Financing (as therein described). In addition, each of the Notes is issued with warrants to purchase Company common stock at a strike price of $0.05 per share. The number of warrants granted is determined by multiplying the face value of each note issued by four. In October the Board of Directors of the Company approved an increase in the amount to be raised under this financing to $1,500,000. A total of $1,107,500 had been raised as of November 10, 2006, when the Company closed the round. As of September 30, 2007, the Company was in default on all Notes totaling a principal amount of $1,107,500. In the event of a default resulting from the Company's non-payment of principal or interest when due, a holder of the Notes may declare all unpaid principal and accrued interest due and payable immediately. The Company was served a complaint from one investor demanding repayment of $55,000 under one of the Notes (see Note 4). No notice has been received from any other holder of the Notes and the Company is currently in the process of renegotiating the terms of the Notes; however there can be no assurance that such negotiations will be successful.
On December 22, 2006, the Company entered into a securities purchase agreement with an accredited investor (the “Investor”) for the sale of $1,000,000 Convertible Debentures (the “Debentures”). In connection with the Agreement, the Investor received (i) a warrant to purchase 8,928,571 shares of common stock (“Long-Term Warrants”) exercisable at $0.30 and (ii) a warrant to purchase 1,785,714 shares of common stock (“Short Term Warrants”) exercisable at $0.143 per share. The Long Term Warrants and the Short Term Warrants are exercisable for a period four years from the date of issuance and the earlier of (i) December 22, 2007 and (ii) the date a registration statement(s) covering the resale of all Registrable Securities (as defined in the Registration Rights Agreement) is declared effective by the SEC (the “Initial Exercise Date”) and on or prior to the close of business on the four month anniversary of the Initial Exercise Date, respectively. The Company incurred approximately $62,000 in interest expense relating to the Debentures due to the “Liquidating Damages” clause specified in the Purchase Agreement as a registration statement covering the Registrable Securities was declared effective by the SEC on June 25, 2007, 93 days after the agreed upon date in the Purchase Agreement, March 23, 2007.
The default on the Notes discussed above is an “Event of Default” in accordance with the terms of the Debenture and, therefore, the Debenture holder may declare all principal and interest due and payable immediately; however, the Company has received no notice from the Debenture holder demanding such repayment.
The Debentures bear interest at 4% until June 22, 2007 and 9% thereafter, payable in arrears and mature three years from the date of issuance. Accrued interest is payable in cash semi-annually, beginning on July 1, 2007. The Company has not made the interest payment of $21,271 due on July 1, 2007 and intends to negotiate a settlement with the Debenture holder; however there can be no assurance that such negotiation will be successful.
10
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(5) | Convertible Notes and Derivative Liabilities (continued) |
Derivative Financial Instruments (continued)
Warrants have been accounted for as derivative instrument liabilities (see below) in accordance with EITF 00-19, "Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled In, a Company's Own Common Stock" (“EITF 00-19”). Accordingly, the initial fair values of the warrants, amounting to an aggregate of $82,239 relating to the issuance of the Notes, and $964,286 relating to the issuance of the Debentures, were recorded as a derivative instrument liability. The fair value of the warrants was determined using the Black-Scholes valuation model, based on the market price of the common stock on the dates the warrants were issued, an expected dividend yield of 0%, a risk-free interest rate based on constant maturity rates published by the U.S. Federal Reserve, applicable to the life of the warrants, expected volatility of 114% (based on analysis of historical stock prices of the Company and its selected peers), and the five year and four year life of the warrants relating to the Notes and Debentures, respectively. The Company is required to re-measure the fair value of the warrants at each reporting period.
Because the conversion price of the Notes is not fixed, they are not “conventional convertible debt” as that term is used in EITF 00-19. Accordingly, the Company is required to bifurcate and account separately for the embedded conversion options, together with any other derivative instruments embedded in the Notes. The Debentures are a hybrid instrument that embodies several derivative features. The instrument is not afforded the “conventional” convertible exemption because of certain full-ratchet anti-dilution protections afforded the investors. Further, certain derivative features did not meet the conditions for equity classification set forth in EITF 00-19. As a result, the Company has combined all embedded derivatives into one compound derivative financial instrument for financial accounting and reporting.
The freestanding warrants issued with the Debentures are also hybrid instruments that embody derivative features. While bifurcation of the embedded derivatives was not required, the warrants did not otherwise meet all of the conditions for equity classification set forth in EITF 00-19. As a result, the Company has recorded the warrants as derivative liabilities at fair value.
The conversion option related to each of the Notes was bifurcated from the Note and accounted for separately as a derivative instrument liability (see below). The bifurcated embedded derivative instruments, including the embedded conversion options which were valued using the Flexible Monte Carlo Simulation methodology, were recorded at their initial fair value of an aggregate of $801,911.
The discount from the face amount of the Notes represented by the value assigned to the warrants and bifurcated derivative instruments is being amortized over the period to the due date of each of the Notes, using the effective interest method. Amortization related to the Notes for the period ended September 30, 2007, was $139,622.
On August 23, 2007, the Company issued an aggregate of 5,672,655 shares of common stock in exchange for the conversion of convertible promissory notes with the principal amount of $263,315 and accrued interest of $20,318 totaling $283,633, based on a conversion price of $0.05 per share. This transaction was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. The balance of the notes at September 30, 2007 is $902,722.
The conversion option related to the Debentures was bifurcated from the Debentures and accounted for separately as a derivative instrument liability (see below). The bifurcated embedded derivative instruments, including the embedded conversion option which was valued using the Flexible Monte Carlo Simulation methodology, was recorded at its initial fair value of an aggregate of $553,466.
The discount from the face amount of the Debentures represented by the value assigned to the warrants and bifurcated derivative instruments is being amortized over the period to the due date of the Debentures, using the effective interest method. Amortization related to the Debentures for the three months and six months ended September 30, 2007, was $10,421 and $17,475, respectively.
11
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(5) | Convertible Notes and Derivative Liabilities (continued) |
Derivative Financial Instruments (continued)
A summary of the Debentures and related derivative instrument liabilities at September 30, 2007, is as follows:
Debenture; 4% per annum (increasing to 9% per annum in July 2007); due December 22, 2009 | $ | 1,000,000 | ||
Less: unamortized discount related to warrants and bifurcated embedded derivative instruments | (967,750 | ) | ||
Total carrying value at September 30, 2007 | $ | 32,250 |
The total carrying value of the Notes and Debentures at September 30, 2007 was $934,971.
The Company uses the Black-Scholes valuation model to value the warrants and the embedded conversion option components of any bifurcated embedded derivative instruments that are recorded as derivative liabilities.
In valuing the warrants and the embedded conversion option components of the bifurcated embedded derivative instruments, at the time they were issued and at September 30, 2007, the Company used the market price of our common stock on the date of valuation, an expected dividend yield of 0% and the remaining period to the expiration date of the warrants or repayment date of the Notes. All warrants and conversion options can be exercised by the holder at any time.
Because of the limited historical trading period of the Company’s common stock, the expected volatility of the Company’s common stock over the remaining life of the conversion options and warrants has been estimated at 114% (based on analysis of historical stock prices of the Company and its selected peers). The risk-free rates of return used were based on constant maturity rates published by the U.S. Federal Reserve, applicable to the remaining life of the conversion options or warrants.
At September 30, 2007, the following derivative liabilities related to common stock warrants and embedded derivative instruments were outstanding as a result of the issuance of the Notes:
Exercise | Value | Value | ||||||||||||||
Price Per | Issue | September 30, | ||||||||||||||
Issue Dates | Expiry Dates | Share | Date | 2007 | ||||||||||||
May 22, through | May 22, through | 1,600,000 | ||||||||||||||
October 26, 2006 | October 26, 2011 | warrants | $ | 0.05 | $ | 82,239 | $ | 143,831 | ||||||||
Fair value of freestanding derivative instrument liabilities for warrants | $ | 143,831 | ||||||||||||||
May 22, through | May 22, through | |||||||||||||||
October 26, 2006 | October 26, 2011 | $ | 801,911 | $ | 849,184 | |||||||||||
Fair value of bifurcated embedded derivative instrument | ||||||||||||||||
liabilities associated with the above convertible notes | $ | 849,184 | ||||||||||||||
Total derivative financial instruments | $ | 993,015 |
The following table reflects the number of common shares into which the aforementioned derivatives resulting from the issuance of Notes are indexed at September 30, 2007:
Embedded derivative instruments | 35,000,000 | |||
Freestanding derivatives (warrants) | 4,430,000 | |||
39,430,000 |
12
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(5) | Convertible Notes and Derivative Liabilities (continued) |
Derivative Financial Instruments (continued)
At September 30, 2007, the following derivative liabilities related to common stock warrants and embedded derivative instruments were outstanding as a result of the issuance of the Debentures:
Exercise | Value | Value | ||||||||||||||
Price Per | Issue | September 30, | ||||||||||||||
Issue Dates | Expiry Dates | Share | Date | 2007 | ||||||||||||
December 22, 2006 | October 26, 2011 | 10,714,285 warrants | $ | 0.05 | $ | 964,286 | $ | 384,264 | ||||||||
Fair value of freestanding derivative instrument liabilities for warrants | $ | 384,264 | ||||||||||||||
December 22, 2006 | December 22, 2009 | $ | 553,466 | $ | 275,338 | |||||||||||
Fair value of bifurcated embedded derivative instrument | ||||||||||||||||
liabilities associated with the above convertible notes | $ | 275,338 | ||||||||||||||
Total derivative financial instruments | $ | 659,602 |
The following table reflects the number of common shares into which the aforementioned derivatives resulting from the issuance of the Debentures are indexed at September 30, 2007:
Embedded derivative instruments | 9,749,041 | |||
Freestanding derivatives (warrants) | 12,714,285 | |||
22,463,326 |
The total value of Derivative Financial Instruments at September 30, 2007 was $1,652,617.
(6) | Subsequent Events |
On July 24, 2007, the Company entered into a Stock Purchase Agreement (the “Agreement”) with AcXess, Inc., its wholly owned subsidiary, (“AcXess”), Thomas Elowson, President of AcXess, (“Elowson”), Raymond Leitz, Chief Technical Officer of AcXess, (“Leitz”), and Helge Solberg, Chief Architect of AcXess, (“Solberg”), (collectively, Elowson, Leitz, and Solberg referred to herein as the “Buyers”) wherein (i) AcXess redeemed shares of its common stock from the Company in return for the issuance of a promissory note to the benefit of the Company (the “Note”) and the signing of a Non-Exclusive License Agreement with the Company, (the “License Agreement”) and (ii) the Buyers exchanged stock of the Company held by them (the “Stock”) in exchange for stock in AcXess and Elowson canceled options for stock in the Company held by him (the “Options”) in exchange for stock in AcXess. Immediately following the above redemptions and exchanges, the Company will continue to own 984,457 shares, or approximately 21.9% of the outstanding common stock, of AcXess. The transactions contemplated by the Agreement are expected to close upon approval of the transactions by the Company’s shareholders. AcXess has 4,500,000 shares of common stock outstanding.
The Note will be in the principal amount of $1,000,000, have a term of two years, and bear an interest rate of 10% per annum, interest to accrue until maturity. The Note is subject to a security agreement (the “Security Agreement”) which collateralizes the Note with all assets of AcXess and has an acceleration clause for any material default. AcXess will redeem 1,000,000 shares of its common stock from the Company with the issuance of the Note.
The License Agreement grants the Company a non-exclusive worldwide right and license under AcXess’s patents and any improvements relating to business continuity software to make, have made, use, sell and otherwise commercialize business continuity solutions, with restricted rights on the part of the Company to grant sublicenses. In addition, the License Agreement grants the Company “Best Pricing” on AcXess’ current and future products and services. The License Agreement, like the Note, was granted in consideration of the sale by the Company to AcXess of 1,500,000 shares of AcXess common stock.
13
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(7) | Subsequent Events (continued) |
In the above-described exchange, the Buyers exchanged 4,477,292 shares of common stock of the Company for 537,275 shares of common stock of AcXess held by the Company.
Elowson received 478,268 shares of common stock of AcXess held by the Company in exchange for the cancellation of his options to purchase 5,978,349 shares of common stock of the Company. These options were fully vested, had an exercise price of $0.13 per share and an expiration of August 9, 2016.
On October 11, 2007 the Company and Bernard Mathaisel entered into a mutual settlement agreement to dismiss a complaint filed by Mr. Mathaisel against the Company (see Note 4).
Between October 12, 2007 and October 18, 2007, the Company issued an aggregate of 14,633,759 shares of common stock in exchange for the conversion of convertible promissory notes and accrued interest therein in the aggregate amount of $731,688, based on a conversion price of $0.05 per share.
On October 12, 2007, the Company’ Chief Financial Officer accepted an offer from the Company to convert $60,500 in accrued expenses and wages into 1,210,000 shares of the Company’s common stock, based on a conversion price of $0.05 per share. The accrued expenses comprised wages and expenses accrued in the 2006 calendar year.
On October 12, 2007, the Company granted Philip D. Ellett, the Company’s Chief Executive Officer, and Christopher J. Floyd, the Company’s Chief Financial Officer, 21,000,000 options and 7,500,000 options, respectively, to purchase shares of common stock of the Company at an exercise price of $0.05 per share. The closing price of the Company’s common stock, as quoted on the Pink Sheets on October 11, 2007, was $0.03. The options vested according to the following schedule: (1) 25% of each person’s options on the date of grant and (2) the remaining 75% of each person’s options will vest pro-rata over the 36 months thereafter. The options issued to Mr. Ellett and Mr. Floyd have an expiration date of October 11, 2017.
On October 19, 2007 the Company issued an aggregate of 574,630 shares of common stock in exchange for the conversion of a convertible promissory note and accrued interest therein in the aggregate amount of $28,732, based on a conversion price of $0.05 per share. This transaction was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.
On November 1, 2007, the Board of Directors of the Company approved the dismissal of Mayer Hoffman McCann P.C. ("MHM") as independent auditors for the Company and its subsidiaries. MHM’s reports on the Company's financial statements for the prior year did not contain an adverse opinion or disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles. MHM’s report for the year ended March 31, 2007 was modified to include an emphasis regarding uncertainty about our ability to continue as a going concern. There have been no disagreements with MHM on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of MHM, would have caused it to make reference to the subject matter of the disagreement in connection with its report.
On November 1, 2007, the Board of Directors approved the Company's engagement of PMB Helin Donovan, LLP ("Helin") as independent auditors for the Company and its subsidiaries. The Company engaged Helin on November 1, 2007.
On October 1, 2007, Innovative Software Technologies, Inc. (the “Company”) entered into a Share Purchase Agreement (the “Agreement”) to purchase all of the outstanding shares of Xalles Limited, an Irish corporation (“Xalles”). The Agreement was entered into among the Company, Xalles, and Meridian Bay Limited, a Hong Kong corporation and the owner of 100% of the stock of Xalles (“Seller”). Under the Agreement Xalles will become a wholly owned subsidiary of the Company at the time of the closing of the transaction (the “Closing”). At Closing, the Agreement calls for the delivery of 20 million shares of the Company’s common stock to Seller in exchange for all the issued and outstanding shares of Xalles. In addition, the Agreement provides for the issuance of additional shares to Seller based on the future net income before tax of Xalles (“NIBT”) as follows: 20 million shares issuable based on Xalles NIBT of at least $1,000,000 for the 2008 calendar year, and 20 million shares issuable based on Xalles NIBT of at least $1,600,000 for the 2009 calendar year.
14
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
(A DEVELOPMENT STAGE COMPANY)
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(7) | Subsequent Events (continued) |
The Closing of this transaction is subject to certain conditions, including the completion of the reincorporation merger of the Company through which the Company will no longer be a California corporation and will become a Delaware corporation (“Redomicile”). The Redomicile was approved by a majority of the Company’s shareholder’s on August 24, 2007, as previously reported on the Preliminary Information Statement on Schedule 14C filed filed with the SEC on 28, 2007. Timing of the Closing is expected to be within 90 days of the filing of the Form 8-K.
The offers and sale of the Company common stock to Seller pursuant to the Agreement is being made pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. Such offer and sale is being made without any form of general solicitation and with full access to any information requested by the Seller regarding the Company or the Company common stock offered pursuant to the Agreement.
15
Item 2. Management’s Discussion and Analysis or Plan of Operations
The information presented in this section should be read in conjunction with our audited financial statements and related notes for the periods ended March 31, 2007 and 2006 included in our Form 10-KSB, filed July 19,2007, as well as the information contained in the financial statements, including the notes thereto, appearing elsewhere in this report. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the section entitled “Risk Factors” and elsewhere in this report.
The following discussion includes statements that are forward looking in nature. The accuracy of such statements depends on a variety of factors that may affect the business and operations of the Company. Certain of these factors are discussed under “Business - Factors Influencing Future Results and Accuracy of Forward-Looking Statements” included in Part 1 of this report. When used in this discussion, the words “expect(s)”, “feel(s)”, “believe(s)”, “will”, “may”, “anticipate(s)” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, and actual results could differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, and are urged to carefully review and consider the various disclosures elsewhere in this Form 10-QSB.
Overview
The following discussion summarizes information about our accounting policies and practices and information about our operations in a comparative manner for the six months ended September 30, 2007, and 2006. Our management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere herein.
Acquisition of AcXess, Inc.
On June 26, 2006, the Company completed the acquisition of AcXess, Inc., a Florida corporation (“AcXess”), in a stock exchange transaction (the “Transaction”) pursuant to a Stock Exchange Agreement by and between Innovative, AcXess, the Shareholders of AcXess, and Anthony F. Zalenski, acting as the Shareholder’s Agent (the “Exchange Agreement”). As a result of the Transaction, AcXess became a wholly owned subsidiary of the Company. Following FAS 141, as governing and operating control of the combined entity was under Mr. Zalenski, AcXess is deemed to be the purchaser in the Transaction for financial reporting purposes. Therefore, reverse acquisition accounting applies whereby AcXess is deemed to have issued its common stock for the net assets or liabilities of Innovative accompanied by a recapitalization of AcXess. For accounting purposes, AcXess is treated as the continuing reporting entity.
AcXess was formed to provide Business Continuity (“BC”) products and services to the Small and Medium Enterprise (“SME”) market. “Business Continuity” products and services are an advanced form of disaster recovery solutions for electronic data backup wherein the data and/or applications are available upon failure through means of connectivity to remote server locations. Management believes that the North American SME market for BC services (defined as companies with 50 to 5,000 employees) is underserved and that various technologies have matured to a point where the SME market can now be supplied robust BC services, which were previously only available to large corporations and at substantial cost.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the Company's financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company’s critical accounting policies are discussed in its annual report on Form 10-KSB for the year ended March 31, 2007.
16
Results of Operations
Three months ended September 30, 2007, compared to the three months ended September 30, 2006.
Revenues
Revenues for the three months ended September 30, 2007, and 2006 were $39,080 and $37,095, respectively. Revenues derived primarily from our High Availability product line.
Cost of Sales and Margins
Cost of sales for the three months ended September 30, 2007, and 2006 were $18,195 and $23,605, respectively. The decrease in the cost of sales over the two periods is primarily due to the termination of our Boca collocation agreement which was primarily used for initial project setup purposes and which is no longer needed. Our gross margins increased to approximately 46% from 36% for the three months ended September 30, 2007 and 2006, respectively, due primarily to the reduction in network costs from the termination of the Boca collocation agreement.
Operating Expenses
General and administrative expenses for the three months ended September 30, 2007, and 2006 were $220,089 and $1,108,671, respectively. General and administrative expenses consisted primarily of salaries and wages, professional fees, rent, travel expenses, payroll taxes, telephone expenses and other general and administrative expenses. The decrease in general and administrative expenses is due primarily to the decrease in number of employees and therefore in salaries and decreased marketing and travel expenses.
Other Loss
Other loss, for the three months ended September 30, 2007, and 2006 was $406,273 and $173,929, respectively. Other income for the period ended September 30, 2007 comprise primarily of derivative and interest income offset by interest expense and other expense (see Note 5 in the Notes to the Financial Statements). The decrease in the fair value of the derivatives was 349,244 and 10,623 for the three months ended September 30, 2007 and 2006, respectively. Interest expense was 62,814 and 209,715 for the three months ended September 30, 2007 and 2006, respectively. Interest expense for the three months ended September 30, 2006 was due primarily to the amortization of debt discounts and deferred financing costs relating to the issuance of convertible notes which discounts and deferred financing costs have been fully amortized in the present period.
Net Loss
Our net loss for the three months ended September 30, 2007, amounted to $605,477, and resulted from a loss from operations of $199,204 primarily due to decreased general and administrative expenses. Our net loss for the three months ended September 30, 2006 was $1,269,110 and resulted from a loss from operations of $1,095,180 primarily due to the general and administrative expenses.
Six months ended September 30, 2007, compared to the six months ended September 30, 2006.
Revenues
Revenues for the six months ended September 30, 2007, and 2006 were $71,220 and $38,667, respectively. Revenues derived primarily from our High Availability product line.
Cost of Sales and Margins
Cost of sales for the six months ended September 30, 2007, and 2006 were $39,907 and $36,566, respectively. Our gross margins increased to approximately 44% from 5% for the six months ended September 30, 2007 and 2006, respectively, due primarily to the startup nature of the business in 2006.
Operating Expenses
General and administrative expenses for the six months ended September 30, 2007, and 2006 were $550,589 and $1,254,734, respectively. General and administrative expenses consisted primarily of salaries and wages, professional fees, rent, travel expenses, payroll taxes, telephone expenses and other general and administrative expenses. The decrease in general and administrative expenses is due primarily to the decrease in number of employees and therefore in salaries and decreased marketing and travel expenses.
17
Other Loss
Other loss, for the six months ended September 30, 2007, and 2006 was $31,514 and $211,270, respectively. Other income for the period ended September 30, 2007 comprise primarily of derivative and interest income offset by interest expense and other expense (see Note 5 in the Notes to the Financial Statements). The increase in the fair value of derivatives for the six months ended September 30, 2007 was 270,919, and a loss of 10,579 for the six months ended September 30, 2006. Interest expense was 308,691 and 209,715 for the six months ended September 30, 2007 and 2006, respectively. Interest expense for the periods comprised primarily the amortization of debt discounts relating to convertible note issuances as well as the amortization of deferred financing costs.
Net Loss
Our net loss for the six months ended September 30, 2007, amounted to $550,790, and resulted from a loss from operations of $519,276. Our net loss for the six months ended September 30, 2006 was $1,463,902 and resulted from a loss from operations of $1,252,632.
Liquidity and Capital Resources
The September 30, 2007, financial statements have been prepared assuming the Company will continue as a going concern. However, the Company has incurred a loss of $3,962,041 from inception (January 12, 2005) through September 30, 2007, and has a working capital deficiency and stockholder deficit of $3,368,734 and $3,222,237, respectively, at September 30, 2007. The Company currently has minimal revenue generating operations and expects to incur substantial operating expenses in order to expand its business. As a result, the Company expects to incur operating losses for the foreseeable future. In addition, the Company is in default on two convertible notes in the aggregate principal amount of $155,000. The accompanying financial statements do not include any adjustments that might become necessary should the Company be unable to continue as a going concern.
Management intends to continue to finance operations through fundraising activities as well as to seek potential acquisitions that have positive cash flows; however there can be no assurance of successful fundraising or acquisition activity in the future.
In January 2006, our Board of Directors approved the raising of up to $1,000,000 via the issuance of promissory notes to accredited investors. These notes have a term of six months, are convertible into shares of our common stock at a 30% discount to a future Qualified Financing (as therein described), and have 20% warrant coverage at a strike price of $0.05 and an expiration of 5 years from the date of issuance. In October our board of directors approved an increase in the limit of funding under these terms to $1,500,000. A total of $1,107,500 had been raised as of November 10, 2006, when the Company closed the round.
On December 22, 2006, the Company entered into a securities purchase agreement with an accredited investor (the “Investor”) for the sale of $1,000,000 Convertible Debentures (the “Debentures”). In connection with the Agreement, the Investor received (i) a warrant to purchase 8,928,571 shares of common stock (“Long-Term Warrants”) exercisable at $0.30 and (ii) a warrant to purchase 1,785,714 shares of common stock (“Short Term Warrants”) exercisable at $0.143 per share. The Long Term Warrants and the Short Term Warrants are exercisable for a period four years from the date of issuance and the earlier of (i) December 22, 2007 and (ii) the date a registration statement(s) covering the resale of all Registrable Securities (as defined in the Registration Rights Agreement) is declared effective by the SEC (the “Initial Exercise Date”) and on or prior to the close of business on the four month anniversary of the Initial Exercise Date, respectively. The Company incurred approximately $62,000 in interest expense relating to the Debentures due to the “Liquidating Damages” clause specified in the Purchase Agreement as a registration statement covering the Registrable Securities was declared effective by the SEC on June 25, 2007, 93 days after the agreed upon date in the Purchase Agreement, March 23, 2007.
The default on the Notes discussed above is an “Event of Default” in accordance with the terms of the Debenture and, therefore, the Debenture holder may declare all principal and interest due and payable immediately; however, the Company has received no notice from the Debenture holder demanding such repayment.
The Debenture bears interest at 4% until June 22, 2007 and 9% thereafter, payable in arrears, and matures three years from the date of issuance. Accrued interest is payable in cash semi-annually, beginning on July 1, 2007. The Company has not made the interest payment of $21,271 due on July 1, 2007 and intends to negotiate an extension with the Investor; however there can be no assurance that such negotiation will be successful.
18
In February 2007, we entered into a master leasing arrangement with Gulf Pointe Capital, LLC for equipment purchases up to a total of $500,000 (see Contractual Obligations below).
At September 30, 2007, we had current liabilities of $3,615,155.
We have no material commitments for capital expenditures.
Contractual Obligations
In February 2007, the Company entered into a $500,000 Master Lease Line for Equipment Purchases (the “Master Lease Agreement”). At that time, the Company sold property and equipment for $125,000 and leased them back under the Master Lease Agreement. The Company recognized a gain on the sale of those assets of $10,633, which was deferred and will be recognized over the 24 month term of the lease.
The Master Lease Agreement calls for draws of a minimum of $100,000, a minimum term of 18 months and a maximum term of 36 months. The leasing factor for each new lease under the master lease is as follows; 18 Months - 0.06476, 24 Months - 0.05090, 30 Months - 0.04263, 36 Months - 0.03716. The lease entered into in February 2007 has a lease factor of 0.0509 resulting in monthly payments of $6,363. The lease entered into in February 2007 has a lease factor of 0.0509 resulting in monthly payments of $6,363. The Company accounted for this lease as a capital lease.
In connection with the Master Lease Agreement, the Company agreed to issue five year warrants to the lender to purchase 1,350,000 shares of the Company’s common stock at an exercise price of $0.18 per share. Ten percent (135,000) of the warrants vested upon execution of the Master Lease Agreement. The remaining 90% of the warrants vest as on a pro rata basis as the lender provides funding under the Master Lease Agreement. As such 303,750 warrants vested upon execution of the sale lease-back described above. The total number of warrants, 438,750, was valued using the Black-Scholes method and applied to the capital lease obligation in accordance with APB 14. This resulted in a decrease in capital lease obligation of $37,726 and a corresponding increase in additional paid-in capital.
Item 3. Controls and Procedures
As of September 30, 2007, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in our periodic reports is recorded, processed, summarized and reported, within the time periods specified for each report and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
There was no change in our internal controls over financial reporting that has materially affected, or is reasonable likely to materially affect, our internal control over financial reporting during the quarter covered by this Report.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm business. Except as disclosed below we are currently not aware of any such legal proceedings or claims that will have, individually or in the aggregate, a material adverse affect on business, financial condition, operating results, or cash flows.
Kansas City Explorers
The Company is a defendant in a lawsuit in the Circuit Court of Platte County, Missouri, “Kansas City Explorers vs. Innovative Software” Case no. 04CV82050 in which the claimant is seeking money for advertising which it alleges is still due, and have alleged damages of $50,028. The claimant has been court ordered to produce answers to certain discovery requests of the Company which they have failed to produce. Management intends to aggressively defend the claim based upon the lack of contract between the parties, lack of proof of damages, as well as minimal proof of advertising services actually performed for Company products and services, and other legal and equitable defenses.
Bernard F. Mathaisel
On June 14, 2007 the Company was served with a complaint from Bernard F. Mathaisel for breach of contract relating to an alleged consulting agreement with the Company and breach of contract alleging failure to repay a Note due him in the principal amount of $55,000. On October 11, 2007, Mr. Mathaisel and the Company executed a mutual release and the complaint was dismissed on October 25, 2007 following the purchase of the Mathaisel note by another investor.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On June 5, 2007, the Company issued 459,778 shares of its common stock with a fair market value of $22,989 for legal expenses. On July 27, 2007, the Company issued 336,862 shares of its common stock with a fair market value of $6,737 for legal expenses. The shares of stock issued in the above transactions were valued at the closing market price on the date of issue.
On August 9, 2007, the Company sold 2,000,000 shares of its common stock to an accredited investor at a price of $0.05 per share. Proceeds will be used for general corporate purposes. The shares of stock issued in the following transactions were valued at the closing market price on the date of issue.
On August 23, 2007, Innovative Software Technologies, Inc. (the “Company”) issued an aggregate of 5,672,655 shares of common stock in exchange for the conversion of convertible promissory notes and accrued interest therein in the aggregate amount of $283,633, based on a conversion price of $0.05 per share.
Item 3. Defaults Upon Senior Securities
As of November 14, 2007, the Company was in default on two convertible promissory notes totaling a principal amount of $155,000 as the term of these notes had passed. In the event of a default resulting from the Company's non-payment of principal or interest when due, the note holder may declare all unpaid principal and accrued interest due and payable immediately. The Company has received no notice from either note holder. On August 23, 2007, one holder converted notes with the principal amount of $263,315 and accrued interest of $20,318 totaling $283,633, for 5,672,655 shares of common stock. This transaction was exempt from registration pursuant to Section 4(2) of the Securities.
Between October 12, 2007 and October 18, 2007, the Company issued an aggregate of 14,633,759 shares of common stock in exchange for the conversion of convertible promissory notes and accrued interest therein in the aggregate amount of $731,688, based on a conversion price of $0.05 per share. This transaction was exempt from registration pursuant to Section 4(2) of the Securities.
Item 4. Submission of Matters to a Vote of Security Holders
None.
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Item 5. Other Information
None.
Item 6. Exhibits.
Exhibits included or incorporated by reference herein are set forth in the attached Exhibit Index.
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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.
Innovative Software Technologies, Inc. | ||
Date: November 19, 2007 | /s/ Philip D. Ellett Philip D. Ellett Chief Executive Officer |
Date: November 19, 2007 | /s/ Christopher J. Floyd Christopher J. Floyd Chief Financial Officer, Vice President of Finance, and Secretary |
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INDEX TO EXHIBITS
Exhibit Number | Description | |
31.1 | Certification of Chief Executive Officer of Innovative Software Technologies, Inc. pursuant to Rule 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended. | |
31.2 | Certification of Chief Financial Officer of Innovative Software Technologies, Inc. pursuant to Rule 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended. | |
32.1 | Certification of Chief Executive Officer of Innovative Software Technologies, Inc. pursuant to 18 U.S.C. 1350. | |
32.2 | Certification of Chief Financial Officer of Innovative Software Technologies, Inc. pursuant to 18 U.S.C. 1350. |
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