United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Period Ended August 31, 2005.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Transition Period from ______________________ to
_________________________.
Commission file number 0-22814
---------------
INSYNQ, INC.
---------------
(Exact name of registrant as specified in its charter)
NEVADA 22-3894506
(State or Other Jurisdiction
of Incorporation or Organization) (IRS Employer Identification No.)
1127 BROADWAY PLAZA, SUITE 202
TACOMA, WASHINGTON 98402-3519
(Address of Principal Executive Office)(Zip Code)
(253) 284-2000 (Registrant's telephone
number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods 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 [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Common Stock, $0.001 Par Value 316,686,293 as of October 24, 2005
Transitional Small Business Disclosure Format (Check One): Yes [ ] No [X]
<table>
PART I FINANCIAL INFORMATION..............................................................................3
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ITEM 1 CONDENSED FINANCIAL STATEMENTS OF INSYNQ, INC...................................................3
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CONDENSED BALANCE SHEETS........................................................................3
------------------------
CONDENSED STATEMENTS OF OPERATIONS..............................................................4
----------------------------------
CONDENSED STATEMENT OF STOCKHOLDERS' DEFICIT....................................................5
--------------------------------------------
STATEMENTS OF CONDENSED CASH FLOWS..............................................................6
----------------------------------
NOTES TO CONDENSED FINANCIAL STATEMENTS.........................................................7
---------------------------------------
ITEM II MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..........16
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ITEM 3. CONTROLS AND PROCEDURES........................................................................28
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PART II. OTHER INFORMATION..............................................................................28
- -------- -----------------
ITEM 1. LEGAL PROCEEDINGS..............................................................................28
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS....................................28
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ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................................................28
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................28
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ITEM 5. OTHER INFORMATION..............................................................................28
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...............................................................29
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SIGNATURES....................................................................................................30
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2
PART I FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS OF INSYNQ, INC.
INSYNQ, INC.
CONDENSED BALANCE SHEETS
August 31, 2005 May 31, 2005
--------------------- ---------------------
(unaudited)
Assets
Current assets
Cash $ 225,388 $ 703,028
Accounts receivable, net of allowance for doubtful
accounts of $35,000 at August 31, 2005 and May 31,
2005, respectively 74,853 59,211
--------------------- ---------------------
Total current assets 300,241 762,239
--------------------- ---------------------
Equipment, net 80,055 33,146
--------------------- ---------------------
Other assets
Intellectual property, net 306,862 323,001
Deposits and prepaid expenses 28,790 40,350
--------------------- ---------------------
Total other assets 335,652 363,351
--------------------- ---------------------
Total assets 715,948 $ 1,158,736
===================== =====================
Liabilities and Stockholders' Deficit
Current liabilities
Accounts payable $ 580,476 $ 598,177
Accrued liabilities 2,268,211 2,152,900
Convertible debentures 1,201,212 1,300,045
Convertible notes payable, net of unamortized discount
of $2,247,534 and $2,472,534 at August 31, 2005 and
May 31, 2005, respectively 452,466 227,466
Notes payable 116,500 121,234
Customer deposits and other obligations 43,528 43,161
--------------------- ---------------------
Total current liabilities 4,662,393 4,442,983
--------------------- ---------------------
Commitments and contingencies
Stockholders' deficit
Preferred stock, $0.001 par value, 10,000,000 shares
authorized, 165,000 of Series A shares issued and
outstanding at August 31, 2005 and May 31, 2005,
respectively 165 165
Class A common stock, $0.001 par value, 10,000,000
shares authorized, -0- shares issued and outstanding
at August 31, 2005 and May 31, 2005, respectively -- --
Common stock, $0.001 par value, 2 billion shares
authorized, 227,786,293 and 87,707,271 shares issued
and outstanding at August 31, 2005 and May 31, 2005,
respectively 227,786 87,707
Additional paid-in capital 26,224,462 26,265,708
Related party receivables, net of allowance for doubtful
accounts of $99,000 at August 31, 2005 and May 31, 2005,
respectively (319,209) (187,050)
Unearned compensation -- (16,667)
Accumulated deficit (30,079,649) (29,434,110)
--------------------- ---------------------
Total stockholders' deficit (3,946,445) (3,284,247)
--------------------- ---------------------
Total liabilities and stockholders' deficit $ 715,948 $ 1,158,736
===================== =====================
The accompanying notes are an integral part of these condensed financial
statements.
3
INSYNQ, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the three months ended August 31,
------------------------------------
2005 2004
--------------- -------------
Revenues
Unrelated parties $ 335,648 $ 299,709
Related parties 33,462 21,828
--------------- -------------
Total revenues 369,110 321,537
--------------- -------------
Costs and expenses
Direct cost of services 294,352 213,886
Selling, general and administrative
Non-cash compensation 16,667 --
Other 330,997 320,399
--------------- -------------
Total costs and expenses 642,016 534,285
--------------- -------------
Loss from operations (272,906) (212,748)
--------------- -------------
Other (expense) income
Gain on forgiveness and settlements of debts 1,604 125,805
Interest expense
Non-cash (225,000) (67,889)
Other (150,271) (112,366)
Other income 1,034 451
--------------- -------------
Total other expense (372,633) (53,999)
--------------- -------------
Net loss $ (645,539) $ (266,747)
=============== =============
Net loss per share of common stock:
Basic and Diluted $ (0.00) $ (0.03)
=============== =============
Weighted average of common shares outstanding:
Basic and Diluted 147,071,196 8,907,569
=============== =============
The accompanying notes are an integral part of these condensed financial
statements.
4
INSYNQ, INC.
CONDENSED STATEMENT OF STOCKHOLDERS' DEFICIT
FOR THE THREE MONTHS ENDED AUGUST 31, 2005
(UNAUDITED)
Additional Related
Preferred Stock Common Stock Paid-In Party
Shares Amount Shares Amount Capital Receivables
---------- -------- ------------- --------- ------------- -----------
Balance at May 31, 2005 165,000 $165 87,707,271 $87,707 $26,265,708 $(187,050)
Issuance of common stock
for the conversion of
debentures -- -- 140,079,022 140,079 (41,246) --
Amortization of unearned
compensation -- -- -- -- -- --
Amount due from related
party receivables -- -- -- -- -- (132,159)
Net loss for the three
months ended August 31, 2005 -- -- -- -- -- --
-------- --------- ----------- -------- ----------- ----------
Balance at August 31, 2005 165,000 $165 227,786,293 $227,786 $26,224,462 $(319,209)
======== ========= =========== ======== =========== ==========
The accompanying notes are an integral part of this condensed financial
statement.
5
(Continued from table above, first column repeated)
Total
Unearned Accumulated Stockholders'
Compensation Deficit Deficit
--------------- -------------- -------------
Balance at May 31, 2005 $(16,667) $(29,434,110) $(3,284,247)
Issuance of common stock
for the conversion of
debentures -- -- 98,833
Amortization of unearned
compensation 16,667 -- 16,667
Amount due from related
party receivables -- -- (132,159)
Net loss for the three
months ended August 31, 2005 -- (645,539) (645,539)
--------------- -------------- -------------
Balance at August 31, 2005 $ -- $(30,079,649) $(3,946,445)
=============== ============== =============
The accompanying notes are an integral part of this condensed financial
statement.
5
INSYNQ, INC.
STATEMENTS OF CONDENSED CASH FLOWS
(UNAUDITED)
For the three months ended August 31,
-------------------------------------
2005 2004
-------------------------------------
Cash flows from operating activities
Net loss .................................................................. $(645,539) $(266,747)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ......................................... 21,155 41,233
Bad debts ............................................................. 3,328 983
Gain on forgiveness and settlements of debts .......................... (1,604) (125,805)
Amortization of unearned compensation ................................. 16,667 --
Amortization of discounts related to convertible notes payable ........ 225,000 67,899
Changes in operating assets and liabilities:
Accounts receivable - trade ....................................... (18,970) (39,422)
Accounts payable .................................................. (17,700) (6,469)
Accrued liabilities ............................................... 116,913 (255,258)
Customer deposits ................................................. 367 749
Prepaid expenses .................................................. (15,022) (15,879)
--------- ---------
Net cash used in operating activities .......................... (315,405) (598,716)
--------- ---------
Cash flows from investing activities
Purchase of equipment .................................................... (25,112) --
--------- ---------
Net cash used in investing activities ......................................... (25,112) --
--------- ---------
Cash flows from financing activities
Related party receivables ................................................. (132,159) (28,549)
Payments on bank notes payable ............................................ (4,734) (4,117)
Increase other deposits ................................................... (230) (26)
Proceeds from convertible notes payable ................................... -- 900,000
Proceeds from issuance of preferred stock ................................. -- 165
Deposit refund ............................................................ -- 657
Payment on capital lease obligation ....................................... -- (1,519)
--------- ---------
Net cash (used in) provided by financing activities ............ (137,123) 866,611
--------- ---------
Net (decrease) increase in cash ............................................... (477,640) 267,895
Cash at beginning of the period ............................................... 703,028 80,359
--------- ---------
Cash at end of the period ..................................................... $ 225,388 $ 348,254
========= =========
The accompanying notes are an integral part of these condensed financial
statements.
6
INSYNQ, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
AUGUST 31, 2005
(UNAUDITED)
Note 1 - Business and Background
BUSINESS
Insynq, Inc. (the Company) is a Nevada corporation headquartered in Tacoma,
Washington USA. The Company is primarily an application hosting and managed
software service provider that provides server-based computing access and
services to customers who have decided to outsource all or part of their
information technology requirements. Customers pay a monthly fee for their
services and connect to the Company's server farm through an internet-enabled
workstation. As of April 30, 2005, the Company also sells its own proprietary
accounting and financial quoting software applications.
BACKGROUND
On February 18, 2000, the Company merged with Xcel Management, Inc. (Xcel), a
non-reporting public shell company. The merger was accompanied by a
re-capitalization and was accounted for as a change in capital structure. On
August 3, 2000 Xcel completed a re-incorporation as a Delaware corporation and
changed its name to Insynq, Inc.
On July 25, 2002, the Board of Directors approved a re-incorporation merger of
the Company with its wholly owned subsidiary, Insynq, Inc., a Nevada
corporation, and effectuated a 100 to 1 common stock exchange of the Company's
currently issued and outstanding shares of common stock. The re-incorporation,
which was effective December 23, 2002, resulted in the exchange of 59,013,393
common shares of the terminating entity, Insynq, Inc. - Delaware, for 590,134
common shares of the surviving entity, Insynq, Inc. - Nevada.
On July 16, 2004, the Board of Directors approved a 1 for 50 reverse split of
the Company's authorized common stock. Accordingly, the date of record and the
effective date was August 2, 2004. Par value remained unchanged at $.001 per
share. The effect of the reverse split reduced the number of authorized shares
from 500,000,000 to 10,000,000 and reduced the number of outstanding and issued
shares of common stock from 445,384,987 shares to 8,907,700 shares.
In addition, at the same board meeting on July 16, 2004, the Directors adopted,
by unanimous consent, to approve the increase of the number of authorized shares
of common stock from 10 million shares to 2 billion shares. On August 2, 2004,
in lieu of a meeting of the stockholders, written consents were received from
stockholders who were entitled to vote a majority of the common stock and the
Series A Preferred Stock, which then approved the July 16, 2004 actions of the
Board of Directors.
All shares of common stock and per share amounts in the accompanying financial
statements and notes to financial statements have been retroactively restated to
reflect this August 2, 2004 transaction.
7
NOTE 2 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Certain information and footnote disclosures, normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America, have been condensed or omitted. It is suggested
that these condensed financial statements be read in conjunction with the
financial statements and notes thereto included in the Annual Report on Form
10-KSB for the fiscal year ended May 31, 2005 filed by the Company on September
13, 2005.
A summary of the significant accounting policies consistently applied in the
preparation of the accompanying condensed financial statements is as follows:
REVENUE RECOGNITION
The Company has two sources of revenue, described as follows:
A. APPLICATION SERVICE PROVIDER
The Company's principal source of revenue is generated from application
hosting, managed software and related types of services. Application
hosting and managed services revenues are generated through a variety of
contractual arrangements directly with customers. The Company sells its
services directly to customers through annual or month-to-month
subscription agreements. Subscription arrangements include monthly
subscriber fees, application hosting fees, user setup fees and a last month
deposit. Revenue is recognized when earned and over the period of the
contractual arrangement. Customer discounts, if any, are recorded as a
reduction of revenue at the time of sale.
B. Sales of Software and Licensing Fees
The Company's second source of revenue is generated from the sales of the
Company's financial and quoting software applications and from licensing
fees billed to the Company's Value Added Resellers (VARS).
Sales of the Company's quoting software products are recognized at the time
of sale to the end-user. The Company generally uses their own website or
that of an e-commerce website to procure payment by credit card.
VARS enter into a licensing agreement that allows them to resell to an end
user either: (a.) a custom suite of enterprise accounting and management
software or (b.) a standard off-the-shelf accounting software application.
VARS sign an agreement with the Company for a period, generally one year,
for a predetermined fixed licensing fee. The licensing fee revenue is
recognized upon execution of agreement. Once an agreement is executed, the
VARS are then entitled to resell or license the Company's software under
their proprietary name. The VARS will purchase the Company's software
(usually at wholesale prices) and may customize the software to the end
users' specifications. The Company recognizes revenue for the sale of its
software to the VARS at the time of sale.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the
8
United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to the previously reported amounts to
conform to the Company's current interim period presentation
FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments consist principally of cash, accounts and related party
receivables, accounts payable, accrued liabilities, and shot-term debt
obligations. The carrying amounts of such financial instruments in the
accompanying balance sheets approximate their fair values due to their
relatively short-term nature. It is management's opinion that the Company is not
exposed to any significant currency or credit risks arising from these financial
instruments.
STOCK-BASED COMPENSATION
The Company accounts for stock based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25 - "Accounting for Stock Issued to Employees"' and the related
interpretations, and complies with the disclosure provisions of SFAS No. 148 - "
Accounting for Stock-Based Compensation". Under APB No. 25, compensation expense
is based on the difference, if any, on the date the number of shares receivable
is determined, between the estimated fair value of our stock and the exercise
price of the options to purchase that stock.
The Company applies the provisions of SFAS No. 123 for stock-based awards to
those entities other than employees. Stock-based compensation expense for these
awards is calculated over related service or vesting periods. Companies choosing
the intrinsic-value method are required to disclose the pro-forma impact of the
fair value method on net income or net loss.
LOSS PER COMMON SHARE
Basic loss per common share is computed by dividing the net loss applicable to
the common stockholders by the weighted average number of shares of outstanding
common stock during the period. Diluted loss per share is computed by dividing
the net loss by the weighted average number of common shares including the
dilutive effect of common share equivalents then outstanding. For the three
months ended August 31, 2005 and 2004, common stock equivalents are not included
in the computation of diluted net loss per common share because the effect would
be anti-dilutive.
RECENT AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS
In June 2005, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 154, "Accounting Changes and
Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and
FASB Statement No. 3, Reporting Accounting Changes in Interim Financial
Statements." SFAS No. 154 changes the requirements for the accounting for and
reporting of a change in accounting principle. Previously, most voluntary
changes in accounting principles were required recognition via a cumulative
effect adjustment within net income for the period of the change. SFAS No. 154
requires retrospective application to prior periods' financial statements,
unless it is impracticable to determine either the period-specific effects or
the cumulative effect of the change. SFAS No. 154 is effective for accounting
changes made in fiscal years beginning after December 15, 2005;
9
however, SFAS no. 154 does not change the transition provisions of any existing
accounting pronouncements. The Company does not believe the adoption of SFAS No.
154 will have a material impact on its financial condition or results of
operations.
In March 2004, the FASB Emerging Issues Task Force ("EITF") released Issue No.
03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to
certain Investments." EITF 03-1 provides guidance for determining whether
impairment for certain debt and equity investments is other-than-temporary and
the measurement of an impaired loss. The recognition and measurement
requirements of EITF 03-1 were initially effective for reporting periods after
June 15, 2004. However, in September 2004, the FASB staff issued FASB Staff
Position ("FSP") EITF 03-1-1 that delayed the effective date for certain
measurement and recognition guidance contained in EITF 03-1. The FSP requires
that entities continue to apply previously existing "other-than-temporary"
guidance until a final consensus is reached. The Company does not anticipate
that the issuance of a final consensus will materially impact its financial
condition or results of operations.
Note 3 - Going Concern and Management's Plans
The Company's financial statements as of and for the three months ended August
31, 2005 have been prepared on a going concern basis, which contemplates the
realization of assets and the settlement of liabilities and commitments in the
normal course of business. For the three months ended August 31, 2005, the
Company had a net loss of $645,539 and a negative cash flow from operations of
$315,405. The Company had a working capital deficit of $4,362,152 and a
stockholders' deficit of $3,946,445 at August 31, 2005. The Company's working
capital deficit as of August 31, 2005 may not enable it to meet certain
financial objectives as presently structured. The accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
As of August 31, 2005 and through October 20, 2005, the Company is not in
compliance with the proper registration and licensing of certain software
applications and products critical to support the customer base and its own
internal operations. The Company has initiated negotiations with these software
vendors in an effort to remedy this deficiency by either offering to purchase or
lease/rent the licenses to meet the licensing requirements. Should the Company
not reach a satisfactory agreement with these vendors, and due to the vital and
critical nature of these licenses to support its services, sales and operations
it may be forced to cease operations and/or to file bankruptcy.
The rate at which the Company expends its resources is variable, may be
accelerated, and will depend on many factors. The Company will need to raise
substantial capital to finance its operations and may seek such additional
funding through public or private equity or new debt. There can be no assurance
that such additional funding, if any, will be available on acceptable terms. The
Company's continued existence as a going concern is ultimately dependent upon
its ability to secure additional financing.
Note 4 - Related Party Transactions
As of August 31, 2005, the Company has extended credit and/or loaned money to
three business entities that are related to one or more officers/stockholders of
the Company and since the amounts due from the related parties are uncertain as
to the timing of repayment they are recorded in the stockholders' deficit
section in the accompanying balance sheets. The following discusses the
activities and balances due from the respective entities:
o Two of the businesses were related to a corporate officer, stockholder
and director. Insynq provided these two businesses monthly application
hosting services and other related management services. At August 31,
2005, the balance due from these two companies aggregated $104,576, and
an allowance for past due collections of $99,000 was set up on these
accounts. During the three months ended August 31, 2005, the Company
billed these related businesses approximately $9,044.
10
o The third business is partially owned by two officers of Insynq. As of
August 31, 2005, Insynq has advanced $289,215 in the form of cash,
paid expenses and administrative and operational support. (See also
Note 12)
In June 2005, Insynq and this related entity entered into a five year
agreement whereby Insynq was awarded an application management services
agreement in exchange for supplying business technology, IT management
and communications infrastructure. For the three months ended August
31, 2005, Insynq has, under this agreement, billed this entity $24,418
for hosting of applications and rental of infrastructure and technology
equipment.
Note 5 - Notes Payable
The Company had five notes payable, one with a bank and four with private
parties. The private party notes, all of which are in default, plus the accrued
interest, were generally due within one year from the date of issuance or on
demand. The following describes the general terms and current conditions of the
notes:
August 31, 2005 May 31, 2005
------------------- -------------------
Note payable to bank, $15,000 revolving line of
credit, bearing interest prime plus 12.00% and
personally guaranteed by an officer. On June 7,
2005, this note, plus accrued interest, was paid off
and the account was closed. $ -- $ 4,734
Four notes payable to private parties, all past due,
bearing default interest ranging from 10% to 21%,
and are unsecured. 116,500 116,500
------------------- -------------------
$ 116,500 $ 121,234
=================== ===================
Note 6 - Accrued Liabilities
Accrued liabilities consist of the following at:
August 31, May 31,
2005 2005
---------------------------
Salaries and benefits ........ $ 266,148 $ 302,902
Taxes
Payroll ................. 1,737 8,588
Business ................ 35,037 33,397
Penalties and interest .. 206,443 215,058
Interest ..................... 1,158,365 1,011,503
Licenses, consulting and other 600,481 581,452
---------- ----------
$2,268,211 $2,152,900
========== ==========
On July 11, 2005 the Company entered into an installment agreement with the
Internal Revenue Service (IRS) to pay a remaining obligation that accrued during
prior periods from the non-payment of payroll
11
taxes. The obligation, at the time of execution of the installment agreement,
was $215,058 and was made up of unabated penalties and accrued interest. Terms
require the Company to pay not less than $5,000 per month, including interest,
over a 50-month period or until the balance is zero. At August 31, 2005, the
Company owes the IRS approximately $206,000. The IRS has a lien on Company
assets.
A lien for approximately $28,000 was filed several years ago by a State for
prior years' income taxes assessed to the predecessor company of Insynq, Inc.
The assessment was disputed and the Company filed amended returns to correct
this deficiency. As of the date of this report, the State has not responded to
the amended returns, thereby, neither granting approval nor denying the filing
of the amended returns. This obligation is recorded under business taxes.
Note 7 - Secured Convertible Securities
CONVERTIBLE DEBENTURES
Between June 2001 and March 2003, the Company issued a total of $2,050,000 of
secured convertible debentures, under three separate private financing
transactions with four investor groups (See also Convertible Notes below). Terms
of each of the three private financing transactions, are essentially the same:
the debentures are convertible into shares of common stock at the lesser of (i)
$15 per share and (ii) the average of the lowest three intraday trading prices
in the twenty-day trading period immediately preceding the notice to convert,
discounted by sixty percent (60%). Pursuant to an amendment in June 2004, the
due date of the debentures was extended for an additional two years until June
25, 2006. As of August 31, 2005, the Company owes $1,201,212 on the convertible
debentures, and approximately $1,008,800 of accrued interest related to the
debentures. Accrued interest is included in accrued liabilities in the
accompanying balance sheets. (See also Note 12.)
For the three months ended August 31, 2005, the Company issued 140,079,022
shares of common stock in redemption of $98,833 of principal on these
debentures.
Warrants were granted to the investors in conjunction with the convertible
debenture transactions. Investors may exercise each warrant at $12.50 per share.
As of August 31, 2005, 104,000 of these warrants were outstanding and were
unexercised with an amended expiration period until June 25, 2009.
As of August 31, 2005, the Company is in default on these securities because of
non-compliance with certain terms and conditions underlying the debentures.
Therefore, these securities are classified as a current liability.
CONVERTIBLE NOTES PAYABLE
On February 28, 2005, the Company entered into a Securities Purchase Agreement
for the issuance of $2,700,000 in the form of 8% secured convertible notes
payable to four investor groups, who are also the holders of the Company's
convertible debentures. The notes are due three years from the date of issuance,
bear interest at 8% per annum, and interest is payable quarterly in cash. No
interest will be charged in any month in which the reported intraday trading
price is greater than 125% of the initial market price ($0.005) or $0.0063 for
each trading day of that month. The notes or portions of these notes are
immediately convertible into shares of the Company's common stock during the
term. The conversion price is equal to the lesser of: (a.) $0.0075, the fixed
conversion price, and, (b.) the average of the lowest three intraday trading
prices during the twenty days immediately prior to the conversion date
multiplied by 40%, the applicable conversion percentage.
The Company recorded a discount on the convertible notes payable totaling
$2,700,000, an amount equal to the fair value of the warrants, as determined by
applying the Black-Scholes pricing model, and the intrinsic value of the
beneficial conversion feature, which is the difference between the conversion
price and the fair market value of the common stock on the date of issuance. The
amount attributable to the beneficial
12
conversion feature and warrants was recorded as a discount on the debt and
accretes over a thirty-six month period as interest expense in accordance with
paragraph 19 of Emerging Issues Task Force ("EITF") No. 00-27 and APB No. 14,
Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.
For the three months ended August 31, 2005, the Company recognized as interest
expense, discounts on the convertible notes payable totaling $225,000.
In the event of default under the terms of these notes, the investors have the
right to redeem the notes at 130% of the outstanding principal balance, plus
accrued and unpaid interest, plus default interest and other penalty payments
that may be due. The default interest is at 15% per annum, if any amounts due
under the notes are not paid when due. At the option of the investors, such
redemption payments may be made in shares of common stock. If certain conditions
are satisfied, the Company may elect to prepay the notes before the scheduled
maturity at a premium. The premium is 150% of the outstanding principal balance
plus accrued and unpaid interest, plus default interest and other penalty
payments due, depending on when the prepayments occurs. Because the Company is
not in compliance with certain terms and conditions underlying this agreement,
the principal amount due is reported in the balance sheet as a currently
liability.
As a condition to the above Security Purchase Agreement, the Company granted the
investors 5,400,000 warrants at an exercise price of $0.007 per share and
exercisable from time to time until February 28, 2010.
The Company also granted the investors of the convertible securities a security
interest in all corporate assets.
Note 8 - Class A Common Stock
The Board of Directors is authorized to issue of up to 10,000,000 shares of
Class A common stock pursuant to which the holders are entitled to three votes
for each share held, on all matters submitted to stockholders, which voting
power may be used by the holders of such stock to create voting impediments or
otherwise delay or prevent a change in control or to modify the rights of
holders of the Company's common stock.
Note 9 - Preferred Stock
The Board approved and authorized in its July 16, 2004 meeting, the designation
of 1,000,000 shares of "Series A, Non-Participating Preferred Stock" as part of
the authorized 10,000,000 preferred shares. The par value of this series of
preferred stock is $0.001 per share, with each share having 1,000 votes on all
matters upon which the shareholders are entitled to vote. The Board then issued
165,000 shares of this designated preferred stock in equal portions to its three
corporate officers.
Note 10 - Contingencies and Commitments
LAWSUITS
On July 18, 2005, the Company was served with a complaint for a material breach
of contract. The complaint was filed by the Company's former landlords for the
breach of a long-term lease for office space. The lease term was March 2002
through July 2006. The claim is for an unspecified amount of damages. The
Company denies the allegations under this claim and believes this claim is
without merit and intends to continuously and vigorously defend against it. The
Company has not recognized an expense for this claim in the August 31, 2005
condensed financial statements.
The Company is also subject to other legal proceedings and business disputes
involving ordinary and routine claims. The ultimate legal and financial
liability with respect to such matters cannot be estimated with certainty and
requires the use of estimates in recording liabilities for potential litigation
settlements. Estimates for losses from litigation are made after consultation
with outside counsel. If estimates of potential losses increase or the related
facts and circumstances change in the future, the Company may be required to
record either more or less litigation related expense.
13
It is management's opinion that none of the open matters at August 31, 2005 and
through October 20, 2005, will have a material adverse effect on the Company's
financial condition or operations.
LICENSING
The Company is operating without proper registration and a current licensing
agreement for hosting certain software. The Company has been accruing monthly an
estimated liability to cover this obligation. As of August 31, 2005 the Company
estimates it owes this vendor approximately $384,500, which is included in
accrued liabilities in the accompanying condensed balance sheets. The Company is
in contact with the vendor company to negotiate the amount due and execute a
definitive agreement in order to use the software according to a standard
licensing registration.
CONSULTING AND DISTRIBUTION AGREEMENTS
The Company is obligated on the two following agreements:
o Consulting Agreement - A $5,000 per month consulting agreement was
assumed on April 30, 2005 by the Company as a condition to closing an
asset purchase agreement between the seller (a related party to Insynq)
of the intellectual property and the original seller of the
intellectual property to the related party. Insynq agreed to honor the
remaining term of the consulting agreement in exchange for the original
sellers' expertise and guidance. The agreement will terminate on or
before May 2006.
o Distribution Agreement - At the time of purchase on April 30, 2005, a
distribution agreement existed between the same original selling party
as discussed above, and the related party. Insynq assumed the
responsibility for fulfilling the terms of this agreement as part of
the asset purchase agreement. This agreement stipulates that 5.5% of
gross cash receipts from the sales of certain software products will be
paid each quarter to the original selling party. This agreement is in
perpetuity. There is, however, a $1,250,000 buyout provision whereby at
any time the obligator may completely satisfy the terms underlying this
agreement.
Note 11 - Other Disclosures
NON-CASH INVESTING AND FINANCING
Non-cash investing and financing activities included the following for the three
months ended:
August 31,
2005 2004
------------------------
Conversion of debentures into common stock .............. $98,333 $ --
Deposit applied to equipment purchase ................... 26,812 --
Record discounts on convertible notes payable issued with
warrants ............................................. -- 741,640
SUPPLEMENTAL CASH FLOWS INFORMATION
Cash paid for interest expense for the three months ended August 31, 2005 and
2004 was $2,971 and $255, respectively.
Note 12 - Subsequent Events
DEBT RESTRUCTURED
On September 29, 2005, the Company restructured approximately $588,400 of
accrued interest related to
14
certain secured convertible debentures into four callable secured convertible
notes payable, bearing interest at 2% per annum and maturing on September 29,
2008. These convertible notes have conversion features similar to those
discussed in Note 7.
RELATED PARTY TRANSACTIONS
In October 2005, the Company received an unsecured promissory note for
approximately $334,000 from the related party (the third business), as discussed
in Note 4. The promissory note bears interest at eight percent per annum and is
short-term.
CONVERTIBLE DEBENTURES
From August 31, 2005 to October 20, 2005, the Company has issued 75,700,000
shares of common stock for the principal redemption of $41,683 of convertible
debentures.
ITEM II MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with the
condensed financial statements, including notes thereto, appearing in this Form
10-QSB and in our May 31, 2005 Annual Report on Form 10-KSB.
Except for the historical information contained herein, this Quarterly Report
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
as amended. We believe it is important to communicate our expectations.
You can identify these statements by forward-looking words such as "may",
"will"', "believes", "anticipates", "estimates", "expects", "continues"' and/or
words of similar import. Forward-looking statements are based upon our
management's current expectations and beliefs concerning future developments and
their potential effects upon us that may involve substantial risks and
uncertainties. There may be events in the future that we are not able to
accurately predict or over which we have no control. Our actual results could
differ materially from those anticipated for many reasons in these
forward-looking statements. Factors that could cause or contribute to the
differences include, but are not limited to, availability of financial resources
adequate for short-, medium- and long-term needs, demand for our products and
services and market acceptance, as well as those factors discussed in the "Item
2, Management's Discussion and Analysis of Financial Condition and Results of
Operations" and elsewhere in this report.
We believe it is important to communicate our expectations, however, our
management disclaims any obligation to update any forward-looking statements
whether as a result of new information, future events or otherwise.
A more detailed discussion of these factors is presented in our May 31, 2005
Annual Report of Form 10-KSB.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
GENERAL
Our discussion and analysis of our financial condition and results of operations
as of and for the three months ended August 31, 2005, are based upon our
condensed financial statements. As such, we are required to make certain
estimates, judgments and assumptions that management believes are reasonable
based upon the information available. We base these estimates on our historical
experience, future expectations and various other assumptions that we believe to
be reasonable under the circumstances, the results of which form the basis for
our judgments that may not be readily apparent from other sources. These
estimates and assumptions affect the reported amounts of assets and liabilities
and the disclosure of contingent assets and liabilities at the dates of the
condensed financial statements and the reported amounts of revenue and expenses
during the reporting periods. These estimates and assumptions relate to
estimates of collectibility of accounts receivable, the realization of
intangible assets, the expected term of a customer
15
relationship, accruals and other factors. We evaluate these estimates on an
ongoing basis. Actual results could differ from those estimates under different
assumptions or conditions, and any differences could be material.
The condensed financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC) and, in the opinion
of management, our condensed financial statements include all adjustments
necessary for a fair presentation of the results of operations, financial
position, changes in stockholders' deficit and cash flows for each period
presented.
A summary of the significant accounting policies which we believe are the most
critical to aid in fully understanding and evaluating the accompanying condensed
financial statements include the following:
REVENUE RECOGNITION
APPLICATION SERVICE PROVIDER
Our principal source of revenue is generated from application hosting, managed
software and other similar and related types of services. Application hosting
and managed services revenues are generated through a variety of contractual
arrangements directly with customers. We sell our services directly to customers
through annual service subscriptions or month-to-month subscriptions.
Subscription arrangements include monthly subscriber fees, user setup fees and a
last month deposit. New subscription service fees are prorated and invoiced
during the first month of service. Ensuing subscription services are invoiced at
the beginning of each month for that month of service. User setup fees received
are recognized at the time of the order. Any prepaid amount, regardless if it is
non-refundable, is recorded as a customer deposit and is generally applied to
the last month's service fee. Sale and promotional discounts are recorded as a
reduction of revenues.
LICENSING FEES AND SALES OF SOFTWARE
On May 1, 2005, we added another source of revenue. This new source of revenue
is generated primarily from licensing fees billed to our value added reseller
(VARS) and from the sales of our accounting and quoting software applications.
Sales of the quoting software products are recognized at the time of sale to the
end-user. Our software is sold using either an e-commerce website or our own,
www.qwikquote.com, to procure payment by credit card.
VARS enter into a licensing agreement that allows them to resell to an end user
either: (a.) a custom suite of enterprise accounting and management software or
(b.) a standard off-the-shelf accounting software application. VARS sign an
agreement for a period, generally one year, for a predetermined fixed licensing
fee. The licensing fee revenue is recognized upon execution of agreement. Once
an agreement is executed, the VARS are then entitled to resell or license our
software under their proprietary name. The VARS will purchase the software
(usually at wholesale prices) and customize the software to the end users'
specifications. We recognize revenue for the sale of its software to the VARS at
the time of sale.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments consist principally of cash, accounts and related party
receivables, trade and related
16
party payables, accrued liabilities, and short and long-term debt obligations.
The carrying amounts of such financial instruments in the accompanying condensed
balance sheets approximate their fair values due to their relatively short-term
nature. It is our opinion that we are not exposed to significant
currency or credit risks arising from these financial instruments.
USE OF ESTIMATES
The preparation of condensed financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the condensed financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
STOCK-BASED COMPENSATION
We account for stock based employee compensation arrangements in accordance with
the provisions of Accounting Principles Board ("APB") Opinion No. 25 -
"Accounting for Stock Issued to Employees"' and the related interpretations, and
complies with the disclosure provisions of SFAS No. 148 - " Accounting for Stock
Based Compensation". Under APB No. 25, compensation expense is based on the
difference, if any, on the date the number of shares receivable is determined,
between the estimated fair value of our stock and the exercise price of the
options to purchase that stock.
We apply the provisions of SFAS No. 123 for stock-based awards to those entities
other than our employees. Stock-based compensation expense for these awards is
calculated over related service or vesting periods. Companies choosing the
intrinsic-value method are required to disclose the pro-forma impact of the fair
value method on its net income or net loss.
LOSS PER COMMON SHARE
We compute basic and diluted loss per share of common stock by dividing the net
loss by the weighted average number of common shares outstanding available to
common stockholders during the respective reporting period. However, common
stock equivalents have been excluded from the computation of diluted loss per
share of common stock for the three months ended August 31, 2005 and 2004,
respectively, because their effect would be anti-dilutive.
RECLASSIFICATIONS
Certain reclassifications have been made to the previously reported amounts to
conform to our current period presentation.
RECENT AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS
In June 2005, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 154,"Accounting Changes and Error
Corrections, a replacement of Accounting Principles Board ("APB") Opinion No.
20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes
in Interim Financial Statements." SFAS No. 154 changes the requirements for the
accounting for and reporting of a change in accounting principle. Previously,
most voluntary changes in accounting principles were required recognition via a
cumulative effect adjustment within net income for the period of the change.
SFAS No. 154 requires retrospective application to prior periods' financial
statements, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. SFAS No. 154 is effective for
accounting changes made in fiscal years beginning after December 15, 2005;
however, SFAS no. 154 does not change the transition provisions of any existing
accounting pronouncements. We do not believe the adoption of SFAS No. 154 will
have a material impact on our financial condition or results of operations.
In March 2004, the FASB Emerging Issues Task Force ("EITF") released Issue No.
03-1, "The Meaning of
17
Other-Than-Temporary Impairment and Its Application to certain Investments."
EITF 03-1 provides guidance for determining whether impairment for certain debt
and equity investments is other-than-temporary and the measurement of an
impaired loss. The recognition and measurement requirements of EITF 03-1 were
initially effective for reporting periods after June 15, 2004. However, in
September 2004, the FASB staff issued FASB Staff Position ("FSP") EITF 03-1-1
that delayed the effective date for certain measurement and recognition guidance
contained in EITF 03-1. The FSP requires that entities continue to apply
previously existing "other-than-temporary" guidance until a final consensus is
reached. We do not anticipate that the issuance of a final consensus will
materially impact our financial condition or results of operations.
OVERVIEW
On July 16, 2004, our Board of Directors approved a 50 for 1 reverse split of
our authorized common stock. Accordingly, the date of record and the effective
date was August 2, 2004. Par value remained unchanged at $.001 per share. The
effect of the reverse split reduced the number of authorized shares from
500,000,000 to 10,000,000 and reduced the number of outstanding and issued
shares of common stock from 445,384,987 at August 2, 2004 shares to 8,907,700.
Upon the conversion, all resulting fractional shares were rounded up to nearest
whole share. In addition, we cancelled all of the shareholders holding nine or
less shares of post-split stock.
For comparative purposes, all shares of common stock and per share amounts in
the Form 10-KSB, and the accompanying financial statements and notes to
financial statements have been retroactively restated to reflect this August 2,
2004 transaction.
In addition, our Board approved in its July 16, 2004 meeting, the authorization
of 1,000,000 shares of its 10,000,000 shares of preferred stock to be
specifically designated as, "Series A Non-Participating Preferred Stock", with a
par value at $0.001 per share. Also, each share has 1,000 votes on all matters
upon which the shareholders are entitled to vote. Our Board then issued 165,000
shares of this stock in equal amounts to its three corporate officers. As a
result of the reverse split on August 2, 2004 and the July 16, 2004 issuance of
the 165,000 shares of Series A, Non-Participating Preferred Stock, our three
corporate officers have the ability to control the outcome of any item coming to
a vote before the stockholders.
Also at the July 16, 2004 Board Meeting, our Board of Directors adopted, by
unanimous consent, to approve the increase of the number of authorized shares of
common stock from 10 million to 2 billion shares. On August 2, 2004, we received
the written consent in lieu of a meeting of stockholders from our stockholders
who were entitled to vote a majority of the common stock and Series A Preferred
Stock, which approved the July 16, 2004 action of our Board of Directors.
OUR BUSINESS
Our Company has been operating since 1998, primarily as an application service
provider ("ASP"). On April 30, 2005 we purchased certain assets from Aptus
Corp., a related party, namely its intellectual property. We now own the
licensing rights, the code and the trademarks of intellectual property allowing
us to sell and license our own proprietary software applications to end users as
further explained below. Therefore, our Company now has two principal revenue
sources:
(I.) hosting of software applications and related services commonly referred to
ASP's, and,
(II.) licensing and sales of our proprietary software applications.
The following discussion more fully describes these complimentary services and
products:
I. An ASP offers the infrastructure, servers and data center(s) and the
technical expertise to host software business solutions distributed over
Internet ready computers. The hosted customer uses a web browser to access
software and data products, anywhere at anytime, without the need to download or
install a software application. We manage and host software applications and
data, Web hosting services, Web-based local and wide area networks, and access
to Internet marketing assistance and other related equipment and
18
services. These products and services are offered as components or as an
integrated whole, either sold directly or on a fee or a subscription basis.
We target small and medium enterprises and the high-end segment of the small
office and home office market for the sale of hardware and hosted software and
access to internet-related services. We provide products and services to our
customer subscriber base, which allows our customers to adopt "web-based"
computing that serves as an alternative to both traditional local or wide area
networks and traditional client-server implementations. Generally, we market
ourselves as an Internet utility company that can provide all of the computer
networking needs for its customers on a cost effective basis.
II. As of May 1, 2005, we sell a proprietary family of accounting and management
software applications known as "Appgen Custom Suite" and "MyBooks Professional"
and a quoting software application known as "QwikQuote". We primarily
promote the sale of our Appgen software through value added resellers, commonly
referred to as VARs. A VAR will participate in one of four reseller programs.
Each reseller program offers an incremental level of benefits, and the fees for
each program is structured accordingly. These resellers often develop their own
applications around the Appgen Custom Suite and open up entirely new vertical
markets for themselves while integrating the new packages or modules and
customizations with the accounting software. MyBooks Professional is,
essentially, "canned software", designed to accommodate the accounting and
financial reporting needs of a small to medium sized business.
We sell our QwikQuote software, through our website and through a web-based,
on-line e-commerce site. QwikQuote is a sales quotation and product management
software product designed to assist a company's sales force in calculating and
recalculating pricing arrangements, products' margins and commissions and to
interact with leading contact management software.
RESULTS OF OPERATIONS
We reported a net loss of $645,539 and $266,747 for the three months ended
August 31, 2005 and 2004, respectively. The current quarter's net loss increased
$378,792 over the same period one year ago primarily because of:
o The recognition of approximately an additional $157,100 of amortization of
discounts associated with our convertible notes payable, and
o An increase in interest expense of approximately $37,900, and
o The increase in revenues of approximately $47,600, and
o The decrease in forgiveness and settlements of debts of approximately
$124,200, and o The overall net increase in costs, expenses and other
income of approximately $107,200.
For the three months ended August 31, 2005, net revenues increased approximately
$47,600 or 14.8% over the same period one-year ago. The revenue increase can be
directly attributable to the addition of sales from our software and licensing
division, which was added to our operations on May 1, 2005. Our first quarter
net revenue from this new division was approximately $96,800.
Revenue from our traditional hosting services ASP division was approximately
$272,200, down from the comparable quarter one year ago by $49,300, yet it did
report better earnings than our most recent quarter
19
ended May 31, 2005 by approximately $3,200. In fiscal 2005, we lost a few key
enterprise customers who had a low number of seats but high revenues per seat.
This statistic is supported by the number of seats billed in quarter ended
August 31, 2004 as compared to quarter ended August 31, 2005. We accounted for
3,342 seats for the three months ended August 31, 2004 as compared to 3,992
seats accounted for the three months ended August 31, 2005. The number of seats
has increased 19.4% over the same period one year ago, but revenues dropped.
Regardless of our efforts to increase the number of seats for quarter ended
August 31, 2005 over quarter ended August 31, 2004, we were not able to generate
new revenues equal to the loss of our customer's who had cancelled. Those few
enterprise customers who had cancelled generated disproportionately higher
revenues per seat, and, generally without discounts. In addition, in order to
attract new customers, we granted to a larger of number customers, more than the
planned amount of discounts for this current quarter. We believe, however, our
customer base is finding immediate and long-term advantages to the "host on
demand" concept, both administratively and financially, because it allows them
to be able to have immediate access to their corporate computing needs anytime
and anywhere in the world for a competitive fee.
We have intensified our marketing and sales efforts via the Internet, enhanced
and improved our website and now offer more professional products, such as
the Appgen Custom Suite, MyBooks Professional and QwikQuote applications.
Our management believes we will grow the revenues of our business principally
through web-based contacts and the addition of our VARs and selected e-commerce
sites selling our products.
In order to provide competitive pricing to our customers, and to encourage new
customers to use our service and products, we have traditionally offered
short-term discounts and, for limited periods, free product usage through
various promotional offerings. Discounted offerings will continue into fiscal
2006 as part of our promotional efforts to be recognized in our industry as
competitive, and gaining more share of the market. Discounts and promotional
adjustments related to our ASP services for the quarter ended August 31, 2005
and 2004 were $29,573 and $22,340, respectively, or 9.8% and 6.5% of gross
revenues. Discounts recognized this quarter related to our software sales and
licensing division was $30,282, or 23.8% of this division's gross revenue.
In the beginning of our existence, we had to demonstrate and educate consumers
of the value and simplicity of operations, whereby encouraging signups by
offering discounts on selected products and services. As a business practice, we
do not advocate, nor promote the use of long-term discounts to attract potential
customers and maintain positive relationships with existing customers. Discounts
will continue to be offered if it means we will attract and keep a valued and
credit worthy customer. There are many criteria to meet before we can justify
discounting our pricing structure for a customer. We also consider pricing
adjustments, similar to a discount, to a customer, if the business model and
pricing structure means a mutually long-term business relationship.
We believe our marketing campaign, our improved website and our links to other
notable partner websites, will substantially increase consumer understanding and
awareness of our "host on demand" technology and our software products. Our main
priorities relating to the generation of new customers and revenues are:
o Increase market awareness of our products and services through our
strategic marketing plan,
o Increase the number of seats and applications per customer,
o Increase the number of VAR's and software installations to end-users,
o Continue to accomplish technological economies of scale, and
o Continue to streamline and maximize efficiencies in our system
implementation model.
As a result of these efforts, we believe we will sustain a reasonable and
controlled growth rate of new customers. Even though we have experienced a
decrease in our "host-on-demand" revenue this fiscal quarter over our comparable
fiscal quarter, our customer population has been growing. The decline in quarter
ended August 2005 "host-on-demand" revenues, as compared to prior period
revenues, should not be considered necessarily indicative as the trend to
20
forecast our future revenues.
COSTS AND EXPENSES
DIRECT COSTS OF REVENUES
For the three months ended August 31, 2005, we incurred direct costs of services
totaling $294,352 or 79.7% of revenues as compared to $213,886 or 66.5% of
revenues for the same quarter one year ago. This category of expense increased
primarily due to the addition of new staff and consultants directly supporting
the software and licensing division. Overall, we estimate these new charges
added approximately $112,600 of expense to our base of traditional hosting
direct costs. We did, however, reduce the direct expenses associated with our
traditional hosting services by approximately $32,100. This decrease can be
primarily identified with the reduction of depreciation expense of $36,218.
Other expense items in this classification increased a nominal $4,100.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $347,664 and $320,399 for the
quarters ended August 31, 2005 and 2004, respectively. These expenses are
allocated between non-cash and other compensation. Non-cash compensation is
generally representative of the fair value of common stock, options and warrants
issued to certain non-employees for services rendered and the amortization of
unearned compensation.
A net increase of approximately $27,300 or 8.5% occurred between these
comparable quarters. Approximately 88.8% of this increase, or $24,300, is
directly associated with the implementation of our marketing plan in fiscal
2005. We have committed a certain level of resources to market our products and
services and bring awareness to our target markets by increasing our exposure on
the web and by attending at various business and trade shows, generally
sponsored by state CPA societies and other notable and prominent business
organizations and associations.
We incurred a small net increase in the administrative portion of this expense
category of approximately $3,000 this quarter over our comparable quarter one
year ago. This minor increase is primarily a result of increased salaries and
related burden, which was then an offset principally by a reduction of
professional type fees.
Under the circumstances, we believe our costs are under control, as planned,
and, within proximate range of management's forecasts.
The primary components of our interest expense are:
For the three months ended
August 31,
--------------------------
2005 2004
--------------------------
Amortization of discounts on
convertible securities ..... $225,000 $ 67,899
Interest on convertible
securities ................. 139,333 94,516
21
Interest on other obligations
and notes payable .......... 10,938 17,840
-------- --------
Total ..................... $375,271 $180,255
======== ========
Other Interest .............. $150,271 $112,366
Non-cash interest ........... 225,000 67,889
-------- --------
Total ..................... $375,271 $180,255
======== ========
LIQUIDITY AND CAPITAL RESOURCES
Our condensed financial statements as of and for the three months ended August
31, 2005 have been prepared on a going concern basis, which contemplates the
realization of assets and the settlement of liabilities and commitments in the
normal course of business. For the quarter ended August 31, 2005, we had a net
loss of $645,539 and negative cash flows from operations of $315,405. Also at
August 31, 2005, we had a working capital deficit of $4,362,152 and a
stockholders' deficit of $3,946,445. Our working capital deficit at August 31,
2005 and as of October 20, 2005 may not enable us to meet certain financial
objectives as presently structured.
We had a cash balance of $225,388 at August 31, 2005 and a cash balance at
October 20, 2005 of approximately $29,900. We finance our operations and capital
requirements primarily through private debt and equity offerings.
As of August 31, 2005, we classified all our convertible security debts as
current liabilities because of non-compliance with the underlying terms,
conditions and covenants governing these debt instruments. We consider
non-compliance with any major term of a debt instrument to be in violation of
the agreement; therefore, the debt automatically becomes a current liability.
Our balance sheet at August 31, 2005 reports current liabilities of $4,662,393;
however, this amount is net of an unamortized discount of $2,247,534. Total
current debts actually total $6,909,927, thereby, increasing our working capital
deficit to $6,609,686. Unless we are able to pay a significant portion of our
debt from operational profits or from new equity financing, our negative working
capital is expected to continue to increase in fiscal 2006.
In June 2005, we have entered into a five-year hosting and management services
agreement with Gotaplay Interactive, Inc. ("Gotaplay"), a related party, whereby
we will supply business technology, IT management and communications
infrastructure and other services as needed. For the three months ended August
31, 2005 we have billed Gotaplay $24,418 for hosting services and rental of
infrastructure and technology equipment. As well, we have also advanced
approximately $289,215 as of August 31, 2005 to this related party in the
support of their ongoing development and integration of its strategic business
plan. At August 31, 2005, we are owed approximately $313,633. In October 2005,
we received a short-term promissory note for approximately $334,000 from
Gotaplay. The promissory note bears interest at eight percent per annum and is
unsecured. Our relationship stems from the fact that two of our officers, are
also officers, directors and stockholders of Gotaplay.
CONVERTIBLE DEBENTURES
Between June 2001 and March 2003, we sold to four investor groups a total
$2,050,000 in the form of three private financing transactions for 12% secured
convertible debentures. At various times, we
22
have been in default on these instruments and, accordingly, have classified the
balances due on these debentures as a current liability. However, on June 25,
2004, we were able to negotiate an extension of the past due maturity dates for
an additional two years, until June 25, 2006. However, because of our
non-compliance with certain provisions of these securities, we have classified
the entire balance of $1,201,212 as a current liability on our condensed balance
sheets.
Between September 1, 2005 and October 14, 2005 we issued 62,500,000 shares of
common stock to our investors and reduced the principal balance due on our
convertible debentures by $35,875. At October 14, 2005 we owe on our convertible
debentures $1,165,337.
Amended terms, due to the extension discussed above, for all three private
financing transactions are essentially the same: the debentures are convertible
into shares of common stock at the lesser of (i) $15.00 per share and (ii) the
average of the lowest three intraday trading prices in the twenty-day trading
period immediately preceding the notice to convert, discounted by 60%. Interest
accrues at 12% and default rate of interest is 15%.
We granted 104,400 warrants to purchase common stock to the investors in
conjunction with each convertible debenture transaction. Investors may exercise
each warrant at $12.50 per share and the warrants carry an expiration date of
June 25, 2009.
On September 29, 2005, we restructured approximately $588,400 of accrued
interest related to these convertible debentures into four callable secured
convertible promissory notes, bearing interest at 2% per annum. These notes will
mature on September 29, 2008. These notes are subject to conversion features
similar to those outlined directly below under the discussion of our convertible
notes payable.
CONVERTIBLE NOTES PAYABLE
On February 28, 2005, we entered into a $2,700,000 Securities Purchase Agreement
with four investor groups, who are also holders of our convertible debentures.
Under terms of the agreement, we:
(a.) issued four 8% callable secured convertible notes that aggregated
$2,700,000, and,
(b.) granted 5,400,000 warrants with an exercise price of $0.007 and are
exercisable from time to time until February 28, 2010.
The notes are due three years from the date of issuance, bear interest at 8% per
annum, payable quarterly in cash. No interest will be charged in any month in
which the reported intraday trading price is greater than 125% of the initial
market price ($0.005) or $0.0063 for each trading day of that month. The notes
or portions of these notes are immediately convertible into shares of our common
stock during the term. The conversion price is equal to the lesser of:
(a.) $0.0075, the fixed conversion price, and,
(b.) the average of the lowest three intraday trading prices during the twenty
days immediately prior to the conversion date discounted by 60%.
We also recorded a $2.7 million dollar discount on the convertible notes
payable, an amount equal to the fair value of the warrants, as determined by
applying the Black-Scholes pricing model, and the intrinsic value of the
beneficial conversion feature, which is the difference between the conversion
price and the fair market value of the common stock on the date of issuance. The
amount attributable to the beneficial conversion feature and the warrants was
recorded as a discount on the debt and accretes over a thirty -six month period
as interest expense in accordance with paragraph 19 of Emerging Issues Task
Force ("EITF") No. 00-27.
In the event of default under the terms of these Notes, the investors have the
right to redeem the Notes at
23
130% of the outstanding principal balance, plus accrued and unpaid interest,
plus default interest and other penalty payments that may be due. The default
interest is at 15% per annum, if any amounts due under the Notes are not paid
when due. At the option of the investors, such redemption payments may be made
in shares of common stock. If certain conditions are satisfied, we may elect to
prepay the Notes before the scheduled maturity at a premium. The premium is 150%
of the outstanding principal balance plus accrued and unpaid interest, plus
default interest and other penalty payments due, depending on when the
prepayments occur.
The conversion price of the convertible securities and the exercise price of the
warrants may be adjusted in certain circumstances such as if we pay a stock
dividend, subdivide or combine outstanding shares of common stock into a greater
or lesser number of shares, or take such other actions as would otherwise result
in dilution of the investor's position. We have also granted the above holders
of our convertible securities a security interest in all our assets. If we
should default under any of the terms of our convertible securities, the
outstanding principal balance on the convertible debentures and convertible
notes is due, plus the accrued interest. The fair market values of our warrants
are estimated on the grant date using the Black-Scholes option pricing method as
required under SFAS 123. As of August 31, 2005, a total of 5,558,000 warrants
have been granted to the holders of our convertible securities, and as of the
date of this report, these warrants are unexercised.
We have granted a security interest in all assets to the investors of the
convertible securities.
As of October 20, 2005, we are not in compliance with the proper registration
and licensing of certain software applications and products critical to support
the customer base and our own internal operations. Management has initiated
negotiations with these software vendors in an effort to purchase or lease/rent
the licenses to meet the licensing requirements.
On July 11, 2005 we entered into an installment agreement with the Internal
Revenue Service to pay a remaining obligation of unabated penalties and interest
of $215,058 that accrued from unpaid taxes in 2000 and 2001. All payroll taxes
related to this obligation were fully off in August 2004. Terms of this
agreement require us to pay no less than $5,000 per month, including interest,
over the next 50 months or until the balance is zero. The IRS has a lien on
Company assets. Since the execution of this installment agreement, we have made
three payments against this obligation.
A lien for approximately $28,000 was filed several years ago by the State of
Utah for prior years' income taxes assessed to the predecessor company of
Insynq, Inc. The assessment was disputed and we filed amended returns to correct
this deficiency. As of the date of this report, the State has not responded to
the amended returns, thereby, neither granting approval nor denying the filing
of the amended returns. This obligation is recorded under accrued liabilities
(business taxes) in the accompanying financial statements.
On July 18, 2005, we were served with a complaint for a material breach of
contract. The complaint was filed by our former landlords for the breach of a
long-term lease for office space. This claim did not specify an amount for
damages. We deny the allegations under this claim and believe this claim is
without merit and intend to continuously and vigorously defend against it. We
have not recognized an expense for this claim in the August 31, 2005 condensed
financial statements.
We are also subject to other legal proceedings and business disputes involving
ordinary and routine claims. The ultimate legal and financial liability with
respect to such matters cannot be estimated with certainty and requires the use
of estimates in recording liabilities for potential litigation settlements.
Estimates for losses from litigation are made after consultation with outside
counsel. If estimates of potential losses increase or the related facts and
circumstances change in the future, we may be required to record either more or
less litigation related expense.
Pursuant to the asset purchase agreement to purchase the intellectual property
from a related party dated April 30, 2005, whereby we acquired certain
intellectual property, we assumed certain other long-term obligations. The
following describes these obligations:
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o Consulting Agreement - A $5,000 per month consulting agreement existed
at the time of sale (April 30, 2005) between the related party
(seller) to Insynq (Company) and the original seller of the
intellectual property to the related party. We agreed to honor the
remaining term of the monthly consulting agreement in exchange for the
original consultants' expertise and guidance. This agreement
terminates on or before May 2006.
o Distribution Agreement - At the time of purchase, a distribution
agreement existed between the same original selling party, as
discussed above, and the related party. We assumed the responsibility
for fulfilling the terms of this agreement as a part of the asset
purchase agreement. This agreement stipulates that 5.5% of gross cash
receipts from the sales of certain software products will be paid each
quarter to the original selling party. This agreement is in
perpetuity. There is, however, a buyout provision whereby at any time
the obligator may completely satisfy the terms underlying this
agreement for $1,250,000.
Our continuation as a going concern is dependent on our ability to grow
revenues, obtain additional financing, and, generate sufficient cash flow from
operations to meet our obligations on a timely basis. Our ability to raise
capital in the future will be difficult because our securities purchase
agreements with our investors prohibit us from entering into any financial
arrangement, which would involve the issuance of common stock for a period of
two years without offering a right of first refusal to the debenture investors.
Moreover, our ability to raise capital would also be difficult because our
convertible securities have floating conversion features which, when converted,
would cause purchasers of our common stock to experience a substantial dilution
of their investment.
We currently have no material commitments for capital requirements. If we were
forced to purchase new equipment to replace the equipment we currently lease,
any new leases would constitute a material capital commitment; however, we are
currently unable to quantify such amounts. If this occurs, we will attempt to
raise the necessary finances to make such purchases, but there is no assurance
that we will be able to do so. Without the ability to quantify these amounts, we
nonetheless believe that it would have a material impact on our business and our
ability to maintain our operations.
We have developed a brand of business solutions called e-Accounting, which has
been designed to assist the accounting professional manage and expand their
business. Our e-Accounting Center portal is located at WWW.CPAASP.COM. It
includes resources for marketing, promotion, professional education, and web
design, as well as, step-by-step tips for transforming a traditional accounting
business into an e-Accounting practice. In addition, we host many popular
accounting software applications, such as QuickBooks, in our secure data centers
for accounting professional firms throughout the country. By centrally hosting
the application and data in our data centers, we give the professional secure
central access remotely to their client's' data. This gives the accounting
professional the ability to manage more their clients with fewer staff, and
thereby, we believe, generating greater profitability for their accounting or
bookkeeping firm.
We also offer for sale:
o Appgen Custom Suite. This is a comprehensive and customizable family
of accounting and management software, to meet the needs of mid-sized
enterprises. This product is a collection of collaborative commerce
modules that may be assembled and customized in any way that suits the
needs of the business, and
o MyBooks Professional. This is a collaborative accounting system
marketed to the small to mid-sized businesses and is designed to
simplify the approach to accounting with jargon-free menus, making it
easy to use and manage a user's business accounting and reporting
requirements, and
25
o QwiQuote Software. This software allows the user to generate
customized sales quotations and assists sales people by managing
inventory or products.
We also intend to target regional Internet service providers and
telecommunication companies and create similar product offerings for them. We
would gain access to their customer base to sell our products and services, and
depending on their relative size, our services could then be private labeled and
re-sold through their own sales infrastructure.
Other services include business functions such as e-commerce, sales force
automation, customer support, human resource and financial management, messaging
and collaboration, and professional services automation. We believe that
technology outsourcing, focused on these business fundamentals, will be the
primary adopters of application service providers and managed service solutions
in the next year. We are focusing all possible resources in developing our
domain expertise in these areas to gain additional leverage and build broader
service offerings that complement our current services already being delivered
to those markets. There can be no assurances, however, that we will
substantially increase our monthly recurring revenues.
We are continually developing and refining our acquisition and expansion
strategy. If we expand more rapidly than currently anticipated, if our working
capital needs exceed our current expectations, or if we consummate acquisitions,
we will need to raise additional capital from equity or debt sources. We cannot
be sure that we will be able to obtain the additional financings to satisfy our
cash requirements or to implement our growth strategy on acceptable terms or at
all. Our ability to raise capital in the future will be difficult because our
securities purchase agreements prohibit us from entering into any financial
arrangement which would involve the issuance of common stock for a period of two
years without offering a right of first refusal to the holders of our
securities. If we cannot obtain such financings on terms acceptable to us, our
ability to fund our planned business expansion and to fund our on-going
operations will be materially adversely affected. If we incur debt, the risks
associated with our business and with owning our common stock could increase. If
we raise capital through the sale of equity securities, the percentage ownership
of our stockholders will be diluted. In addition, any new equity securities may
have rights, preferences, or privileges senior to those of our common stock.
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
The Company maintains disclosure controls and procedures (as defined in Rule
13a-14(c) and Rule 15d-14(c) of the Exchange Act) designed to ensure that
information required to be disclosed in the reports of the Company filed under
the Exchange Act is recorded, processed, summarized, and reported within the
required time periods. The Company's Chief Executive Officer and Principal
Accounting Officer has concluded, based upon their evaluation of these
disclosure controls and procedures as of the date of this report, that, as of
the date of their evaluation, these disclosure controls and procedures were
effective at ensuring that the required information will be disclosed on a
timely basis in the reports of the Company filed under the Exchange Act.
(b) Changes in Internal Controls.
The Company maintains a system of internal controls that is designed to provide
reasonable assurance that the books and records of the Company accurately
reflect the Company's transactions and that the established policies and
procedures of the Company are followed. There were no significant changes to the
internal controls of the Company or in other factors that could significantly
affect such internal controls subsequent to the date of the evaluation of such
internal controls by the Chief Executive Officer and Principal Accounting
Officer, including any corrective actions with regard to significant
deficiencies and material weaknesses.
26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 18, 2005, were served with a complaint for a material breach
of contract. The complaint was filed by the Company's former landlords
for the breach of a long-term lease for office space. The lease term
was March 2002 through July 2006. The claim is for an unspecified
amount of damages.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As of October 24, 2005, we have considered $1,154,512 of principal and
approximately $472,000 of accrued interest due on our secured
convertible debentures to be in default because we are not in
compliance with certain provisions underlying these security
instruments. Also, we have considered one of our two secured
convertible notes, in the amount of $2,700,000, plus the related
accrued interest of approximately $98,800, to be in default because we
are not in compliance with certain provisions underlying this security
instrument.
We are in contact with the holders of these security instruments with
the intention of restructuring the terms and conditions of these
instruments. However, we have not reached an agreement on our
proposals and there is no assurance that a mutual agreement will be
reached.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
- ----------------- -------------------------------------------------------------------------------------------
EXHIBIT
NUMBER DESCRIPTION
- ----------------- -------------------------------------------------------------------------------------------
31.1* Certification by the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
- ----------------- -------------------------------------------------------------------------------------------
31.2* Certification by the Principal Accounting Officer and Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
- ----------------- -------------------------------------------------------------------------------------------
32.1* Certification by the Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- ----------------- -------------------------------------------------------------------------------------------
32.2* Certification by the Principal Accounting Officer, Pursuant to
18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
- ----------------- -------------------------------------------------------------------------------------------
* Filed herewith
(b) Reports on Form 8-K
None.
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SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
the requirements for filing on Form 10-QSB and has duly caused this Quarterly
Report to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Tacoma, State of Washington, on October 24, 2005.
INSYNQ, INC.
By: /S/ JOHN P. GORST
John P. Gorst
Chief Executive Officer
By: /S/ M. CARROLL BENTON
M. Carroll Benton
Chief Administrative Officer,
Principal Accounting Officer and
Principal Financial Officer
28