UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-QSB
-----------
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarter Ended June 30, 2002
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
Commission File Number: 000-1084047
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
-----------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
California 95-4691878
----------------------------------- -----------------------------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
204 NW Platte Valley Drive
--------------------------
Riverside, MO 64150
-------------------
(Address of principal executive offices)
(816) 583-8030
--------------
(Issuer's telephone number)
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 such shorter period that the Registrant was
required to file such report(s)), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
There were 51,804,361 shares of common stock, $0.001 par value, outstanding as
of August 14, 2002.
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS
Page
----
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - June 30, 2002 (Unaudited)
and December 31, 2001.................................................................. 3
Condensed Consolidated Statements of Operations (Unaudited) for the
Three and Six Months Ended June 30, 2002 and 2001...................................... 4
Condensed Consolidated Statements of Comprehensive Income (Unaudited) for the
Three and Six Months Ended June 30, 2002 and 2001...................................... 5
Condensed Consolidated Statement of Stockholders' Equity (Unaudited) for the
Six Months Ended June 30, 2002......................................................... 6
Condensed Consolidated Statements of Cash Flows (Unaudited) for the
Six Months Ended June 30, 2002 and 2001................................................ 7
Notes to the Condensed Consolidated Financial Statements (Unaudited)..................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................................... 16
PART II - OTHER INFORMATION
Item 2. Changes in Securities................................................................. 19
Item 6. Exhibits and Reports on Form 8-K...................................................... 20
Signatures ................................................................................ 21
PART I - FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
--------------------
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
------------- --------------
ASSETS
Current Assets
Cash $ 776,482 $ 282,307
Accounts receivable, net of allowance for doubtful accounts
of $128,500 and $4,000, respectively 489,020 49,392
Other receivables 20,112 2,543
Investments - Available for sale 39,982 549,896
Prepaid expenses 20,235 6,571
Other assets 311,911 --
Deferred income tax asset 812 812
------------ ------------
Total Current Assets 1,658,554 891,521
------------ ------------
Property and Equipment, Net 415,751 61,512
------------ ------------
Other Assets
Goodwill 13,549,932 13,549,932
Other assets -- 23,810
Deposit 36,198 4,491
Deferred income tax asset - non-current 2,908 2,908
------------ ------------
Total Assets $ 15,663,343 $ 14,534,174
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Note payable - Line of credit $ 44,971 $ --
Current maturities of long-term debt 20,190 --
Trade accounts payable and accrued expenses 579,864 156,014
Other liabilities 93,525 --
Deferred revenue 179,690 --
Accrued federal and state income tax 221,844 --
Reserve for sales returns and allowances 134,964 100,000
------------ ------------
Total Current Liabilities 1,275,048 256,014
------------ ------------
Long-term debt, net of current maturities 53,820 --
Other liabilities 76,053 --
------------ ------------
Stockholders' Equity
Preferred stock - no par; $1.00 stated value; 25,000,000 shares authorized
Series A preferred stock; 1,850,000 shares issued and outstanding 1,850,000 1,850,000
Series B preferred stock; 248,491 shares issued and outstanding 248,491 248,491
Common stock - $0.001 par value; 60,000,000 shares authorized
48,389,983 and 48,285,283 shares issued and outstanding, respectively 48,390 48,285
Additional paid-in-capital 12,768,416 12,626,679
Accumulated comprehensive loss (714,268) (204,354)
Retained earnings/(Accumulated deficit) 57,393 (290,941)
------------ ------------
Total Stockholders' Equity 14,258,422 14,278,160
------------ ------------
Total Liabilities and Stockholders' Equity $ 15,663,343 $ 14,534,174
============ ============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
Innovative Software Technologies, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Sales $ 2,994,339 $ 4,000 $ 5,789,035 $ 4,000
Cost of Sales 999,229 -- 2,121,684 --
------------ ------------ ------------ ------------
Gross Profit 1,995,110 4,000 3,667,351 4,000
------------ ------------ ------------ ------------
Operating Expenses
General and administrative 916,707 254,959 1,658,777 272,790
Selling 681,308 34,585 1,282,199 35,585
------------ ------------ ------------ ------------
Non-recurring expenses 169,578 -- 169,578 --
------------ ------------ ------------ ------------
Total Operating Expenses 1,767,593 289,544 3,110,554 308,375
------------ ------------ ------------ ------------
Income (Loss) From Operations 227,517 (285,544) 556,797 (304,375)
------------ ------------ ------------ ------------
Other Income (Expense)
Other income 16,390 -- 18,092 --
Interest expense (6,555) -- (6,555) --
------------ ------------ ------------ ------------
Total Other Income (Expense) 9,835 -- 11,537 --
------------ ------------ ------------ ------------
Income (Loss) Before Income Taxes 237,352 (285,544) 568,334 (304,375)
Income Tax Expense 85,326 -- 220,000 --
------------ ------------ ------------ ------------
Net Income (Loss) $ 152,026 $ (285,544) $ 348,334 $ (304,375)
============ ============ ============ ============
Basic and Diluted Income (Loss) per Share $ 0.00 (0.01) $ 0.01 $ (0.01)
============ ============ ============ ============
Weighted Average Number of Common
Shares Used in Per Share Calculation 48,319,952 45,247,546 48,303,618 43,747,562
============ ============ ============ ============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Net income/(loss) $ 152,026 $(285,544) $ 348,334 $(304,375)
Other comprehensive income/(loss), net of tax:
Unrealized loss on investments (86,518) (375) (509,914) (25,575)
--------- --------- --------- ---------
Other comprehensive income/(loss) $ (86,518) $ (375) $(509,914) $ (25,575)
--------- --------- --------- ---------
Comprehensive income/(loss) 65,508 (285,919) (161,580) (329,950)
========= ========= ========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
(SPLIT TABLE)
Preferred Stock Common Stock
-------------------------- --------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
Balance - December 31, 2001 2,098,491 $ 2,098,491 48,285,283 $ 48,285
Issuance of common stock for
Services provided -- -- 4,000 4
Issuance of common stock -- -- 40,730 41
Issuance of common stock for
Services provided -- -- 6,125 6
Issuance of common stock for
Software -- -- 53,845 54
Unrealized loss on investments -- -- -- --
Net income for the six months
ended June 30, 2002 -- -- -- --
------------ ------------ ------------ ------------
Balance - June 30, 2002 2,098,491 $ 2,098,491 48,389,983 $ 48,390
------------ ------------ ------------ ------------
Retained
Additional Accumulat- Earnings Total
Paid in ed Compreh- (Accumulated Stockholders'
Capital ensive loss Deficit) Equity
------------ ------------ ------------ ------------
Balance - December 31, 2001 $ 12,626,679 $ (204,354) $ (290,941) $ 14,278,160
Issuance of common stock for
Services provided 14,196 -- -- 14,200
Issuance of common stock 36,951 -- -- 36,992
Issuance of common stock for
Services provided 20,644 -- -- 20,650
Issuance of common stock for
Software 69,946 -- -- 70,000
Unrealized loss on investments -- (509,914) -- (509,914)
Net income for the six months
ended June 30, 2002 -- -- 348,334 348,334
------------ ------------ ------------ ------------
Balance - June 30, 2002 $ 12,768,416 $ (714,268) $ 57,393 $ 14,258,422
------------ ------------ ------------ ------------
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months
Ended June 30,
2002 2001
--------- ---------
Cash Flows From Operating Activities
Net income/(loss) $ 348,334 $(304,375)
Adjustments to reconcile net income/(loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 40,798 2,610
Allowance for doubtful accounts 124,500 --
Non-cash expenses 34,850 27,166
Changes in operating assets and liabilities:
Accounts receivable (564,128) --
Prepaid expenses (13,664) (2,550)
Other receivables (17,569) --
Other current assets (311,911) (597)
Other assets 23,810 (2,615)
Deposits (31,707) --
Accounts payable and accrued expenses 423,850 21,936
Other liabilities 169,578 --
Deferred revenue 179,690 --
Reserve for returns and allowances 34,964 --
Accrued federal and state income tax 221,844 --
--------- ---------
Net Cash Provided By/(Used In) Operating Activities 663,239 (258,425)
--------- ---------
Cash Flows Used In Investing Activities
Capital expenditures (325,037) (27,102)
--------- ---------
Net Cash Used In Investing Activities (325,037) (27,102)
--------- ---------
Cash Flows From Financing Activities
Issuance of common stock 36,992 400,000
Proceeds from borrowings under line of credit 50,000 --
Repayments on line of credit (5,029) --
Proceeds from borrowing under note payable 81,186 --
Repayments on notes payable (7,176) --
Proceeds from borrowing under note payable to related party -- 35,503
Payment on note payable to related party -- (51,425)
--------- ---------
Net Cash Provided by Financing Activities 155,973 384,078
--------- ---------
Net Increase in Cash and Cash Equivalents 494,175 98,551
Cash and Cash Equivalents at Beginning of Period 282,307 888
--------- ---------
Cash and Cash Equivalents at End of Period $ 776,482 $ 99,439
========= =========
Supplemental Cash Flow Information:
Unrealized loss on securities available for sale $(509,914) $ (25,575)
========= =========
Issuance of common stock for services provided $ 34,850 $ 27,166
========= =========
Issuance of common stock for software $ 70,000 $ --
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
7
Innovative Software Technologies, Inc.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - COMPANY DESCRIPTION
Innovative Software Technologies, Inc. (Innovative) is a software
company, operating in one business segment, specializing in the
aggregation and distribution of business-to-business and
business-to-consumer eService platforms. Through its acquisition of
Hackett Media, Inc. on April 16, 2001, the Company has four main products
that consist of The Financial Toolkit 1.0, an integrated financial
services educational program; Bizkit 1.0, a turnkey e-commerce solution
targeted at small businesses which provides all the resources necessary
to successfully plan, launch, and grow an online presence; Skills in
Demand, an eLearning certification course catering to Information Systems
and Internet Professionals; and etaxnet, a provider of online tax and
consulting services.
On April 16, 2001, Innovative, with immaterial net assets, acquired 100%
of the outstanding common stock of Hackett Media, Inc. (Hackett). The
acquisition resulted in the owners and management of Hackett having
effective operating control of the combined entity after the acquisition,
with the existing Innovative investors continuing as only passive
investors.
Under accounting principles generally accepted in the United States, the
above noted acquisition is considered to be a capital transaction in
substance, rather than a business combination. That is, the acquisition
is equivalent to the issuance of stock by Hackett for the net monetary
assets of Innovative, accompanied by a recapitalization, and is accounted
for as a change in capital structure. Accordingly, the accounting for the
acquisition is identical to that resulting from a reverse acquisition,
except that no goodwill intangible is recorded. Under reverse takeover
accounting, the post reverse-acquisition comparative historical financial
statements of the "legal acquirer" (Innovative Software Technologies),
are those of the "legal acquiree" (Hackett) (i.e. the accounting
acquirer). The Securities and Exchange Commission requires that capital
transactions consummated after year end but prior to the issuance of the
consolidated financial statements should be given retroactive effect as
if the transaction had occurred on December 31, 2000.
On December 31, 2001, the Company purchased all of the outstanding shares
of Energy Professional Marketing Group, Inc.'s (EPMG), a technology
marketing company specializing in product fulfillment for outside vendors
and technology and database marketing, based in Orem, UT. In connection
with the acquisition, the Company issued 1,500,000 and 3,529,412 of
Series A preferred and common shares, respectively.
8
Innovative Software Technologies, Inc.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - COMPANY DESCRIPTION - Continued
The purchase price for the acquisition above has been allocated on the
basis of the fair value on the acquisition dates as follows:
Assets acquired:
Goodwill............................ 13,549,932
Net assets acquired................. 25,068
---------------
Total Assets Acquired............... 13,575,000
==============
Total Purchase Price................ 13,575,000
==============
The acquisition described above was accounted for as a purchase transaction in
accordance with Statements of Financial Accounting Standards No. 141 (SFAS 141),
"Business Combinations," and, accordingly, the results of operations and assets
and liabilities of the acquired company are included in the consolidated
financial statements from their respective acquisition dates. The Company will
supplementally provide proforma information related to the acquisition of EPMG.
A summary of the company's significant accounting policies applied
in the preparation of the accompanying financial statements follows.
NOTE B - SUMMARY OF ACCOUNTING POLICIES
1. Interim Condensed Financial Statements
The accompanying condensed consolidated financial statements are
unaudited. In the opinion of management, all necessary adjustments
(which include only normal recurring adjustments) have been made to
present fairly the financial position, results of operations and cash
flows for the periods presented. Certain information and disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted. Accordingly, these condensed consolidated
financial statements should be read in conjunction with the Company's
financial statements and notes thereto included in the Form 10-KSB
dated December 31, 2001. The results of operations for the six months
ended June 30, 2002 are not necessarily indicative of the operating
results to be expected for the full year.
2. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 141, Business
Combinations, and SFAS 142, Goodwill and Intangible Assets. SFAS 141 is
effective for all business combinations completed after June 30, 2001.
SFAS 142 is effective for fiscal years beginning after December 15,
2001; however, certain provisions of this Statement apply to goodwill
and other intangible assets acquired between July 1, 2001 and the
effective date of SFAS 142. Major provisions of these Statements and
their effective dates for the Company are as follows:
9
Innovative Software Technologies, Inc.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
o All business combinations initiated after June 30, 2001
must use the purchase method of accounting. The pooling of
interests method of accounting is prohibited except for
transactions initiated before July 1, 2001.
o Intangible assets acquired in a business combination must
be recorded separately from goodwill if they arise from
contractual or other legal rights or are separable from
the acquired entity and can be sold, transferred,
licensed, rented or exchanged, either individually or as
part of a related contract, asset or liability.
o Goodwill, as well as intangible assets with indefinite
lives, acquired after June 30, 2001, will not be
amortized.
o Effective January 1, 2002, all previously recognized
goodwill and intangible assets with indefinite lives will
no longer be subject to amortization.
o Effective January 1, 2002, goodwill and intangible assets
with indefinite lives will be tested for impairment
annually and whenever there is an impairment indicator.
o All acquired goodwill must be assigned to reporting units
for purposes of impairment testing and segment reporting.
As of December 31, 2001, which is the beginning of fiscal 2002, the
Company will not amortize the goodwill which it recognized in
connection with the acquisition of EPMG. The Company's goodwill is
subject to a transitional impairment test as of December 31, 2001 and
an annual impairment test, using a two-step process prescribed by SFAS
No. 142. The Company has completed the transitional impairment test for
EPMG, the applicable reporting unit, and no impairment of goodwill was
found to exist as of the beginning of fiscal 2002. During 2002 and in
future periods, the Company will evaluate goodwill for possible
impairment at least on an annual basis.
In August 2001, the FASB issued SFAS 143, Accounting for Asset
Retirement Obligations. SFAS 143 applies to all entities, including
rate-regulated entities, that have legal obligations associated with
the retirement of a tangible long-lived asset that result from
acquisition, construction or development and (or) normal operations of
the long-lived asset. The application of this Statement is not limited
to certain specialized industries, such as the extractive or nuclear
industries. This Statement also applies, for example, to a company that
operates a manufacturing facility and has a legal obligation to
dismantle the manufacturing plant and restore the underlying land when
it ceases operation of that plant. A liability for an asset retirement
obligation should be recognized if the obligation meets the definition
of a liability and can be reasonable estimated. The initial recording
should be at fair value. SFAS 143 is effective for financial statements
issued for fiscal years beginning after June 15, 2002, with earlier
application encouraged. The provisions of the Statement are not
expected to have a material impact on the financial condition or
results of operations of the Company.
In August 2001, the FASB issued SFAS 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS 144 retains the existing
requirements to recognize and measure the impairment of long-lived
assets to be held and used or to be disposed of by sale. However, SFAS
144 makes changes to the scope and certain measurement requirements of
existing accounting guidance. SFAS 144 also changes the requirements
relating to reporting the effects of a disposal
10
Innovative Software Technologies, Inc.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
or discontinuation of a segment of a business. SFAS 144 is effective
for financial statements issued for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal years. The
adoption of this Statement did not have a significant impact on the
financial condition or results of operations of the Company.
3. Principles of Consolidation
---------------------------
The accompanying consolidated balance sheet includes the accounts of
Innovative Software Technologies, Inc. and the accounts of its
wholly-owned subsidiary Energy Professional Marketing Group, Inc.
(EPMG) as of and for the six months ended June 30, 2002. All
significant intercompany transactions and balances have been eliminated
in consolidation.
4. Revenue Recognition
-------------------
The Company recognizes revenue in accordance with Statement of Position
97-2, Software Revenue Recognition, which states that revenue is
recognized after delivery of the product. In most cases this occurs the
same day payment is received from our customers. The Company also
reserves for sales returns and allowances based upon historical
experience.
The Company provides support services for some of its products. The
associated revenue is recognized over the term of the sessions which
are typically six weeks in duration.
5. Investments in Equity Securities
--------------------------------
All equity securities are classified as available-for-sale. These
securities have been adjusted to their fair market value based upon
quoted market prices. Unrealized holding gains and losses are reported
as a separate component of Stockholder's equity. Unrealized holding
losses amounted to $714,266 and $204,356 as of June 30, 2002 and
December 31, 2001, respectively. Investments consist of 75,000 shares
of common stock of Ensurge, Inc. and 1,900,000 shares of common stock
of Knowledge Transfer Systems, Inc.
6. Property and Equipment
----------------------
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is recognized using the straight-line method
over the estimated useful lives of the assets, which range from three
to seven years. Leasehold improvements are amortized using the
straight-line method over the lesser of the estimated useful lives or
remaining lease term.
7. Use of Estimates
----------------
To comply with accounting principles generally accepted in the United
States, the Company makes estimates and assumptions that effect the
amounts reported in the financial statements and disclosures made in
the accompanying notes. Estimates are used for, but not limited to
reserves for product returns, the collectibility of accounts receivable
and deferred taxes. The Company also uses estimates to determine the
remaining economic lives and carrying value of goodwill and fixed
assets. Despite our intention to establish accurate estimates and
assumptions, actual results may differ from our estimates.
11
Innovative Software Technologies, Inc.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
8. Software Development Costs
--------------------------
In accordance with Statement of Financial Accounting Standards, or SFAS
No. 86, "Accounting for Costs of Computer Software to be Sold, Leased,
or otherwise Marketed," software development costs are expensed as
incurred until the product is available for general release to
customers. To date, the Company's software has been available for
general release concurrent with the establishment of technological
feasibility and, accordingly, no development costs have been
capitalized.
The Company capitalizes costs related to the development of computer
software developed or obtained for internal use in accordance with the
American Institute of Certified Public Accountants Statement of
Position 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use." Costs incurred in the application
development phase are capitalized and amortized over their useful life,
not to exceed five years.
9. Advertising Costs
-----------------
Advertising and promotion costs are expensed as incurred. Advertising
costs charged against income for the six months ended June 30, 2002 and
2001, were $519,782 and $34,586, respectively.
10. Impairment and Long-term Assets
-------------------------------
The Company will regularly perform reviews to determine if the carrying
values of our long-lived assets are impaired. The reviews look for the
existence of facts or circumstances, either internal or external, which
indicate that the carrying value of the asset cannot be recovered.
There have been no events or circumstances indicating the possible
impairment of our long-lived asset as of June 30, 2002.
NOTE C - MARKETABLE SECURITIES
The Company currently holds two marketable securities, which the Company
acquired in connection with strategic business transactions and relationships.
Our available-for-sale equity securities are carried at fair value and
unrealized gains or losses are included in stockholders' equity. The Company
held the following marketable securities at June 30, 2002 and December 31, 2001.
The cost basis of our marketable securities reflects adjustments for other than
temporary impairments in value as well as sales of securities.
12
Innovative Software Technologies, Inc.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
Available-for-sale Equity Cost Gross Unrealized Estimated
Securities Basis Gains Losses Fair Value
--------- -------- --------- ---------
December 31, 2001
EnSurge, Inc. common stock $ 26,250 $ -- $ (25,950) $ 300
KT Solutions common stock 728,000 10,500 (188,904) 549,596
--------- -------- --------- ---------
$ 754,250 $ 10,500 $(214,854) $ 549,896
========= ======== ========= =========
June 30, 2002
EnSurge, Inc. common stock $ 26,250 $ -- $ (26,168) $ 82
KT Solutions common stock 728,000 -- (688,100) 39,900
--------- -------- --------- ---------
$ 754,250 $ -- $(714,268)$ 39,982
========= ======== ========= =========
The KT Solutions common stock was received in consideration for the sale of four
software coaching platforms to Ensurge, Inc. These securities were recorded at a
30% discount due to restrictions and limitations contained in Rule 144 of the
Securities and Exchange Commission. The primary restriction relates to the one
year holding period of the securities after the effective date of sale.
These securities we hold are traded on the OTC Bulletin Board. All of our
marketable securities are stocks of high technology companies whose market
prices have been extremely volatile. The market prices of these companies'
stocks have declined substantially the past two years. The market prices of
these stocks could continue to decline. These declines could result in a
material reduction in the carrying value of these assets and have a negative
impact on our operating results and financial condition. If our
available-for-sale securities experience further declines in fair value that are
considered other than temporary, the Company will reflect the additional loss in
our net income in the period when subsequent permanent impairment becomes
apparent.
NOTE D - PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation.
Depreciation is recognized using the straight-line method over the estimated
useful lives of the assets, which range from 3 to 7 years. Leasehold
improvements are amortized using the straight-line method over the lesser of the
estimated useful lives or remaining lease term. Property and equipment consist
of the following:
June 30, December 31,
2002 2001
---------------------------------
Machinery and Equipment............$ 173,939 $ 55,615
Furniture and Fixtures............. 97,696 18,740
Computer Software.................. 180,224 5,667
Leasehold improvements............. 26,077 2,877
-------------- --------------
................................... 477,936 82,899
Less: Accumulated depreciation..... (62,185) (21,387)
-------------- --------------
Net Property and Equipment.........$ 415,751 $ 61,512
============== ==============
Depreciation and amortization expense for the six months ended June 30, 2002 and
2001 was $40,798 and $2,610, respectively.
12
Innovative Software Technologies, Inc.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
NOTE E - NOTES PAYABLE
June 30, December 31,
2002 2001
------- ------
<c>
Notes payable, financial institution, principal and
interest payable in monthly installments of $1,250
due in August 2004 $25,797 --
Notes payable, financial institution, principal and accrued interest at 7.78%
payable in monthly installments of principal and interest maturing from $217 to
$655 from
November 2006 to February 2007 48,213 --
------- ------
74,010 --
Less Current Portion 20,190 --
------- ------
Notes Payable - Long-Term $53,820 $ --
======= ======
The Company has an unsecured line of credit facility with a financial
institution for borrowings up to $50,000. Borrowings under the line bear
interest at Prime plus 2% (the Prime rate of interest as of June 30, 2002 was
4.75%). As of June 30, 2002, there was $5,029 available on the credit facility.
NOTE F - Capital Transactions
Stock-split - Innovative's Board of Directors authorized a three-for-one stock
split on July 11, 2001. This was affected by distributing a 200% stock dividend
on August 10, 2001 to stockholders of record on July 31, 2001. All share and per
share amounts referred to in the financial statements and notes have been
restated to reflect this stock split.
Issuance of common stock - The Company issued 40,730 shares of its common stock
in the current quarter through private placements to individual investors
overseas.
Issuance of common stock for software - The Company issued 53,845 shares of its
common stock in the current quarter as part of payment under the terms of a
software purchase agreement entered into by the Company. The agreement
stipulates that the Company receives business management software for both the
Internet and real estate markets as well as hosting and maintenance services.
Stock issued for services - The Company issued 4,000 shares of its common stock
at a fair market value of $3.55 per share on February 12, 2002. In addition, the
Company issued 6,125 shares of its common stock during the current quarter at an
average fair market value of $3.37 per share. Shares were issued as compensation
expense for the six months ended June 30, 2002.
Finance Agreement - The Company has financed its operation to date primarily
through a Finance Agreement of convertible debt and securities. The Finance
agreement calls for financing of up to $2.5 million of which $1 million would be
received in increments in 2001, if necessary, and the remaining $1.5 million
would be received based upon the Company's performance. As of June 30, 2002,
$700,000 of the initial $1 million investment was received by the Company. These
proceeds were converted to equity securities during 2001.
14
During the fourth quarter 2001, all of the common shares issued in connection
with the conversion of debt in connection with the Finance Agreement above were
reissued as Series A preferred shares and common shares as follows: Of the
initial $700,000 invested in 2001, $350,000 was converted to Series A preferred
shares at a stated value of $1 per share. The remaining $350,000 was reissued as
700,000 shares of common stock at $0.50 per share.
NOTE G - Related Party Transactions
On December 31, 2001, a company executive and shareholder converted a note
payable amounting to $248,491 to Series B preferred stock at a conversion rate
of a $1 per share stated value. There was no formal maturity date and there was
no interest associated with the note.
During 2001, the Company sold four software platforms to NowSeven.com, Inc.,
Ziabon, Inc., SF Acquisition Corp., Inc., and Ishopper Internet Services, Inc.
in exchange for investment securities amounting to $308,000, $133,000, $147,000,
and $140,000, respectively. The President and Chief Executive Officer of the
Company is the former President and Chief Executive Officer of Ensurge, Inc.,
which is the parent company of the above wholly-owned subsidiaries listed above.
NOTE H - COMMITMENTS AND CONTINGENCIES
In March and May 2002, the Company entered into operating leases for certain
office space. Future minimum lease payments under these operating leases as of
June 30, 2002 are as follows:
Year Ending December 31:
2002....................................$ 70,300
2003.................................... 140,600
2004.................................... 140,600
2005.................................... 49,433
2006.................................... --
-----------
Total...................................$ 400,933
========--=
Rent expense for the six months ended June 30, 2002 and 2001 was $44,879 and
$5,625, respectively.
NOTE I - PENDING ACQUISITION
On March 12, 2002, the Company signed a definitive agreement to acquire iCrypt,
Inc., a Torrance, California, technology company that has developed a suite of
email encryption software products for both corporate and consumer markets, for
$10,000,000 in restricted preferred stock and the Company's common stock. The
closing of this acquisition is contingent upon due diligence findings and the
ability of the companies to meet certain terms and conditions precedent to
close. On April 29, 2002, the due diligence process was completed and
negotiations on certain terms and conditions are ongoing. There is no assurance
that this transaction will be consummated.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
------------------------------------------------------------------------
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, which could cause actual results to 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.
Critical Accounting Policies
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
the Company to make estimates and judgments that affect the reported amount 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
believes that its critical accounting policies include those described below.
For a detailed discussion on the application of these and other accounting
policies, see Note B in the Notes to the Consolidated Financial Statements
included in the Company's Annual Report on Form 10-KSB for the fiscal year ended
December 31, 2001.
Goodwill and Intangible Assets
As discussed Note A in the accompanying interim financial statements, the
Company, on December 31, 2001, purchased all of the outstanding shares of Energy
Professional Marketing Group Inc. (EPMG) for $13.575 million in stock.
Purchase accounting requires extensive use of accounting estimates and judgments
to allocate the purchase price to the fair market value of the assets purchased
and liabilities assumed. The Company has accounted for its acquisitions using
the purchase method of accounting. Values were assigned principally to goodwill
based upon management's allocation of the purchase price to EPMG's workforce in
place at the date of the transaction.
Effective January 1, 2002, the Company adopted the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets. This statement affects the Company's
treatment of goodwill and other intangible assets. The statements require that
goodwill existing at the date of adoption be reviewed for possible impairment
and that impairment tests be periodically repeated, with impaired assets written
down to fair value. Additionally, existing goodwill and intangible assets must
be assessed and classified within the statement's criteria. Intangible assets
with finite useful lives will continue to be amortized over those periods.
Amortization of goodwill and intangible assets with indeterminable lives will
cease.
The Company completed the first step of the transitional goodwill impairment
test during the six months ended June 30, 2002 based on the amount of goodwill
as of the beginning of fiscal year 2002, as required by SFAS No. 142. The
Company performed a discounted cash flow analysis to determine the fair value of
the EPMG reporting unit based on various valuation multiples. Based on the
results of the first step of the transitional goodwill impairment test, the
Company has determined that the fair value of the EPMG reporting unit exceeded
its carrying amount and, therefore, no goodwill impairment existed as of January
1, 2002. As a result, the second step of the transitional goodwill impairment
test is not required to be completed. The Company will be required to continue
to perform a goodwill impairment test on an annual basis.
16
Marketable securities
Marketable securities are considered to be impaired when a decline in fair value
below cost basis is determined to be other than temporary. The Company employs a
methodology in evaluating whether a decline in fair value below cost basis is
other than temporary that considers available evidence regarding its marketable
securities. In the event that the cost basis of a security exceeds its fair
value, the Company evaluates, among other factors: the duration of the period
that, and extent to which, the fair value is less than cost basis; the financial
health of and business outlook for the investee, including industry and sector
performance, changes in technology and operational and financing cash flow
factors; overall market conditions and trends, and; the Company's intent and
ability to hold the investment. Once a decline in fair value is determined to be
other than temporary, a write-down is recorded and a new cost basis in the
security is established. Assessing the above factors involves inherent
uncertainty. Accordingly, write-downs, if recorded, could be materially
different from the actual market performance of marketable securities in the
Company's portfolio, if, among other things, relevant information related to the
Company's marketable securities was not publicly available or other factors not
considered by the Company would have been relevant to the determination of
impairment. As discussed in Note C to the accompanying financial statements, the
Company owns, as of June 30, 2002, marketable securities that have depreciated
in value by $714,268 from their original cost basis. Based upon the above
methodology, management believes that this decline is temporary in nature.
With any accounting policy that applies judgments and estimates, actual results
could significantly differ from those estimates
Results of Operations for the Three Months Ended June 30, 2002 compared to Three
Months Ended June 30, 2001
Revenues
Sales for the three months ended June 30, 2002 and 2001 were $2,994,339 and
$4,000, respectively, which represents a significant increase from the prior
period. The company's principal source of revenue for the three months ended
June 30, 2002 consisted of product sales. The main reason for the increase in
product sales can be attributed to the acquisition of EPMG as of December 31,
2001. This wholly-owned subsidiary of the Company accounted for $2,410,305 in
sales of existing products and services for the three months ended June 30,
2002.
Cost of Sales
Cost of sales for the three months ended June 30, 2002 and 2001 was $999,229 and
$0, respectively. Cost of sales for the three months ended June 30, 2002
represented costs associated with the generation of sales leads and the
providing of coaching services to customers that purchase our products. The main
reason for the increase in cost of sales can be attributed to the acquisition of
EPMG as of December 31, 2001. This wholly-owned subsidiary accounted for
$731,214 in cost of sales of existing products and services for the three months
ended June 30, 2002.
Selling
Selling expenses for the three months ended June 30, 2002 and 2001 were
$681,308 and $34,585, respectively. These costs consisted primarily of marketing
and advertising expenses associated with key products and commissions. The
advertising and marketing expenses within the current period consisted primarily
of expenses related to Internet marketing and sales commissions. The main reason
for the increase in selling costs can be attributed to the acquisition of EPMG
as of December 31, 2001. This wholly-owned subsidiary accounted for $418,695 in
sales commissions and advertising for the three months ended June 30, 2002.
General and Administrative
General and administrative expenses for the three months ended June 30,
2002 and 2001 were $916,707 and $254,959, respectively. The Company's general
and administration expenses during 2002 and 2001 consisted primarily of salaries
and wages, professional fees, rent, travel expenses, payroll taxes, telephone
expenses and other general and administrative expenses necessary to support the
operations of EPMG in the current period.
17
Non-recurring Expenses
Non-recurring expense for the three months ended June 30, 2002 and 2001 was
$169,578 and $0, respectively. Non-recurring expense for the three months ended
June 30, 2002 represented back wages due to the EPMG's employees. This cost
resulted from a recently completed examination of the Company's labor practices
by the United States Department of Labor. The period of examination covered the
Company's operations from May 2000 to May 2002.
Depreciation and Amortization
Depreciation and amortization expense for the three months ended June 30,
2002 and 2001 was $23,632 and $1,980, respectively. Depreciation and
amortization expense increased primarily as a result of the additions of
computer equipment, furniture and fixtures, and computer software in the second
half of 2001 and 2002.
Income Tax Expense
The Company recorded a tax expense from continued operations of $85,326
and $0 for the three months ended June 30, 2002 and 2001, respectively. The tax
expense in the current period reflects the recording of federal and state taxes
at an effective annual rate of approximately 35%.
Results of Operations for the Six Months Ended June 30, 2002 compared to Six
Months Ended June 30, 2001
Revenues
Sales for the six months ended June 30, 2002 and 2001 were $5,789,035 and
$4,000, respectively, which represents a significant increase from the prior
period. The company's principal source of revenue for the six months ended June
30, 2002 consisted of product sales. The main reason for the increase in product
sales can be attributed to the acquisition of EPMG, based in Orem, UT, as of
December 31, 2001. This wholly-owned subsidiary of the Company accounted for
$4,417,535 in sales of existing products and services for the six months ended
June 30, 2002. The remaining revenue for the six months ended June 30, 2002
resulted from sales of products and services generated from the Company's
operations in Riverside, MO.
Cost of Sales
Cost of sales for the six months ended June 30, 2002 and 2001 was $2,121,684 and
$0, respectively. Cost of sales for the six months ended June 30, 2002
represented costs associated with the generation of sales leads and the
providing of coaching services to customers that purchase our products. The main
reason for the increase in cost of sales can be attributed to the acquisition of
EPMG as of December 31, 2001. This wholly-owned subsidiary accounted for
$1,728,457 in cost of sales of existing products and services for the six months
ended June 30, 2002. The remaining cost of sales for the six months ended June
30, 2002 resulted from costs associated with sales of products and services
generated from the Company's operations in Riverside, MO.
Selling
Selling expenses for the six months ended June 30, 2002 and 2001 were
$1,282,199 and $35,585, respectively. These costs consisted primarily of
marketing and advertising expenses associated with key products and commissions.
The advertising and marketing expenses within the current period consisted
primarily of expenses related to Internet marketing and sales commissions. The
18
main reason for the increase in selling costs can be attributed to the
acquisition of EPMG as of December 31, 2001. This wholly-owned subsidiary
accounted for $783,047 in sales commissions and advertising for the six months
ended June 30, 2002. The remaining selling costs for the six months ended June
30, 2002 resulted from Internet marketing and sales commission costs generated
from the Company's operations in Kansas City, MO.
General and Administrative
General and administrative expenses for the six months ended June 30,
2002 and 2001 were $1,658,777 and $272,790, respectively. The Company's general
and administration expenses during 2002 and 2001 consisted primarily of salaries
and wages, professional fees, rent, travel expenses, payroll taxes, telephone
expenses and other general and administrative expenses necessary to support the
operations of EPMG for the six months ended June 30, 2002.
Non-recurring Expenses
Non-recurring expense for the six months ended June 30, 2002 and 2001 was
$169,578 and $0, respectively. Non-recurring expense for the six months ended
June 30, 2002 represented back wages due to the EPMG's employees. This cost
resulted from a recently completed examination of the Company's labor practices
by the United States Department of Labor. The period of examination covered the
Company's operations from May 2000 to May 2002.
Depreciation and Amortization
Depreciation and amortization expense for the six months ended June 30,
2002 and 2001 was $40,798 and $2,610, respectively. Depreciation and
amortization expense increased primarily as a result of the additions of
computer equipment, furniture and fixtures, and computer software in the second
half of 2001 and 2002.
Income Tax Expense
The Company recorded a tax expense from continued operations of $220,000
and $0 for the six months ended June 30, 2002 and 2001, respectively. The tax
expense in the current period reflects the recording of federal and state taxes
at an effective annual rate of approximately 38%.
Liquidity and Capital Resources
At June 30, 2002, cash was $776,482, an increase of $494,175 from December
31, 2001. Cash flow provided by operations was $663,239 for the six months ended
June 30, 2002. The primary reason for the positive operating cash flow for the
six months ended June 30, 2002, can be attributed to the Company's higher sales
volume during the first six months of 2002. The acquisition of EPMG as of
December 31, 2001, has had a significant impact on sales during this period
which consequently positively increased cash flows from operating activities. In
addition, the Company experienced an increase in its deferred revenue balances
for the six months ended June 30, 2002. The Company's higher sales volume
regarding coaching sessions was the primary reason for the increase in deferred
revenue. Other assets increased $311,911 for the six months ended June 30, 2002.
This was primarily due to credit card processors, utilized by the Company,
holding additional funds as a reserve for the significant volume increase in
credit card transactions. The Company received proceeds from a line of credit
facility during the six months ended June 30, 2002 amounting to $50,000. In
addition, the Company entered into four term loans during the six months ended
June 30, 2002 amounting to $81,186 to purchase vehicles and equipment.
Stockholders' equity amounts to $14,258,422 as of June 30, 2002.
19
The Company was financed, during 2001, primarily through a Finance
Agreement of convertible debt and securities. The Finance agreement called for
financing of up to $2.5 million of which $1 million would be received in
increments in 2001, if necessary, and the remaining $1.5 million would be
received based upon the Company's performance, as defined in the agreement. As
of December 31, 2002, $700,000 of the initial $1 million investment was received
by the Company. These proceeds were converted to equity securities during 2001.
No amounts were advanced to the Company in the six months ended June 30, 2002.
In addition, during 2001, all of the common shares issued in connection
with the Finance Agreement above were reissued as Series A preferred shares and
common shares as follows: Of the initial $700,000 invested in 2001, $350,000 was
converted to Series A preferred shares at a stated value of $1 per share. The
remaining $350,000 was reissued as 700,000 shares of common stock at $0.50 per
share.
The Company issued 4,000 shares of its common stock for various services
provided February 12, 2002.
The Company issued 6,125 shares of its common stock for various services
provided during the current quarter.
The Company issued 40,730 shares of its common stock for cash in the
current quarter through private placements to individual investors overseas.
The Company issued 53,845 shares of its common stock in the current
quarter as part of payment under the terms of a software purchase agreement
entered into by the Company.
The company expects that its existing cash resources, cash flow generated
from operations, and available financing will be sufficient to meet its
operating requirements and ordinary capital spending needs going forward.
However, the Company will continue to seek additional sources of capital for
expansion and possible acquisitions either through its existing Finance
Agreement or through private placements of equity securities.
PART II - OTHER INFORMATION
-----------------
Item 1. Legal Proceedings
-----------------
None
Item 2. Changes in Securities
---------------------
The company in the current quarter issued 6,125 shares of common stock as
compensation expense. These securities were issued under the exemption provided
by Section 4(2) of the Securities Act of 1933.
The company in the current quarter issued 40,730 shares of common stock
for cash in the current quarter through private placements to individual
investors overseas. These securities were issued under the exemption provided by
Section 4(2) of the Securities Act of 1933.
The company in the current quarter issued 53,845 shares of common stock
in the current quarter as part of payment under the terms of a software purchase
agreement entered into by the Company. These securities were issued under the
exemption provided by Section 4(2) of the Securities Act of 1933.
20
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
None
OTHER ITEMS
There were no other items to be reported under Part II of this report.
21
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: August 14, 2002 /s/ Douglas S. Hackett
---------------------------------------------------
Douglas S. Hackett
President, Chief Executive Officer and Director
22