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 September 30, 2003
[ ] 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)
5072 North 300 West
Provo, UT 84604
----------------------------------------
(Address of principal executive offices)
(801) 371-0755
---------------------------
(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 52,897,186 shares of common stock, $0.001 par value, outstanding as
of November 19, 2003.
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2003
TABLE OF CONTENTS
Page
----
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - September 30, 2003 (Unaudited)
and December 31, 2002............................................... 3
Condensed Consolidated Statements of Operations (Unaudited) for the
Three and ine Months Ended September 30, 2003 and 2002.............. 4
Condensed Consolidated Statement of Stockholders' Equity/(Deficiency)
(Unaudited) for the Nine Months Ended September 30, 2003............ 5
Condensed Consolidated Statements of Cash Flows (Unaudited) for the
Nine Months Ended September 30, 2003 and 2002....................... 6
Notes to the Condensed Consolidated Financial Statements (Unaudited).. 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................. 21
Item 3. Controls and Procedures.......................................... 30
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................ 32
Item 3. Defaults upon Senior Securities.................................. 33
Item 6. Exhibits and Reports on Form 8-K................................. 33
Signatures............................................................... 34
PART I - FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
--------------------
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
ASSETS 2003 2002
------------- -------------
CURRENT ASSETS
Cash $ 3,857,987 $ 1,338,345
Accounts Receivable 154,499 14,700
Investments - available for sale - -
Other Receivables 114,868 59,772
Prepaid Expenses 23,586 67,179
Other Assets 1,140,874 706,486
------------- -------------
Total Current Assets 5,291,814 2,186,482
------------- -------------
Property and Equipment, Net 455,167 379,349
------------- -------------
Other Assets
Goodwill 1,088,686 1,088,686
Deferred income taxes - Non-current - -
Deposits 42,965 48,698
------------- -------------
Total Assets $ 6,878,632 $ 3,703,215
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of Credit $ 3,740 $ 40,660
Current maturities of long-term debt 11,508 44,274
Accounts payable and accrued expenses 1,208,534 861,366
Deferred revenue 512,455 256,148
Other current liabilities 1,069,796 83,278
Accrued income taxes 471,890 -
Reserve for sales returns and allowances 588,686 220,266
------------- -------------
Total current liabilities 3,866,609 1,505,992
------------- -------------
Note Payable - Long-term 66,272 87,223
------------- -------------
Total liabilities 3,932,881 1,593,215
STOCKHOLDERS' EQUITY
Preferred stock - authorized, 25,000,000 shares of $1.00
stated value;
Series A preferred stock; issued and outstanding,
1,697,167 shares 1,650,500 1,650,500
Series B preferred stock; issued and outstanding,
328,491 shares 408,491 328,491
Common stock - authorized, 100,000,000 shares of $.001 par
value; issued and outstanding, 52,897,186 and 52,481,289
shares, respectively 52,897 52,481
Additional paid-in capital 13,136,970 13,119,719
Accumulated deficit (12,303,107) (13,041,191)
------------- -------------
Total Stockholders' Equity 2,945,751 2,110,000
------------- -------------
Total Liabilities and Stockholders' Equity $ 6,878,632 $ 3,703,215
============= =============
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 For The
Three Months Ended Nine Months Ended
---------------------------- ----------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------- ------------- ------------- -------------
Sales $ 9,232,162 $ 4,225,488 $ 21,723,365 $ 10,014,523
Cost of Sales 4,612,375 1,528,534 10,674,800 3,650,218
----------- ----------- ------------ ------------
Gross profit 4,619,787 2,696,954 11,048,565 6,364,305
----------- ----------- ------------ ------------
Operating expenses
General and administrative 1,832,115 1,069,191 5,246,503 2,727,968
Selling 1,958,032 729,388 4,716,849 2,011,587
Loss on investment securities - 687,750 - 687,750
Non-recurring expenses - - - 169,578
----------- ----------- ------------ ------------
Total Operating Expenses 3,790,147 2,486,329 9,963,352 5,596,883
----------- ----------- ------------ ------------
Income (Loss) from Operations 829,640 210,625 1,085,213 767,422
----------- ----------- ------------ ------------
Other Income/(Expense)
Other income 11,588 154,105 86,460 172,197
Interest income 26,131 - 61,962 -
Interest expense (9,993) (2,500) (23,661) (9,055)
----------- ----------- ------------ ------------
Total Other Income (Expense) 27,726 151,605 124,761 163,142
----------- ----------- ------------ ------------
Income (Loss) Before Income Taxes 857,366 362,230 1,209,974 930,564
----------- ----------- ------------ ------------
Income Taxes 334,373 137,048 471,890 357,048
----------- ----------- ------------ ------------
Net income $ 522,993 $ 225,182 $ 738,084 $ 573,516
=========== =========== =========== ============
Basic and Diluted Income (Loss) per
Share $ 0.01 $ 0.00 $ 0.01 $ 0.01
=========== =========== ============ ============
Weighted Average Number of Common Shares
Used in Per Share Calculation (basic and
diluted) 52,897,186 48,402,172 52,846,602 48,336,469
=========== =========== ============ ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS'
EQUITY/(DEFICIENCY)
(UNAUDITED)
Preferred Stock Series A Preferred Stock Series B Common Stock
--------------------------- ---------------------------- ----------------------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------- ------------- ------------
Balance - December 31, 2001 1,850,000 $ 1,850,000 248,491 $ 248,491 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
Issuance of Common stock 24,375 24
Issuance of Common Stock
for services provided 291,250 291
Conversion of Series A Preferred
Stock to Common Stock (199,500) (199,500) 3,000,000 3,000
Issuance of Common stock
for services provided 5,000 5
Issuance of Common stock 76,960 77
Issuance of Common stock 23,169 23
Issuance of Common stock
for services provided 39,702 40
Series A Preferred Stock Dividend 107,568 108
Series A Preferred Stock Dividend 30,734 31
Series A Preferred Stock Dividend 420,054 420
Series B Preferred Stock Dividend 72,494 72
Issuance of Series B Preferred
Stock for Executive Compensation 80,000 80,000
Unrealized loss on investments
Unrealized loss on investments
recognized in income due to
other than temporary impairment
Net income for the year
ended December 31, 2002 - - - -
------------ ------------ ------------ ------------- ------------- ------------
Balance - December 31, 2002 1,650,500 $ 1,650,500 328,491 $ 328,491 52,481,289 $ 52,481
============ ============ ============ ============= ============= ============
Issuance of Common stock
for prepaid public relations 233,333 233
Issuance of Common stock
for charitable contribution 133,333 134
Issuance of Series B Preferred
Stock for Executive Compensation 80,000 80,000
Issuance of Common Stock
for services provided 49,231 49
Net income for the nine months
ended September 30, 2003 - - - -
------------ ------------ ------------ ------------- ------------- ------------
Balance as of September 30, 2003 1,650,500 $ 1,650,500 408,491 $ 408,491 52,897,186 $ 52,897
============ ============ ============ ============= ============= ============
5
(table continued) Retained
Additional Accum. Earnings Total
paid-in- Comprehen- (Accum. Stockholders'
capital sive 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
Issuance of Common stock 23,219 23,243
Issuance of Common Stock
for services provided 21,553 21,844
Conversion of Series A Preferred
Stock to Common Stock 196,500 -
Issuance of Common stock
for services provided 370 375
Issuance of Common stock 18,939 19,016
Issuance of Common stock 3,992 4,015
Issuance of Common stock
for services provided 4,760 4,800
Series A Preferred Stock Dividend 13,892 (14,000) 0
Series A Preferred Stock Dividend 3,969 (4,000) (0)
Series A Preferred Stock Dividend 54,250 (54,670) -
Series B Preferred Stock Dividend 9,859 (9,931) 1
Issuance of Series B Preferred
Stock for Executive Compensation 80,000
Unrealized loss on investments (1,424,896) (1,424,896)
Unrealized loss on investments
recognized in income due to
other than temporary impairment 1,629,250 1,629,250
Net income for the year
ended December 31, 2002 - - (12,667,649) (12,667,649)
------------ ------------- ------------- ------------
Balance - December 31, 2002 $ 13,119,719 $ - $ (13,041,191) $ 2,110,000
============ ============= ============= ============
Issuance of Common stock
for prepaid public relations 2,017 2,250
Issuance of Common stock
for charitable contribution 10,533 10,667
Issuance of Series B Preferred
Stock for Executive Compensation 80,000
Issuance of Common Stock
for services provided 4,701 4,750
Net income for the nine months
ended September 30, 2003 - - 738,084 738,084
------------ ------------- ------------- ------------
Balance as of September 30, 2003 $ 13,136,970 $ - $(12,303,107) $ 2,945,751
============ ============= ============= ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months
Ended September 30,
---------------------------
2003 2002
----------- ----------
Cash flows from operating activities
Net income (loss) $ 738,084 $ 573,516
Adjustments to reconcile net income (loss) to
net cash provided by operating activities
Depreciation and amortization 150,497 83,016
Sale of software platform for investment securities - (875,000)
Write down on investment securities - 687,750
Prepaid non-cash executive compensation 20,000 -
Allowance for doubtful accounts - 132,000
Non-cash expenses 77,667 34,850
Net change in operating assets and liabilities
Accounts receivable (139,799) (594,133)
Prepaid expenses 43,593 (13,664)
Other receivables (55,096) (10,999)
Other current assets (434,388) (428,336)
Deposits and other assets 5,733 (20,397)
Accounts payable and accrued expenses 347,169 396,700
Deferred revenue 256,307 252,956
Other current liabilities 986,518 -
Reserve for returns and allowances 368,420 179,472
Accrued federal and state income tax 471,890 374,362
----------- ----------
Net cash provided by/(used in) operating activities 2,836,595 772,093
----------- ----------
Cash flows from investing activities
Capital expenditures (226,316) (362,520)
----------- ----------
Net cash used in investing activities (226,316) (362,520)
----------- ----------
Cash flows from financing activities
Issuance of common stock - 60,235
Proceeds from borrowings on line of credit - 50,000
Proceeds from borrowings under note payable 8,085 155,360
Repayments under line of credit agreement (36,920) (6,758)
Repayments on notes payable (61,802) (14,555)
Net cash provided by/(used in) financing activities (90,637) 244,282
----------- ----------
Net Increase (Decrease) in Cash and Cash Equivalents 2,519,642 653,855
Cash and Cash Equivalents at Beginning of Year 1,338,345 282,307
----------- ----------
Cash and Cash Equivalents at End of Year $ 3,857,987 $ 936,162
=========== ==========
Supplemental Cash Flow Information:
Unrealized loss on securities available for sale $ - $ -
=========== ==========
Issuance of common stock for software - 70,000
=========== ==========
Issuance of common stock for services/
charitable contributions 17,667 34,850
=========== ==========
Issuance of Series B Preferred Stock as
executive Compensation $ 80,000 $ -
=========== ==========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
6
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - COMPANY DESCRIPTION
Innovative Software Technologies, Inc. (the "Company" or "Innovative"),
operating in one business segment, is a software company specializing in
small business and financial eLearning tools and consulting services. The
Company's main products are: EMS, a turnkey web builder, e-commerce
solution and data management system targeted to small businesses; The
Financial Toolkit 1.0, an integrated financial services and education
program; Skills in Demand, consisting of eLearning courses that cater to
small business owners and entrepreneurs; OneCrypt, an email and file
encryption software product; and eTaxNet, a provider of online tax and
consulting services. In addition for most of its software and learning
products the Company offers technical support and coaching services.
The Company's management combines its expertise in the field of direct
marketing, software, coaching and sales management to small businesses and
consumers. The combination of marketing and technological support offers
clients complete end-to-end business services solutions designed to fit
their e-business transactional technology training needs.
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 prior Innovative investors continuing as passive investors.
Under accounting principles generally accepted in the United States (US
GAAP), 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).
On December 31, 2001, the Company purchased all of the outstanding shares
of Energy Professional Marketing Group, Inc. (EPMG), a technology marketing
company specializing in product fulfillment for outside vendors and
technology and database marketing, based in Provo, Utah. In connection with
the acquisition the Company issued 1,500,000 shares of Series A preferred
stock and 3,529,412 shares of common stock.
7
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - COMPANY DESCRIPTION - Continued
The purchase price for the acquisition of EPMG has been allocated on the
fair value basis on the acquisition date 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 Statement 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 the acquisition date. A
portion of the goodwill has been written down by the Company as of December
31, 2002. See Note B to the Condensed Consolidated Financial Statements
(Unaudited).
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the Company's significant accounting policies applied in the
preparation of the accompanying financial statements follows.
1. 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:
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.
8
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 January 1, 2002, 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 was 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 completed
the transitional impairment test for EPMG at September 30, 2002, the
applicable reporting unit, and no impairment of goodwill was found to
exist as of the beginning of fiscal 2002.
During 2002, the trading price of the Company's stock declined
significantly, raising questions about whether the fair value of goodwill
exceeds its carrying amount. An evaluation of the carrying amount of
goodwill was conducted during the 4th quarter 2002, which included an
evaluation of whether the decline in the trading price of the Company's
stock is other than temporary. The Company determined that the decline in
its trading price was other than temporary and subsequent to December 31,
2002, engaged an independent valuation firm to perform a valuation of the
Company. This resulted in a write-down in goodwill by the Company of
$12,461,246 as of December 31, 2002.
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. A
liability for an asset retirement obligation should be recognized if the
obligation meets the definition of a liability and can be reasonably
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 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.
In April 2002, the FASB issued SFAS No. 145 (SFAS 145). Any gain or loss
on extinguishment of debt that was classified as an extraordinary item in
prior periods presented that does not meet the criteria in APB 30 for
classification as an extraordinary item shall be reclassified. SFAS 145
also amends SFAS 13, Accounting for Leases as well as other existing
authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their
9
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
applicability under changed conditions. Certain provisions of SFAS 145 are
effective for transactions occurring after May 15, 2002 while other are
effective for fiscal years beginning after May 15, 2002. The Company does
not expect SFAS 145 to have a material effect on its financial condition
or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS 146). This standard
addresses financial accounting and reporting for costs associated with
exit or disposal activities. SFAS 146 requires that a liability for costs
associated with an exit or disposal activity be recognized when the
liability is incurred. The provisions of SFAS 146 are effective for exit
or disposal activities that are initiated by the Company after December
31, 2002. The Company does not expect SFAS 146 to have a material effect
on its financial condition or results of operations.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions" (SFAS 147). This standard relates to the
application of the purchase method of accounting to all acquisitions of
financial institutions, except transactions between two or more mutual
enterprises. This standard also relates to the application of SFAS 144 to
certain long-term customer-relationship intangible assets recognized in an
acquisition of a financial institution, including those acquired in
transactions between mutual enterprises. SFAS 147 is effective on October
1, 2002. The Company does not expect SFAS 147 to have a material effect on
its financial condition or results of operations.
In December 2002, the FASB issued SFAS No. 148 Accounting for Stock-Based
Compensation--Transition and Disclosure (SFAS 148). This standard amends
the disclosure and certain transition provisions of SFAS 123, Accounting
for Stock-Based Compensation. Its disclosure provisions are effective for
2002 annual financial statements for calendar year-end companies. The
Company does not expect that adoption of SFAS 148 will have a material
impact on its financial condition or results of operations.
2. Interim Condensed Consolidated 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 US GAAP 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, 2002. The results of operations for the nine months ended
September 30, 2003 are not necessarily indicative of the operating results
to be expected for the full year. The balance sheet as of December 31,
2002 has been derived from the Company's audited consolidated balance
sheet as of that date.
10
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. Principles of Consolidation
---------------------------
The accompanying consolidated financial statements include the accounts of
Innovative Software Technologies, Inc., and the accounts of its
wholly-owned subsidiaries, Energy Professional Marketing Group, Inc.
(EPMG), and Hackett Media, Inc., as of and for the nine months ended
September 30, 2003. All significant intercompany transactions and balances
have been eliminated in consolidation.
4. Revenue Recognition
-------------------
The Company recognizes revenue after delivery of the product. To the
extent the Company sells software, revenue is recognized in accordance
with Statement of Position 97-2, Software Revenue Recognition, as amended
by SOP 98-4 and SOP 98-9 and clarified by Staff Accounting Bulletin (SAB)
101 Revenue Recognition in Financial Statements. 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. Payments
received by the Company for these services are generally recorded as
deferred revenue and recognized over the term of the services.
The Company also provides extended payment terms on the sale of its
software and related coaching for up to two years. Since payments terms on
these sales exceed 12 months, the fee for the software and license is
presumed not to be determinable. In addition, the probability of
collection decreases as the payment terms are extended. As a result, the
Company recognizes revenue on these sales as the payments are collected
from the customer.
5. Investment Securities
---------------------
All investment securities are classified as available-for-sale. These
investment 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. The Company will
regularly perform reviews of the fair value of its investment securities
and assess whether there exists any other than temporary impairment.
6. Property and Equipment
----------------------
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is recognized using the straight-line and
double-declining balance 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 US GAAP, 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
11
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
8. Software Development Costs
--------------------------
In accordance with Statement of Financial Accounting Standards 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.
10. Impairment and Long-lived Assets
--------------------------------
The Company will regularly perform reviews to determine if the carrying
values of our long-lived assets are impaired. The reviews take into
account facts or circumstances, either internal or external, which
indicate that the carrying value of the asset cannot be recovered.
11. Income Taxes
------------
The Company records its federal and state tax liability in accordance with
Financial Accounting Standards Board Statement No. 109 "Accounting for
Income Taxes". Deferred taxes payable are recorded for temporary
differences between the recognition of income and expenses for tax and
financial reporting purposes, using current tax rates. Deferred assets and
liabilities represent the future tax consequences of those differences,
which will either be taxable or deductible when the assets and liabilities
are recovered or settled.
12. Cash and Cash Equivalents
-------------------------
For purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months
or less to be cash equivalents to the extent the funds are not being held
for investment purposes.
12
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C - INVESTMENT SECURITIES
The Company held three investment securities during the fiscal quarter ended
September 30, 2003, which the Company acquired in connection with strategic
business transactions and relationships. Our available-for-sale securities are
carried at fair value and unrealized gains or losses are included in
stockholders' equity. The Company held the following investment securities at
September 30, 2003 and December 31, 2002. The cost basis of our investment
securities reflects adjustments for other than temporary impairments in value.
Investment Cost Gross Unrealized Estimated
Securities Basis Gains Losses Fair Value
-------------------------- --------- --------- -------- ----------
September 30, 2003
EnSurge, Inc. common stock $ - $ - $ - $ -
$ - $ - $ - $ -
========= ========= ======== ==========
Investment Cost Gross Unrealized Estimated
Securities Basis Gains Losses Fair Value
-------------------------- --------- --------- -------- ----------
December 31, 2002
EnSurge, Inc. common stock $ - $ - $ - $ -
$ - $ - $ - $ -
========= ========= ======== ==========
The Company received EnSurge, Inc. common stock in consideration for the sale of
certain vintage furniture in 2000. Due to the decline in market value of
EnSurge, Inc. common stock, the Company considered the carrying value of $26,250
permanently impaired which resulted in a loss on investment securities of
$26,250 during the year ended December 31, 2002.
The Company received Knowledge Transfer Systems, Inc. common stock from EnSurge,
Inc. in consideration for the sale of four software coaching platforms to
EnSurge, Inc. in September - December, 2001. These investment 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 investment securities after the effective
date of sale. As of December 31, 2002, the one-year holding period on these
investment securities expired and the investment securities were recorded at
100% of their fair market value. Due to the decline in market value of Knowledge
Transfer Systems, Inc. common stock, the Company considered the value of these
securities permanently impaired and wrote down the entire carrying value of
these investment securities as of December 31, 2002. The reduction in carrying
value on these investment securities resulted in a loss on investment of
$728,000 during the year ended December 31, 2002. Shane Hackett, who is the
President and Chief Executive Officer of the Company, was the President and
Chief Executive Officer of EnSurge, Inc. from November 1, 1999 until February
28, 2001, and owned 7,725,000 shares of the common stock of EnSurge, Inc. during
the time of the transactions in 2001, which then constituted approximately nine
percent (9%), of the outstanding common stock of EnSurge, Inc.
The Company received 875,000 Knowledge Transfer Systems, Inc. preferred shares
with a stated value of $1.00 per share from Knowledge Transfer Systems, Inc. on
September 23, 2002 as consideration for the sale of the Business Development
Series, e-learning content and software. The preferred shares are
13
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
convertible, at the discretion of the Company, to Knowledge Transfer Systems,
Inc. common stock at 95% of the fair market value of Knowledge Transfer System's
common stock based on a five day average preceding the date of conversion. Due
to the disclosure by the management of Knowledge Transfer Systems, Inc. of the
possible bankruptcy of its wholly-owned subsidiary, KT Solutions, Inc., the
Company considered the value of these securities permanently impaired and wrote
down the entire carrying value of these investment securities as of December 31,
2002. The reduction in carrying value on these investment securities resulted in
a loss on investment of $875,000 during the year ended December 31, 2002. The
Company has retained a valuation firm to determine the value of the 875,000
shares of preferred stock of the Knowledge Transfer Systems, Inc., as of the
time of their transfer to the Company on September 23, 2002, to determine the
tax consequences of the transaction. See Note I - Commitments and Contingencies.
At the time of the sale of the Business Development Series to Knowledge Transfer
Systems, Inc. for 875,000 shares of Knowledge Transfer Systems, Inc. preferred
stock, there was no related party relationship between the companies and/or the
officers and directors of the companies except for the interest described below.
According to the Form 10-KSB of Knowledge Transfer Systems, Inc. for the period
ended December 31, 2002, EnSurge, Inc. beneficially owned 2,600,000 shares, or
5.1% of the outstanding common stock of Knowledge Transfer Systems, Inc., and
according to the Form 10-KSB of Knowledge Transfer Systems, Inc. for the period
ended December 31, 2001, EnSurge, Inc. beneficially owned 5,700,000 shares, or
14.1% of the outstanding common stock of Knowledge Transfer Systems, Inc. Shane
Hackett, who is the President and Chief Executive Officer of the Company, was
the President and Chief Executive Officer of EnSurge, Inc. from November 1, 1999
until February 28, 2001, and owned 7,725,000 shares of the common stock of
EnSurge, Inc. during the time of the transaction between the Company and
Knowledge Transfer Systems, Inc. in 2002, which then constituted approximately
eight percent (8%), of the outstanding common stock of EnSurge, Inc. Mr. Hackett
continues to own 7,725,000 shares of the common stock of EnSurge, Inc.
During the quarter ended September 30, 2003, the Company entered into a Purchase
and Sale Agreement (the "KT Purchase Agreement") with Knowledge Transfer
Systems, Inc., and a Content License and Resale Agreement (the "KT License
Agreement") with both KT Solutions, Inc. and Knowledge Transfer Systems, Inc.
The transactions each occurred on August 25, 2003. KT Solutions, Inc. is a
subsidiary of Knowledge Transfer Systems, Inc. Pursuant to the KT Purchase
Agreement, the Company purchased the Business Development Series from Knowledge
Transfer Systems, Inc. in exchange for the 875,000 shares of Knowledge Transfer
Systems, Inc. preferred stock owned by the Company. The Business Development
Series consists of multimedia software titles, hard copy titles, website,
domain, copyright, titles, and all related interests, including certain product
deliverables, product contracts and product licenses. Pursuant to the KT License
Agreement, the Company obtained a non-exclusive, world-wide license to a line of
KT Solutions, Inc. products for resale through the Company's on-line learning
services, in exchange for a 35% royalty on product revenues recognized by the
Company, subject to a $125,000 royalty credit as a start-up concession to the
Company. The licensed product line consists of training materials suitable for
access and use by a customer through on-line learning services. The initial
license term is for five years and is renewable year-to-year thereafter unless
canceled by either party. Due to concerns the Company had about the continued
existence of KT Solutions, Inc. as an operating entity, the Company also
obtained a guarantee by its parent, Knowledge Transfer Systems, Inc., of all of
KT Solutions Inc.'s obligations under the KT License Agreement, in exchange for
the 1,900,000 shares of Knowledge Transfer Systems, Inc. common stock owned by
the Company. As a result of these transactions, among other things, the Company
has reacquired full ownership of the Business Development Series previously sold
by the Company to Knowledge Transfer Systems, Inc., and the Company no longer
owns any common or preferred stock or any other equity interest in Knowledge
14
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Transfer Systems, Inc. The Company did not record any gain or loss with respect
to the transactions that occurred during the quarter that ended Spetember 30,
2003.
NOTE D - PROPERTY & EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation as
follows:
September 30, December 31,
2003 2002
--------------------------------
Machinery and Equipment...............$ 341,243 $ 246,594
Furniture and Fixtures................ 65,263 51,683
Computer Software..................... 306,785 190,624
Leasehold improvements................ 36,018 34,092
---------- ---------
749,309 522,993
Less: Accumulated depreciation
and amortization.................... (294,142) (143,644)
---------- ---------
Property and Equipment, Net...........$ 455,167 $ 379,349
========== =========
NOTE E - OTHER ASSETS
The Company has established several merchant service accounts whereby the
Company processes a high volume of customer sales transactions through certain
credit card vendors. These merchant service companies typically hold a
percentage of each sales transaction as a reserve against future cancellations.
The amount held by these merchant service companies amounts to $1,073,850 and
$706,486 as of September 30, 2003 and December 31, 2002, respectively.
NOTE F - LONG-TERM DEBT
Long-term debt consists of the following:
September 30, December 31,
2003 2002
------------- ------------
Notes payable, financial institution,
collateralized by telephone equipment,
principal and imputed interest
payable in monthly installments of $1,250
and $385 respectively, due in August 2004,
and January 2006. $ 18,606 $ 20,469
Notes payable, financial institution,
secured by a lien on certain
furniture and equipment, principal
and interest payable in monthly
installments of $2,464 due in July 2005 49,928 67,175
15
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Notes payable, financial institution,
collateralized by Vehicles, principal
and accrued interest at 7.78% payable
in monthly installments of principal
and imputed interest maturing from $217
to $655 from November 2006 to February 2007 9,246 43,853
------------- ------------
77,780 131,497
Less Current Maturities 11,508 44,274
------------- ------------
Long-term - net of current maturities $ 66,272 $ 87,223
============= ============
The Company has an unsecured line of credit facility with a financial
institution for borrowings up to $50,000 expiring August 31, 2005. Borrowings
under the line bear interest at Prime plus 2% (the Prime rate of interest as of
September 30, 2003 was 4.00%). As of September 30, 2003, there was $46,260
available on the credit facility.
NOTE G - CAPITAL TRANSACTIONS
Stock-split - Innovative's Board of Directors authorized a three-for-one stock
split on July 11, 2001. This was effective 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, 24,375, 76,960, and 23,169
shares of its common stock in 2002 through private placements to individual
foreign investors.
Issuance of Series B preferred stock - The Company issued 80,000 shares of its
Series B preferred stock to certain directors of the Company as compensation at
a stated value of $1.00 per share in 2002.
Issuance of common stock for software - The Company issued 53,845 shares of its
common stock in 2002 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 in the first quarter 2002. In
addition, the Company issued 6,125 shares of its common stock during the second
quarter 2002 at fair market value of $3.37 per share.
Stock issued for services - The Company issued 291,250 and 5,000 shares of its
common stock at a fair market value of $0.075 per share in the fourth quarter
2002. In addition, the Company issued 39,702 shares of its common stock during
the first quarter 2003 for services rendered in fourth quarter 2002 at an
average fair market value of $0.121 per share.
Conversion of Series A Preferred Stock - Two directors of the Company converted
199,500 shares of Series A preferred stock to 3,000,000 shares of common stock
during the fourth quarter 2002. The Series A preferred stock is convertible to
the Company's common stock at 95% of the fair market value of the common stock
at the date of conversion. The Market Price of the Company's common stock on the
date of conversion was $0.07.
16
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Series A Preferred Stock Dividend - The Company issued 558,356 shares of its
common stock as a Series A preferred stock dividend during the fourth quarter
2002. The holders of the shares of Series A Preferred received dividends at the
rate of 4% per annum payable in shares of the Company's common stock. The number
of shares of common stock distributed as a dividend was calculated by dividing
such payment by 95% of the Market Price on the average of the first five trading
days after January 1 of each year. The term "Market Price" means, as of any
date, the average of the daily closing price for the five consecutive trading
days ending on such date. The Company has withheld 137,942 of such shares of
common stock payable to two stockholders in connection with a dispute with such
stockholders.
Series B Preferred Stock Dividend - The Company issued 72,494 shares of its
common stock as a Series B preferred stock dividend during the fourth quarter
2002. The holders of the shares of Series B Preferred received dividends at the
rate of 4% per annum payable in shares of the Company's common stock. The number
of shares of common stock distributed as a dividend was calculated by dividing
such payment by 100% of the Market Price on the average of the first five
trading days after January 1 of each year. The term "Market Price" means, as of
any date, the average of the daily closing price for the five consecutive
trading days ending on such date.
Financing Agreement - During 2001, Hackett Media, Inc. financed its operation
primarily through a Financing Agreement of convertible debt and securities. The
Financing 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
September 30, 2002, $700,000 of the initial $1 million investment was received
by the Company. These proceeds were converted to equity securities during 2001.
During the fourth quarter 2001, all of the common shares issued in connection
with the conversion of debt in connection with the Financing Agreement above
were reissued as Series A preferred shares and common shares as follows: of the
$700,000 invested in 2001, $350,000 was converted to Series A preferred shares
at a stated value of $1 per share and the remaining $350,000 was reissued as
700,000 shares of common stock at $0.50 per share. During the fourth quarter
2002, the Company passed a Board of Directors' resolution to formally terminate
the Financing Agreement with Iwasaka Investments, Ltd. due to the non-compliance
by Iwasaka Investments, Ltd. with the terms of the agreement. The Company
believes that the termination of this agreement will have no adverse effect on
the operations of the Company.
Issuance of Series B preferred stock - The Company issued 80,000 shares of its
Series B preferred stock to certain directors of the Company as prepaid
executive compensation and executive compensation at a stated value of $1.00 per
share in the first quarter 2003. The Company recorded non-cash executive
compensation of $60,000 for the nine months ended September 30, 2003. The
remaining $20,000 will be incurred during the fourth quarter of 2003.
Stock issued for prepaid services - The Company issued 233,333 shares of its
common stock in exchange for $2,250 of prepaid public relation services in the
first quarter 2003.
Stock issued for charitable contribution - The Company issued 133,333 shares of
its common stock as a charitable contribution at a fair market value of $0.08
per share in the first quarter 2003.
Stock issued for services - The Company issued 49,231 shares of its common stock
at a fair market value of $0.096 per share in the second quarter 2003 for
professional services rendered.
17
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE H - RELATED PARTY TRANSACTIONS
On December 31, 2001, a Company executive and shareholder converted a
non-interest bearing 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.
Also, in September - December 2001, the Company sold four software coaching
platforms to NowSeven.com, Inc., Ziabon, Inc., SF Acquisition Corp., Inc., and
Ishopper Internet Services, Inc., which are subsidiaries of EnSurge, Inc., in
exchange for investment securities of Knowledge Transfer Systems, Inc. amounting
to $308,000, $133,000, $147,000, and $140,000, respectively. Shane Hackett, who
is the President and Chief Executive Officer of the Company, was the President
and Chief Executive Officer of Ensurge, Inc. from November 1, 1999 until
February 28, 2001, and owned 7,725,000 shares of the common stock of EnSurge,
Inc. during the time of the transactions in 2001, which then constituted
approximately nine percent (9%), of the outstanding common stock of EnSurge,
Inc. Due to the decline in market value of Knowledge Transfer Systems, Inc.
common stock, the Company considered the value of these securities permanently
impaired and wrote down the entire carrying value of these investment securities
as of December 31, 2002. At the time of the sale of the Business Development
Series to Knowledge Transfer Systems, Inc. for 875,000 Knowledge Transfer
Systems, Inc. preferred shares in 2002, EnSurge, Inc. was a stockholder of
Knowledge Transfer Systems, Inc. According to the Form 10-KSB of Knowledge
Transfer Systems, Inc. for the period ended December 31, 2002, EnSurge, Inc.
beneficially owned 2,600,000 shares, or 5.1% of the outstanding common stock of
Knowledge Transfer Systems, Inc., and according to the Form 10-KSB of Knowledge
Transfer Systems, Inc. for the period ended December 31, 2001, EnSurge, Inc.
beneficially owned 5,700,000 shares, or 14.1% of the outstanding common stock of
Knowledge Transfer Systems, Inc. Shane Hackett, who is the President and Chief
Executive Officer of the Company, was the President and Chief Executive Officer
of Ensurge, Inc. from November 1, 1999 until February 28, 2001, and owned
7,725,000 shares of the common stock of EnSurge, Inc. during the time of the
transaction between the Company and Knowledge Transfer Systems, Inc. in 2002,
which then constituted approximately eight percent (8%), of the outstanding
common stock of EnSurge, Inc. (See Note C: Investment Securities).
During the quarter ended September 30, 2003, the Company entered into a Purchase
and Sale Agreement (the "KT Purchase Agreement") with Knowledge Transfer
Systems, Inc., and a Content License and Resale Agreement (the "KT License
Agreement") with both KT Solutions, Inc. and Knowledge Transfer Systems, Inc.
The transactions each occurred on August 25, 2003. KT Solutions, Inc. is a
subsidiary of Knowledge Transfer Systems, Inc. Pursuant to the KT Purchase
Agreement, the Company purchased the Business Development Series from Knowledge
Transfer Systems, Inc. in exchange for the 875,000 shares of Knowledge Transfer
Systems, Inc. preferred stock owned by the Company. The Business Development
Series consists of multimedia software titles, hard copy titles, website,
domain, copyright, titles, and all related interests, including certain product
deliverables, product contracts and product licenses. Pursuant to the KT License
Agreement, the Company obtained a non-exclusive, world-wide license to a line of
KT Solutions, Inc. products for resale through the Company's on-line learning
services, in exchange for a 35% royalty on product revenues recognized by the
Company, subject to a $125,000 royalty credit as a start-up concession to the
Company. The licensed product line consists of training materials suitable for
access and use by a customer through on-line learning services. The initial
license term is for five years and is renewable year-to-year thereafter unless
canceled by either party. Due to concerns the Company had about the continued
existence of KT Solutions, Inc. as an operating entity, the Company also
obtained a guarantee by its parent, Knowledge Transfer Systems, Inc., of all of
KT Solutions Inc.'s obligations under the KT License Agreement, in exchange for
the 1,900,000 shares of Knowledge Transfer Systems, Inc. common stock owned by
the Company. As a result of these
18
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
transactions, among other things, the Company has reacquired full ownership of
the Business Development Series previously sold by the Company to Knowledge
Transfer Systems, Inc., and the Company no longer owns any common or preferred
stock or any other equity interest in Knowledge Transfer Systems, Inc. The
Company did not record any gain or loss with respect to the transactions that
occurred during the quarter that ended September 30, 2003.
During 2002, the Company initiated the purchase of sales leads from Education
Success Institute, Inc. (ESI). ESI is owned and operated by two officers of the
Company's operating subsidiary, Energy Professional Marketing Group Inc. (Ethan
Andrew Willis and James Randolph Garn). The Company paid ESI a total of
$3,894,816 for sales lead generation for the nine months ended September 30,
2003. In addition, the Company reserved for potential returned sales from ESI in
the amount of $296,140 as of September 30, 2003. Also, revenue received by the
Company for ESI's use of merchant accounts, office supplies and rent totaled
$72,554 for the nine months ended September 30, 2003.
NOTE I - COMMITMENTS AND CONTINGENCIES
Leases
- ------
In March, May and September 2002, the Company entered into operating leases for
certain office space. In October 2003 we leased additional space for our
coaching office. The Company leases space for three separate locations. The
total monthly obligation is $23,601. Future minimum lease payments under these
operating leases as of September 30, 2003 are as follows:
Year Ending December 31:
2003....................................... 71,261
2004....................................... 239,922
2005....................................... 173,853
2006....................................... 37,467
-----------
Total......................................$ 522,502
===========
SEC Investigation
- -----------------
As described in Part II, Section 1, on June 24, 2003, the Securities and
Exchange Commission ("SEC") issued a formal order of investigation with respect
to the Company, authorizing the investigation of certain securities matters
relating to the Company. The SEC staff has taken the testimony of certain
officers of the Company and has informed the Company that it intends to take
additional testimony. The SEC staff has also issued additional requests for the
voluntary production of documents. Prior to the issuance of the order, the
Company had voluntarily provided documents and information to the SEC staff in
response to informal, non-public inquiries by the staff. The Company intends to
fully cooperate with the SEC in its investigation.
Legal Proceedings
- -----------------
On or about September 5, 2003, a lawsuit was filed by Independent Marketing,
Inc. (IMI) against certain employees of the Company. The lawsuit was filed in
the Fourth Judicial District Court of Utah County, State of Utah as Case No.
030403929. While the Company was initially named as a Defendant, the Company was
not named in the Amended Complaint filed in this lawsuit, In the lawsuit, IMI is
claiming that these employees have breached certain employment and non-compete
agreements and IMI is seeking
19
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
compensatory damages and injunctive relief. Although the Company is not a party
to the litigation, because the lawsuit affects certain employees of the Company,
some or all of whom are key employees, the Company's operating results and
competitive position may be adversely affected in the event of a Court ruling
which limits those employees' involvement with the Company.
As disclosed in Part II, Item 1, James Randolph Garn and Ethan Andrew Willis
have resigned as officers of the Company and as members of the Company's Board
of Directors and have informed the Company that they are prepared to file a suit
to rescind the Company's December 31, 2001 acquisition from them of the
Company's operating subsidiary, Energy Professional Marketing Group, Inc.,
unless the Company reaches a negotiated compromise with them effecting a
rescission of the acquisition. The Company is not aware of any suit being filed.
The Company is investigating this matter and the parties have attempted to
negotiate a resolution of this matter. The commencement of litigation or any
adverse determination in such litigation could have a material adverse effect on
the Company's business, financial condition and results of operations.
Valuation of the 2002 Sale of Business Development Series for Stock. As noted in
Note C - Investment Securities, the Company has retained a valuation firm to
determine the value of the 875,000 shares of preferred stock of the Knowledge
Transfer Systems, Inc., as of the time of their transfer to the Company on
September 23, 2002, to determine the tax consequences of the transaction. The
results of this valuation cannot be predicted at this time. However, should the
valuation be substantially lower than the previously reported amount, the
Company may need to restate its SEC filing for the third quarter of 2002 and for
the 2002 year. In the event such a restatement is required the Company expects
the effect to be limited as the entire amount of this consideration was written
off at the end of 2002. However, if the valuation of the preferred stock exceeds
approximately $300,000, the Company will be required to accrue tax liability
relating to the excess.
NOTE J - CONCENTRATION OF CREDIT RISK
The Company has increasingly relied on ESI to provide the Company with sales
leads. As a percentage of the overall sales leads provided to the Company for
the three months ended September 30, 2003, 89% of the leads were provided by
ESI. This is compared to 57% for the three months ended June 30, 2003.
NOTE K - SUBSEQUENT EVENTS
In October of 2003 we entered into a capital lease for the amount of $139,940
for phone equipment, the term of which is 4 years. In November, 2003 the Company
entered into an equipment lease in the amount of approximately $5,000 for 2
years.
20
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
----------------------------------------------------------------------
The Company is a software company specializing in small business and
financial eLearning tools and consulting services. The Company's main products
are EMS, a turnkey web builder, e-commerce solution and data management system
targeted to small businesses; The Financial Toolkit 1.0, an integrated financial
services and education program; Skills in Demand, consisting of eLearning
courses that cater to small business owners and entrepreneurs, and eTaxNet, a
provider of online tax and consulting services. In addition, the Company offers,
for most of its software and learning products, technical support and coaching
services.
When used in this discussion, the words "expect(s)", "feel(s)", "believe(s)",
"will", "may", "anticipate(s)" and similar expressions are intended to identify
forward-looking statements. Such statements are subject to certain risks and
uncertainties, and actual results could differ materially from those projected.
Readers are cautioned not to place undue reliance on these forward-looking
statements, and are urged to carefully review and consider the various
disclosures elsewhere in this Form 10-QSB, including those set forth under
"Cautionary Statement Concerning Forward-Looking Statements" below.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of
operations are based upon the Company's condensed 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 amounts of assets and liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities at the date of the
Company's financial statements. Actual results may differ from these estimates
under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. The Company
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, 2002.
Goodwill and Intangible Assets
As discussed in Note A in the accompanying consolidated financial statements,
the Company, on December 31, 2001, purchased all of the outstanding shares of
Energy Professional Marketing Group Inc. (EPMG) for $13.5 million in Innovative
common and Series A preferred 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 (SFAS 142). This statement affects the
Company's treatment of goodwill and
21
other intangible assets. The statement requires 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.
During 2002, the trading price of the Company's stock declined significantly,
raising questions about whether the fair value of goodwill exceeds its carrying
amount. An evaluation of the carrying amount of goodwill was conducted during
the 4th quarter 2002, which included an evaluation of whether the decline in the
trading price of the Company's stock is other than temporary. The Company
determined that the decline in its trading price was other than temporary and
subsequent to December 31, 2002, engaged an independent valuation firm to
perform a valuation of the Company. This resulted in a write-down in goodwill by
the Company of $12,461,246 as of December 31, 2002. Goodwill amounts to
$1,088,868 as of September 30, 2003.
Investment Securities
Investment 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
investment 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 investment securities in the
Company's portfolio, if, among other things, relevant information related to the
Company's investment 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 wrote down the value of investment securities by $1,629,250 in 2002. The
new cost basis in the investment securities written-down, as of December 31,
2002, is $0.
Revenue Recognition
The Company recognizes revenue after delivery of the product. To the extent
the Company sells software, revenue is recognized in accordance with Statement
of Position 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP
98-9 and clarified by Staff Accounting Bulletin (SAB) 101 Revenue Recognition in
Financial Statements. 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. Payments
received by the Company for these services are generally recorded as deferred
revenue and recognized over the term of the services. The Company estimates the
amount earned for services based upon the period of time that has elapsed since
the invoice date. For example, if an agreement provides for a ten-week course of
coaching services, the Company estimates that one-half of the revenues for
coaching services are earned after five weeks. If
22
the ten-week course begins five weeks before the end of a fiscal quarter, the
Company will recognize one-half of the coaching revenues as revenues received in
the fiscal quarter and will record one-half as deferred revenue. The Company
makes two assumptions in recognizing coaching revenues: (1) that coaching
services begin immediately after the invoice date and (2) that customers do not
make-up missed coaching sessions. The Company believes that these assumptions
are reasonable based upon the Company's experience.
The Company also provides extended payment terms on the sale of its software
and related coaching for up to two years. Since payments terms on these sales
exceed 12 months, the fee for the software and license is presumed not to be
determinable. In addition, the probability of collection decreases as the
payment terms are extended. As a result, the Company recognizes revenue on these
sales as the payments are collected from the customer.
Results of Operations for the Three Months Ended September 30, 2003 Compared to
Three Months Ended September 30, 2002
Sales
Sales for the three months ended September 30, 2003 and 2002 were $9,232,162
and $4,225,488, respectively, which represents a 118% increase from the prior
period. The Company's principal source of revenue for the three months ended
September 30, 2003 consisted of software product and service sales. The primary
reason for the increase in sales can be attributed to the consolidation of all
of its administrative and accounting functions to the Provo, UT office in an
effort to improve the Company's fulfillment and shipping operations and improve
corporate responsiveness. This consolidation was completed in September 2002.
This has enabled the Utah office to greatly improve its ability to service its
customers. The Company has experienced substantial increases in sales per sales
associate as a result of the consolidation. In conjunction with this
consolidation, the Company has hired additional sales and marketing associates
which has also positively impacted sales for the nine months ended September 30,
2003. Also, in first quarter 2003, the Company initiated the utilization of its
training center in Orem, UT to assist its customers in maintaining and expanding
their Internet presence. Among the Company's products and services, sales of the
Company's personal finance products and services have been increasing at a
faster rate than its other products and services.
Cost of Sales
Cost of sales for the three months ended September 30, 2003 and 2002 was
$4,612,375 and $1,528,534, respectively, representing an increase of 202%. Cost
of sales for the three months ended September 30, 2003 and 2002 represented
costs associated with the generation of sales leads and the providing of
coaching services to customers that purchase the Company's products. The main
reason for the increase in cost of sales for the three months ended September
30, 2003, as compared to a year ago for the same period, can be attributed to
cost of sales increasing in conjunction with the increase in sales for the
period as well as the rise in the cost of generating sales leads and the
providing of coaching services for the same period a year ago. See "Related
Party Transactions - Relationship with ESI" below.
23
Gross Margin
Gross profit as a percentage of revenues was 50% for the three months ended
September 30, 2003 and 63.8% for the three months ended September 30, 2002. The
decrease was caused by the rise in costs of generating sales leads and the
providing of coaching services. See "Cost of Sales" above.
Selling
Selling expenses for the three months ended September 30, 2003 and 2002 were
$1,958,032 and $729,388, respectively, representing an increase of 168%. These
costs consisted primarily of commissions paid to sales associates as well as
marketing and advertising expenses associated with key products and services.
The main reason for the increase in selling costs can be attributed to the
increase in sales of products and services from new and existing sales
associates. Selling costs have increased as a percentage of sales for the three
months ended September 30, 2003 and 2002.
General and Administrative
General and administrative expenses for the three months ended September 30,
2003 and 2002 were $1,832,115 and $1,069,191, respectively, representing an
increase of 71%. The Company's general and administration expenses consisted
primarily of salaries and wages, professional and legal fees, rent, travel
expenses, payroll taxes, telephone expenses and other general and administrative
expenses necessary to support the operations of the Company in the current
period. The primary reason for the increase in general and administrative
expenses was attributable to higher administrative wage costs and legal expenses
for the three months ended September 30, 2003. The Company pays 40% of net
earnings before taxes into a profit sharing pool that is divided equally among
three executive officers of the Company and its subsidiaries.
Income Taxes
The Company accrued $334,373 and $137,048 for income taxes for the three
months ended September 30, 2003 and 2002, respectively. The Company's effective
income tax rates were 39% and 36% for the three months ended September 30, 2003
and 2002, respectively
Net Income
The Company had net income of $522,993 for the three months ended September 30,
2003, a net margin of 5.7% of revenue, compared to net income of $225,182 for
the three months ended September 30, 2002, a net margin of 5.3% of revenue. Net
income increased over the comparable period in 2002 primarily due to a loss on
investment securities during the comparable period in 2002.
24
Results of Operations for the Nine Months Ended September 30, 2003 Compared to
Nine Months Ended September 30, 2002
Sales
Sales for the nine months ended September 30, 2003 and 2002 were $21,723,365
and $10,014,523, respectively, which represents a 117% increase from the prior
period. The Company's principal source of revenue for the nine months ended
September 30, 2003 consisted of software product and service sales. The primary
reason for the increase in sales can be attributed to the consolidation of all
of its administrative and accounting functions to the Provo, UT office in an
effort to improve its fulfillment and shipping operations and improve corporate
responsiveness. This consolidation was completed in September 2002. This has
enabled the Utah office to greatly improve the Company's ability to service its
customers. The Company has experienced substantial increases in sales per sales
associate as a result of the consolidation. In conjunction with this
consolidation, the Company has hired additional sales and marketing associates,
which has also positively impacted sales for the first nine months of 2003.
Also, in first quarter 2003, the Company initiated the utilization of its
training center in Orem, UT to assist its customers in maintaining and expanding
their Internet presence. Among the Company's products and services, sales of the
Company's personal finance products and services have been increasing at a
faster rate than its other products and services.
Cost of Sales
Cost of sales for the nine months ended September 30, 2003 and 2002 was
$10,674,800 and $3,650,218, respectively, representing an increase of 192%. Cost
of sales for the nine months ended September 30, 2003 and 2002 represented costs
associated with the generation of sales leads and the providing of coaching
services to customers that purchase the Company's products. The main reason for
the increase in cost of sales for the nine months ended September 30, 2003, as
compared to a year ago for the same period, can be attributed to cost of sales
increasing in conjunction with the increase in sales for the period as well as
the rise in the cost of generating sales leads and the providing of coaching
services for the same period a year ago. See "Related Party Transactions -
Relationship with ESI" below.
Gross Margin
Gross profit as a percentage of revenues was 50.9% for the nine months ended
September 30, 2003 and 63.6% for the nine months ended September 30, 2002. The
decrease was caused by the rise in the cost of generating sales leads and of
providing of coaching services for the same period a year ago.
Selling
Selling expenses for the nine months ended September 30, 2003 and 2002 were
$4,716,849 and $2,011,587, respectively, representing an increase of 134%. These
costs consisted primarily of commissions paid to sales associates as well as
marketing and advertising expenses associated with key products and services.
The increase in selling costs can be attributed primarily to the increase in
sales of products and services from new and existing sales associates. Selling
costs have increased as a percentage of sales for the nine months ended
September 30, 2003 and 2002.
25
General and Administrative
General and administrative expenses for the nine months ended September 30,
2003 and 2002 were $5,246,503 and $2,727,968, respectively, representing an
increase of 92%. The Company's general and administration expenses 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 the Company in the current period. The
primary reason for the increase in general and administrative expenses was
attributable to higher administrative wages and legal fees for the nine months
ended September 30, 2003. The Company pays 40% of net earnings before taxes into
a profit sharing pool that is divided equally among three executive officers of
the Company and its subsidiaries.
Non-recurring Expenses
Non-recurring expense for the nine months ended September 30, 2003 and
2002 was $0 and $169,578, respectively. Non-recurring expense in 2002
represented back wages due to EPMG's employees. This cost resulted from a
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.
Income Taxes
The Company accrued $471,890 and $357,048 for income taxes for the nine months
ended September 30, 2003 and 2002, respectively. The Company's effective income
tax rates were 39% and 36% for the nine months ended September 30, 2003 and
2002, respectively. In its 10-QSB filing for the period ended June 30, 2003, the
Company did not accrue income taxes as management believed at that time that a
portion of the write-down in goodwill (See Note B in the "Notes to the Condensed
Consolidated Financial Statements") provided an offset to Net Income for tax
purposes. The Company now believes that the write-down in goodwill does not
provide an offset to Net Income for tax purposes. The $471,890 income tax
accrual recognizes the full amount of tax liability without consideration of the
write-down in goodwill. The Company has retained a tax expert to confirm the
Company's conclusion.
Net Income
We had net income of $738,084 for the nine months ended September 30, 2003
compared to net income of $573,516 for the nine months ended September 30, 2002,
an increase of 29%. The increase in net income was due to overall increased
revenues and better cost controls. Net income increased over the comparable
period in 2002 primarily due to a loss on investment securities during the
comparable period in 2002.
Related Party Transactions
Relationship with ESI. In September 2002, Energy Professional Marketing
Group, Inc. (EPMG), a wholly-owned subsidiary of the Company, entered into an
Opportunity and Strategic Alliance Agreement with Education Success Institute
(ESI). Under the agreement, EPMG purchases sales leads from ESI. ESI is owned
and operated by Ethan A. Willis and James R. Garn, each of whom serves as a vice
president and director of EPMG and served as an officer and director of the
Company prior to September 26, 2003. Under the agreement, with respect to cash
sales made by EPMG to sales leads generated by ESI, gross sales after a reserve
of 4% are divided 66% to EPMG and 34% to ESI. The Company believes that the
agreement is the product of arm's length negotiation between the parties. The
Company was generating a significant portion of their sales leads internally;
however, this was generally unprofitable for the
26
Company and the decision was made to outsource the generation of sales leads to
ESI. The Company paid ESI a total of $2,044,027 for sales lead generation for
the three months ended September 30, 2003and $3,894,816 for sales lead
generation for the nine months ended September 30, 2003. In addition, the
Company reserved for potential returned sales from ESI in the amount of $296,140
as of September 30, 2003. Also, revenue received by the Company for ESI's use of
merchant accounts, office supplies and rent totaled $39,876 for the three months
ended September 30, 2003 and $72,554 for the nine months ended September 30,
2003.
Liquidity and Capital Resources
At September 30, 2003, the Company had cash and cash equivalents of
$3,857,987, an increase of $2,519,642 from December 31, 2002. At September 30,
2003, the Company had net working capital of $1,425,205 compared to net working
capital of $680,490 at December 31, 2002. The ratio of current assets to current
liabilities decreased to 1.37 at September 30, 2003 from 1.45 at December 31,
2002. Cash provided by operations was $2,836,595 for the nine months ended
September 30, 2003. The primary reason for the positive operating cash for the
nine months ended September 30, 2003 can be attributed to the Company's higher
sales volume during the first nine months of 2003. In addition, the Company's
primary merchant service company ceased holding a percentage of each sales
transaction as a reserve against future cancellations, which has positively
impacted cash in the current quarter. The Company also experienced non-cash
prepaid expenses and non-cash expenditures of $97,667 during the nine months
ended September 30, 2003, which also positively effected cash. The Company paid
down its note payable and line of credit balances by a net amount of $90,637
during the nine months ended September 30, 2003. The Company anticipates paying
down additional notes payable amounts during 2003. Stockholders' equity amounts
to $2,945,751 as of September 30, 2003.
The Company issued 80,000 shares of its Series B preferred stock to
certain directors of the Company as prepaid executive compensation and executive
compensation at a stated value of $1.00 per share in the first quarter 2003. The
Company recorded non-cash executive compensation of $60,000 for the nine months
ended September 30, 2003, related to these Series B preferred shares. The
remaining $20,000 will be incurred during the fourth quarter of 2003.
The Company issued 233,333 shares of its common stock during the first
quarter 2003 for prepaid public relation services to be provided in future
periods.
The Company issued 133,333 shares of its common stock as a charitable
contribution during the first quarter 2003.
The Company issued 39,702 shares of its common stock for professional
services provided during the first quarter 2003.
The Company issued 49,231 shares of its common stock for professional
services provided during the second quarter 2003.
The Company expects that its existing cash resources and cash flow
generated from operations will be sufficient to meet its operating requirements
and ordinary capital expenditure needs during the next twelve months.
Trends
27
The following is a description of certain trends, events and uncertainties
that may affect the Company's future financial results. Due to the potential for
change in factors associated with our business, it is impossible to predict or
quantify future changes in the Company's business, results of operations and
financial condition. See "-Cautionary Statement Concerning Forward-Looking
Statements."
Resignation of Garn & Willis and Threatened Litigation. As disclosed in Part
II, Item 1, James Randolph Garn and Ethan Andrew Willis resigned as Officers of
the Company and as members of the Company's Board of Directors and have informed
the Company that they are prepared to file a suit to rescind the Company's
December 31, 2001 acquisition from them of the Company's operating subsidiary,
Energy Professional Marketing Group, Inc., unless the Company reaches a
negotiated compromise with them effecting a rescission of the acquisition. The
Company is not aware of any such complaint being filed. The Company is
investigating this matter and the parties have attempted to negotiate a
resolution of this matter. The commencement of litigation or any adverse
determination in such litigation could have a material adverse effect on the
Company's business, financial condition and results of operations.
SEC Investigation. As disclosed in Part II, Item 1, the Securities and
Exchange Commission issued a formal order of investigation with respect to the
Company, authorizing the investigation of certain securities matters relating to
the Company. The Company cannot predict the length or potential outcome of the
SEC investigation, or the potential impact of the investigation on the Company.
If the SEC's investigation results in any formal adverse determination, which
may include a fine or other remedies, the Company's financial condition, results
of operations and business could be materially adversely affected. The Company
has incurred, and may continue to incur, significant legal and other costs in
connection with this investigation.
Reliance on Education Success Institute, Inc. (ESI). As disclosed in the
"Related Party Transactions" section above, the Company has increasingly relied
on ESI to provide the Company with sales leads. As a percentage of the overall
sales leads provided to the Company for the three months ended September 30,
2003, 89% of the leads were provided by ESI. This is compared to 57% for the
three months ended June 30, 2003. ESI is owned by James Randolph Garn and Ethan
Andrew Willis, who have threatened litigation against the Company relating to
the Company's December 31, 2001 acquisition from them of the Company's operating
subsidiary, Energy Professional Marketing Group, Inc. If the lead generation
provided by ESI were to cease for any reason, the Company's financial condition,
results of operations and business could be materially adversely affected.
Internet Marketing Programs. A substantial portion of the Company's sales
are developed through marketing programs on the Internet. In the Company's
experience, specific marketing programs or methods of marketing on the Internet
generally have limited periods of effectiveness. The Company may not rely upon
any single marketing program or method of marketing for any significant period
of time. In order to continue to market effectively on the Internet, the Company
must continue to adapt its current marketing programs and develop new effective
programs. Any failure by the Company to continue to develop effective Internet
marketing programs could have a material adverse effect on the Company's
business, results of operations and financial condition.
Retention of Sales Personnel. The Company's business is substantially
dependent upon the Company's ability to attract and retain effective sales
personnel. Any substantial turnover among sales personnel or the loss of key
sales personnel could have a material adverse effect on the Company's business,
results of operations and financial condition.
Valuation of the 2002 Sale of Business Development Series for Stock.
28
As noted in Note C - Investment Securities, the Company has retained a valuation
firm to determine the value of the 875,000 shares of preferred stock of the
Knowledge Transfer Systems, Inc., as of the time of their transfer to the
Company on September 23, 2002, to determine the tax consequences of the
transaction. The results of this valuation cannot be predicted at this time.
However, should the valuation be substantially lower than the previously
reported amount, the Company may need to restate its SEC filing for the third
quarter of 2002 and for the 2002 year. In the event such a restatement is
required the Company expects the effect to be limited as the entire amount of
this consideration was written off at the end of 2002. However, if the valuation
of the preferred stock exceeds approximately $300,000, the Company will be
required to accrue tax liability relating to the excess.
Cautionary Statement Concerning Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-QSB that are
not statements of historical fact may constitute "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. These statements are subject to risks and uncertainties, as described
below.
Examples of forward-looking statements include, but are not limited to: (i)
projections of revenues, income or loss, earnings or loss per share, capital
expenditures, the payment or non-payment of dividends, capital structure and
other financial items, (ii) statements of plans and objectives of the Company's
management or Board of Directors, including plans or objectives relating to the
Company's products or services, (iii) statements of future economic performance,
and (iv) statements of assumptions underlying the statements described in (i),
(ii) and (iii). Forward-looking statements can often be identified by the use of
forward-looking terminology, such as "believes," "expects," "may," "will,"
"should," "could," "intends," "plans," "estimates" or "anticipates," variations
thereof or similar expressions.
Forward-looking statements are not guarantees of future performance or
results. They involve risks, uncertainties and assumptions. The Company's future
results of operations, financial condition and business operations may differ
materially from those expressed in these forward-looking statements. Investors
are cautioned not to put undue reliance on any forward-looking statement.
There are a number of factors that could cause actual results to differ
materially from those discussed in the forward-looking statements, including
those factors described below. Other factors not identified herein could also
have such an effect. The Company provides a detailed discussion of risk factors
in various SEC filings, including its Form 10-KSB for the fiscal year ended
December 31, 2002, and readers are encouraged to review these filings. Among the
factors that could cause actual results to differ materially from those
discussed in the forward-looking statements are the following:
o the outcome of the current dispute between the Company and Garn and Willis
regarding the acquisition of Energy Professional Marketing Group, Inc. by
the Company from Garn and Willis;
o the Company's ability to generate sales leads in a cost-effective manner;
o the Company's ability to develop strategic relationships with other
businesses;
o the level of competition in the Company's industry;
o the rate of growth of the Internet and online commerce;
29
o the Company's ability to manage rapid growth in its business;
o customer spending patterns;
o the mix of products sold to customers;
o the mix of net sales derived from products as compared with services;
o the Company's ability to develop new products and services that keep up
with rapid technological change;
o the Company's ability to attract and retain qualified personnel;
o the Company's ability to retain senior management and other key employees;
o the outcome of the current SEC investigation involving the Company;
o the effects, if any, of the valuation of the 2002 Sale of the Business
Development Series eLearning Software for stock
o changes in general economic conditions.
All statements herein are made as of the date of this report. The Company
does not undertake to publicly release any revisions to forward-looking
statements to reflect events occurring or information obtained after the date of
this report.
Item 3. Controls and Procedures
-----------------------
The Company maintains disclosure controls and procedures (as defined in Rule
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended)
that are designed to ensure that information required to be disclosed in the
Company's reports under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosures. Any
controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving the desired control objectives. The
Company's management, with the participation of the Company's Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
September 30, 2003. Based upon that evaluation and subject to the foregoing, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
design and operation of the Company's disclosure controls and procedures
provided reasonable assurance that the disclosure controls and procedures are
effective to accomplish their objectives.
30
In addition, there was no change in the Company's internal control over
financial reporting that occurred during the quarter ended September 30, 2003
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
Resignation of Garn & Willis and Threatened Litigation. On September 26,
2003, the Company received, by certified mail and hand delivery, letters from
James Randolph Garn and Ethan Andrew Willis stating that each was resigning
immediately as an Officer of the Company and as a member of the Company's Board
of Directors (the "Letters"). The Letters also indicate that neither Garn nor
Willis is resigning from positions as an officer or director of the operating
subsidiary, Energy Professional Marketing Group, Inc. (EPMG). The Letters did
not state a reason for the resignations of Garn or Willis; however, the Company
did receive a Memorandum dated September 26, 2003 ("Memorandum") from the law
firm of Holme Roberts & Owen LLP, which represents Garn and Willis. The
Memorandum alleges that Garn and Willis are entitled to rescind the Company's
December 31, 2001 acquisition of EPMG from Garn and Willis because they were
defrauded in connection with this acquisition. This acquisition was reported in
the Company's Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 15, 2002. The Memorandum states that Garn and Wills are
prepared to file a suit to effect this rescission unless the Company reaches a
negotiated compromise with Garn and Willis affecting a rescission of the
acquisition. The Company is not aware of any such complaint being filed. The
Company is investigating this matter and the parties have attempted to negotiate
a resolution of this matter. The commencement of litigation or any adverse
determination in such litigation could have a material adverse effect on the
Company's business, financial condition and results of operations.
SEC Investigation. As previously disclosed, on June 24, 2003, the Securities
and Exchange Commission ("SEC") issued a formal order of investigation with
respect to the Company, authorizing the investigation of certain securities
matters relating to the Company. The SEC staff has taken the testimony of
certain officers of the Company and has informed the Company that it intends to
take additional testimony. The SEC staff has also issued additional requests for
the voluntary production of documents. Prior to the issuance of the order, the
Company had voluntarily provided documents and information to the SEC staff in
response to informal, non-public inquiries by the staff. The Company intends to
fully cooperate with the SEC in its investigation.
The Company cannot predict the length or potential outcome of the SEC
investigation, or the potential impact of the investigation on the Company. If
the SEC's investigation results in any formal adverse determination, which may
include a fine or other remedies, the Company's financial condition, results of
operations and business could be materially adversely affected. The Company has
incurred, and may continue to incur, significant legal and other costs in
connection with this investigation.
In addition, the Company has formed a committee of independent directors
of the Company to investigate the matters raised by Grant Thornton LLP in a
letter to the Company dated April 4, 2003, which is filed as Exhibit 99.2 to the
Current Report on Form 8-K filed by the Company on April 24, 2003. The committee
is also authorized to investigate such other matters relating to the Company as
it deems advisable.
IMI Litigation. On or about September 5, 2003, a lawsuit was filed by
Independent Marketing, Inc. (IMI) against certain employees of the Company. The
lawsuit was filed in the Fourth Judicial District Court of Utah County, State of
Utah as Case No. 030403929. While the Company was initially named as a
Defendant, the Company was not named in the Amended Complaint filed in this
lawsuit, In the lawsuit, IMI is claiming that these employees have breached
certain employment and non-compete
32
agreements and IMI is seeking compensatory damages and injunctive relief.
Although the Company is not a party to the litigation, because the lawsuit
affects certain employees of the Company, some or all of whom are key employees,
the Company's operating results and competitive position may be adversely
affected in the event of a Court ruling which limits those employees'
involvement with the Company.
The Company is subject to various other claims and lawsuits from time to
time in the ordinary course of business. Management does not believe that the
outcome of these other matters will have a material adverse effect on the
Company's financial condition, results of operations or business.
Item 3. Defaults upon Senior Securities
-------------------------------
(b) There has not been any material arrearage in the payment of dividends
on any preferred stock. The Company has withheld a dividend payment of 137,942
shares of common stock payable on Series A Preferred Stock to two stockholders
in connection with a dispute with such stockholders.
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
a. Exhibits
The exhibits required by this item are listed in the Index to Exhibits
set forth at the end of this Form 10-QSB.
b. Reports of Form 8-K
During the period covered by this report, the Company filed the
following report on Form 8-K:
On October 3rd, 2003, the Company filed a Current Report on Form
8-K regarding the receipt of letters of resignation from officers
and directors James Randolph Garn and Ethan Andrew Willis, and
the receipt of a Memorandum dated September 26, 2003 from the law
firm of Holme Roberts & Owen LLP, which represents Garn and
Willis. The Memorandum alleges that Garn and Willis are entitled
to rescind the Company's December 31, 2001 acquisition of the
Subsidiary from Garn and Willis because they were defrauded in
connection with this acquisition. The Memorandum states that Garn
and Wills are prepared to file a suit to effect this rescission
unless the Company reaches a negotiated compromise with Garn and
Willis affecting a rescission of the acquisition.
33
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
Date: November 19, 2003 /s/ Douglas S. Hackett
------------------------
Douglas S. Hackett
President, Chief Executive Officer
and Director
/s/ Linda W. Kerecman
------------------------
Linda W. Kerecman
Chief Financial Officer
34
INDEX TO EXHIBITS
Exhibit
Number Description
- ------ -----------
3.1 Amendment to the Articles of Incorporation of Innovative Software
Technologies, Inc.*
3.2 Articles of Incorporation of Innovative Software Technologies,
Inc., as amended.*
3.3 Certificate of Designation of the Series A Preferred Stock of
Innovative Software Technologies, Inc. (incorporated by reference
from Exhibit 2.2 to the Company's Current Report on Form 8-K/A
filed March 14, 2002).
3.4 Certificate of Designation of the Series B Preferred Stock of
Innovative Software Technologies, Inc.*
3.5 By-laws of Innovative Software Technologies, Inc. (incorporated
by reference from Exhibit 3(b) to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1999).
4.1 Specimen Certificate of Common Stock (incorporated by reference
from Exhibit 4(a) to the Company's Annual Report on Form 10-KSB
for the year ended December 31, 1999).
4.2 Articles FOURTH and FIFTH of the Articles of Incorporation of
Innovative Software Technologies, Inc., as amended (incorporated
by reference from Exhibit 3.2 to this Quarterly Report on Form
10-QSB).
4.3 Certificate of Designation of the Series A Preferred Stock of
Innovative Software Technologies, Inc. (incorporated by reference
from Exhibit 2.2 to the Company's Current Report on Form 8-K/A
filed March 14, 2002).
4.4 Certificate of Designation of the Series B Preferred Stock of
Innovative Software Technologies, Inc. (incorporated by reference
from Exhibit 3.4 to this Quarterly Report on Form 10-QSB).
4.5 Sections 3 - 17, 28, 39 - 46 and 51 - 53 of the By-laws of
Innovative Software Technologies, Inc. (incorporated by reference
from Exhibit 3(b) to the Company's Annual Report on Form 10-KSB
for the year ended December 31, 1999).
4.6 Financing Agreement dated January 25, 2001 among Iwasaka
Investments Limited, Shane Hackett and Hackett Media, Inc.*
35
4.7 Amendment to Finance Agreement dated December 31, 2001 between
Iwasaka Investments Limited and Innovative Software Technologies
Executive Compensation Plans and Arrangements: Exhibits 10.2, 10.3, 10.4,
10.5 and 10.6 to the Quarterly Report on Form 10-QSB for fiscal quarter ended
September 30, 2003
10.1 Opportunity and Strategic Alliance Agreement dated September 1,
2002 by and between Energy Professional Marketing Group, Inc. and
Education Success, Inc.*
10.2 Employment Agreement dated April 15, 2001 between Innovative
Software Technologies, Inc. and Douglas S. Hackett.*
10.3 Employment Agreement dated December 31, 2001 between Energy
Professional Marketing Group, Inc. and James R. Garn.*
10.4 Amendment dated July 15, 2002 to the Employment Agreement between
Energy Professional Marketing Group, Inc. and James R. Garn.*
10.5 Employment Agreement dated December 31, 2001 between Energy
Professional Marketing Group, Inc. and Ethan A. Willis.*
10.6 Amendment dated July 15, 2002 to the Employment Agreement between
Energy Professional Marketing Group, Inc. and Ethan A. Willis.*
10.7 Indemnity Agreement dated August 17, 2001 between Innovative
Software Technologies, Inc. and Douglas Shane Hackett.*
10.8 Indemnity Agreement/Hold Harmless Agreement dated August 17, 2001
among Innovative Software Technologies, Inc. and Scott Mehaffey,
Shawn M. Thomas, Margie Hackett and Douglas S. Hackett.*
10.9 Indemnity Agreement dated August 17, 2001 between Innovative
Software Technologies, Inc. and Margie Hackett.*
10.10 Indemnity Agreement dated August 17, 2001 between Innovative
Software Technologies, Inc. and Scott Mehaffey.*
10.11 Indemnity Agreement dated August 17, 2001 between Innovative
Software Technologies, Inc. and Margie Hackett.*
10.12 Indemnity Agreement dated August 17, 2001 between Innovative
Software Technologies, Inc. and Shawn M. Thomas.*
10.13 Indemnity Agreement dated January 9, 2002 among Innovative
Software Technologies, Inc. and Ethan Willis and Randy Garn.*
10.14 Indemnity Agreement dated August 16, 2002 among Innovative
Software Technologies, Inc. and Ethan Willis and Randy Garn.*
36
10.15 Indemnity Agreement dated August 15, 2002 among Innovative
Software Technologies, Inc. and Douglas Shane Hackett.*
10.16 Director Indemnification Agreement dated September 15, 2003
between Innovative Software Technologies, Inc. and Peter Justen
10.17 Director Indemnification Agreement dated August 14, 2003 between
Innovative Software Technologies, Inc. and Peter M. Peterson
10.18 Director Indemnification Agreement dated August 4, 2003 between
Innovative Software Technologies, Inc. and William E. Leathem
21 Subsidiaries of the Registrant.*
31.1 Certification of Chief Executive Officer of Innovative Software
Technologies, Inc. dated November 19, 2003.
31.2 Certification of Chief Financial Officer of Innovative Software
Technologies, Inc. dated November 19, 2003.
32.1 Certification of Chief Executive Officer of Innovative Software
Technologies, Inc. dated November 19, 2003, which is accompanying
this Quarterly Report on Form 10-QSB for the quarter ended
September 30, 2003 and is not treated as filed in reliance on
Section 601(b)(32) of Regulation S-B.
32.2 Certification of Chief Financial Officer of Innovative Software
Technologies, Inc. dated November 19, 2003, which is accompanying
this Quarterly Report on Form 10-QSB for the quarter ended
September 30, 2003 and is not treated as filed in reliance on
Section 601(b)(32) of Regulation S-B.
99.1 Resignation Letter dated September 26, 2003 from James Randolph
Garn to the Company.**
99.2 Resignation Letter dated September 26, 2003 from Ethan Andrew
Willis to the Company.**
99.3 Memorandum of Holme Roberts & Owen LLP dated September 26,
2003.**
* Incorporated by reference from the exhibit to the Company's Quarterly Report
on Form 10-QSB for the fiscal quarter ended June 30, 2003 which bears the same
exhibit number.
** Incorporated by reference from the exhibit to the Company's Current Report on
Form 8-K filed with the Commission on October 3, 2003 which bears the same
exhibit number.
37