UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 March 31, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE EXCHANGE ACT
COMMISSION FILE NUMBER: 000-1084047
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
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(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 95-4691878
------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
204 NW PLATTE VALLEY DRIVE, RIVERSIDE, MO 64150
- ----------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(816) 584-8030
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $.001
par value
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ___
There were 52,897,186 shares of common stock, $0.001 par value, outstanding as
of May 21, 2004.
1
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
FORM 10-QSB
QUARTER ENDED MARCH 31, 2004
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2004 (Unaudited)
and December 31, 2003 .............................................. 3
Condensed Consolidated Statements of Operation (Unaudited) for the
Three Months Ended March 31, 2004 and 2003 ......................... 4
Condensed Consolidated Statements of Cash Flow (Unaudited) for the
Three Months Ended March 31, 2004 and 2003 ......................... 6
Notes to the Condensed Consolidated Financial Statements (Unaudited).. 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................ 12
Item 3. Controls and Procedures ........................................... 17
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ................................................. 18
Item 3. Defaults upon Senior Securities ................................... 19
Item 6. Exhibits and Reports on Form 8-K .................................. 19
Signatures ................................................................. 20
Index to Exhibits .......................................................... 21
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
ASSETS
CURRENT ASSETS
Cash $ 4,974,623 $ 3,890,929
Accounts receivable:
Merchant accounts receivable 1,160,022 1,104,051
Other receivables 181,595 101,590
Notes receivable, net of allowance for doubtful accounts
of $424,876 and $454,529 respectively 1,161,624 949,891
Inventory 48,602 48,291
Prepaid expenses and other current assets 207,295 15,986
Deferred income taxes 457,890 457,890
------------ ------------
TOTAL CURRENT ASSETS 8,191,652 6,568,628
------------ ------------
PROPERTY AND EQUIPMENT, NET 580,620 574,291
GOODWILL 1,088,686 1,088,686
DEFERRED INCOME TAXES 17,688 17,688
DEPOSITS 53,965 43,965
------------ ------------
TOTAL ASSETS $ 9,932,610 $ 8,293,258
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 4,342,563 $ 3,342,084
Deferred revenue 2,103,538 1,857,247
Accrued income taxes 978,346 822,533
Current maturities of capital lease obligations 72,714 67,049
------------ ------------
TOTAL CURRENT LIABILITIES 7,497,161 6,088,913
CAPITAL LEASE OBLIGATIONS 118,793 126,336
------------ ------------
TOTAL LIABILITIES 7,615,953 6,215,249
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 5) -- --
STOCKHOLDERS' EQUITY
Series A preferred stock; issued and outstanding, 1,650,500 shares 1,650,500 1,650,500
Series B preferred stock; issued and outstanding, 428,491 shares 448,491 448,491
Common stock - authorized, 100,000,000 shares of
$.001 par value; issued and outstanding, 52,897,186 52,897 52,897
Additional paid-in capital 13,163,749 13,163,749
Accumulated deficit (12,998,980) (13,237,628)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 2,316,657 2,078,009
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,932,610 $ 8,293,258
============ ============
See accompanying notes.
3
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
FOR THE THREE MONTHS
ENDED MARCH 31,
-----------------------------
(RESTATED)
2004 2003
------------ ------------
REVENUE
Services revenue $ 3,501,942 $ 2,360,188
Product sales 5,753,120 3,219,020
Other revenue 394,327 --
------------ ------------
TOTAL REVENUE 9,649,389 5,579,208
COST OF REVENUE
Cost of services revenue 1,496,463 1,054,413
Cost of product sales and other revenue 3,015,195 1,492,479
------------ ------------
TOTAL COST OF REVENUE 4,511,658 2,546,892
------------ ------------
GROSS PROFIT 5,137,731 3,032,316
------------ ------------
OPERATING EXPENSES
General and administrative 2,923,724 1,741,157
Commissions and other selling expenses 1,885,458 1,455,118
------------ ------------
TOTAL OPERATING EXPENSES 4,809,182 3,196,275
------------ ------------
INCOME FROM OPERATIONS 328,549 (163,959)
------------ ------------
OTHER INCOME (EXPENSES)
Interest and penalties on late tax payments (21,748) --
Other income 53,514 44,112
Interest income, deposits 5,485 17,387
Interest income, financing arrangements 32,191 --
Interest expense (3,528) --
------------ ------------
TOTAL OTHER INCOME (EXPENSE) 65,915 61,499
------------ ------------
INCOME BEFORE INCOME TAXES 394,463 (102,460)
INCOME TAXES (155,813) 125,000
------------ ------------
NET INCOME 238,650 22,540
UNDECLARED PREFERRED STOCK DIVIDENDS & ACCRETIONS (20,790) (19,790)
------------ ------------
INCOME APPLICABLE TO COMMON STOCKHOLDERS $ 217,860 $ 2,750
============ ============
BASIC INCOME PER COMMON SHARE $ 0.00 $ 0.00
============ ============
DILUTED INCOME PER COMMON SHARE $ 0.00 $ 0.00
============ ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
USED IN BASIC PER SHARE CALCULATION 52,897,186 52,674,733
============ ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
USED IN BASIC PER SHARE CALCULATION 57,188,189 61,527,364
============ ============
See accompanying notes.
4
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS
Ended March 31,
--------------------------
(Restated)
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 238,650 $ 22,540
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation and amortization 78,695 45,093
Prepaid non-cash compensation and expenses -- 62,250
Non-cash expenses -- 30,667
Net change in operating assets and liabilities
Merchant account receivables (55,972) --
Other receivables (80,007) (28,308)
Inventory (311) --
Prepaid expenses and other current assets (201,309) (225,103)
Accounts payable and accrued expenses 1,000,479 221,684
Deferred revenue 246,291 97,392
Accrued income taxes 155,813 --
----------- -----------
NET CASH FLOWS FROM OPERATING ACTIVITIES 1,382,330 226,215
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Change in notes receivable from financed sales (211,733) --
Capital expenditures (69,832) (104,181)
----------- -----------
NET CASH FLOWS FROM INVESTING ACTIVITIES (281,565) (104,181)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowing under note payable -- 8,085
Repayments under line of credit agreement -- (36,142)
Payments on capital lease obligations (17,071) (46,859)
----------- -----------
NET CASH FLOWS FROM FINANCING ACTIVITIES (17,071) (74,916)
----------- -----------
NET INCREASE IN CASH 1,083,694 47,119
CASH AT BEGINNING OF PERIOD 3,890,929 1,338,345
----------- -----------
CASH AT END OF PERIOD $ 4,974,623 $ 1,385,464
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Issuance of Series B Preferred Stock as Compensation $ -- $ 20,000
=========== ===========
Property and equipment acquired under capital leases $ 15,521 $ --
=========== ===========
See accompanying notes.
5
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) ORGANIZATION, BASIS OF PRESENTATION, AND CERTAIN INTERIM ACCOUNTING
POLICIES
(a) Organization and Description of Business:
Innovative Software Technologies, Inc. (the "Company") was
incorporated in the State of California in May 1998. The
Company together with its wholly-owned subsidiaries is engaged
in the development, marketing and delivery of business-type
educational programs, generally to individuals, throughout the
United States of America. The Company's educational programs
combine both self-training and coaching by Company employees.
During the quarterly period ended March 31, 2004, the
Company's educational programs were concentrated in two
product lines, Real Estate and Internet Marketing, which
together comprised approximately 91% of first quarter 2004
revenues.
(b) Basis of Presentation:
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally
accepted accounting principles for interim financial
information and with the instructions to Form 10-QSB and
Regulation S-B. Accordingly, they do not contain all of the
information and footnotes required by generally accepted
accounting principles for complete consolidated financial
statements. In the opinion of management, the accompanying
unaudited condensed consolidated financial statements reflect
all adjustments (consisting only of normal recurring
adjustments) considered necessary for a fair presentation of
the Company's financial condition as of March 31, 2004, and
the results of their operations and their cash flows for the
three months ended March 31, 2004 and 2003. These unaudited
condensed consolidated financial statements should be read in
conjunction with the Company's audited 2003 consolidated
financial statements, including the notes thereto, and the
other information set forth therein, included in the Company's
Annual Report on Form 10-KSB for the year ended December 31,
2003. Operating results for the three-month period ended March
31, 2004 are not necessarily indicative of the operating
results that may be expected for the year ending December 31,
2004.
(c) Principles of Consolidation:
The consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries, EPMG, Inc. and
Hackett Media, Inc. All significant intercompany balances and
transactions have been eliminated in consolidation.
(d) Income Taxes in Interim Periods:
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences
between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and
operating loss and tax credit carryforwards. For purposes of
interim financial reporting, the Company projects its
effective income tax rate for the entire fiscal year, taking
into account all taxing jurisdictions, and applies such rate
to interim pre-tax income. Changes in the projected effective
tax rate in future quarters, if any, are accounted for
prospectively in the period of change.
6
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(e) Earnings Per Common Share:
Basic net income per common share is computed by dividing (i)
the net income (loss), as adjusted for the effects of
cumulative dividends on the Series A and B Preferred Stock by
(ii) the weighted average common shares outstanding during the
period. Diluted net income (loss) per share is computed
similarly but includes the effects of dilutive securities in
the denominator. The diluted income per common share for the
quarterly period ended March 31, 2004 includes the effects of
4,291,003 common shares into which the Company's Series A and
Series B Convertible Preferred Stock is convertible on an
if-converted basis. The following table reflects the
components of the basic and diluted income per common share
for the quarterly periods ended March 31, 2004 and 2003:
2004 2003
----------- -----------
Basic:
Income applicable to common stockholders $ 217,860 $ 2,750
=========== ===========
Weighted average common shares outstanding 52,897,186 52,647,733
=========== ===========
Basic income per common share $ 0.00 $ 0.00
=========== ===========
Diluted:
Income applicable to common stockholders $ 217,860 $ 2,750
Plus: Undeclared preferred stock dividends 20,790 19,790
----------- -----------
Adjusted numerator $ 238,650 $ 22,540
=========== ===========
Weighted average number of shares 52,897,186 52,647,733
Shares convertible from preferred stock 4,291,003 14,879,631
----------- -----------
Adjusted denominator 57,188,189 61,527,364
=========== ===========
Diluted income per common share $ 0.00 $ 0.00
=========== ===========
(2) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following as of
March 31, 2004 and December 31, 2003:
Accrued sales splits to lead providers $1,353,826 $1,255,770
Accrued wages and other 1,838,198 773,707
Reserves for returns and refunds 830,800 742,568
Accounts payable 75,794 351,089
Interest and penalties on late tax payments 240,698 218,950
Credit facility (a) 3,247 3,440
---------- ----------
$4,342,563 $3,342,084
========== ==========
(a) The Company has a credit facility that provides for borrowings
up to $50,000, with interest at Prime Rate, plus 2%.
7
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(3) STOCKHOLDERS' EQUITY
(a) Convertible Preferred Stock:
The Company has 25,000,000 shares of preferred stock
authorized and has 1,650,500 shares of Series A Preferred
issued and outstanding and 428,491 shares of Series B
Preferred issued and outstanding. The Series A and Series B
Preferred Stock (collectively "Preferred Stock") have the same
terms and conditions. The Preferred Stock is (i) entitled to
cumulative dividends at a rate of 4.0% of the liquidation
value ($1.00 per share), (ii) convertible at any time into
common stock at a rate of 95% of the average closing market
price of the common stock for five days preceding conversion
(4,291,003 and 7,125,605 common shares as of March 31, 2004
and December 31, 2003, respectively), (iii) redeemable at any
time by the Company for $1.00 per share, (iv) entitled to one
vote per share.
As of March 31, 2004 and December 31, 2003, the Company has
cumulative, undeclared dividends in arrears on the Preferred
Stock of $103,500 and $82,510, respectively.
(4) RELATED PARTY TRANSACTIONS
The Company purchases sales leads from Education Success Institute,
Inc. (ESI), which is owned by two employees of the Company. The cost of
sales leads purchased during the quarter ended March 31, 2004, which is
based upon a percentage of revenue, amounted to $2,188,444. In
addition, ESI subleases office space from the Company. Sub-rental
receipts amount to $700 each month through August 2005. See Note 5.
(5) COMMITMENTS AND CONTINGENCIES
(a) Leases:
Future minimum lease payments under noncancelable operating
leases (with initial terms in excess of one year) and future
minimum capital lease payments as of March 31, 2004 are as
follows:
Capital Operating
Year ending December 31: Leases Leases
--------------------------------
Nine-months ended December 31, 2004 $ 68,028 $ 198,146
2005 70,717 174,426
2006 48,591 37,467
2007 42,296
--------------------------------
Total noncancelable lease payments 229,632 $ 410,039
=============
Less amount representing interest (38,124)
--------------
$ 191,508
==============
Principal amount due in one year 72,714
Principal amount due after one year 118,794
--------------
$ 191,508
==============
8
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Rent expense under all operating leases for the quarter
ended March 31, 2004 was $76,465. This amount was exclusive
of $2,100 of sub-lease payments received from a related
party. See Note 4.
(b) Lead Arrangements:
The Company is a party to several lead agreements with
Education Success, Inc. and certain other lead generators. The
continuous generation of sales leads is a critical element to
the Company's continuing viability. The agreements provide for
the transfer of sales leads to EPMG, Inc. for commissions of,
generally, 34% of gross revenue, subject to certain
adjustments. The ESI agreement was executed in 2002 and has a
term coextensive with the terms of the related party
employees' employment contracts.
(c) Content Providers:
The Company is a party to several agreements that provide for
the educational content and multimedia materials used in the
educational offerings. Generally, these agreements provide for
a commission, generally 8% to 10% of actual sales. The
maintenance of content agreements is a critical element to the
Company's continuing viability.
(d) Servicing Arrangements:
The Company is a party to a servicing agreement with a third
party financial institution for the servicing of the Company's
financed sales. The agreement provides for the collection,
servicing and remittance of notes receivable as an agent to
the Company. The counterparty receives certain fees for this
servicing arrangement, which is included as a reduction of the
interest income on the notes receivable.
(e) SEC Investigation:
On June 24, 2003, the Securities and Exchange Commission
issued a formal order of investigation authorizing subpoenas
for documents and testimony in connection with the
investigation of certain securities matters. The Company has
and intends to continue to fully cooperate with the SEC in its
investigation.
(f) Litigation:
On September 26, 2003, counsel representing the former
principals of EPMG, Inc., who were former officers of EPMG,
Inc. and the Company and are now employees of EPMG, Inc.,
notified the Company that they were allegedly entitled to
rescind the Company's 2001 acquisition of EPMG, Inc. which was
accomplished in a stock-for-stock exchange, accounted for as a
purchase business combination. The notification alleges that
the former principals were defrauded in connection with the
Company's acquisition of EPMG, Inc. and that they would seek
litigation to affect a rescission of the 2001 purchase. On
January 2, 2004, the Company and these former principals
entered into a Memorandum of Understanding that provides for
the settlement of the principals' claims through exchange of
certain operating assets of EPMG, Inc. for the Company's
common and preferred stock previously issued in connection
with the acquisition.
9
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The former principals have had the right since March 15, 2004
to terminate their obligations under the Memorandum of
Understanding, but have not notified the Company of their
intent to do so. As of May 21, 2004, the parties were in the
process of renegotiating certain elements of the proposed
transaction in an effort to reach mutually agreeable terms.
The former principals are currently employed by EPMG, Inc.
which corporate entity contributes the majority of the
Company's consolidated revenues.
The Company does not believe that the current terms of the
settlement will result in reporting the EPMG, Inc. component
as a discontinued operation in future reports. The criteria
for reporting the EPMG, Inc. results as discontinued include
the requirement that the Company will not have any significant
continuing involvement in the operations of EPMG, Inc. after
the disposition date. Since the current settlement arrangement
provides for a continuing business relationship and exchange
of products and services, this criterion has not been
achieved.
(g) Income Tax Returns:
The Company has not filed its 2003 and 2002 Federal and State
of Utah income tax returns. Combined current income taxes
payable for these periods are currently estimated to be
$224,306 and $513,936, respectively. Interest and penalties
through March 31, 2004 have been recorded in the amount of
approximately $240,698. The Company has engaged an accountant
who is in the process of preparing its past due returns.
(6) UNAUDITED QUARTERLY RESTATEMENTS.
The following table reflects the quarterly net income of the Company as
previously reported by the Company in its quarterly report on Form
10-QSB and as restated for the matters discussed below:
March 31,
2003
---------
Net income (loss) before adjustments $ 100,000
Reserve for notes receivable (a) (230,000)
Deferred revenue (b) 86,000
Stock compensation (c) (58,000)
Penalties and interest (d) --
Income taxes (e) 125,000
---------
Net income (loss), adjusted $ 23,000
=========
(a) The Company changed its estimate of reserve for bad debts in the
fourth quarter based upon historical performance. This adjustment gives
effect to the estimate change for each quarter using that annual rate
applied in the fourth quarter.
10
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(b) This adjustment adjusts the quarterly deferred revenue calculation
for the following matter: Prior to February 2003, the Company
outsourced coaching to a third party contractor who was responsible for
delivery of the services and who provided the Company with records for
accounting purposes. Since February 2003, the Company has employed its
internal coaching staff and has developed internal operations databases
to track coach-student encounters. During the fourth fiscal quarter of
2003, the Company began utilizing the populated operations databases to
calculate the number of future coaching sessions for purposes of
deferred revenue. Other estimates of future coaching sessions were used
during the prior quarters.
(c) This adjustment allocates certain stock based compensation that was
recorded in the fourth fiscal quarter of 2003 to the quarters to which
such compensation was earned.
(d) There was no adjustment to reflect the allocation of the penalties
and interest for non-payment of the Company's 2002 Federal and state
income taxes. Amounts that were recorded in the fourth quarter, were
allocated to the second and third quarters of 2003.
(e) This adjustment includes the tax effects for the aforementioned
adjustments, plus the allocation of income taxes to the quarterly
periods based upon the effective tax rate applicable to the year ended
December 31, 2003.
The Company intends to amend its previous filing on Form 10-QSB for the
quarterly period ended March 31, 2003 for these matters.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion includes statements that are forward looking in nature.
The accuracy of such statements depends on a variety of factors that may affect
the business and operations of the Company. 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. These risks and uncertainties
include, but are not limited to, the matters discussed under the caption
"Factors Affecting Future Results" in the Company's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2003 and other risks and uncertainties
discussed in filings made with the Securities and Exchange Commission (including
risks described in subsequent reports on Form 10-QSB, Form 10-KSB, Form 8-K and
other filings). Readers are cautioned not to place undue reliance on these
forward-looking statements, and are urged to carefully review and consider the
various disclosures elsewhere in this Form 10-QSB.
OVERVIEW
The following discussion summarizes information about our accounting policies
and practices and information about our operations in a comparative manner for
the quarters ended March 31, 2004 and 2003. Our management's discussion and
analysis of financial condition and results of operations should be read in
conjunction with our consolidated financial statements and related notes thereto
included elsewhere herein.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations
are based upon the Company's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
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.
Allowances for Doubtful Accounts
Our net notes receivable amounted to $1,161,624 as of March 31, 2004 and relate
to product financing arrangements entered into with our clients. These notes are
unsecured, bear interest at 15% and have terms ranging between one and two
years. The Company has not and does not intend to sell or otherwise transfer
these receivables.
The allowance for doubtful accounts is based upon our best estimate of the
amount of probable credit losses in the existing notes based upon our historical
loss rates experienced on such financing arrangements. A note is considered
impaired pursuant to Financial Accounting Standards Board Statement 114,
Accounting by Creditors for Impairment of a Loan. Pursuant to Statement 114, a
note is impaired if it is probable that the Company will not collect all
principal and interest contractually due. The impairment is measured based on
the present value of expected future cash flows discounted at the
12
note's effective interest rate. The Company does not accrue interest when a note
is considered impaired. When ultimate collectibility of the principal balance of
the impaired note is in doubt, all cash receipts on impaired notes are applied
to reduce the principal amount of such notes until the principal has been
recovered and are recognized as interest income thereafter. Impairment losses
are charged against the allowance when all possible means of collection have
been exhausted and the potential for recovery is considered remote.
Revenue Recognition and Returns and Allowances
We have evaluated our product offerings in the context SAB 101 Revenue
Recognition and EITF 00-21 Revenue Arrangements with Multiple Deliverables and
have determined that revenues associated with the multimedia educational
materials (product sales) require accounting separate from the educational and
coaching services (services revenue). The fair value of these offerings is
established through separate third party sales of each of these products and
services.
Product Sales: We recognize product sales upon delivery to our students, as
evidenced by third party shipping providers, which is the point where the
student assumes ownership and risk of loss. Shipping costs are billed to
students and are included as a component of revenue and cost of product sales.
Returns are provided for based upon the Company's historical return experience.
Services Revenues: The Company's educational offering includes multiple sessions
with a Company employed coach. We recognize services revenue pro rata as
coaching/training sessions are rendered. Deferred revenue represents the price
of future coaching sessions that students have paid for ($4,857,000), less the
applicable commissions to lead generators and content providers ($1,797,362) and
sales commissions ($956,100).
Our obligation to provide coaching and training ceases one year following the
sale. Refunds for unused courses are not provided for in the sales arrangement
with the student. However, the Company offers refunds in certain circumstances
for which a history has been developed to estimate and reserve such amounts.
RESULTS OF OPERATIONS
Quarter ended March 31, 2004 compared to the quarter ended March 31, 2003.
Revenues
Revenues for the quarters ended March 31, 2004 and 2003 were $9,649,389 and
$5,579,208, respectively, which represents an 73% increase. The Company's
principal source of revenue for the quarters ended March 31, 2004 and 2003
consisted of business education and coaching services. These revenues increased
substantially as a result of increasing our sales staff and focusing on the
offerings that, based upon our accumulated experience, have the higher sales
rate among our targeted customer base.
We record revenues for multimedia education materials (product sales) upon
delivery of the material to our students. We record revenues for coaching
sessions rendered and we defer revenue for coaching sessions that are paid for
but have not yet been rendered. We deferred $395,117 of services revenue as of
March 31, 2004 and $0 as of March 31, 2003. Our deferral as of March 31, 2004
was larger than the amount deferred as of December 31, 2003 because of the
increase in our service related sales.
13
Substantially all of our revenues are derived from our EPMG subsidiary. On
September 26, 2003, legal counsel representing the former principals of EPMG,
who are currently employees of our EPMG subsidiary, notified us with an
allegation that they were entitled to rescind the 2001 acquisition of EPMG. The
notification alleges that the former principals were defrauded in connection
with our acquisition of EPMG, Inc. and that they would seek litigation to effect
a rescission of the 2001 purchase. On January 2, 2004, the Company and these
former principals entered into a Memorandum of Understanding that provides for
the settlement of the principals' claims through exchange of certain operating
assets of EPMG for the common and preferred stock previously issued in
connection with the merger.
The former principals have had the right since March 15, 2004 to terminate their
obligations under the Memorandum of Understanding, but have not notified us of
their intent to do so. As of May 21, 2004, the parties were in the process of
renegotiating certain elements of the proposed transaction in an effort to reach
mutually agreeable terms. The former principals are currently employed by EPMG,
which corporate entity contributes the majority of our consolidated revenues.
In the event that the final settlement is executed with the type of transaction
described in the Memorandum of Understanding, dated January 2, 2004, our
operations will be significantly curtailed and our consolidated assets will be
significantly diminished. While the divestiture will result in the retention of
sufficient operating assets to support the Company's operating needs in the
foreseeable future, management's plans for the future of the Company include (i)
aggressively developing and marketing existing proprietary platforms and (ii)
seeking acquisition candidates. There can be no assurances that management will
be successful in these plans.
In the event that the Company does not enter into a final settlement with the
former principals of EPMG, then it is possible that the former principals of
EPMG will file a rescission action against the Company. The Company has reviewed
and analyzed with legal counsel the allegations made by the former principals
and has concluded that such allegations are without merit. Accordingly, the
Company will vigorously defend any such action. Nonetheless, the time and
expense associated with the defense of any such action could have a material
adverse effect on the business, operations and financial condition of the
Company.
Cost of Sales and Margins
Cost of sales for the quarters ended March 31, 2004 and 2003 were $4,511,658 and
$2,546,892, respectively, representing an increase of 77%. Cost of sales include
(i) the cost of the multimedia educational materials that we ship to our
students, (ii) the wages paid to our coaches and (iii) the commissions that we
pay to lead sources. Our Cost of Sales remained constant as a percentage of
sales revenue. The increase in our Cost of Sales reflected our increased sales
volume.
Selling Expenses
Selling expenses for the quarters ended March 31, 2004 and 2003 were $1,885,458
and $1,455,118, respectively, representing an increase of 30%. Selling expenses
consisted primarily of commissions paid to lead providers and to sales
associates as well as marketing and advertising expenses associated with key
products and services. The increase in selling expenses is attributed to the
increase in sales of products and services. As a percentage of sales, selling
expenses decreased from 26% to 20% for the quarters ending March 31, 2003 to
March 31, 2004.
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General and Administrative Expenses
General and administrative expenses for the quarters ended March 31, 2004 and
2003 were $2,923,724 and $1,741,157, respectively, representing an increase of
68%. 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 reason for the
increase in general and administrative expenses was attributable to higher
administrative wages and legal fees.
Other Income (Expense)
Other income, net of other expenses for the quarters ended March 31, 2004 and
2003 were $65,915 and $61,499, respectively, representing an increase of 7%. The
increase is principally attributable to the increase in interest on our
financing notes receivable of $32,191 offset by the recognition of $21,748 in
interest and penalties on late tax payments.
Income Taxes
Our income tax provision amounted to $155,813 for the period ended March 31,
2004 and a benefit of $125,000 for the period ended March 31, 2003. For purposes
of interim financial reporting, the Company projects its effective income tax
rate for the entire fiscal year (39.5% for the quarterly period ended March 31,
2004), taking into account all taxing jurisdictions, and applies such rate to
interim pre-tax income. Changes in the projected effective tax rate in future
quarters, if any, are accounted for prospectively in the period of change. Our
income tax for the quarterly period ended March 31, 2003 was different than the
statutory rates applicable to our taxing jurisdictions because of valuation
allowances and non-deductible permanent differences (primarily income tax
penalties).
Net Income
Our net income for the quarter ended March 31, 2004 amounted to $238,650,
compared to $22,540 for the quarter ended March 31, 2003. As previously
mentioned, we reported income taxes of $155,813 for the quarter ended March 31,
2004 and a benefit of $125,000 for the quarter ended March 31, 2003. Excluding
these differences our pretax income as a percentage of revenues increased from
0.0% to 2.5%. This increase was attributable to the matters discussed in our
cost of sales section above.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2004 we had current assets of $8,191,652, which represents an
increase of $1,623,024 over current assets as of December 31, 2003. Much of the
increase is attributable to an increase in cash. At March 31, 2004 we had cash
on hand of $4,974,623, which represents an increase of $1,083,694 over the
balances as of December 31, 2003. Other material increases in current assets
resulted from notes receivable and deferred income taxes. Notes receivable of
$1,161,624, as of March 31, 2004 is net of our estimated reserve of $424,876 for
bad debts. Our finance activity increased substantially in 2003 and 2004,
resulting in gross notes receivable of $1,586,500 as of March 31, 2004 compared
to $788,455 as of March 31, 2003.
At March 31, 2004 we had current liabilities of $7,497,161, which represents an
increase of $1,408,248 over current liabilities as of December 31, 2003. Our
current liabilities include significant amounts associated with deferred
revenue, commissions and reserves for returns. These accounts require complex
subjective estimates. Our net deferred revenue of $2,103,538, which will not
require cash outlays,
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increased $246,291 over the balance as of December 31, 2003. This increase is
attributable to our increase in revenues. We are liable for commissions to our
sales force and to lead providers. Commissions included as a component of
accounts payable and accrued liabilities are $1,413,790 as of March 31, 2004.
As March 31, 2004 our working capital increased to $694,491 from $479,715 as of
December 31, 2003. We believe that our operating activities in 2004 will be
sufficient to fulfill our obligations as they become due in the normal course of
business.
We have no material commitments for capital expenditures. Capital expenditures
in the quarter ended March 31, 2004 were $69,832. We may require additional
facilities and support equipment if our growth rate continues at the current
rate.
We have not filed our 2003 and 2002 Federal and State of Utah income tax
returns. Combined current income taxes payable for these periods are currently
estimated to be $224,306 and $513,936, respectively. Interest and penalties have
been recorded in the amount of approximately $240,698.
We currently do not have a stock option or stock purchase plan. We also
currently do not have any employee benefit plans that would require the use of
our securities.
EPMG TRANSACTION AND POSSIBLE FUTURE EFFECTS
On September 26, 2003, counsel representing the former principals of EPMG, Inc.,
who are currently employees of EPMG, Inc., notified the Company that they were
allegedly entitled to rescind the Company's 2001 acquisition of EPMG, Inc.,
which was accomplished in a stock-for-stock exchange, accounted for as a
purchase business combination. The notification alleges that the former
principals were defrauded in connection with the Company's acquisition of EPMG,
Inc. and that they would seek litigation to effect a rescission of the 2001
purchase. On January 2, 2004, the Company and these former principals entered
into a Memorandum of Understanding that provides for the settlement of the
principals' claims through exchange of certain operating assets of EPMG for the
Company's common stock previously issued in connection with the merger.
The former principals have had the right since March 15, 2004 to terminate their
obligations under the Memorandum of Understanding, but have not notified the
Company of their intent to do so. As of May 21, 2004, the parties were in the
process of renegotiating certain elements of the proposed transaction in an
effort to reach mutually agreeable terms. The former principals are currently
employed by EPMG, which corporate entity contributes the majority of our
consolidated revenues.
In the event that the final settlement is executed with the type of transaction
described in the Memorandum of Understanding, dated January 2, 2004, the
Company's operations will be significantly curtailed and the Company's
consolidated assets will be significantly diminished.
The Company does not believe that the current expected terms of the settlement
will result in reporting the EPMG, Inc. component as a discontinued operation in
future reports. The criteria for reporting the EPMG, Inc. results as
discontinued include the requirement that the Company will not have any
significant continuing involvement in the operations of EPMG, Inc. after the
disposition date. Since the current expected settlement arrangement provides for
a continuing business relationship and exchange of products and services, this
criteria has not been achieved.
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OFF BALANCE-SHEET ARRANGEMENTS
The Company has no material off-balance sheet arrangements as of March 31, 2004.
ITEM 3. CONTROLS AND PROCEDURES
(a) As of March 31, 2004, the Chief Executive Officer and Chief Financial
Officer of the Company, with the participation of the Company's
management, carried out an evaluation of the effectiveness of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based on that evaluation, the Chief Executive Officer and the
Chief Financial Officer believe that, as of the date of the evaluation,
the Company's disclosure controls and procedures are effective in making
known to them material information relating to the Company (including its
consolidated subsidiaries) required to be included in this report.
(b) There were no changes in the Company's internal controls or in other
factors that could significantly affect internal controls, known to the
Chief Executive Officer or the Chief Financial Officer, subsequent to the
date of the evaluation.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
SEC Investigation
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.
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 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 has reviewed
and analyzed with legal counsel the allegations made by Garn and Willis and has
concluded that such allegations are without merit. Accordingly, the Company
currently intends to vigorously defend any action that is filed by Garn and
Willis.
Effective January 2, 2004, the Company, EPMG, and Garn and Willis entered into a
Memorandum of Understanding ("MOU") relating this matter. In the MOU, the
parties agree to an adjustment of the business of EPMG and the establishment of
an ongoing business relationship as described therein as a complete settlement
of the disputed claims among them. The MOU provides, among other things, that
the Company will cause EPMG to transfer certain assets to the Company and the
Company will assume certain liabilities from EPMG and that, at closing, the
Company will transfer 100% of the EPMG stock to
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Garn and Willis in exchange for all of the capital stock of the Company owned by
Garn and Willis. The MOU provides that a final Settlement and Reorganization
Agreement will be prepared to implement the MOU. Under the MOU, the Company has
engaged a qualified investment bank satisfactory to Garn and Willis to render a
fairness opinion on the agreement. The MOU requires that the parties will work
in good faith to complete closing within 30 days of the issuance of a fairness
opinion. The parties are currently renegotiating certain elements of the
transaction to ensure that fairness opinion will be obtainable for the
transaction. Should the proposed transaction not be completed the Company may
face litigation which could negatively impact its operations.
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 on Form 8-K
During the period covered by this report, the Company filed the following
reports on Form 8-K:
On January 9th, 2004, the Company filed a Current Report on Form
8-K under Item 5 (Other Events and Regulation FD Disclosure)
reporting that the Company, its subsidiary Energy Professional
Marketing Group, Inc., and former officers and directors James
Randolph Garn and Ethan Andrew Willis, had entered into a
Memorandum of Understanding ("MOU") relating to certain claims
previously made by Garn and Willis against the Company and
others.
On February 4th, 2004, the Company filed a Current Report on
Form 8-K under Item 4 (Changes in Registrant's Certifying
Accountant) reporting the Company's dismissal of Robison, Hill &
Co. ("Robison") as independent auditors for the Company and its
subsidiaries.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
DATE: May 24, 2004
------------------------------------------
Douglas S. Hackett
President, Chief Executive Officer, and Director
------------------------------------------
Linda W. Kerecman
Chief Financial Officer
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INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
31.1 Certification of Chief Executive Officer of Innovative
Software Technologies, Inc. pursuant to Rule 13a-15(e) or
15d-15(e) of the Securities Exchange Act of 1934, as amended.
31.2 Certification of Chief Financial Officer of Innovative
Software Technologies, Inc. pursuant to Rule 13a-15(e) or
15d-15(e) of the Securities Exchange Act of 1934, as amended.
32.1 Certification of Chief Executive Officer of Innovative
Software Technologies, Inc. pursuant to 18 U.S.C. 1350.
32.2 Certification of Chief Financial Officer of Innovative
Software Technologies, Inc. pursuant to 18 U.S.C. 1350.
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