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 June 30, 2004
[ ] 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 of (I.R.S. Employer Identification No.)
Incorporation or Organization)
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 53,112,424 shares of common stock, $0.001 par value, outstanding
as of August 23, 2004.
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2004
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2004
(Unaudited) and December 31, 2003........................................3
Condensed Consolidated Statements of Operation (Unaudited)
for the Three and Six Months Ended June 30, 2004 and 2003................4
Condensed Consolidated Statements of Cash Flow (Unaudited)
for the Six Months Ended June 30, 2004 and 2003..........................5
Notes to the Condensed Consolidated Financial Statements
(Unaudited)..............................................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................13
Item 3. Controls and Procedures.............................................18
PART II - OTHER INFORMATION
Item 1. Legal Proceedings...................................................19
Item 3. Defaults upon Senior Securities.....................................20
Item 6. Exhibits and Reports on Form 8-K....................................20
Signatures ...............................................................21
Index to Exhibits............................................................22
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 30, DECEMBER 31,
2004 2003
------------ ------------
ASSETS
CURRENT ASSETS
Cash $ 4,959,208 $ 3,890,929
Accounts receivable:
Merchant accounts receivable 1,159,882 1,104,051
Other receivables 15,215 101,590
Notes receivable, net of allowance
for doubtful accounts of $359,018
and $454,529 respectively 1,315,964 949,891
Inventory 48,602 48,291
Prepaid expenses and other current assets 463,832 15,986
Deferred income taxes 457,890 457,890
------------ ------------
TOTAL CURRENT ASSETS 8,420,593 6,568,628
------------ ------------
PROPERTY AND EQUIPMENT, NET 597,934 574,291
GOODWILL 1,088,686 1,088,686
DEFERRED INCOME TAXES 17,688 17,688
DEPOSITS 53,965 43,965
------------ ------------
TOTAL ASSETS $ 10,178,866 $ 8,293,258
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 5,129,534 $ 3,342,084
Deferred revenue 1,305,437 1,857,247
Accrued income taxes 1,088,795 822,533
Current maturities of capital lease obligations 58,689 67,049
------------ ------------
TOTAL CURRENT LIABILITIES 7,582,455 6,088,913
CAPITAL LEASE OBLIGATIONS 110,585 126,336
------------ ------------
TOTAL LIABILITIES 7,693,040 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 (12,829,811) (13,237,628)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 2,485,826 2,078,009
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 10,178,866 $ 8,293,258
============ ============
See accompanying notes.
3
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- ----------------------------
(RESTATED) (RESTATED)
2004 2003 2004 2003
------------ ------------ ------------ ------------
REVENUE
Services revenue $ 4,063,888 $ 7,565,830
Product sales 3,200,204 8,953,324
Other revenue 354,001 748,329
------------ ------------
TOTAL REVENUE 7,618,093 $ 6,992,995 17,267,483 $ 12,572,203
COST OF REVENUE
Cost of services revenue 1,995,586 3,492,050
Cost of product sales and other revenue 1,594,430 4,609,625
------------ ------------
TOTAL COST OF REVENUE 3,590,016 3,515,533 8,101,675 6,062,425
------------ ------------ ------------ ------------
GROSS PROFIT 4,028,077 3,477,462 9,165,808 6,509,778
------------ ------------ ------------ ------------
OPERATING EXPENSES
General and administrative 1,601,454 1,763,167 4,525,179 3,504,324
Commissions and other selling expenses 2,193,531 1,611,699 4,078,989 3,066,817
------------ ------------ ------------ ------------
TOTAL OPERATING EXPENSES 3,794,985 3,374,866 8,604,168 6,571,141
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS 233,092 102,596 561,640 (61,363)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSES)
Interest and penalties on late tax payments (23,340) (73,000) (45,088) (73,000)
Other income 34,053 30,760 87,567 74,872
Interest income, deposits 5,485 18,444 10,969 35,831
Interest income, financing arrangements 31,879 -- 64,070 --
Interest expense (1,548) (13,668) (5,075) (13,668)
------------ ------------ ------------ ------------
TOTAL OTHER INCOME (EXPENSE) 46,529 (37,464) 112,443 24,035
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 279,620 65,132 674,083 (37,328)
INCOME TAXES (110,449) (55,000) (266,262) 70,000
------------ ------------ ------------ ------------
NET INCOME 169,171 10,132 407,821 32,672
UNDECLARED PREFERRED STOCK DIVIDENDS (20,790) -- (41,580) --
------------ ------------ ------------ ------------
INCOME APPLICABLE TO COMMON STOCKHOLDERS $ 148,381 $ 10,132 $ 366,241 $ 32,672
============ ============ ============ ============
BASIC INCOME PER COMMON SHARE $ 0.00 $ 0.00 $ 0.01 $ 0.00
============ ============ ============ ============
DILUTED INCOME PER COMMON SHARE $ 0.00 $ 0.00 $ 0.01 $ 0.00
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
USED IN BASIC PER SHARE CALCULATION 52,897,186 52,870,136 52,897,186 52,821,170
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
USED IN DILUTED PER SHARE CALCULATION 57,188,189 52,870,136 57,188,189 52,821,170
============ ============ ============ ============
See accompanying notes.
4
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
(RESTATED)
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (Loss) $ 407,820 $ 32,672
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation and amortization 166,123 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 (55,832) --
Other receivables 86,373 (28,308)
Inventory (311) --
Prepaid expenses and other current assets (457,845) (225,103)
Accounts payable and accrued expenses 1,787,449 221,684
Deferred revenue (551,810) 97,392
Accrued income taxes 266,262 --
----------- -----------
NET CASH FLOWS FROM OPERATING ACTIVITIES 1,648,229 236,347
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Change in notes receivable from financed sales (366,073) --
Capital expenditures (174,574) (104,181)
----------- -----------
NET CASH FLOWS FROM INVESTING ACTIVITIES (540,647) (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 (39,303) (46,859)
----------- -----------
NET CASH FLOWS FROM FINANCING ACTIVITIES (39,303) (74,916)
----------- -----------
NET INCREASE IN CASH 1,068,279 57,251
CASH AT BEGINNING OF PERIOD 3,890,929 1,338,345
----------- -----------
CASH AT END OF PERIOD $ 4,959,208 $ 1,395,596
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Issuance of Series B Preferred Stock as Compensation $ -- $ 20,000
=========== ===========
Property and equipment acquired under capital leases $ 15,192 $ --
=========== ===========
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
June 30, 2004, the Company's educational programs were concentrated in
two product lines, Real Estate and Internet Marketing, which together
comprised approximately 94% of second 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 June 30, 2004,
and the results of their operations for the three and six months ended
June 30, 2004 and June 30, 2003, and the cash flows for the six months
ended June 30, 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 and six month periods ended June
30, 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 June 30, 2004 includes the effects of
6,712,919 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 and six month periods ended
June 30, 2004 and 2003:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Basic:
Income applicable to common stockholders $ 148,381 $ 10,132 $ 366,241 $ 32,672
=========== =========== =========== ===========
Weighted average common shares outstanding 52,897,186 52,870,136 52,897,186 52,821,170
=========== =========== =========== ===========
Basic income per common share $ 0.00 $ 0.00 $ 0.01 $ 0.00
=========== =========== =========== ===========
Diluted:
Income applicable to common stockholders $ 148,381 $ 10,132 $ 366,241 $ 32,672
Plus: Undeclared preferred stock dividends 20,790 0 41,580 0
----------- ----------- ----------- -----------
Adjusted numerator $ 169,169 $ 10,132 $ 407,820 $ 32,672
=========== =========== =========== ===========
Weighted average number of shares 52,897,186 52,870,136 52,897,186 52,821,170
Shares convertible from preferred stock 6,712,919 17,478,701 6,712,919 17,478,701
----------- ----------- ----------- -----------
Adjusted denominator 59,610,105 70,348,837 59,610,105 70,299,871
=========== =========== =========== ===========
Diluted income per common share $ 0.00 $ 0.00 $ 0.01 $ 0.00
=========== =========== =========== ===========
7
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(2) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following:
JUNE 30, DECEMBER 31,
2004 2004
----------- -----------
Accrued sales splits to lead providers $ 900,595 $ 1,255,770
Accrued wages and other 1,846,298 773,707
Reserves for returns and refunds 943,002 742,568
Accounts payable 1,177,194 351,089
Interest and penalties on late tax payments 262,446 218,950
Credit facility (a) -- 3,440
----------- -----------
$ 5,129,534 $ 3,345,524
=========== ===========
(a) The Company has a credit facility that provides for borrowings up to
$50,000, with interest at Prime Rate, plus 2%.
(3) STOCKHOLDERS' EQUITY
(a) Convertible Preferred Stock:
As of June 30, 2004, the Company had 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 (6,712,919 and
8,105,228 common shares as of June 30, 2004 and December 31, 2003,
respectively), (iii) redeemable at any time by the Company for $1.00
per share, and (iv) entitled to one vote per share.
As of June 30, 2004 and December 31, 2003, the Company had cumulative,
undeclared dividends in arrears on the Preferred Stock of $103,500 and
$82,510, respectively.
(4) RELATED PARTY TRANSACTIONS
During the periods shown, the Company purchased sales leads from Education
Success Institute, Inc. (ESI), which is owned by two individuals who were
employees of the Company during such periods. The cost of sales leads
purchased during the six months ended June 30, 2004, which is based upon a
percentage of revenue, amounted to $3,927,171. In addition, during the
periods shown, ESI subleases office space from the Company. Sub-rental
receipts amounted to $700 each month during such periods. See Note 5.
8
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(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 June 30, 2004 are as follows:
CAPITAL OPERATING
Year ending December 31: LEASES LEASES
----------- -----------
Six months ending December 31, 2004 43,268 152,931
2005 70,717 174,426
2006 48,066 37,467
2007 28,772 0
----------- -----------
Total noncancelable lease payments 190,823 364,823
===========
Less amount representing interest 21,549
-----------
169,274
===========
Principal amount due in one year 58,689
Principal amount due after one year 110,585
-----------
$ 169,274
===========
Rent expense under all operating leases for the quarter ended June 30,
2004 was $152,931. This amount was exclusive of $4,200 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.
(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.
9
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(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:
None.
(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 June 30, 2004 have been
recorded in the amount of approximately $262,446. 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
for the quarter ended June 30, 2003 and as restated for the matters
discussed below:
JUNE 30, 2003
-------------------------
THREE MONTHS SIX MONTHS
ENDED ENDED
----------- -----------
Net income (loss) before adjustments $ 252,711 $ 352,608
Reserve for notes receivable (a) (78,000) (308,000)
Deferred revenue (b) (5,000) 81,000
Stock compensation (c) (31,579) (89,936)
Penalties and interest (d) (73,000) (73,000)
Income taxes (e) (55,000) 70,000
----------- -----------
Net income (loss), adjusted $ 10,132 $ 32,672
=========== ===========
10
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(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.
(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 June 30, 2003 for these matters.
(7) SUBSEQUENT EVENTS.
On July 2, 2004, Innovative Software Technologies, Inc. (the "Company")
entered into a Settlement Agreement with James R. Garn, Ethan W. Willis,
and Ethan and Randy, LC (the "Settlement Agreement") pursuant to which the
parties agreed to settle all disputes between them, including all disputes
relating to the Company's 2001 acquisition from Garn and Willis of the
outstanding stock of Energy Professional Marketing Group, Inc. ("EPMG").
Under the terms of the Settlement Agreement, Garn and Willis (the
"Principals") have surrendered to the Company all of their shares of
capital stock of the Company, comprising 6,784,762 shares of common stock,
1,200,500 shares of Series A Preferred Stock, and 80,000 shares of Series B
Preferred Stock, in exchange for certain assets of EPMG. These assets
include EPMG's rights under certain credit card processing contracts
(including receivables relating to reserves under those contracts in the
amount of approximately $1,000,000), substantially all of the tangible
fixed assets of EPMG's Utah facility, and certain intangible assets of
EPMG, such as specified website domain names, software, and customer lead
data.
The Settlement Agreement also sets forth certain agreements and covenants
relating to the relationship between the parties on a going-forward basis
and the parties' respective businesses activities, including the following:
o The Company and an entity controlled by the Principals have entered into
agreements providing for the reciprocal supply of products and customer
leads to each other on a going-forward basis.
11
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
o A company controlled by the Principals has agreed to assume all of EPMG's
outstanding service obligations to EPMG's coaching customers in
consideration of the payment of service fees by the Company totaling
$425,000.
o A newly created company controlled and owned by the Principals has assumed
the lease of EPMG's facility in Provo, Utah, and substantially all
employees at such facility have transferred their employment to such newly
created company. Pursuant to the Settlement Agreement, the Company has
released all such employees from their non-compete obligations to the
Company.
o The Company has agreed to refrain from soliciting the services of certain
lead providers for a six-month period of time and from marketing to current
active coaching customers for 120 days following the Settlement Agreement.
Pursuant to the Settlement Agreement, the Company, the Principals, and
their respective affiliates have entered into mutual waivers and releases
relating to any and all claims that they may have had against one another
other at any time through the date of the Settlement Agreement. Subsequent
to the settlement, EPMG will remain a wholly owned subsidiary of the
Company and, together with the Company, will focus on growing its business
through its traditional coaching and mentoring products, new software
products relating to improving the efficiency of small businesses, and
future planned software products targeting the IT departments of medium and
large businesses.
The Company recorded the settlement on the effective date of the
settlement. No gain or loss arose from the settlement pursuant to generally
accepted accounting principles which requires a company's receipt of its
own securities in such transactions to be treated as transactions affecting
only stockholders' equity. In addition, the Company has concluded that the
transaction does not meet the conditions for treatment of EPMG as a
discontinued operation due to the fact that continuing agreements between
the Company and EPMG for cross selling of each others products and services
rise to the level of the Company's significant continuing involvement in
the operations of the disposed component.
12
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 three and six months ended June 30, 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 $1,315,964 as of June 30, 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 note's
13
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 ($3,150,600), less the
applicable commissions to lead generators and content providers ($1,228,739) and
sales commissions ($616,424).
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
Three and six month periods ended June 30, 2004 and June 30, 2003.
Revenues
Revenues for the three months ended June 30, 2004 and 2003 were $7,618,093 and
$6,992,995, respectively, which represents a 9% increase. Revenues for the six
months ended June 30, 2004 were $17,267,483, and $12,572,203, respectively,
which represents a 37% increase. The Company's principal source of revenue for
the three months ended June 30, 2004 and 2003 consisted of business education
and coaching services. Revenues increased substantially in the first quarter
2004 (73% over the first quarter of 2003) as a result of increasing the sales
staff and focusing on the offerings that, based upon our accumulated experience,
have the higher sales rate among our targeted customer base. The slow down in
sales during the second quarter 2004 resulted from operations being hampered by
the continued negotiations between the former principals of EPMG and the Company
and the efforts to split the Utah operations of our EPMG subsidiary.
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. Our total services revenue deferral as of June
14
30, 2004 was $3,150,600 compared to $4,461,883 as of December 31, 2003. These
deferred revenues are partially offset by lead splits and sales commissions paid
when funds are received. Our deferral as of June 30, 2004 was less than the
amount deferred as of December 31, 2003 as the number of open coaching sessions
decreased.
Substantially all of our revenues through June 30, 2004 were 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 alleged 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 July 2, 2004, the Company entered into a Settlement Agreement with the former
principals of EPMG pursuant to which the parties agreed to settle all disputes
between them. Under the terms of the Settlement Agreement, the former principals
have surrendered to the Company all of their shares of capital stock of the
Company, comprising 6,784,762 shares of common stock, 1,200,500 shares of Series
A Preferred Stock, and 80,000 shares of Series B Preferred Stock, in exchange
for certain assets of EPMG. These assets include EPMG's rights under certain
credit card processing contracts (including receivables relating to reserves
under those contracts in the amount of approximately $1,000,000), substantially
all of the tangible fixed assets of EPMG's Utah facility, and certain intangible
assets of EPMG, such as specified website domain names, software, and customer
lead data. (See Form 8-K report filed on July 19, 2004.)
Cost of Sales and Margins
Cost of sales for the three months ended June 30, 2004 and 2003 were $3,590,016
and $3,515,533, respectively, representing gross margins of 52.9% and 49.7%,
respectively. For the six months ended June 30, 2004 and 2003, cost of sales
were $8,101,675 and $6,062,425 respectively, representing gross margins of 53.1%
and 51.8%, respectively. 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 increased
gross profit margins reflect slight decreases in our lead split and fulfillment
costs.
Selling Expenses
Selling expenses for the three months ended June 30, 2004 and 2003 were
$2,193,531 (28.8% of revenue) and $1,611,699 (23.0% of revenue), respectively.
Selling expenses for the six months ended June 30, 2004 and 2003 were $4,078,989
(23.6% of revenue) and $3,066,817 (24.4% of revenue), respectively. Selling
expenses consisted primarily of commissions paid to sales associates as well as
marketing and advertising expenses associated with key products and services.
The overall increase in selling expenses is attributed to the increase in sales
of products and services.
General and Administrative Expenses
General and administrative expenses for the three months ended June 30, 2004 and
2003 were $1,601,454 (21.0% of revenue) and $1,763,167 (25.2% of revenue),
respectively. General and administrative expenses for the six months ended June
30, 2004 and 2003 were $4,525,179 (26.2% of revenue) and $3,504,324 (27.9% of
revenue), respectively. General and administration expenses consisted primarily
of salaries and wages, professional fees, rent, travel expenses, payroll taxes,
15
telephone expenses and other general and administrative expenses necessary to
support the operations of the Company. The decrease in general and
administrative expenses was attributable to lower legal fees.
Other Income (Expense)
Other income, net of other expenses for the three months ended June 30, 2004 and
2003 was $46,529 and $(37,464), respectively. For the six months ended June 30,
2004 and 2003, other income, net of other expenses was $112,443 and $24,035,
respectively. The increase is principally attributable to the increase in
interest on our financing notes receivable of $64,070 offset by the recognition
of $45,088 in interest and penalties on late tax payments, for the six months
ended June 30, 2004.
Income Taxes
Our income tax provision amounted to $266,262 for the period ended June 30, 2004
and a benefit of $70,000 for the period ended June 30, 2003. For purposes of
interim financial reporting, the Company projects its effective income tax rate
for the entire fiscal year (39.5% for the six month period ended June 30, 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 June 30, 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 three and six months ended June 30, 2004 amounted to
$169,171 and $407,821, respectively, compared to $10,132 and $32,672 for the
three and six months ended June 30, 2003. These increases were attributable to
the matters discussed above.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2004 we had current assets of $8,420,593, which represents an
increase of $1,851,964 over current assets as of December 31, 2003. Much of the
increase is attributable to an increase in cash. At June 30, 2004 we had cash on
hand of $4,959,208, which represents an increase of $1,068,279 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 $1,315,964,
as of June 30, 2004 is net of our estimated reserve of $359,018 for bad debts.
Gross notes receivable were $1,602,982 as of June 30, 2004 compared to
$1,507,358 as of June 30, 2003.
At June 30, 2004 we had current liabilities of $7,582,455, which represents an
increase of $1,493,542 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 $1,305,437, which will not
require cash outlays, decreased $551,810 from the balance as of December 31,
2003. This decrease is attributable to our increase in our number of coaches and
associated coaching sessions completed. We are liable for commissions to our
sales force and to lead providers. These commissions payable, included as a
component of accounts payable and accrued liabilities, are $1,746,892 as of June
30, 2004.
As June 30, 2004 our working capital increased to $838,139 from $479,176 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.
16
We have no material commitments for capital expenditures. Capital expenditures
in the quarter and six months ended June 30, 2004 were $119,934 and $189,766,
respectively. 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 $262,446. The Company has engaged
an accountant who is in the process of preparing its past due returns.
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 were then 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 alleged 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 July 2, 2004, the Company entered into a Settlement Agreement with the former
principals pursuant to which the parties agreed to settle all disputes between
them. Under the terms of the Settlement Agreement, the former principals have
surrendered to the Company all of their shares of capital stock of the Company,
comprising 6,784,762 shares of common stock, 1,200,500 shares of Series A
Preferred Stock, and 80,000 shares of Series B Preferred Stock, in exchange for
certain assets of EPMG. These assets include EPMG's rights under certain credit
card processing contracts (including receivables relating to reserves under
those contracts in the amount of approximately $1,000,000), substantially all of
the tangible fixed assets of EPMG's Utah facility, and certain intangible assets
of EPMG, such as specified website domain names, software, and customer lead
data. (See Form 8-K report filed on July 19, 2004.)
OFF BALANCE-SHEET ARRANGEMENTS
The Company has no material off-balance sheet arrangements as of June 30, 2004.
17
ITEM 3. CONTROLS AND PROCEDURES
(a) As of June 30, 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.
18
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.
Garn & Willis Settlement
On September 26, 2003, counsel representing the former principals of EPMG, Inc.,
who were then 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. The notification alleged
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 July 2, 2004, the Company entered into a Settlement Agreement with the former
principals pursuant to which the parties agreed to settle all disputes between
them. Under the terms of the Settlement Agreement, the former principals have
surrendered to the Company all of their shares of capital stock of the Company,
comprising 6,784,762 shares of common stock, 1,200,500 shares of Series A
Preferred Stock, and 80,000 shares of Series B Preferred Stock, in exchange for
certain assets of EPMG. These assets include EPMG's rights under certain credit
card processing contracts (including receivables relating to reserves under
those contracts in the amount of approximately $1,000,000), substantially all of
the tangible fixed assets of EPMG's Utah facility, and certain intangible assets
of EPMG, such as specified website domain names, software, and customer lead
data. (See Form 8-K report filed on July 19, 2004.)
19
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 did not file any
reports on Form 8-K.
20
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
Date: August 23, 2004 /s/ Peter M. Peterson
--------------------------------------
Peter M. Peterson
Chief Executive Officer
/s/ Christopher J. Floyd
--------------------------------------
Christopher J. Floyd
Chief Financial Officer
21
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- ----------------------------------------------------------------------
10.1 Employment Contract for Peter M. Peterson, Chief Executive Officer of
Innovative Software Technologies, Inc.
10.2 Employment Contract for Christopher J. Floyd, Chief Financial Officer,
Vice President Finance, and Corporate Secretary of Innovative Software
Technologies, Inc.
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.
22