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 September 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)
100 NORTH TAMPA STREET, SUITE 2410, TAMPA, FLORIDA 33602
(Address of principal executive offices)(zip code)
Telephone number of registrant, including area code: (813) 387-3310
204 NW PLATTE VALLEY DRIVE, RIVERSIDE,
MISSOURI 64150 (Former name or former address, if
changed since last report.)
---------------------------
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 55,586,198 shares of common stock, $0.001 par value, outstanding as
of November 1, 2004.
1
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2004 (Unaudited)
and December 31, 2003.................................................................. 3
Condensed Consolidated Statements of Operation (Unaudited) for the Three and Nine
Months Ended September 30, 2004 and 2003............................................... 4
Condensed Consolidated Statements of Stockholders' Equity (Unaudited) for the Nine
Months Ended September 30, 3004 and 2003............................................... 5
Condensed Consolidated Statements of Cash Flow (Unaudited) for the Nine
Months Ended September 30, 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.................................................................... 13
Item 3. Controls and Procedures.............................................................. 18
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.................................................................... 19
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)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------ ------------
ASSETS
CURRENT ASSETS
Cash $ 2,439,339 $ 3,890,929
Accounts receivable:
Merchant accounts receivable 84,670 1,104,051
Other receivables 120,071 101,590
Notes receivable, net of allowance for doubtful accounts
of $359,018 and $454,529 respectively 1,001,520 949,891
Inventory 1,033 48,291
Prepaid expenses and other current assets 83,147 15,986
Deferred income taxes 457,890 457,890
------------ ------------
TOTAL CURRENT ASSETS 4,187,670 6,568,628
------------ ------------
PROPERTY AND EQUIPMENT, NET 176,503 574,291
GOODWILL 1,088,686 1,088,686
DEFERRED INCOME TAXES 17,688 17,688
DEPOSITS 63,281 43,965
------------ ------------
TOTAL ASSETS $ 5,533,828 $ 8,293,258
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 2,129,590 $ 3,342,084
Deferred revenue 105,216 1,857,247
Accrued income taxes 679,954 822,533
Current maturities of capital lease obligations 8,744 67,049
------------ ------------
TOTAL CURRENT LIABILITIES 2,923,504 6,088,913
CAPITAL LEASE OBLIGATIONS 9,234 126,336
------------ ------------
TOTAL LIABILITIES 2,932,738 6,215,249
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 5) -- --
STOCKHOLDERS' EQUITY
Series A preferred stock; issued and outstanding, 450,000 shares 450,000 1,650,500
Series B preferred stock; issued and outstanding, 368,491 shares 368,491 448,491
Common stock - authorized, 100,000,000 shares of
$.001 par value; issued and outstanding, 46,112,560 53,112 52,897
Additional paid-in capital 17,043,878 13,163,749
Accumulated deficit (15,314,391) (13,237,628)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 2,601,090 2,078,009
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,533,828 $ 8,293,258
============ ============
See accompanying notes.
3
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS FOR THE NINE MONTHSS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------- -------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
REVENUE
Services revenue $ 89,700 $ -- $ 7,655,530 $ --
Product sales 164,963 -- 9,118,286 --
Other revenue -- -- 748,329 --
------------ ------------ ------------ ------------
TOTAL REVENUE 254,663 9,076,162 17,522,145 21,648,365
COST OF REVENUE
Cost of services revenue 51,501 3,543,551 --
Cost of product sales and other revenue 47,399 4,657,024 --
------------ ------------ ------------ ------------
TOTAL COST OF REVENUE 98,900 4,612,375 8,200,575 10,674,800
------------ ------------ ------------ ------------
GROSS PROFIT 155,763 4,463,787 9,321,570 10,973,565
------------ ------------ ------------ ------------
OPERATING EXPENSES
General and administrative 3,408,669 1,863,694 7,933,848 5,368,018
Commissions and other selling expenses 11,856 2,072,032 4,090,845 5,138,849
------------ ------------ ------------ ------------
TOTAL OPERATING EXPENSES 3,420,525 3,935,726 12,024,693 10,506,867
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS (3,264,762) 528,061 (2,703,123) 466,698
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSES)
Interest and penalties on late tax payments 611,920 (73,000) 566,831 (146,000)
Other income (86,002) 11,588 1,565 86,460
Interest income, deposits 33,091 26,131 44,061 61,962
Interest income, financing arrangements -- -- 64,070 --
Interest expense (45,088) (9,993) (50,163) (23,661)
------------ ------------ ------------ ------------
TOTAL OTHER INCOME (EXPENSE) 513,921 (45,274) 626,364 (21,239)
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES (2,750,841) 482,787 (2,076,759) 445,459
INCOME TAXES 266,262 (1,067,373) -- (1,134,890)
------------ ------------ ------------ ------------
NET LOSS (2,484,579) (584,586) (2,076,759) (689,431)
UNDECLARED PREFERRED STOCK DIVIDENDS (20,790) -- (41,580) --
------------ ------------ ------------ ------------
LOSS APPLICABLE TO COMMON STOCKHOLDERS $ (2,505,369) $ (584,586) $ (2,118,339) $ (689,431)
============ ============ ============ ============
BASIC AND DILUTED LOSS PER COMMON SHARE $ (0.05) $ (0.01) $ (0.04) $ (0.01)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
USED IN BASIC AND DILUTED PER SHARE CALCULATION 52,897,186 52,870,136 52,897,186 52,846,602
============ ============ ============ ============
See accompanying notes.
4
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2003 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
PREFERRED STOCK PREFERRED STOCK COMMON
SERIES A SERIES B STOCK
---------------------------- ---------------------------- --------
SHARES AMOUNT SHARES AMOUNT AMOUNT
------------- ------------- ------------- ------------- --------
Balance as of December 31, 2002 1,650,500 1,650,500 328,491 $ 328,491 $ 52,481
------------- ------------- ------------- ------------- --------
Issuance of Common stock for
services and charitable donation 416
Issuance of Series B Preferred
Stock for Compensation 100,000 126,315
Net loss
Preferred Stock Accretions (6,315)
------------- ------------- ------------- ------------- --------
Balance as of December 31, 2003 1,650,500 1,650,500 428,491 $ 448,491 $ 52,897
============= ============= ============= ============= ========
Issuance of Series B Preferred
Stock for Compensation
Cancellation of Stock and net increase in
Additional Paid-in-Capital due to the
the Settlement Agreement (1,200,500) (1,200,500) (80,000) (80,000) (6,785)
Issuance of common stock for
executive signing bonuses 7,000
Net Loss
------------- ------------- ------------- ------------- --------
Balance as of September 30, 2004 450,000 $ 450,000 348,491 $ 368,491 $ 53,112
============= ============= ============= ============= ========
RETAINED
ADDITIONAL EARNINGS TOTAL
PAID-IN- (ACCUM. STOCKHOLDERS'
CAPITAL DEFICIT) EQUITY
----------- ------------- -----------
Balance as of December 31, 2002 $13,119,719 $ (13,041,191) $ 2,110,000
----------- ------------- -----------
Issuance of Common stock for
services and charitable donation 44,030 44,446
Issuance of Series B Preferred
Stock for Compensation 126,315
Net loss (202,755) (202,755)
Preferred Stock Accretions 6,315 --
----------- ------------- -----------
Balance as of December 31, 2003 $13,163,749 $ (13,237,631) $ 2,078,006
=========== ============= ===========
Issuance of Series B Preferred
Stock for Compensation --
Cancellation of Stock and net increase in
Additional Paid-in-Capital due to the
the Settlement Agreement 2,137,129 849,843
Issuance of common stock for
executive signing bonuses 1,743,000 1,750,000
Net Loss (2,076,759) (2,076,759)
----------- ------------- -----------
Balance as of September 30, 2004 $17,043,878 $ (15,314,390) $ 2,601,090
=========== ============= ===========
The accompanying notes are an integral part of these condensed
consolidated financial statement.
5
INNOVATIVE SOFTWARE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS
Ended September 30,
----------------------------
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (Loss) $(2,076,760) $ (689,431)
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation and amortization 176,219 150,498
Prepaid non-cash compensation and expenses -- 20,000
Stock base compensation 1,750,000 121,515
Non-cash expenses -- 77,667
Net change in operating assets and liabilities
Merchant account receivables (55,832) (139,801)
Other receivables (143,483) (49,362)
Inventory (1,344) --
Prepaid expenses and other current assets (86,477) (390,794)
Accounts payable and accrued expenses 970,841 347,169
Deferred revenue (446,594) 331,307
Other current liabilities (1,053,644) 1,132,518
Reserve for returns and allowances 230,532 1,031,420
Accrued federal and state income tax (142,579) 893,890
----------- -----------
NET CASH FLOWS FROM OPERATING ACTIVITIES (879,121) 2,836,595
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in notes receivable from financed sales (51,629) --
Purchase of Fixed Assets (178,108) (226,316)
----------- -----------
NET CASH FLOWS FROM INVESTING ACTIVITIES (229,737) (226,316)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on capital lease obligations (42,732) (53,716)
Payment under Settlement Agreement (300,000) --
Repayments under line of credit agreement -- (36,920)
----------- -----------
NET CASH FLOWS FROM FINANCING ACTIVITIES (342,732) (90,637)
----------- -----------
NET INCREASE (DECREASE) IN CASH (1,451,590) 2,519,643
CASH AT BEGINNING OF PERIOD 3,890,929 1,338,345
----------- -----------
CASH AT END OF PERIOD $ 2,439,339 $ 3,857,988
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Issuance of common stock for services / charitable contributions $ -- $ 17,667
=========== ===========
Issuance of Series B Preferred Stock as Compensation 80,000
-----------
Property and equipment acquired under capital leases $ 15,192 $ --
=========== ===========
EPMG Settlement Transaction:
Decrease in Operating Assets $ 1,548,814
Decrease in Fixed Assets 414,870
Decrease in Operating Liabilities (2,665,661)
Decrease in Long-term Liabilities (147,867)
Increase in Equity 849,844
-----------
$ --
===========
The accompanying notes are an integral part of these condensed
consolidated financial statement.
6
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 consulting by Company employees, as well as
providing seminar training. Recently the Company has expanded its
activities to include business to business sales of software and
services through its SoftSale, Inc. wholly owned subsidiary.
(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 September 30, 2004, and the results of
their operations for the three and nine months ended September 30,
2004 and September 30, 2003, and the cash flows for the nine months
ended September 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 nine month periods ended September 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., Triad Media,
Inc. (f/k/a Hackett Media, Inc.) and SoftSale, 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.
7
(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. Due to the Net
Losses in each period, the calculation for diluted income per common
share in each period is anti-dilutive. Therefore, Basic and Diluted
Net Loss per common share are the same.
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Basic:
Loss applicable to common stockholders ($2,505,369) ($584,586) ($2,118,340) ($689,431)
============== =============== ================= ==============
Weighted average common shares outstanding 51,432,769 52,870,136 52,405,484 52,846,602
============== =============== ================= ==============
Basic and diluted loss per common share ($0.05) ($0.01) ($0.04) ($0.01)
============== =============== ================= ==============
(2) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following:
SEPTEMBER 30, DECEMBER 31,
2004 2004
---------- ----------
Accrued sales splits to lead providers $ -- $1,255,770
Accrued wages and other 1,461,066 773,707
Reserves for returns and refunds 30,098 742,568
Accounts payable 432,859 351,089
Interest and penalties on late tax payments 205,565 218,950
Credit facility (a) -- 3,440
---------- ----------
$2,129,589 $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%.
8
(3) STOCKHOLDERS' EQUITY
(a) Convertible Preferred Stock:
The Company has 25,000,000 shares of preferred stock authorized and
has 450,000 shares of Series A Preferred issued and outstanding and
80,000 shares of Series B Preferred issued and outstanding as of
September 30, 2004. 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 (4,404,885 and 8,105,228 common shares as of
September 30, 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 September 30, 2004 and December 31, 2003, the Company has
cumulative, undeclared dividends in arrears on the Preferred Stock
of $0 and $82,510, respectively.
(b) Settlement Agreement:
On July 2, 2004, 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.
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.
9
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. 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 other's products and services rise to the level of the
Company's significant continuing involvement in the operations of
the disposed component.
(c) Signing Bonus:
On August 4, 2004, the Board of Directors unanimously approved a
resolution authorizing the hiring of a new Chief Executive Officer,
Peter M. Peterson, and a new Chief Financial Officer, Christopher J.
Floyd, under specific terms of employment. Among those terms were
the issuance to each executive 3,500,000 shares of common stock of
the Company, having the usual restrictive legend and no vesting
period (see Exhibits 10.1 and 10.2 of the Company's June 30, 2004
Report on Form 10QSB).
(4) RELATED PARTY TRANSACTIONS
(a) Sales Leads:
The Company purchased sales leads from Education Success Institute,
Inc. (ESI), which was owned by two former employees of the Company.
The cost of sales leads purchased during the nine months ended
September 30, 2004, which is based upon a percentage of revenue,
amounted to $3,927,171.
(b) Settlement Agreement:
The Company and two former officers of the Company were involved in
a dispute that was settled on July 2, 2004 (see 3(b) "Settlement
Agreement" above).
10
(c) Collection Agreement:
In October 2004 the Company entered into a Collection Agreement with
Magna Charter, Inc. a firm owned by a former officer of the Company
who is also related to the President of the Company. We believe the
contract was negotiated at arms length and contains terms comparable
to the terms that would be obtained in such an agreement with an
unrelated third party.
(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 September 30, 2004 are as follows:
Capital Operating
Year ending December 31: Leases Leases
------------------- -------------------
Three months ending December 31, 2004 4,294 27,593
2005 7,169 72,454
2006 5,770 34,888
2007 - -
-------- --------
Total noncancelable lease payments 17,233 134,935
======== ========
Less amount representing interest 1,651
--------
15,582
========
Principal amount due in one year 8,744
Principal amount due after one year 6,838
--------
$15,582
========
Rent expense under all operating leases for the quarter ended
September 30, 2004 was $20,117.
(b) 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.
(c) 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.
11
(d) 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.
(e) Litigation:
None.
(f) Income Tax Returns:
Accrued income taxes related to prior tax periods and accrued
interest/tax penalties related to prior tax periods amounted to
$601,400 and $183,110, respectively as of September 30, 2004. In
November 2004 the Company filed its 2003 and 2002 Federal and State
of Utah income tax returns. The Company intends to pay approximately
$685,000 in accrued taxes and interest before the end of November
2004. In November, the Company also filed an amended return for 2001
that seeks the reduction of the total tax, interest and penalty from
approximately $1,000,000, which was recorded in 2001, to $784,410.
(6) SUBSEQUENT EVENTS.
Effective November 12, 2004, Peter Justen resigned from the Board of
Directors.
On November 18, 2004, the Company closed a transaction to acquire
all of the assets and the business of Get in the Game. The Company
will operate this new business as a wholly owned subsidiary, Get in
the Game, Inc. This new business is focused on providing information
and consulting, primarily through seminars and online marketing, to
student athletes and their parents. The acquisition was accounted
for as an asset purchase valued at $341,000 comprising $200,000 in
equity and the assumption of $141,000 in debt. Equity was in the
form of restricted shares of the Company's common stock, valued at
$0.2075, the 20 trading day average closing price prior to closing.
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 nine months ended September 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
This 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 $1,001,520 as of September 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 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
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.
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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 ($114,300), less the
applicable commissions to sales employees ($9,084).
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 nine month periods ended September 30, 2004 and September 30, 2003.
Revenues
Revenues for the three months ended September 30, 2004 and 2003 were $254,663
and $9,076,162, respectively, which represents a 97.2 % decrease. Revenues for
the nine months ended September 30, 2004 and 2003 were $17,522,145, and
$21,648,365, respectively, which represents a 19.1% decrease. The Company's
principal source of revenue for the quarters ended September 30, 2004 and 2003
consisted of business education and coaching services. Revenues decreased
substantially in the third quarter over the third quarter of 2003 as a result of
the Settlement Agreement with Garn and Willis whereby the majority of our EPMG
subsidiary's operations, along with certain assets and liabilities, were
transferred to Garn and Willis (see note 3(b) in the Notes to the Condensed
Consolidated Financial Statements herein).
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
September 30, 2004 was $114,300 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 September 30, 2004
was less than the amount deferred as of December 31, 2003 as the number of open
coaching sessions for which the Company is responsible for decreased markedly
under the terms of the Settlement Agreement.
14
Substantially all of our revenues to date were derived from our EPMG subsidiary.
On September 26, 2003, legal counsel representing the former principals of EPMG,
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 January 2, 2004,
the Company and these former principals entered into a Memorandum of
Understanding that provided 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.
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.)
Cost of Sales and Margins
Cost of sales for the quarters ended September 30, 2004 and 2003 were $98,900
and $4,612,375, respectively, representing gross margins of 61.2% and 49.2%,
respectively. For the nine months ended September 30, 2004 and 2003, cost of
sales were $8,200,575 and $10,674,800 respectively, representing gross margins
of 53.2% and 50.7%, 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 margin in the third quarter of 2004 reflects the
Company's focus on internal generation of leads.
Selling Expenses
Selling expenses for the three months ended September 30, 2004 and 2003 were
$11,856 (4.7% of revenue) and $2,072,032 (22.8% of revenue), respectively.
Selling expenses for the nine months ended September 30, 2004 and 2003 were
$4,090,845 (23.3% of revenue) and $5,138,849 (23.7% 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 decrease in selling expenses in the third quarter is
attributed to the overall decrease in sales of products and services.
General and Administrative Expenses
General and administrative expenses for the three months ended September 30,
2004 and 2003 were $3,408,669 (1,338% of revenue) and $1,863,694 (20.5% of
revenue), respectively. General and administrative expenses for the nine months
ended September 30, 2004 and 2003 were $7,933,848 (45.3% of revenue) and
$5,368,018 (24.8% of revenue), respectively. 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. The increase in
general and administrative expenses was primarily attributable to a 7 million
share signing bonus for the Chief Executive Officer and Chief Financial Officer,
which was valued at $0.25 per share and expensed in the period.
15
Other Income (Expense)
Other Income (Expense) for the three months ended September 30, 2004 and 2003
were $513,921 and ($45,274), respectively. For the nine months ended September
30, 2004 and 2003, other income, net of other expenses was $626,363 and
($21,239), respectively. The increase in the current period Other Income is due
primarily to the revaluation of the Company's estimated income tax liability.
Income Taxes
Our income tax provision amounted to $0.00 for the period ended September 30,
2004 versus a provision of $1,134,890 for the period ended September 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 nine month period
ended September 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 September 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 Loss
Our net loss for the three and nine months ended September 30, 2004 amounted to
$2,484,579 and $2,076,760, respectively, compared to net losses of $584,586 and
$689,431 for the three and nine months ended September 30, 2003. Current year
losses are attributable to the matters discussed above.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2004 we had current assets of $4,187,669, which represents a
decrease of $2,380,960 over current assets as of December 31, 2003. Most of the
decrease is attributable to a decrease in cash and a decrease in Merchant
Account balances. At September 30, 2004 we had cash on hand of $2,439,339, which
represents an decrease of $1,451,591 over the balances as of December 31, 2003.
The Company transferred approximately $1,000,000 in Merchant Account reserves
under the terms of the Settlement Agreement. Notes receivable of $1,001,520, as
of September 30, 2004 is net of our estimated reserve of $359,018 for bad debts.
Gross notes receivable were $1,360,537 as of September 30, 2004 compared to
$1,404,420 as of December 31, 2003.
At September 30, 2004 we had current liabilities of $2,923,504, which represents
a decrease of $3,165,408 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 $114,300, which will not
require cash outlays, decreased $1,742,947 from the balance as of December 31,
2003, again due primarily to the terms of the Settlement Agreement whereby the
liability for fulfilling coaching sessions was assumed by a third pary. We are
also liable for commissions to our sales force and to lead providers. These
commissions payable, included as a component of accounts payable and accrued
liabilities, total $9,084 as of September 30, 2004. The minimal figure is due to
our focus on generating leads internally.
16
As September 30, 2004, our working capital increased to $1,264,164 from $479,716
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 and nine months ended September 30, 2004 were $0.00 and $189,766,
respectively.
Accrued income taxes related to prior tax periods and accrued interest/tax
penalties related to prior tax periods amounted to $601,400 and $183,110,
respectively as of September 30, 2004. In November 2004 the Company filed its
2003 and 2002 Federal and State of Utah income tax returns. The Company intends
to pay approximately $685,000 in accrued taxes and interest before the end of
November 2004. In November, the Company also filed an amended return for 2001
that seeks the reduction of the total tax, interest and penalty from
approximately $1,000,000, which was recorded in 2001, to $784,410.
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
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 January 2, 2004, the Company and these former principals entered
into a Memorandum of Understanding that provided 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.
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 September 30,
2004.
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ITEM 3. CONTROLS AND PROCEDURES
(a) As of September 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 during the
quarterly period ended September 30, 2004 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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(b)There has not been any material arrearage in the payment of dividends on any
preferred stock.
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 third quarter of the period convered by this report, the Company
filed the following report on Form 8-K:
On July 19, 2004 the Company filed a Form 8-K (Items 2, 5 and 7) disclosing the
results of the closing of a Settlement Agreement with two former officers and
directors of the Company.
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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: November 22, 2004
----------------------------------------
Peter M. Peterson
Chief Executive Officer and Director
----------------------------------------
Christopher J. Floyd
Chief Financial Officer
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INDEX TO EXHIBITS
Exhibit
Number Description
2.1 Asset Purchase Agreement by and between Douglas W. Single,
Innovative Software Technologies, Inc., and Get in the Game,
Inc. dated as of November 18, 2004.
10.1 Employment Contract for Douglas W. Single, Vice President of
Business Development 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.
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