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EX-32.1 - SWORDFISH FINANCIAL, INC.sword10qex32103009.txt
EX-31.2 - SWORDFISH FINANCIAL, INC.sword10qex312093009.txt
EX-31.1 - SWORDFISH FINANCIAL, INC.sword10qex311093009.txt

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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                             -----------------------

                                    FORM 10-Q

             |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                For the quarterly period ended September 30, 2009

               |_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
                            THE EXCHANGE ACT OF 1934

              For the transition period from _________ to _________

                         Commission File Number : 0-7475

                             -----------------------

                            SWORDFISH FINANCIAL, INC.
             (Exact name of registrant as specified in its charter)

           Minnesota                                        41-0831186
(State or other jurisdiction of                          (I.R.S. Employer
 incorporation or organization)                         Identification No.)

                                 142 Wembley Way

                              Rockwall, Texas 75032
                    (Address of principal executive offices)

                                 (972) 310-1830
                         (Registrant's telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required
to be  filed by  Section  13 or 15(d) of the  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  requirements  for the
past 90 days.
|X|  Yes?  |_|  No

Indicate by check mark whether the registrant is a large  accelerated  filer, an
accelerated filer, a non-accelerated  filer, or a smaller reporting company. See
definitions  of "large  accelerated  filer",  "accelerated  filer" and  "smaller
reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer  |_|     Accelerated filer  |_|
Non-accelerated filer  |_|       Smaller reporting company  |X|

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). |_| Yes? |X| No

The  number of shares of  issuer's  common  stock,  par value  $0.16 per  share,
outstanding  as of March 1, 2010,  was  13,300,000.  The registrant has no other
classes of securities outstanding.


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NATURE VISION, INC. INDEX PART I FINANCIAL INFORMATION Page Number Item 1 : Financial Statements Consolidated Balance Sheets - September 30, 2009 (Unaudited) and December 31, 2008 1 Consolidated Statements of Operations - Three Months and Nine Months Ended September 30, 2009 and 2008 (Unaudited) 2 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2009 and 2008 (Unaudited) 3 Notes to Consolidated Financial Statements (Unaudited) 4 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 4T: Controls and Procedures 26 PART II OTHER INFORMATION Item 4: Submission of Matters to a Vote of Security Holders 27 Item 6 : Exhibits 27 Signatures 28 --------------------------------------------------------------------------------
Part I - FINANCIAL INFORMATION Item 1: Financial Statements Swordfish Financial, Inc. and Subsidiaries Consolidated Balance Sheets September 30, 2009 and December 31, 2008 Unaudited ------------ September 30, December 31, 2009 2008 ------------ ------------ ASSETS CURRENT ASSETS Cash and Cash Equivalents $ 151,676 $ -- Accounts Receivable, net -- 2,962,869 Other Receivables 45,281 4,260 Note Receivable 3,500,000 -- Inventories, net -- 4,313,759 Current Portion of Prepaid Expenses -- 221,443 Current Assets Retained Relating to Discontinued Operations -- 236,927 ------------ ------------ Total Current Assets 3,696,957 7,739,258 ------------ ------------ PROPERTY AND EQUIPMENT, NET 7,000 1,901,650 ------------ ------------ NON-CURRENT ASSETS Prepaid Expenses, net of Current Portion -- 32,422 Intangibles, net -- 965,430 ------------ ------------ Total Non-Current Assets -- 997,852 ------------ ------------ TOTAL ASSETS $ 3,703,957 $ 10,638,760 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Checks Issued in Excess of Cash in Bank $ -- $ 22,236 Current Portion of Long-Term Debt 235,952 258,405 Note Payable - Related Party 450,000 700,000 Current Portion of Deferred Retirement Benefits 50,550 60,438 Line of Credit, Bank -- 3,084,956 Accounts Payable 948,984 679,673 Accrued Payroll and Payroll Taxes 2,603 107,858 Accrued Expenses 1,158,674 559,377 Accrued Sales and Warranty Reserve 200,000 450,000 ------------ ------------ Total Current Liabilities 3,046,763 5,922,943 ------------ ------------ LONG-TERM LIABILITIES Long-term Debt, Net of Current Portion 367,998 525,401 Note Payable - Related Party 1,154,029 924,775 Deferred Retirement Benefits, Net of Current Portion 387,476 422,776 ------------ ------------ Total Non-Current Liabilities 1,909,503 1,872,952 ------------ ------------ Total Liabilities 4,956,266 7,795,895 ------------ ------------
Swordfish Financial, Inc. and Subsidiaries Consolidated Balance Sheets September 30, 2009 and December 31, 2008 (continued) COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Common Stock, $.16 Par Value per Share, 25,000,000 Shares Authorized: 13,300,000 Issued Outstanding at September 30, 2009 and 2,312,583 at December 31, 2008 2,128,002 370,013 Additional Paid-In Capital 8,889,474 7,141,368 Accumulated Deficit (12,269,785) (4,668,516) ------------ ------------ Total Stockholders' Equity (1,252,309) 2,842,865 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3,703,957 $ 10,638,760 ============ ============ See accompanying notes to consolidated financial statements. 1
Swordfish Financial, Inc. and Subsidiaries Consolidated Statements of Operations (Unaudited) Three months ended September 30, Nine months ended September 30, --------------------------------- ---------------------------------- 2009 2008 2009 2008 --------------- --------------- ---------------- --------------- SALES, NET $ 739,556 $ 2,199,853 $ 4,640,309 $ 6,017,084 COST OF GOOD SOLD 781,804 1,882,706 4,229,949 5,053,292 --------------- --------------- ---------------- --------------- GROSS PROFIT (42,248) 317,147 410,360 963,792 --------------- --------------- ---------------- --------------- SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 354,849 1,040,954 2,251,631 3,053,862 Impairment Allowance for Inventory, Equipment and Intangibles - - 598,434 - --------------- --------------- ---------------- --------------- 354,849 1,040,954 2,850,065 3,053,862 --------------- --------------- ---------------- --------------- LOSS FROM OPERATIONS (397,097) (723,807) (2,439,705) (2,090,070) --------------- --------------- ---------------- --------------- OTHER INCOME (EXPENSE) Interest expense (64,209) (131,776) (331,569) (396,941) Interest income 21,875 - 21,875 - Loss on loan default (1,539,272) - (4,904,566) - Other expenses 2,480 (419) (6,635) (2,078) --------------- --------------- ---------------- --------------- Net Other Income (Expenses) (1,579,126) (132,195) (5,220,895) (399,019) --------------- --------------- ---------------- --------------- LOSS FROM CONTINUING OPERATIONS BEFORE TAXES (1,976,223) (856,002) (7,660,600) (2,489,089) PROVISION FOR INCOME TAX EXPENSE - 428,274 - 428,274 --------------- --------------- ---------------- --------------- LOSS FROM CONTINUING OPERATIONS (1,976,223) (1,284,276) (7,660,600) (2,917,363) GAIN (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX - 303,804 59,332 1,418,609 --------------- --------------- ---------------- --------------- NET LOSS $ (1,976,223) $ (980,472) $ (7,601,268) $ (1,498,754) =============== =============== ================ =============== Loss from continuing operations per common share Basic $ (0.48) $ (0.56) $ (1.85) $ (1.26) Diluted $ (0.48) $ (0.56) $ (1.85) $ (1.26) Gain (loss) from discontinued operations per common share Basic $ 0.00 $ 0.14 $ 0.01 $ 0.61 Diluted $ 0.00 $ 0.14 $ 0.01 $ 0.61 Net loss per common share Basic $ (0.48) $ (0.42) $ (1.83) $ (0.65) Diluted $ (0.48) $ (0.42) $ (1.83) $ (0.65) Weighted average common shares Basic 4,143,819 2,312,583 4,143,819 2,312,583 Diluted 4,143,819 2,312,583 4,143,819 2,312,583 See accompanying notes to consolidated financial statements. 2
Swordfish Financial, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended September 30, 2009 and 2008 2009 2008 ---------------- --------------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (7,601,268) $ (1,498,754) Adjustments to reconcile net loss to net cash flows from operating activities Depreciation and amortization 495,734 593,354 Gain on sale of discontinued operations (465,150) Loss on bank default 4,904,565 - Loss on impairment of leasehold improvements 273,666 28,180 Loss on impairment of prepaid expenses 324,768 - Gain on sale of building, net of income taxes (998,950) Stock based compensation 6,095 1,726 Provision for deferred income taxes 428,274 Amortization of original issue discount 33,379 Changes in operating assets and liabilities: Accounts receivable 2,391,415 1,248,046 Inventories, net 1,246,455 (537,393) Prepaid expenses (70,903 36,398 Accounts payable 269,311 625,090 Accrued payroll and payroll taxes (105,255) (54,178) Accrued expenses 349,297 (151,127) Payments on deferred retirement benefits (9,888) (58,471) ---------------- --------------- Net Cash Flows from Operating Activities 2,473,992 (769,576) ---------------- --------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment - (365,564) Proceeds from sale of property and equipment 24,534 - Purchase of assets associated with Castaic Softbait Brand - (340,641) Purchase of assets from MarCum Technologies - (759,521) Purchase of assets from Innovative Outdoors - (10,753) Proceeds from sale of building - 2,294,941 Proceeds from sale of discontinued operations, net 236,927 243,345 Net proceeds from sale of working capital associated with discontinued operations - 317,461 Purchases of intangible assets - (11,796) ---------------- --------------- Net Cash Flows from (used in) Investing Activities 261,461 1,367,472 ---------------- --------------- CASH FLOWS FROM FINANCING ACTIVITIES Increase (decrease) in checks issued in excess of cash in bank (22,236) 131,119 Net receipts (payments) on line of credit, bank (2,325,639) 1,200,486 Proceeds from current note payable 14,098 - Principal payments on long-term debt (250,000) (2,060,988) -------------- ------------- Net Cash Flows from (used in) Financing Activities (2,583,777) (729,383) ---------------- --------------- Net Change in Cash and Cash Equivalents 151,676 (131,487) CASH AND CASH EQUIVALENTS - January 1, 2009 and 2008 - 131,487 ---------------- --------------- CASH AND CASH EQUIVALENTS - September 30, 2009 and 2008 $ 151,676 $ - ================ =============== See accompanying notes to consolidated financial statements. 3
Index NATURE VISION, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 2009 (Unaudited) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Swordfish Financial, Inc., (f/k/a Nature Vision, Inc. and Photo Control Corporation) (the "Company" or "we") as Nature Vision, Inc. designed, manufactured and marketed outdoor recreation products primarily for the sport fishing and hunting markets. On August 14, 2009, Nature Vision, Inc. entered into a Stock Purchase Agreement with Swordfish Financial, Inc. for 10,987,417 shares (representing approximately 80% of the outstanding shares) of its common stock in exchange for a $3,500,000 promissory note. On August 17, 2009, the shareholders owning a majority of the outstanding common stock voted to change the Company's name from Nature Vision, Inc. to Swordfish Financial, Inc. The Company did not meet the minimum net worth covenants of a line of credit with M&I Business Credit LLC (M&I Bank) as of June 30, 2009, which put the Company in default on the line of credit. On August 14, 2009, simultaneously with the signing of the Swordfish Financial, Inc. stock purchase agreement, M&I Business Credit LLC, owed approximately $1,800,000 by the Company, foreclosed on the line of credit and forced the Company to enter into a Voluntary Surrender Agreement. The Voluntary Surrender Agreement tendered to M&I Business Credit LLC total possession of the Company's Premises, operations and all of the Company's Collateral, which consisted of all of the Company's assets. M&I Business Credit LLC liquidated basically all of the Company's assets to recover the line of credit debt. Based on the limited assets, product lines and resources remaining after the M&I Business Credit LLC liquidation, Swordfish Financial, Inc. has decided that there is not enough remaining of the Nature Vision operations to continue as an outdoor recreations products company and will concentrate on the business on being and asset recovery company and using the financial resources recovered to retire the Company's debts and invest in other businesses domestically and internationally. Because of seasonal and other factors, the results of operations for the nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the Company's full 2009 fiscal year. GOING CONCERN The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business. We incurred net losses of $7,601,268 and $1,498,754, respectively, for the nine months ended September 30, 2009 and 2008 and had an accumulated deficit of $12,269,785 as of September 30, 2009. We have managed our liquidity during the first nine months of 2009 through cost reduction initiatives and the proceeds from collections on accounts receivables. The Company is currently in default of a $450,000 note with its former CEO and is in negotiations to extend the terms (Note 6). The Company is currently in default on its line of credit with a bank and in August 2008 it entered into a voluntary surrender agreement allowing the bank (as discussed in Note 8) with its superior lien position to assume control of the Company's assets and operations until it liquidates sufficient assets to pay off the line of credit which is $873,288 at September 30, 2009. The Company is in default on $603,950 of others notes payable. The Company has historically been a seasonal business with the majority of the Company's revenue being realized in the fourth quarter. On the August 14, 2009 foreclosure by M&I Business Credit LLC and forcing the Company to enter into a Voluntary Surrender Agreement which tendered to M&I Business Credit LLC total possession of the Company's Premises, operations and all of the Company's assets to collect the approximately $1,800,000 owed by the Company. After the M&I Business Credit LLC's liquidations of virtually all of the Company's assets at significant discounts to book value, Swordfish has been left with virtually no product lines to market and continue the Nature Vision outdoor recreations products operations. At September 30, 2009, the Company has recorded a $4,904,566 loss on the bank default and repossession by M&I Business Credit LLC and an impairment loss of $598,434 related to leasehold improvements and prepaid expenses. Despite cost reduction initiatives, the Company will be unable to pay its obligations in the normal course of business or service its debt in a timely manner throughout 2009 without raising additional debt or equity capital. See Note 3, for a discussion of capital acquired by the Company. There can be no assurance that this financing arrangement will alleviate the Company's 12 month working capital needs unless it is funded or the Company can complete a recovery project. 4
INTERIM FINANCIAL INFORMATION The accompanying condensed consolidated balance sheet at September 30, 2009 and the condensed consolidated statements of operations and cash flows for the nine months ended September 30, 2009 and 2008 are unaudited. The unaudited interim condensed consolidated balance sheet and condensed consolidated statements of operations and cash flows have been prepared in accordance with accounting principles generally accepted in the United States of America and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company's financial position, results of operations and its cash flows for the nine months ended September 30, 2009 and 2008. The financial data and other information disclosed in these notes to the condensed consolidated financial statements related to these periods are unaudited. Operating results for the nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. The condensed consolidated financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2008 included in the Annual Report on Form 10-K of the Company filed with the Securities and Exchange Commission. PRINCIPLES OF CONSOLIDATION The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant inter-company transactions and balances have been eliminated in consolidation. FINANCIAL INSTRUMENTS The carrying amounts for all financial instruments approximate fair value. The carrying amounts for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value because of the short maturity of these instruments. The fair value of long-term debt, notes payable, line of credit-bank, and deferred liabilities - retirement benefits approximates the carrying amounts based upon the Company's expected borrowing rate for debt with similar remaining maturities and comparable risk. ACCOUNTS RECEIVABLE The Company reviews customers' credit history before extending unsecured credit and establishes an allowance for uncollectible accounts based upon factors surrounding the credit risk of specific customers and other information. Accounts receivable are due based on agreed upon customer terms. Accounts receivable are considered past due once they are over the due date of these terms. The Company does not accrue interest on past due accounts receivable. If accounts receivable in excess of the provided allowance are determined to be uncollectible, they are charged to expense in the year that the determination is made. Accounts receivable are written off after all collection efforts have failed. The Company had no receivables at September 30, 2009 due to the Company's default on its loan with M&I Business Credit LLC and its repossession of the Company's asset (See Note 8). Accounts receivable at December 31, 2008 were reduced by an allowance for uncollectible accounts of $37,500. INVENTORIES Inventories consist of raw materials and finished goods and are valued at the lower of standard cost (which approximates the first-in, first-out (FIFO) method) or market. Market represents estimated realizable value in the case of finished goods and replacement or reproduction cost in the case of other inventories. Because of changing technology, our customer base, customer needs, general economic conditions, and the level of success of certain sales programs, and market demand, inventory is subject to obsolescence. Management periodically reviews all inventories to determine if any obsolete, discontinued or slow moving items are in inventory. Based on this review, inventory is disposed of or an allowance for obsolescence established to cover any future disposals. Due to the Company's default on its loan with M&I Business Credit LLC and its repossession of the Company's assets, the Company's inventory at September 30, 2009 was reduced to zero (See Note 8). GOODWILL The Company applies SFAS No. 142, "Goodwill and Other Intangible Assets," which sets forth financial and reporting standards for the acquisition of intangible assets, other than those acquired in a business combination, and for goodwill and other intangible assets subsequent to their acquisition. This accounting standard requires that goodwill no longer be amortized but tested for impairment on a periodic basis. During the fourth quarter of fiscal 2008, the Company performed its annual goodwill impairment test with the assistance of a third-party valuation firm. Due to reduced growth expectations resulting from weakening economic conditions and anticipated lower impact on revenues and profitability in future years, the Company recorded a non-cash charge of $666,373 in the fourth quarter of fiscal 2008 for goodwill impairment. The balance of goodwill was $0 as of September 30, 2009 and December 31, 2008, respectively. 5
INTANGIBLE ASSETS AND OTHER ASSETS Other intangible assets consisted primarily of patents and identifiable intangible assets including customer lists, trademarks, other intellectual property and non-compete agreements, which are being amortized using the straight-line method over their estimated useful lives ranging from three to nineteen years. Due to the Company's default on its loan with M&I Business Credit LLC and its repossession of the Company's assets, the Company's intangible assets was reduced to zero at September 30, 2009 (See Note 8). The long-term portion of prepaid expenses consists of deferred financing costs of $-0- and $32,422 at September 30, 2009 and December 31, 2008, respectively. IMPAIRMENT OF LONG-LIVED ASSETS We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, in accordance with FASB SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." An asset or asset group is considered impaired if its carrying amount exceeds the undiscounted future net cash flow the asset or asset group is expected to generate. If an asset or asset group is considered impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds its fair value. If estimated fair value is less than the book value, the asset is written down to the estimated fair value and an impairment loss is recognized. If we determine that the carrying amount of long-lived assets, including intangible assets, may not be recoverable, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model or another valuation technique. Considerable management judgment is necessary in estimating future cash flows and other factors affecting the valuation of long-lived assets, including intangible assets, including the operating and macroeconomic factors that may affect them. We use historical financial information, internal plans, and projections and industry information in making such estimates. Due to the Company's default on its loan with M&I Business Credit LLC and its repossession of the Company's assets, the Company's property and equipment of $967,254 at September 30, 2009 was reduced to $7,000 and included as part of the $4,904,566 loss recorded on the bank loan default as summarized in Note 8. We had an independent appraisal firm complete an appraisal of goodwill and other intangibles as of November 30, 2008. Due to reduced growth expectations resulting from weakening economic conditions and anticipated lower impact on revenues and profitability in future years, we recognized a non-cash impairment charge of $671,877 for our long-lived assets, including intangible assets, during the year ended December 31, 2008. Due to the Company's default on its loan with M&I Business Credit LLC and its repossession of the Company's assets, the Company's intangible assets at September 30, 2009 was reduced to zero (See Note 8) The balance of intangibles was $0 and $965,430 as of September 30, 2009 and December 31, 2008, respectively. In particular, if we no longer believe we will achieve our long-term projected sales or operating expenses, we may conclude in connection with any future impairment tests that the estimated fair value of our long-lived assets, including intangible assets, are less than the book value and recognize an additional impairment charge. Such impairment would adversely affect our earnings. DISCONTINUED OPERATIONS On February 5, 2007, the Company sold certain assets and transferred certain liabilities related to its Vaddio division. These assets met the requirements of SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" as being held for sale. Operations and cash flows were eliminated as a result of the sales and the Company did not have any significant involvement in the operations after the sales. The results of the Vaddio product lines are presented on a historical basis as a separate line in the consolidated statements of operations and the consolidated balance sheets entitled "Assets/Liabilities sold relating to discontinued operations" and "Assets/Liabilities retained relating to discontinued operations." In accordance with EITF 87-24, "Allocation of Interest to Discontinued Operations," the Company elected to not allocate consolidated interest expense to the discontinued operations where the debt is not directly attributed to or related to the discontinued operations. All of the financial information in the consolidated financial statements and notes to the consolidated financial statements has been revised to reflect only the results of continuing operations (see Note 13). 6
REVENUE RECOGNITION The Company recognizes revenue on the date products are shipped to customers and does not sell products with the guaranteed right of return. The Company maintains a warranty on new products up to two years from the date of retail purchase and therefore permits returns for defective product within the first few months of purchase and repairs products up through the end of the warranty period. Estimated reserves for sales / warranty returns are established by management based on historical experience and are subject to ongoing review and adjustment by the Company. Sales are reported net of the provision for actual and estimated future returns in the accompanying consolidated statements of operations. Revenues are reported net of discounts and allowances. The Company's revenue is recognized in accordance with generally accepted accounting principles as outlined in the SEC's Staff Accounting Bulletin No. 104 "Revenue Recognition," which requires that four basic criteria be met before revenue can be recognized: (i) persuasive evidence of an arrangement exists; (ii) the price is fixed or determinable; (iii) reasonably assured it is collectible; and (iv) product delivery has occurred. The Company recognizes revenue as products are shipped based on FOB shipping point terms when title passes to customers. In June 2006, the Financial Accounting Standards Board (FASB) ratified the consensus of Emerging Issues Task Force Issue No. 06-3, " How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation )" (EITF 06-3). EITF 06-3 concluded that the presentation of taxes imposed on revenue-producing transactions (sales, use, value added, and excise taxes) on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy that should be disclosed. The Company adopted EITF 06-3 during the year ended December 31, 2007, and it did not have any impact on our results of operations or financial condition. The Company's policy is to present taxes imposed on revenue-producing transactions on a gross basis. SALES AND WARRANTY RESERVE The Company has established a sales and warranty reserve for sales returns and warranty costs. Reserves are estimated based on historical experience, current product lines being sold, and management's estimates. The Company provides a standard one or two-year warranty program for its products. The sales and warranty reserve for sales returns and warranty costs relating to continuing operations was $200,000 and $450,000 at September 30, 2009 and December 31, 2008, respectively. The sales and warranty reserve represents a significant estimate and actual results could differ from the estimate. The following table provides the activity through the returns and warranty accounts as recorded and charged against the reserve relating to continuing operations for the nine months ended September 30, 2009 and 2008. 2009 2008 --------------- --------------- Accrued balance - beginning, December 31 $ 450,000 $ 300,000 Provision 85,000 201,000 Claims incurred (335,000) (291,000) --------------- --------------- Accrued balance - ending, September 30 $ 200,000 $ 210,000 =============== =============== RESEARCH AND DEVELOPMENT The Company expenses all costs related to product research and development as incurred. STOCK-BASED COMPENSATION In accordance with SFAS No. 123(R), cash flows from income tax benefits resulting from tax deductions in excess of the compensation cost recognized for stock-based awards have been classified as financing cash flows prospectively from January 1, 2006. Prior to adoption of SFAS No. 123(R), such excess income tax benefits were presented as operating cash flows. There were no cash flows from income tax benefits for the nine months ended September 30, 2009 and 2008. 7
There were no stock options granted during the nine months ended September 30, 2009. The following assumptions were used to calculate the value of the options granted during the nine months ended September 30, 2008: dividend yield of 0%, risk-free interest rate of 3%, expected life equal to 3.5 years, and volatility of 76% - 106%. The following are the assumptions used for the Black-Scholes model: o The Company calculates expected volatility for stock options and awards using historical volatility. o The Company used 0% as a forfeiture rate and the Company does not consider forfeitures to be material. o The Company has not, and does not intend to, issue dividends; therefore, the dividend yield assumption is 0%. o The expected term of options is based on the simplified method as allowed under Staff Accounting Bulletins (SAB) No's. 107 and 110 issued by the SEC. The simplified method assumes the option will be exercised midway between the vesting date and the contractual term of the option. The Company is able to use the simplified method as the options qualify as "plain vanilla" options as defined by SAB No. 107 and since the Company does not have sufficient historical exercise data to provide a reasonable basis to estimate expected term. o The risk-free rates for the expected terms of the stock options and awards are based on the U.S. Treasury yield curve in effect at the time of grant. The Company recognizes stock-based compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. As of September 30, 2009, there was $-0- of total unrecognized compensation costs as all of the outstanding options were cancelled during the third quarter of 2009. Stock options issued to non-employees (which no options were issued to non-employees), are accounted for in accordance with Emerging Issues Task Force (EITF) 96-18. LOSS PER COMMON SHARE Net loss per common share was based on the weighted average number of common shares outstanding during the periods when computing the basic net loss per share. When dilutive, stock options and warrants are included as equivalents using the treasury stock market method when computing the diluted net loss per share. There were no dilutive common stock equivalents, options and warrants, for the nine months ended September 30, 2009 and 2008. Anti-dilutive options and warrants were -0- and 219,450 at September 30, 2009 and 2008, respectively. INCOME TAXES The Company accounts for income taxes using the asset and liability approach, which requires the recognition of deferred tax assets and liabilities for tax consequences of temporary differences between the financial statement and income tax reporting bases of assets and liabilities based on currently enacted rates and laws. These temporary differences principally include depreciation, amortization, net operating losses, deferred retirement benefits, paid time off and performance benefits, contract payable, allowance for doubtful accounts, inventory obsolescence allowance, and warranty reserves. Deferred taxes are reduced by a valuation allowance to the extent that realization of the related deferred tax assets is not assured. There is a full valuation allowance recorded as of September 30, 2009 and December 31, 2008. In June 2006, the Financial Accounting Standards Board, or FASB, issued FASB Interpretation No. 48, or FIN 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109," which prescribes comprehensive guidelines for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on tax returns. FIN 48, effective for fiscal years beginning after December 15, 2006, seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. The Company adopted provisions of FASB Interpretation 48, Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement 109, Accounting for Income Taxes ("FIN 48) on January 1, 2007. To the extent interest and penalties would be assessed by taxing authorities on any underpayment of income taxes, such amounts would be accrued and classified as a component of income tax expenses on the consolidated statement of operations. The Company has no material amount of accrued liabilities for interest or penalties recorded related to unrecognized tax benefits. The federal and state tax returns are open to examination for the years 2005-2008. 8
RECLASSIFICATION Certain prior year amounts have been reclassified to conform to the 2009 presentation. The reclassification relates to the breakout of operating expenses on the statement of operations into the following categories: sales and marketing, research and development and engineering, and general and administrative. The Company's opinion is that this breakout provided insight into the different categories of operating expenses the Company incurs. ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. For the Company, significant estimates include the allowance for doubtful accounts receivable, reserves for inventory valuation, impairment of goodwill and long lived assets, reserves for sales returns, reserves for warranty services, and the valuation allowance for deferred tax assets. RECENT ACCOUNTING PRONOUNCEMENTS During December 2007, the FASB issued SFAS No. 141 (Revised 2007), "Business Combinations" ("SFAS 141 (Revised 2007)"). While this statement retains the fundamental requirement of SFAS 141 that the acquisition method of accounting (which SFAS 141 called the purchase method ) be used for all business combinations, SFAS 141 (Revised 2007) now establishes the principles and requirements for how an acquirer in a business combination: recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interests in the acquiree; recognizes and measures the goodwill acquired in the business combination or the gain from a bargain purchase; and determines what information should be disclosed in the financial statements to enable the users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141 (Revised 2007) is effective for fiscal years beginning on or after December 15, 2008. The adoption of SFAS 141 (Revised 2007) did not have a material impact on the Company's financial statements. During December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements an amendment of ARB No. 51" ("SFAS 160"). This statement establishes accounting and reporting standards for noncontrolling interests in subsidiaries and for the deconsolidation of subsidiaries and clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This statement also requires expanded disclosures that clearly identify and distinguish between the interests of the parent owners and the interests of the noncontrolling owners of a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. The adoption of SFAS 160 did not have a material impact on the Company's financial statements. In February 2008, the FASB issued FASB Staff Position ("FSP") No. 157-2, "Effective Date of FASB Statement No. 157" ("FSP 157-2"), which delays the effective date of SFAS 157 until January 1, 2009 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. These non-financial items include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and non-financial assets acquired and liabilities assumed in a business combination. The adoption of the remainder of SFAS 157 did not have a material impact on the Company's financial statements. In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FAS 133" ("SFAS 161"). This statement changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS 161 is effective for fiscal years beginning on or after November 15, 2008. The adoption of SFAS 161 did not have a material impact on the Company's financial statements. In April 2008, the FASB issued FSP No. 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP 142-3"), which amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB Statement No. 142, "Goodwill and Other Intangible Assets". This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. FAS 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. The adoption of FAS 142-3 did not have a material impact on the Company's financial statements. 9
In September 2008, the FASB issued FSP No. 133-1 and FASB Interpretation No. 45-4 ("FSP SFAS 133-1 and FIN 45-4"), "Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others", to require additional disclosure about the current status of the payment/performance risk of a guarantee. The provisions of the FSP that amend SFAS 133 and FIN 45 and effective for reporting periods ending after November 15, 2008. FSP SFAS 133-1 and FIN 45-4 also clarifies the effective date in SFAS 161. Disclosures required by SFAS 161 are effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The adoption of FSP SFAS 133-1 and FIN 45-4 did not have a material impact on the Company's financial statements. In December 2008, the FASB issued FSP No. 140-4 and FIN 46R-8 ("FSP 140-4 and FIN 46R-8"), "Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities." FSP 140-4 and FIN 46R-8 require additional disclosures about transfers of financial assets and involvement with variable interest entities ("VIE's"). The requirements apply to transferors, sponsors, servicers, primary beneficiaries and holders of significant variable interests in a variable interest entity or qualifying special purpose entity. Disclosures required by FSP 140-4 and FIN 46R-8 are effective for the Company in the first quarter of fiscal 2009. Because the Company has no VIE's, the adoption did not have a material impact the Company's financial statements. In January 2009, the Financial Accounting Standards Board ("FASB") approved FASB Accounting Standards Codification (the "Codification"), which is effective July 1, 2009. Other than resolving certain minor inconsistencies in current U.S. GAAP, the Codification is not supposed to change GAAP, but is intend to make it easier to find and research GAAP applicable to a particular transaction or specific accounting issue. The Codification is a new structure which takes accounting pronouncements and organizes them by approximately 90 accounting topics. We do not expect the Codification to have a material impact on our financial position or results of operations. In April 2009, the FASB issued FASB Staff Position SFAS 107-1 ("FSP SFAS 107-1") and Accounting Principles Board Opinion 28-1, Interim Disclosures about Fair Value of Financial Instruments ("APB 28-1"). FSP SFAS 107-1 and APB 28-1 require disclosures about fair value of financial instruments whenever summarized financial information for interim reporting periods is presented. Entities shall disclose the methods and significant assumptions used to estimate the fair value of financial instruments and shall describe changes in methods and significant assumptions, if any, during the period. FSP SFAS 107-1 and APB 28-1 are effective for interim reporting periods ending after June 15, 2009. The Company does not expect the adoption of FSP SFAS 107-1 and APB 28-1 to have a material impact on the Company's financial statements. In April 2009, the FASB issued FSP SFAS 157-4, which provides additional guidance for estimating fair value in accordance with SFAS No. 157, Fair Value Measurements ("SFAS 157"), when the volume and level of market activity for the asset or liability have significantly decreased. FSP SFAS 157-4 emphasizes that even if there has been a significant decrease in the volume and level of market activity for the asset or liability and regardless of the valuation techniques used, the objective of a fair value measurement remains the same. In addition, the statement provides guidance on identifying circumstances that indicate a transaction is not orderly. FSP SFAS 157-4 is effective for interim and annual periods ending after June 15, 2009. The Company does not expect the implementation of FSP SFAS 157-4 to have a material impact on our financial statements. NOTE 2 - ACQUISITIONS Innovative Outdoors asset acquisition On June 27, 2008, the Company closed on the acquisition of certain assets of Innovative Outdoors, Inc. (Innovative Outdoors) a manufacturer and distributor of ice fishing hole covers and other related devices, pursuant to the terms of an asset purchase agreement. The transaction involved the acquisition by the Company of tooling, intellectual property, and general intangibles of Innovative Outdoors for a purchase price of $188,572. The purchase price was paid as follows: (i) $6,000 cash was paid at closing, (ii) $32,572 by a two year unsecured promissory note payable in monthly installments of $1,458 including imputed interest at 7%, and (iii) $150,000 by a three year unsecured promissory note payable in monthly installments of $4,632 including interest at 7%. In connection with the acquisition, the Company incurred transaction costs of $4,753.This purchase allowed the Company to become vertically integrated by purchasing the intellectual property of an existing sales product line. The assets acquired and liabilities assumed in the acquisition were based on their value estimated at the date of acquisition. Additional pro forma disclosures required under SFAS No. 141 "Business Combinations", related to this acquisition, were not considered material. 10
MarCum Technologies asset acquisition On April 30, 2008, the Company closed on the acquisition of certain assets of MarCum Technologies, Inc. (Marcum), a manufacturer and distributor of electronic sonar and underwater camera devices, pursuant to the terms of an asset purchase agreement. The transaction involved the acquisition by the Company of select equipment, inventories, intellectual property, and general intangibles of Marcum for a purchase price of $721,080, of which $650,000 was paid at closing and the remaining $71,080 was paid in June 2008 as part of the inventory adjustment. In connection with the acquisition, the Company incurred transaction costs of $38,441. The assets acquired in the acquisition were based on the fair value estimates at the date of the acquisition. . The purchase provided the Company with an expanded fishing platform and a strong intellectual property platform to develop new products. Castaic Softbait brand acquisition On January 21, 2008, the Company acquired substantially all of the assets associated with the Castaic Softbait brand under an asset purchase agreement. The amount of $323,100 was paid at closing, $81,750 is payable pursuant to three year promissory notes, and $82,860 of liabilities were assumed. The Company incurred transaction costs of $17,541 in connection with the acquisition. The purchase provided the Company with a proven fishing tackle product platform. The assets acquired and liabilities assumed in the acquisition were based on their value estimated at the date of acquisition. Additional pro forma disclosures required under SFAS No. 141 "Business Combinations", related to this acquisition, were not considered material. Pro forma Information for Material Acquisitions The results of MarCum, Innovative Outdoors, and Castaic Softbait brand have been included in the condensed consolidated financial statements since the date of the acquisitions. The following unaudited pro forma condensed results of operations for the three months ended give effect to the acquisition of MarCum as if such transaction had occurred on January 1, 2008. The unaudited pro forma information does not purport to represent what the Company's results of operations would actually have been if such transaction in fact had occurred at such date or to project the Company's results of future operations. For the nine months ended September 30, 2008: September 30, 2008 --------------------------------- As reported Pro forma ----------- --------- Net sales $ 6,017,84 $ 6,261,373 Loss from continuing operations (2,917,363) (3,217,912) Gain from discontinued operations 1,418,609 1,418,609 Net loss $ (1,498,754) $ (1,799,303) Loss per common share: Basic $ (0.65) $ (0.78) Diluted $ (0.65) $ (0.78) For the three months ended September 30, 2008: September 30, 2008 --------------------------------- As reported Pro forma ----------- --------- Net sales $ 2,199,853 $ 2,199,853 Loss from continuing operations (1,284,276) (1,284,276) Gain from discontinued operations 303,804 303,804 Net income $ (980,472) $ (980,472) Income per common share: Basic $ (0.42) $ (0.42) Diluted $ (0.42) $ (0.42) 11
NOTE 3 - RELATED PARTY NOTE RECEIVABLE On August 14, 2009, the Company closed a Stock Purchase Agreement with Swordfish Financial, Inc. (which is controlled by the Company's Chairman of the Board, President, Chief Executive Officer and majority shareholder) pursuant to which the Company sold an aggregate of 10,987,417 shares of its common stock in exchange for a $3,500,000 promissory note, payable in two installments of $1,750,000 each with the first installment being forty-five (45) days from the date of the note and the second installment being one-hundred twenty (120) days from the date of the note. NOTE 4 - INVENTORIES Inventories consisted of the following at: September 30, December 31, 2009 * 2008 ------------ ----------- Raw Materials $ 0 $ 2,200,836 Finished Goods 0 2,267,923 ----------- ----------- Total 0 4,468,759 Less: Valuation allowance (0) (155,000) ----------- ----------- Inventories, net $ 0 $ 4,313,759 =========== =========== *See note 8 for amount of inventory involved in the M&I Business Credit repossession of the Company's assets. NOTE 5 - PROPERTY AND EQUIPMENT Property and equipment consisted of the following at: September 30, December 31, 2009 * 2008 ------------ ----------- Tooling $ 0 $ 1,603,236 Office furniture and equipment 0 560,257 Warehouse equipment 7,000 437,952 Vehicles 0 7,418 Leasehold improvements 0 359,729 Construction in progress 0 77,845 ----------- ----------- Total 7,000 3,046,437 Less: Accumulated depreciation (0) (1,144,787) ----------- ----------- Net $ 7,000 $ 1,901,650 =========== =========== Depreciation expense of $495,734 and $593,354 was recorded for the nine months ended September 30, 2009 and 2008, respectively. *See note 8 for amount of property and equipment involved in the M&I Business Credit repossession of the Company's assets. 12
NOTE 6 - INTANGIBLES Schedule of Intangible Assets at September 30: 2009 * ---------------------------------------------------------------------------- Gross Carrying Loss on Bank Accumulated Net Carrying Amount at June Amount Default Amortization 30, 2009 ------------------ ------------------ ------------------- ----------------- Intangible assets subject to amortization: Trademarks $ 49,235 $ 27,385 $ 21,850 $ 0 Non-compete 197,104 103,667 93,437 0 Customer lists 0 0 0 0 Intellectual property and related patents 266,683 190,254 76,429 0 Other 0 0 0 0 ------------------ ------------------ ------------------- ----------------- Totals $ 513,022 $ 321,306 $ 191,716 $ 0 ================== ================== =================== ================= *See note 8 for amount of inventory involved in the M&I Business Credit repossession of the Company's assets. Schedule of Intangible Assets at December 31: 2008 --------------------------------------------------------------------------------- Gross Carrying Impairment Accumulated Net Carrying Amount at Amount Amortization December 31, 2008 ------------------------------------------------------------- ------------------- Intangible assets subject to amortization: Trademarks $ 404,235 $ - $ 59,455 $ 344,780 Non-compete 315,361 544 90,069 224,748 Customer lists 438,667 398,667 9,389 30,611 Intellectual property and related patents 678,916 272,666 64,826 341,424 Other 24,684 - 817 23,867 ---------------- ---------------- ---------------- --------------- Totals $ 1,861,863 $ 671,877 $ 224,556 $ 965,430 ================ ================ ================ =============== NOTE 7 - RELATED PARTY NOTE PAYABLE AND WARRANTS Board of Director Member Notes Payable On October 19, 2007, the Company borrowed $1,000,000 from a member of its Board of Directors in order to meet its short-term cash flow requirement. This demand promissory note was unsecured and had an interest rate of 15% (55.8% effective rate by including fair value of warrants amortized over a three month term). Interest was payable on the first day of each month, commencing on December 1, 2007. The entire principal and accrued interest was payable upon demand anytime after January 19, 2008. In connection with the loan, the Company issued warrants to the Director to purchase 100,000 shares of common stock at an exercise price of $2.21. The warrants were exercisable from October 19, 2007 through October 19, 2009 (the lender agreed to the cancellation of these warrants on August 14, 2009). The fair value of the warrants was calculated at $102,010 using the Black Scholes model. The following assumptions were used to calculate the value of the warrants: dividend yield of 0%, risk free interest of 5%, expected life to two years, and volatility of 81%. The resulting original issue discount, the fair value of the warrants, was amortized over the life of the debenture using the straight-line method. Amortization expense on the original issue discount was $0 and $20,841 for the nine months ended September 30, 2009 and 2008, respectively, and is included in interest expense. 13
On July 8, 2008, the Company amended the terms and replaced the original demand note issued to the member of its Board of Directors on October 19, 2007. The amended demand note is held by the same member of the Company's Board of Directors. The demand promissory note is unsecured and bears an interest rate of 15% (20% effective rate including new warrants issued to the Director and amortized over a two year term). Interest is payable on the first day of each month commencing on August 1, 2008. The Company incurred approximately $110,500 of interest for the nine months ended September 30, 2009. The entire principal and interest is payable upon demand anytime after June 30, 2010. In connection with the new loan, the Company issued additional warrants to the Director to purchase 100,000 shares of common stock at an exercise price of $1.31. The warrants were exercisable from July 8, 2008 to June 30, 2013 (the Board Member agreed to the cancellation of the warrants on August 14, 2009 as part of the transaction with Swordfish Financial, Inc.). The fair value of the warrants was calculated at $100,300 using the Black Scholes model. The following assumptions were used to calculate the value of the warrants: (i) dividend yield of 0%, risk free interest of 3.34%, expected life of 5 years, and volatility of 103%. The resulting original issue discount, the fair value of the warrants, will be amortized over the life of the debenture using the straight-line method. Amortization expense on the original issue discount was $25,149 for the nine months ended September 30, 2009 and is included in interest expense. On August 17, 2009, the Company borrowed $200,000 from a member of its Board of Directors in order to meet its short-term cash flow requirement. This demand promissory note is secured by a second lien on the Company's assets and has an interest rate of 15%. the entire principal and accrued interest is payable upon demand anytime after February 17, 2010. Chief Executive Officer Note Payable On October 27, 2008, the Company borrowed $700,000 from its Chief Executive Officer (CEO) in order to meet its short-term cash flow requirements. This promissory note was unsecured and had an interest rate of 15%. The entire principal and accrued interest was payable on January 1, 2009. The Company incurred approximately $78,500 of interest for the nine months ended September 30, 2009. In connection with the loan, the Company issued warrants to the CEO to purchase 50,555 shares of common stock at an exercise price of $.90. The warrants were exercisable from October 28, 2008 through October 27, 2010 (the CEO agreed to the cancellation of the warrants on August 14, 2009 as part of the Swordfish Financial, Inc.). The fair value of the warrants was calculated at $31,071 using the Black Scholes model. The following assumptions were used to calculate the value of the warrants: dividend yield of 0%, risk free interest of 1.49%, expected life to two years, and volatility of 140%. The resulting original issue discount, the fair value of the warrants, was amortized over the life of the debenture using the straight-line method. Amortization expense on the original issue discount was $31,071 and was included in interest expense during the fourth quarter of fiscal 2008. The Company paid $250,000 of the note in January 2009. The Company is currently in default on the remaining $450,000 of the note and is in negotiations with its CEO to extend the remaining principal balance of $450,000 in a new note that was outstanding as of September 30, 2009. NOTE 8 - LINE OF CREDIT, BANK On November 8, 2007, the Company entered into a line of credit agreement, a demand note, with M&I Bank for up to a maximum amount of $6,000,000. Interest is payable monthly at the greater of one month LIBOR plus 3.75% or a floor of 5.25% (5.25% at March 31, 2009). The line of credit is collateralized by accounts receivable, inventories, property and equipment, intangible assets and other assets of the Company. The facility is based on the following borrowing base restrictions, 75% of eligible accounts receivable and 50% of eligible inventories. In connection with this agreement, the Company is required to pay an annual line fee of $45,000 and minimum interest of $120,000 on an annual basis. The balance outstanding on the line of credit was $873,288 at September 30, 2009 and $3,084,956 at December 31, 2008. The Company did not meet the minimum net worth covenants as of June 30, 2009, which put the Company in default on its line of credit with the bank and on August 14, 2009, simultaneously with the signing of the Swordfish Financial, Inc. stock purchase agreement, the Company entered into a Voluntary Surrender Agreement with M&I Business Credit LLC (the `Creditor"), who as of August 14, 2009 was owed approximately $1,800,000 by the Company relating the Credit and Security Agreement dated November 8, 2007 (as amended or supplemented, the "Credit Agreement"). In accordance with the Voluntary Surrender Agreement, the Company agreed to tender to M&I Business Credit LLC total possession of the Company's Premises, operations and all of the Company's Collateral, which was basically all of the Company's assets, until M&I Business Credit LLC liquidates sufficient assets to pay off the line of credit owed by the Company. See the calculation below for the Company's loss on the bank loan default. 14
The Company recorded a loss of $4,905,566 against the M&I Business Credit LLC $873,288 loan default as set forth in the following summary; Company assets repossessed by M&I Business Credit LLC Cash accounts $ 113,971 Accounts receivable 530,432 Inventory 3,067,304 Property and equipment 1,231,899 Intangible assets 834,247 ----------- Total assets repossessed by Bank 5,777,853 Bank loan at September 30, 2009 (873,288) ----------- Loss recorded on bank loan default $ 4,904,565 =========== NOTE 9 - LONG-TERM DEBT Long-term debt consisted of the following at: September 30, December 31, 2009 2008 ---------------- ---------------- Unsecured Promissory Note - Cass Creek - monthly installments of approximately $11,000 from $ 386,538 $ 493,932 September 2008 through March 2010, then annual installments ranging from $108,000 to $124,000 beginning September 2010 through September 2012, all payments include interest at 8%, guaranteed by the CEO of the Company. Unsecured Note Payable - Fish Hawk - annual installments of $33,333 plus interest at 8% from July 2008 through July 2010 66,666 66,667 Unsecured Note Payable - Castaic - annual installments of $17,171, including interest at 8%, from January 2009 through January 2011 30,620 44,250 Unsecured Note Payable - Castaic - monthly installments of $1,175, including interest at 8%, from February 2008 through January 2011 20,128 26,978 Unsecured Note Payable - monthly installments of $1,458, including interest at 7%, from August 2008 through July 2010 0 24,850 Unsecured Note Payable - Innovative Outdoors - monthly installments of $4,632, including interest at 7% from August 2008 through July 2011 99,998 127,129 ---------------- ---------------- Totals 603,950 783,806 Less: Current portion 235,952 258,405 ---------------- ---------------- Net Long-Term Debt $ 367,998 $ 525,401 ================ ================ The Company is in default on all the above note payable at September 30, 2009. Future maturities of long-term debt for years ending after September 30, 2009 are as follows: Total ----------- Year ending September 30: 2010 $ 235,952 2011 209,480 2012 117,462 2013 41,056 2014 and forward - ----------- Total Long-Term Debt $ 603,950 =========== 15
NOTE 10 - INCOME TAXES The provision for income taxes for continuing operations consists of the following components for the nine months ended September 30: 2009 2008 ----------- ----------- Current $ - $ - Deferred - - ----------- ----------- Total Benefit from Income Taxes $ - $ - =========== =========== A comparison of the provision for income tax expense at the federal statutory rate of 34% for the nine months ended September 30 to the Company's effective rate is as follows: 2009 2008 --------- --------- Federal statutory rate (34.0) % (34.0) % State tax, net of federal benefit (3.3) (3.3) Permanent differences and other including surtax exemption 0.1 0.1 Valuation allowance 37.2 37.2 --------- --------- Effective Tax Rate -% -% ========= ========= NOTE 11 - COMMITMENTS AND CONTINGENCIES Lease Commitment The Company entered into a lease agreement for its assembly and distribution facility and corporate headquarters in Brainerd, Minnesota. The lease commenced on September 1, 2006 and expires on August 31, 2016. The lease was amended in May 2008 for additional space, a sprinkler system improvement addition, and the term extended through August 31, 2018. The lease was further amended by a second amendment as of July 1, 2009 giving the Company and the Landlord the right to terminate the lease effective as of December 31, 2009 by giving notice of termination 30 days prior to the effective date of termination. This second amendment also reduces the monthly rent from $21,801 to $15,000 with the $6,801 being deferred and waived by the Landlord if the Company timely pays the Adjusted Monthly Charge through December 31, 2009. The Company will record monthly rent expense equal to the total of the payments due over the lease term, divided by the number of months of the lease term. The difference between rent expense recorded and the amount paid will be credited or charged to deferred rent. The Company is also required to pay its portion of operating expenses. Based on the terms of the second amendment the Company will have the right to terminate the lease on December 31, 2009 by giving the Landlord notice 30 days prior to December 31, 2009. The future minimum lease payments through December 31, 2009 are $45,000 as of September 30, 2009. Other Commitments On May 1, 2008, the Company entered into a research and development consulting agreement with an entity that had common ownership with MarCum. The agreement requires the Company to pay the entity as follows: (i) $525,000 in 36 monthly installments of $14,583 for research and development services beginning June 1, 2008, (ii) $200,000 in 24 monthly installments of $8,333 for product support services beginning June 1, 2008. In addition, the Company will pay this entity a royalty of 5% of net sales (for a period of three years following the first sale) on any new product that meets certain requirements as defined in the agreement. The Company has recognized approximately $207,000 of expense relating to this agreement for the nine months ended September 30, 2009, which is included in research and development and engineering expense. 16
On May 1, 2008, the Company entered into a research and development consulting agreement with an entity that had common ownership with MarCum. The agreement requires the Company to pay the entity as follows: (i) $180,000 in 36 monthly installments of $5,000 for research and development services beginning June 1, 2008, (ii) $100,000 in 24 monthly installments of $4,166 for product support services beginning June 1, 2008. In addition, the Company will pay this entity a royalty of 5% of net sales (for a period of three years following the first sale) on any new product that meets certain requirements as defined in the agreement. The Company has recognized approximately $84,000 of expense relating to this agreement for the nine months ended September 30, 2009, which is included in research and development and engineering expense. The Company is under a technology purchase agreement requiring payment of $50,000 by September 30, 2009. NOTE 12 - CONCENTRATIONS Major Customers The Company derived more than 10% of its revenues from the following unaffiliated customers in the following amounts for the nine months ended September 30, 2009 and 2008: 2009 2008 ----------------- ---------------- Customer A $ * $ 407,879 The Company had no receivables at September 30, 2009 due to the Company's default on its loan with M&I Business Credit LLC and its repossession of the Company's asset (See Note 8). The Company had receivable balances greater than 10% of its accounts receivable from the following unaffiliated customers at December 31, 2008: September 30, 2009 ** December 31, 2008 ----------------- ------------------- Customer A $ * $ * Customer B * 485,908 Customer C * 309,721 *Did not represent more than 10% of the Company's revenues or accounts receivable for the period indicated. ** See note 8 for amount of receivables involved in the M&I Business Credit repossession of the Company's assets. Foreign Inventory Included in the consolidated balance sheets are international inventories of $ -0- at September 30, 2009 (due to the Company's default on its loan with M&I Business Credit LLC and its repossession of the Company's asset (See Note 8), and $351,690 at December 31, 2008. Foreign inventories consist of raw material goods held in Asia and Mexico and used in the production of the Company's products. Foreign Sales and Long-Lived Assets The following table presents net sales by geographic area for the nine months ended September 30: Geographic Data 2009 2008 ----------------------------- ---------------- ---------------- Net Sales United States $ 4,144,211 $ 1,933,567 International 496,098 433,498 ---------------- ---------------- Total net sales $ 4,640,309 $ 2,367,065 ================ ================ 17
The following table presents property, plant, and equipment by geographic area as of September 30, 2009 and December 31, 2008: Geographic Data September 30, December 31, 2009 2008 ----------------------------------------- ----------------- ----------------- Property, plant, and equipment United States $ 7,000 $ 1,023,517 International 0 878,133 ----------------- ----------------- Total property, plant, and equipment $ 7,000 $ 1,901,650 ================= ================= NOTE 13 - DISCONTINUED OPERATIONS Vaddio product line sale The sale of Nature Vision's Vaddio product line to New Vad, LLC (New Vad) closed on February 5, 2007 pursuant to the terms of the asset purchase agreement. The transaction involved the sale of fixed assets, equipment, licenses, intellectual property and certain other assets relating to Nature Vision's Vaddio product line. The original purchase price paid by the Buyer was $757,372, which consisted of $710,694 in cash at closing and $46,678 in assumed paid time off. In addition, Nature Vision receives 2% of receipts from the gross sale of all Vaddio products sold by New Vad after March 1, 2007, paid on a monthly basis with a six month deferral, until a total payment of $750,000 is received. The potential deferral proceeds of up to $750,000 have been recorded when earned and collection is deemed probable. Based on the past history of collections, the Company elected to record the deferred sale proceeds as earned rather than collected. The Company had $236,927 included in current assets retained relating to discontinued operations as of December 31, 2008 relating to the deferred sales proceeds. In addition, there were $97,885 remaining of the deferred sale proceeds to be recorded at December 31, 2008. In March 2009, the Company had a $215,206 receivable related to the deferred sale proceeds that was to be paid to the Company over the next six months. The Company gave New Vad, LLC a $32,281 discount in exchange for paying the receivable balance in March 2009. As of March 31, 2009 there were no remaining deferred sale proceeds to be earned or collected. The following are condensed statements of the discontinued operations (Vaddio) for the nine months ended September 30: 2009 2008 -------- -------- Sales, Net $ -- $ -- Cost of goods sold -- -- -------- -------- Gross profit -- -- Selling, general, and administrative -- 37,070 -------- -------- Income (loss) from operations -- (37,070) Other income (expense) -- -- Gain on sale of building -- -- Gain on sale of equipment -- -- Gain on sale of Vaddio product line 59,332 81,647 -------- -------- Income and gain from discontinued operations before income taxes 59,332 44,577 -------- -------- Provision for income taxes -- -- -------- -------- Gain from discontinued operations $ 59,332 $ 44,577 ======== ======== 18
Assets and liabilities retained relating to the discontinued operations (Vaddio) consisted of the following at September 30, 2009 and December 31, 2008. 2009 2008 ---------- ---------- Current assets retained relating to discontinued operations: Accounts receivable $ - $ - Other Receivables - 236,927 Inventory - - ---------- ---------- Total $ - $ 236,927 ========== ========== NOTE 14 - SUPPLEMENTAL CASH FLOWS 2009 2008 ---------- ---------- Supplemental Cash Flow Disclosures Cash paid for interest $ 191,167 $ 112,896 Cash paid for income taxes - - Supplemental cash flow information regarding the Company's acquisition of assets associated with Castaic Softbait brand Fair value of assets acquired $ 505,251 Less liabilities assumed (82,860) Net assets acquired 422,391 Less note payable issued (81,750) ---------- Less cash acquired - Net $ 340,641 ========== NOTE 14 - SUBSEQUENT EVENTS The Company was party to legal action pending in the Ninth Judicial District Court, Crow Wing County, State of Minnesota styled Esox Designs, Inc. vs. Nature Vision, Inc. The Plaintiff filed complaint against the defendants to recover amounts Plaintiff claims under a consulting agreement entered into in 2008. In October 2009, Court issued a default judgment against Nature Vision, Inc. in the amount of $179,166.63, which Swordfish Financial, Inc. will accrue as a liability. 19
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Forward Looking Statements Some of the statements made in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to the safe harbor provisions of the reform act. Forward-looking statements may be identified by the use of the terminology such as may, will, expect, anticipate, intend, believe, estimate, should or continue or the negatives of these terms or other variations on these words or comparable terminology. To the extent that this report contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of our business, you should be aware that our actual financial condition, operating results and business performance may differ materially from that projected or estimated by us in the forward-looking statements. We have attempted to identify, in context, some of the factors that we currently believe may cause actual future experience and results to differ from their current expectations. These differences may be caused by a variety of factors including, but not limited to, adverse economic conditions, intense competition, including entry of new competitors, inability to obtain sufficient financing to support our operations, progress in research and development activities, variations in costs, fluctuations in foreign currencies against the U.S. dollar in countries where we source products, adverse federal, state and local government regulation, unexpected costs, lower sales and net income (or higher net losses, than forecasted), price increases for equipment, inability to raise prices, failure to obtain new customers, the possible fluctuation and volatility of our operating results and financial condition, inability to carry out marketing and sales plans, loss of key executives and other specific risks that may be alluded to in this report. The following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with our audited consolidated financial statements and notes thereto appearing elsewhere in this report, which have been prepared assuming that we will continue as a going concern, and in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2008. As discussed in Note 1 to the condensed consolidated financial statements, our recurring net losses and inability to generate sufficient cash flows to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern. Management's plans concerning these matters are also discussed in Note 1 to the condensed consolidated financial statements. This discussion contains forward-looking statements that involve risks and uncertainties, including information with respect to our plans, intentions and strategies for our businesses. Our actual results may differ materially from those estimated or projected in any of these forward-looking statements. Overview Swordfish Financial, Inc., (f/k/a Nature Vision, Inc. and Photo Control Corporation) (the "Company" or "we") was incorporated as a Minnesota corporation in 1959. On August 31, 2004, the Company changed its name to Nature Vision, Inc. in connection with a merger transaction with Nature Vision Operating Inc. (f/k/a Nature Vision, Inc.) a Minnesota corporation that was incorporated in 1998. As a part of the merger, Nature Vision Operating Inc. became a wholly-owned subsidiary of the Company. On August 17, 2009, the shareholders of the Company owning a majority of the outstanding common stock voted to change its name to Swordfish Financial, Inc. The shares of the Company trade on the Over The Counter (OTC) Pinksheets under the symbol, "SWRF." Nature Vision designed, manufactured and marketed outdoor recreation products primarily for the sport fishing and hunting markets. The Company did not meet the minimum net worth covenants of a line of credit with M&I Business Credit LLC (M&I Bank) as of June 30, 2009, which put the Company in default on the line of credit. On August 14, 2009, simultaneously with the signing of the Swordfish Financial, Inc. stock purchase agreement, M&I Business Credit LLC, owed approximately $1,800,000 by the Company, foreclosed on the line of credit and forced the Company to enter into a Voluntary Surrender. The Voluntary Surrender Agreement tendered to M&I Business Credit LLC total possession of the Company's Premises, operations and all of the Company's Collateral, which consisted of all of the Company's assets. M&I Business Credit LLC liquidated basically all of the Company's assets to recover the line of credit debt. Based on the limited assets, product lines and resources remaining after the M&I Business Credit LLC liquidation, Swordfish Financial, Inc. has made the decided that there is not enough remaining of the Nature Vision operations to continue as an outdoor recreations products company and will concentrate on the business on being and asset recovery company and using the financial resources recovered to retire the Company's debts and invest in other businesses domestically and internationally. Despite cost reduction initiatives, the Company will be unable to pay its obligations in the normal course of business or service its debt in a timely manner throughout 2009 without completing a recovery project, raising additional debt or equity capital. There can be no assurance that the Company will complete a recovery project, raise additional debt or equity capital. 20
Revenue Revenue consists of sales of our products net of returns and allowances. Revenue includes sales via orders from distributors, dealers and direct consumers and includes customer service and shipping charges. New product innovation through the use of technology will continue to be the basis of our organic growth. Demand for our outdoor recreation products is seasonal, with the majority of sales occurring in the fourth and first quarters. We will continually look to strategic acquisitions to provide penetration into new product categories and distribution channels as well as level seasonality. Cost of Goods Sold Cost of goods sold for our products consists of the cost of direct materials, labor to produce the products, freight in, import duty, depreciation of production equipment, amortization of molds and patents, warehousing, associated management, occupancy costs, customer service and warranty, shipping and receiving costs, quality assurance and other indirect manufacturing costs. Cost of goods sold can fluctuate based on the product mix sold for a given period. Increasing oil costs continue to drive up the cost of components and freight to receive and ship products. In addition, currency fluctuations can impact our landed costs in the U.S.A. We continue to evaluate make in-house versus outsource opportunities to minimize product costs. We look to increase our purchasing capacities and distribution abilities in order to achieve efficiencies in certain operating costs. Gross Profit We define gross profit as the difference between revenue and cost of goods sold. We believe that gross profit is our best metric to manage the business on a product line basis. Selling, General and Administrative Expenses Selling, general and administrative expenses include directly identifiable operating costs and other expenses. The majority of these costs are fairly consistent from month to month, with the exception of advertising and sales commissions. Selling expenses consist of payroll, commissions, product management, marketing, advertising and customer relationship costs. General and administrative expenses include payroll, product design, product development, engineering, order processing, management information systems, accounting and administrative costs. Income (Loss) from Operations Income (Loss) from Operations is defined as revenue less cost of goods sold and selling, general and administrative expenses. Other Income (Expense) Other expense consists primarily of interest on the existing line of credit. The interest rate is at the greater of 6% or prime plus .75%. Gain (Loss) from Discontinued Operations On October 20, 2006, Nature Vision, Inc. sold the Norman product line of its Photo Control division (Norman) and renamed the division the Vaddio Division. On February 5, 2007, the Company sold certain assets and transferred certain liabilities related to its Vaddio division (Vaddio). In accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," this operating segment was classified as discontinued operations and the financial results are reported separately as discontinued operations for all periods presented. 21
Results of Operations The following table provides the percentage change in our net sales, gross profit, loss from operations, and net (loss) for the three months and nine months ended September 30, 2009 and September 30, 2008: (in thousands) Three months ended Increase Nine months ended Increase September 30 (Decrease) September 30 (Decrease) ------------------------ ----------- ------------------------ ----------- 2009 2008 2009 2008 NET SALES $ 740 $ 2,200 (66.4%) $ 4,460 $ 6,017 (22.88%) GROSS PROFIT/ LOSS (42) 317 (113.25%) 410 964 (57.47%) LOSS FROM OPERATIONS (397) (724) (45.17%) (2,440) (2,090) 16.75% NET LOSS $(1,976) $ (980) 101.63% $(7,601) $(1,499) 407.07% The following table presents our gross profit, loss from operations and net loss as a percentage of net sales for the three months and nine months ended September 30, 2009 and September 30, 2008: Three months ended Nine months ended September 30 September 30 ------------------------- ------------------------- 2009 2008 2009 2008 GROSS PROFIT/LOSS 5.7% 14.4% 8.8% 16.0% LOSS FROM OPERATIONS 53.65% 32.9% 52.6% 35.7% NET LOSS 267.02% 44.6% 163.8% 24.9% Net Sales Net sales for the quarter ending September 30, 2009 of $739,556 were down by $1,463,297, or 66.4% compared to net sales of $2,199,853 during the same period last year. Year to date net sales for the nine months ending September 30, 2009 of $4,460,309 were down by $1,376,775, or 22.9% compared to net sales of $6,017,084 during the same period last year. Net sales decrease for the third quarter was primarily the result of M&I Business Credit LLC foreclosing on it line of credit loan to the Company and taking total possession of the Company's Premises, operations and all of the Company's Collateral, which consisted of all of the Company's assets. After the foreclosure process, M&I Business Credit LLC disregarded the Company's operations and concentrated on liquidating the Company's assets to recover the line of credit debt as quickly as possible. Net sales decrease for the nine months ending September 30, 2009 was primarily the result of M&I Business Credit LLC foreclosing on it line of credit loan to the Company and taking total possession of the Company's Premises, operations and all of the Company's Collateral, which consisted of all of the Company's assets. After the foreclosure process, M&I Business Credit LLC disregarded the Company's operations and concentrated on liquidating the Company's assets at substantially low values to recover the line of credit debt as quickly as possible. Gross Profit Gross profit (loss) of $(42,248) was 5.7% of net sales for the three months ended September 30, 2009 compared to $317,147 or (14.4)% of net sales for the prior year three months ended. The primary reasons for the increase in the gross margin as compared to the prior year was the result of M&I Business Credit LLC foreclosing on it line of credit loan to the Company and taking total possession of the Company's Premises, operations and all of the Company's Collateral, which consisted of all of the Company's assets. After the foreclosure process, M&I Business Credit LLC disregarded the Company's operations and concentrated on liquidating the Company's assets at substantially low values to recover the line of credit debt as quickly as possible. 22
Gross profit of $410,360 was 8.8% of net sales for the nine months ended September 30, 2009 compared to $963,792 or 16.0% of net sales for the prior year nine months ended. The primary reasons for the decrease in the gross margin as compared to the prior year was the result of M&I Business Credit LLC foreclosing on it line of credit loan to the Company and taking total possession of the Company's Premises, operations and all of the Company's Collateral, which consisted of all of the Company's assets. After the foreclosure process, M&I Business Credit LLC disregarded the Company's operations and concentrated on liquidating the Company's assets at substantially low values to recover the line of credit debt as quickly as possible. Selling, General and Administrative Expenses Total selling, general and administrative expenses for the quarter ending September 30, 2009 of $354,849, or 48% of sales, were down compared to spending of $1,040,954, or 47.3% of sales during the comparative period in 2008. Selling, general and administrative costs decreased due to the termination of all of the Company's employees on August 14, 2009 and the lack of concentration on sales by M&I Business Credit LLC after its August 14, 2009 foreclosure on it line of credit loan to the Company. After the foreclosure process, M&I Business Credit LLC disregarded the Company's operations and concentrated on liquidating the Company's assets at substantially low values to recover the line of credit debt as quickly as possible. Total selling, general and administrative expenses for the nine months ending September 30, 2009 of $2,251,631, or 48.5% of sales, were level percentage wise with spending of $3,053,862, or 50.8% of sales during the comparative period in fiscal 2008. Selling, general and administrative costs decreased due to the termination of all of the Company's employees on August 14, 2009 and the lack of concentration on sales by M&I Business Credit LLC after its August 14, 2009 foreclosure on it line of credit loan to the Company. After the foreclosure process, M&I Business Credit LLC disregarded the Company's operations and concentrated on liquidating the Company's assets at substantially low values to recover the line of credit debt as quickly as possible. Operating Expenses Total operating expenses for the three months ending September 30, 2009 of $354,849, or 48% of sales, down from spending of $1,040,954, or 47.3% of sales during the comparative period in fiscal 2008. Selling, general and administrative costs have decreased for the three months ended June 30, 2009 primarily due to the termination of all of the Company's employees on August 14, 2009 and the lack of concentration on sales by M&I Business Credit LLC after its August 14, 2009 foreclosure on it line of credit loan to the Company. After the foreclosure process, M&I Business Credit LLC disregarded the Company's operations and concentrated on liquidating the Company's assets at substantially low values to recover the line of credit debt as quickly as possible. Total operating expenses for the nine months ending September 30, 2009 of $2,850,065 or 61.4% of sales, were down from spending of $3,053,862, or 50.8% of sales during the comparative period in fiscal 2008. Selling, general and administrative costs decreased by $$203,797 for the nine months ended September 30, 2009 as the result of a decrease of $802,231 in selling, general and administrative expenses resulting from the termination of all of the Company's employees on August 14, 2009 and the lack of concentration on sales by M&I Business Credit LLC after its August 14, 2009 foreclosure on it line of credit loan to the Company. After the foreclosure process, M&I Business Credit LLC disregarded the Company's operations and concentrated on liquidating the Company's assets at substantially low values to recover the line of credit debt as quickly as possible plus an impairment provision of $598,434 against assets. Other Income and Expenses Other expenses increased by $1,446,931 for the three months ended September 30, 2009 as compared to the prior year three months ended September 30, 2008. The increase is due to a loss of $1,539,272 recorded during the quarter relating to the M&I Business Credit LLC foreclosure discussed above offset by a decrease of $66,547 in interest expense and an increase of $21,875 in interest income. Other expense increased by approximately $4,821,876 for the nine months ended September 30, 2009 as compared to the prior year nine months ended September 30, 2008. The increase is due to a loss of $4,904,566 recorded during the nine month period as the result of the M&I Business Credit LLC foreclosure discussed above offset by a decrease of $65,372 in interest expense and an increase of $21,875 in interest income. Loss from Continuing Operations The Company recognized a pretax loss of $1,976,223 for the three months ended September 30, 2009, compared to a pretax loss of $856,002 for the three months ended September 30, 2008. The increase in the pretax loss is as a result of the fluctuations discussed above and $1,539,272 increase during the quarter ended September 30, 2009 in the loss on bank default due to the M&I Bank's taking over the Company's assets and operations on August 14, 2009 and liquidating the assets at substantially low values to recover approximately $1,800,000 owed by the Company as quickly as possible. 23
The Company recognized a pretax loss of $7,660,600 for the nine months ended September 30, 2009, compared to a pretax loss of $2,917,363 for the nine months ended September 30, 2008. The increase in the pretax loss is as a result of the fluctuations discussed above and $4,904,566 loss on bank default and $598,434 in the impairment allowances against the Company's assets due to the M&I Bank's taking over the Company's assets and operations on August 14, 2009 and liquidating the assets at substantially low values to recover approximately $1,800,000 owed by the Company on the repossession date as quickly as possible. Gain from Discontinued Operations In the three months ended September 30, 2009, the Company had no gain from discontinued operations, while in the three months ended September 30, 2008, the Company recognized a gain of $303,804 resulting primarily from the sale of its facilities in New Hope, MN. In the nine months ended September 30, 2009, the Company recognized a $59,332 gain from discontinued operations on the sale of the Vaddio product line, while in the nine months ended September 30, 2008, the Company recognized a gain of $1,418,609 resulting primarily from the sale of its facilities in New Hope, MN. and from the sale of the Vaddio product line. Net Loss The Company recognized a net loss of approximately $1,976,223 for the three months ended September 30, 2009 compared to a net loss of $980,472 for the three months ended September 30, 2008. . The increase in the pretax loss is as a result of the fluctuations discussed above and $1,539,272 increase during the quarter ended September 30, 2009 in the loss on bank default due to the M&I Bank's taking over the Company's assets and operations on August 14, 2009 and liquidating the assets at substantially low values to recover approximately $1,800,000 owed by the Company on the date of repossession as quickly as possible. The Company recognized a net loss of approximately $7,601,268 for the nine months ended September 30, 2009 compared to a net loss of $1,498,754 for the nine months ended September 30, 2008. The increase in the pretax loss is as a result of the fluctuations discussed above and $4,904,566 loss on bank default and $598,434 in the impairment allowances against the Company's assets due to the M&I Bank's taking over the Company's assets and operations on August 14, 2009 and liquidating the assets at substantially low values to recover approximately $1,800,000 owed by the Company on the repossession date as quickly as possible. Liquidity and Capital Resources The Company's cash flow from operating, investing and financing activities, as reflected in the consolidated statements of cash flows, is summarized in the following table for the nine months ended September 30: (thousands) 2009 2008 ------------ ------------ Cash provided by (used for): Operating activities $ 2,473,992 $ (769,576) Investing activities 261,461 1,367,472 Financing activities (2,583,777) (729,383) ------------ ------------ Increase (decrease) in cash and cash equivalents $ 151,676 $ (131,487) ============ ============ Operating Activities Cash flows from operations totaled $2,473,992 and $(769,675) for the nine months ended September 30, 2009 and 2008, respectively. The primary reasons for the cash flow from operations for the nine months ended September 30, 2009 was $5,502,999 of non cash charges for loss on bank default and provisions for impairments and $3,637,870 in liquidation of accounts receivable and inventory which collectively total $9,140,869 compared to the net loss of $7,601,268. Investing Activities Cash flows provided from (used in) investing activities totaled $261,461 and $1,367,472 for the nine months ended September 30, 2009 and 2008, respectively. The proceeds related to the sale of Vaddio generated $236,927 for the nine months ended September 30, 2009. Financing Activities Cash flows provided by (used for) financing activities totaled ($2,583,777) and ($729,383) for the nine months ended September 30, 2009 and 2008, respectively. Payments during the nine months ended September 30, 2009 were $2,325,639 on the bank line of credit and $250,000 on the note payable - related party. 24
On November 8, 2007, the Company entered into a line of credit agreement, a demand note, with M&I Bank for up to a maximum amount of $6,000,000. Interest is payable monthly at the greater of one month LIBOR plus 3.75% or 5.25% (5.25% at March 31, 2009). The line of credit is collateralized by accounts receivable, inventories, property and equipment, and other assets of the Company. The facility is based on the following borrowing base restrictions, 75% of eligible accounts receivable and 50% of eligible inventories. In connection with this agreement, the Company is required to pay an annual line fee of $45,000 and minimum interest of $120,000 on an annual basis. The balance outstanding on the line of credit was $1,698,995 and $3,084,956 at June 30, 2009 and December 31, 2008, respectively. The terms of the credit agreement are written such that the line will stay in place for up to three years if the Company can satisfactorily perform within certain covenants outlined by the bank. The agreement required the Company to be in compliance with the following affirmative covenants as of March 31, 2009: minimum net worth (including subordinated debt) of $5,500,000 and minimum tangible net worth of $2,200,000 and annual capital expenditures not to exceed $500,000. The Company did not meet the minimum net worth covenants as of June 30, 2009. In August 2009, the Company agreed to a Voluntary Surrender Agreement with M&I Bank, which allows the bank to sell Company assets until the line of credit returns to a compliant status. In October 2008, the Company borrowed $700,000 from its Chief Executive Officer (CEO) in order to meet its short-term cash flow requirements. This promissory note was unsecured and had an interest rate of 15%. The entire principal and accrued interest was payable on January 1, 2009, of which the Company paid $250,000 in January 2009. In connection with the loan, the Company issued warrants to the Chief Executive Officer to purchase 50,555 shares of common stock at an exercise price of $.90. The warrants are exercisable from October 28, 2008 through October 27, 2010. The CEO agreed to the cancellation of the warrants in August 2009. The Company is currently in default on the remaining $450,000 of the note and is in negotiations to extend the remaining $450,000 of the CEO's note. The CEO agreed to extend the note for twelve months from August 14, 2009 per the Stock Purchase Agreement with Swordfish Financial, Inc. In July 2008, the Company amended the terms and replaced the original $1,000,000 demand note issued to the member of its Board of Directors in October 2007. The amended $1,000,000 demand note is held by the same member of the Company's Board of Directors. The demand promissory note is unsecured and bears an interest rate of 15%. Interest is payable on the first day of each month commencing on August 1, 2008. The entire principal and interest is payable upon demand anytime after June 30, 2010. The Board of Director agreed to extend the note for twelve months from August 14, 2009 per the Stock Purchase Agreement with Swordfish Financial, Inc. In connection with the new loan, the Company issued additional warrants to the Director to purchase 100,000 shares of common stock at an exercise price of $1.31. The Director agreed to the cancellation of the warrants in August 2009. In May 2008, the Company entered into a research and development consulting agreement with an entity that had common ownership with MarCum. The agreement requires the Company to pay the entity as follows: (i) $525,000 in 36 monthly installments of $14,583 for research and development services beginning June 1, 2008, (ii) $200,000 in 24 monthly installments of $8,333 for product support services beginning June 1, 2008. The Company has recognized approximately $134,000 of expense relating to this agreement for the nine months ended September 30, 2009, which is included in research and development and engineering expense. In May 2008, the Company entered into a research and development consulting agreement with an entity that had common ownership with MarCum. The agreement requires the Company to pay the entity as follows: (i) $180,000 in 36 monthly installments of $5,000 for research and development services beginning June 1, 2008, (ii) $100,000 in 24 monthly installments of $4,166 for product support services beginning June 1, 2008. The Company has recognized approximately $83,000 of expense relating to this agreement for the nine months ended September 30, 2009, which is included in research and development and engineering expense. The Company entered into a lease agreement for its assembly and distribution facility and corporate headquarters in Brainerd, Minnesota. The lease commenced on September 1, 2006 and expires on August 31, 2016. The lease was amended in May 2008 for additional space, a sprinkler system improvement addition, and the term extended through August 31, 2018. The lease was further amended by a second amendment as of July 1, 2009 giving the Company and the Landlord the right to terminate the lease effective as of December 31, 2009 by giving the notice 30 days prior to the effective date of termination. This second amendment also reduces the monthly rent from $21,801 to $15,000 with the $6,801 being deferred and waived by the Landlord if the Company timely pays the Adjusted Monthly Charge through December 31, 2009. The Company will record monthly rent expense equal to the total of the payments due over the lease term, divided by the number of months of the lease term. The difference between rent expense recorded and the amount paid will be credited or charged to deferred rent. The Company is also required to pay its portion of operating expenses. Based on the terms of the second amendment the Company will have the right to terminate the lease on December 31, 2009 by giving the Landlord notice on or before November 30, 2009. The future minimum lease payments through December 31, 2009 are $45,000. The Company is under a technology purchase agreement requiring payment of $50,000 by September 30, 2009. 25
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business. We incurred net losses of $7,601,268 and $1,498,754, respectively, for the nine months ended September 30, 2009 and 2008 and had an accumulated deficit of $12,269,785 as of September 30, 2009. We have managed our liquidity during the first nine months of 2009 through cost reduction initiatives and the proceeds from liquidation of accounts receivable and inventory. The Company is currently in default of the remaining $450,000 of the note payable - related party. The related party agreed in August 2008 to extend the note for twelve months as part of the Swordfish Financial, Inc. stock purchase agreement. The Company is also not in compliance with the terms of its line of credit loan from the bank and in August 2008 voluntarily agreed to surrender the Company's assets and operations to the bank on August 14, 2009 until the bank liquidates enough assets to cover its loan. The Company is also in default on $603,950 of other notes payable. The Company has historically been a seasonal business with the majority of the Company's revenue being realized in the fourth quarter. On the August 14, 2009 foreclosure by M&I Business Credit LLC and forcing the Company to enter into a Voluntary Surrender Agreement which tendered to M&I Business Credit LLC total possession of the Company's Premises, operations and all of the Company's assets to collect the approximately $1,800,000 owed by the Company. After the M&I Business Credit LLC's liquidations of virtually all of the Company's assets at significant discounts to book value, Swordfish has been left with virtually no product lines to market and continue the Nature Vision outdoor recreations products operations. Despite cost reduction initiatives, the Company will be unable to pay its obligations in the normal course of business or service its debt in a timely manner throughout 2009 without raising additional debt or equity capital. See Note 3, for a discussion of capital acquired by the Company. There can be no assurance that this financing arrangement will alleviate the Company's 12 month working capital needs unless it is funded or the Company can complete a recovery project. The Company is currently evaluating strategic alternatives that include the following: (i) raising of capital, or (ii) the sale of the Company's assets to pay off its debts. This process is ongoing and may be lengthy and has inherent costs. There can be no assurance that the this process will result in any specific action to alleviate the Company's 12 month working capital needs or result in any other transaction. In the event future cash flows and borrowing capacities are not sufficient to fund operations at the present level, additional measures will be taken including a reduction in operating and capital expenditures. In addition, we believe that other sources of liquidity are available which may include additional subordinated debt, and raising additional capital. However, there is no assurance that these other sources of liquidity will be available or on terms acceptable to the Company. The Company believes that the effect of inflation has not been material during the nine months ended September 30, 2009. Off-Balance Sheet Financing Arrangements As of September 30, 2009, there were no off-balance sheet arrangements, unconsolidated subsidiaries and commitments or guaranties of other parties. Critical Accounting Policies The Company's critical accounting policies are identified in the Company's Annual Report on Form 10-K for the fiscal year ending December 31, 2008 in Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading "Critical Accounting Policies." There were no significant changes to the Company's critical accounting policies during the nine months ended September 30, 2009. Item 3: Quantitative and Qualitative Disclosures About Market Risk. Not Applicable 26
Item 4T: Controls and Procedures. Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the company's principal executive officer and principal financial officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: o pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; o provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and o provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In September 2009, we conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established in "Internal Control -- Integrated Framework," issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based upon this assessment, we determined that there are material weaknesses affecting our internal control over financial reporting. The matters involving internal controls and procedures that our management considers to be material weaknesses under COSO and SEC rules are: (1) lack of a functioning audit committee and lack of independent directors on our board of directors, resulting in potentially ineffective oversight in the establishment and monitoring of required internal controls and procedures; (2) inadequate segregation of duties consistent with control objectives; (3) insufficient written policies and procedures for accounting and financial reporting with respect to the requirements and application of US GAAP and SEC disclosure requirements; and (4) ineffective controls over period end financial disclosure and reporting processes. The aforementioned potential material weaknesses were identified by our Chief Financial Officer in connection with the preparation of our financial statements as of September 30, 2009 who communicated the matters to our management and board of directors. Management believes that the material weaknesses set forth in items (2), (3) and (4) above did not have an affect on our financial results. However, the lack of a functioning audit committee and lack of a majority of independent directors on our board of directors, resulting in potentially ineffective oversight in the establishment and monitoring of required internal controls and procedures, can impact our financial statements. Management's Remediation Initiatives ------------------------------------ Although we are unable to meet the standards under COSO because of the limited funds available to a company of our size, we are committed to improving our financial organization. As funds become available, we will undertake to: (1) create a position to segregate duties consistent with control objectives, (2) increase our personnel resources and technical accounting expertise within the accounting function (3) appoint one or more outside directors to our board of directors who shall be appointed to a Company audit committee resulting in a fully functioning audit committee who will undertake the oversight in the establishment and monitoring of required internal controls and procedures; and (4) prepare and implement sufficient written policies and checklists which will set forth procedures for accounting and financial reporting with respect to the requirements and application of US GAAP and SEC disclosure requirements. 27
We will continue to monitor and evaluate the effectiveness of our internal controls and procedures and our internal control over financial reporting on an ongoing basis and are committed to taking further action and implementing additional enhancements or improvements, as necessary and as funds allow. However, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Part II - OTHER INFORMATION Item 1. Legal Proceedings. Breach of Contract Action On August 14, 2009, M&I Business Credit LLC, owed approximately $1,800,000 by the Company, foreclosed on the Company's assets under a Credit and Security Agreement dated November 8, 2007 (as amended or supplemented, the "Credit Agreement") and the Company entered into a Voluntary Surrender Agreement which tendered to M&I Business Credit LLC total possession of the Company's Premises, operations and all of the Company's Collateral, which was basically all of the Company's assets, until M&I Business Credit LLC liquidates sufficient assets to pay off the line of credit owed by the Company. On October 30, 2009, M&I Business Credit LLC notified the Company that it had converted sufficient Company assets to recover the Company's debt and was turning back to the Company possession of the Company's Premises, operations and remaining assets. The Company was party to legal action pending in the Ninth Judicial District Court, Crow Wing County, State of Minnesota styled Esox Designs, Inc. vs. Nature Vision, Inc. The Plaintiff filed complaint against the defendants to recover amounts Plaintiff claims under a consulting agreement entered into in 2008. In October 2009, Court Issued a default judgment against Nature Vision, Inc. in the Amount of $179,166.63, which Swordfish Financial, Inc. will accrue as an expense. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. On August 14, 2009, the Company entered into a Stock Purchase Agreement with Swordfish Financial, Inc. pursuant to which the Company sold an aggregate of 10,987,417 shares of its common stock in exchange for a $3,500,000 promissory note, payable in two installments of $1,750,000 each with the first installment being forty-five (45) days from the date of the note and the second installment being one-hundred twenty (120) days from the date of the note. The issuance of these shares was exempt from the registration requirements of the Securities Act of 1933 under Section 4 (2) thereof. Item 3. Defaults Upon Senior Securities. Not applicable. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Item 5. Other Information. As a result of the Swordfish Financial, Inc. stock purchase described in Note 3 to the financial statements, a change in control occurred with respect to the Company's capital stock ownership. Mssrs Richard P. Kiphart, Jeffery P. Zernov, Scott S. Meyers and Curtis A. Sampson served as the members of the Board of Directors. Pursuant to the terms and conditions set forth in the Stock Purchase Agreement, immediately following the closing of the Transaction, (1) On August 13, 2009, Michael D. Alexander and Randy J. Moseley were appointed as a members to the Board of Directors effective August 14, 2009 and (2) Richard P. Kiphart, Jeffery P. Zernov, Scott S. Meyers and Curtis A. Sampson voluntarily tendered their resignations, effective August 14, 2009, as members of the Company's Board of Directors. On August 13, 2009, the Company received from each of Jeffrey P. Zernov, President and Chief Executive Officer and Robert P. King, Chief Financial Officer and Secretary a letter voluntarily resigning their respective officer positions with the Company. On August 17, 2009, the board of directors appointed Michael D. Alexander as the President and Chief Executive Officer of the Company and Randy Moseley as Chief Financial Officer of the Company. On August 17, 2009, the board of directors voted to amend the Company's Articles of Incorporation to change the name of the Company to Swordfish Financial, Inc. 28
Item 6. Exhibits. Listing of Exhibits: 31.1 Certification of Chief Executive Officer. 31.2 Certification of Chief Financial Officer. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 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. SWORDFISH FINANCIAL, INC. Date: March 5, 2010 By: /s/ Michael Alexander ----------------------------- Its: Chief Executive Officer and President Date: March 5, 2010 By: /s/ Randy Moseley ----------------------------- Its: Chief Financial Officer 29