Attached files
file | filename |
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EX-32 - CYBERDEFENDER CORP | v206005_ex32.htm |
EX-31.2 - CYBERDEFENDER CORP | v206005_ex31-2.htm |
EX-31.1 - CYBERDEFENDER CORP | v206005_ex31-1.htm |
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-Q
Mark
One
x
|
Quarterly
report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934 for the quarterly period ended September 30, 2010;
or
|
¨
|
Transition
report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934 for the transition period from ________________ to ________
___________.
|
Commission
File No. 333-138430
CYBERDEFENDER CORPORATION
|
(Exact
name of registrant as specified in its
charter)
|
Delaware
|
65-1205833
|
|
(State
or other jurisdiction of
|
(I.R.S.
Employer Identification No.)
|
|
incorporation
or organization)
|
617 West 7th Street, 10th Floor, Los Angeles, California
90017
|
(Address
of principal executive
offices)
|
(213) 689-8631
|
(Registrant’s
telephone number, including area
code)
|
(Former
name, former address and former fiscal year if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. x Yes ¨ No
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation
S-T (§232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files). ¨ Yes ¨ No (The registrant is
not yet subject to this requirement.)
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
the definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer
|
¨
|
Accelerated
filer
|
¨
|
|
Non-accelerated filer
|
¨
|
(Do not check if a smaller reporting company)
|
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
As of
December 10, 2010, 27,216,890 shares of the registrant’s common stock, $0.001
par value, were outstanding.
FORM
10-Q
September
30, 2010
TABLE OF
CONTENTS
Page Number
|
||
PART
I - FINANCIAL INFORMATION
|
||
Item
1. Financial Statements (Unaudited)
|
||
Condensed
Balance Sheets - September 30, 2010 and December 31, 2009
|
1
|
|
Condensed
Statements of Operations - For the Three and Nine Months Ended September
30, 2010 and 2009
|
2
|
|
Condensed
Statements of Cash Flows - For the Nine Months Ended September 30, 2010
and 2009
|
3
|
|
Notes
to Condensed Financial Statements
|
5
|
|
Forward-Looking
Statements
|
24
|
|
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
|
25
|
|
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
|
33
|
|
Item
4. Controls and Procedures
|
33
|
|
PART
II - OTHER INFORMATION
|
||
Item
1. Legal Proceedings
|
34
|
|
Item
1A. Risk Factors
|
34
|
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
34
|
|
Item
3. Defaults Upon Senior Securities
|
34
|
|
Item
4. Removed and Reserved
|
34
|
|
Item
5. Other Information
|
34
|
|
Item
6. Exhibits
|
35
|
|
Signatures
|
36
|
Part
I - FINANCIAL INFORMATION
Item
1. Financial Statements (Unaudited)
CYBERDEFENDER
CORPORATION
CONDENSED
BALANCE SHEETS
(UNAUDITED)
September
30,
|
December
31,
|
|||||||
2010
|
2009
|
|||||||
(Restated)
|
||||||||
ASSETS
|
||||||||
CURRENT
ASSETS:
|
||||||||
Cash
|
$ | 2,805,701 | $ | 3,357,510 | ||||
Restricted
cash
|
2,520,215 | 1,565,841 | ||||||
Accounts
receivable
|
2,032,724 | 489,464 | ||||||
Deferred
financing costs
|
103,484 | 191,566 | ||||||
Prepaid
expenses
|
307,117 | 302,291 | ||||||
Deferred
charges, current
|
1,811,889 | 3,316,535 | ||||||
Total
Current Assets
|
9,581,130 | 9,223,207 | ||||||
PROPERTY
AND EQUIPMENT, net
|
1,716,746 | 242,927 | ||||||
DEFERRED
CHARGES, net of current portion
|
451,627 | 609,904 | ||||||
OTHER
ASSETS
|
281,572 | 115,497 | ||||||
Total
Assets
|
$ | 12,031,075 | $ | 10,191,535 | ||||
CURRENT
LIABILITIES:
|
||||||||
Accounts
payable
|
$ | 7,850,476 | $ | 4,893,186 | ||||
Accrued
expenses
|
1,010,763 | 862,023 | ||||||
Deferred
revenue, current
|
10,790,277 | 9,662,030 | ||||||
Capital
lease obligations, current
|
115,511 | 9,410 | ||||||
Total
Current Liabilities
|
19,767,027 | 15,426,649 | ||||||
DEFERRED
RENT
|
360,558 | 65,938 | ||||||
DEFERRED
REVENUE, less current portion
|
3,372,994 | 1,117,116 | ||||||
CONVERTIBLE
NOTES PAYABLE, net of discount
|
4,512,822 | 1,593,000 | ||||||
CAPITAL
LEASE OBLIGATIONS, less current portion
|
170,185 | 9,708 | ||||||
Total
Liabilities
|
28,183,586 | 18,212,411 | ||||||
STOCKHOLDERS’
DEFICIT:
|
||||||||
Preferred stock, par value
$0.001; 10,000,000 shares authorized; no shares issued and outstanding at
September 30, 2010 and December 31, 2009,
respectively
|
- | - | ||||||
Common stock, par value $0.001;
100,000,000 shares authorized; 27,034,651 and 25,673,967 shares issued and outstanding at
September 30, 2010 and December 31, 2009,
respectively
|
27,035 | 25,674 | ||||||
Additional
paid-in capital
|
59,968,412 | 36,884,000 | ||||||
Accumulated
deficit
|
(76,147,958 | ) | (44,930,550 | ) | ||||
Total
Stockholders’ Deficit
|
(16,152,511 | ) | (8,020,876 | ) | ||||
Total Liabilities
and Stockholders’ Deficit
|
$ | 12,031,075 | $ | 10,191,535 |
See
accompanying notes to condensed financial statements
1
CYBERDEFENDER
CORPORATION
CONDENSED
STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
|
Nine Months Ended
|
|||||||||||||||
September
30,
|
September
30,
|
September
30,
|
September
30,
|
|||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
(Restated)
|
(Restated)
|
|||||||||||||||
REVENUES:
|
||||||||||||||||
Net
sales
|
$ | 12,746,103 | $ | 4,427,404 | $ | 31,936,019 | $ | 11,305,678 | ||||||||
COST
OF SALES
|
5,833,897 | 1,018,370 | 13,002,748 | 2,451,398 | ||||||||||||
GROSS
PROFIT
|
6,912,206 | 3,409,034 | 18,933,271 | 8,854,280 | ||||||||||||
OPERATING
EXPENSES:
|
||||||||||||||||
Media
and marketing services
|
12,455,307 | 4,717,729 | 34,662,346 | 13,363,588 | ||||||||||||
Product
development
|
742,207 | 464,761 | 2,457,726 | 1,129,995 | ||||||||||||
General
and administrative
|
4,252,866 | 2,128,523 | 11,402,399 | 6,477,178 | ||||||||||||
Depreciation
and amortization
|
51,867 | 8,980 | 127,012 | 29,076 | ||||||||||||
Total
Operating Expenses
|
17,502,247 | 7,319,993 | 48,649,483 | 20,999,837 | ||||||||||||
LOSS
FROM OPERATIONS
|
(10,590,041 | ) | (3,910,959 | ) | (29,716,212 | ) | (12,145,557 | ) | ||||||||
OTHER
INCOME/(EXPENSES):
|
||||||||||||||||
Change
in the value of derivative liabilities
|
- | - | - | 109,058 | ||||||||||||
Interest
expense, net
|
(291,279 | ) | (445,458 | ) | (1,501,196 | ) | (2,164,189 | ) | ||||||||
Total
Other Expenses, net
|
(291,279 | ) | (445,458 | ) | (1,501,196 | ) | (2,055,131 | ) | ||||||||
NET
LOSS
|
$ | (10,881,320 | ) | $ | (4,356,417 | ) | $ | (31,217,408 | ) | $ | (14,200,688 | ) | ||||
Basic
and diluted net loss per share
|
$ | (0.40 | ) | $ | (0.18 | ) | $ | (1.18 | ) | $ | (0.69 | ) | ||||
Weighted
Average Shares Outstanding:
|
||||||||||||||||
Basic
and diluted
|
27,027,189 | 23,619,718 | 26,408,814 | 20,688,198 |
See
accompanying notes to condensed financial statements
2
CYBERDEFENDER
CORPORATION
CONDENSED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended
|
||||||||
September 30,
2010
|
September 30,
2009
|
|||||||
(Restated)
|
||||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
loss
|
$ | (31,217,408 | ) | $ | (14,200,688 | ) | ||
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
Amortization
of debt discount
|
923,143 | 1,044,826 | ||||||
Change
in fair value of derivative liabilities
|
- | (109,058 | ) | |||||
Depreciation
and amortization
|
127,012 | 29,076 | ||||||
Compensation
expense from vested stock options
|
700,569 | 200,479 | ||||||
Amortization
of deferred financing costs
|
186,992 | 375,697 | ||||||
Warrants
issued for media and marketing services
|
18,321,762 | 2,095,548 | ||||||
Shares
and warrants issued for services, interest and penalties
|
592,765 | 2,631,003 | ||||||
Warrants
issued in connection with warrant tender offer
|
- | 548,728 | ||||||
Changes
in operating assets and liabilities:
|
||||||||
Restricted
cash
|
(954,374 | ) | (1,297,093 | ) | ||||
Accounts
receivable
|
(1,543,260 | ) | 73,012 | |||||
Prepaid
expenses
|
(4,826 | ) | (27,151 | ) | ||||
Deferred
charges
|
1,662,923 | (2,244,144 | ) | |||||
Other
assets
|
(213,967 | ) | (6,663 | ) | ||||
Accounts
payable and accrued expenses
|
3,619,039 | 265,938 | ||||||
Deferred
revenue
|
3,384,125 | 5,103,399 | ||||||
Cash
Flows Used In Operating Activities:
|
(4,415,505 | ) | (5,517,091 | ) | ||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Additions
to property and equipment
|
(1,264,231 | ) | (6,567 | ) | ||||
Cash
Flows Used In Investing Activities
|
(1,264,231 | ) | (6,567 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Proceeds
from convertible notes payable and notes payable, net of
costs
|
4,948,982 | 621,700 | ||||||
Principal
payments on capital lease obligations
|
(70,022 | ) | (19,900 | ) | ||||
Proceeds
from exercise of stock options
|
62,392 | 83,086 | ||||||
Proceeds
from exercise of stock warrants, net of placement fees
|
186,575 | 2,024,901 | ||||||
Proceeds
from sale of stock, net of Commercial Funds
|
- | 3,206,880 | ||||||
Cash
Flows Provided by Financing Activities
|
5,127,927 | 5,916,667 | ||||||
NET
INCREASE/(DECREASE) IN CASH
|
(551,809 | ) | 393,009 | |||||
CASH,
beginning of period
|
3,357,510 | 779,071 | ||||||
CASH,
end of period
|
$ | 2,805,701 | $ | 1,172,080 |
See
accompanying notes to condensed financial statements
3
CYBERDEFENDER
CORPORATION
CONDENSED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended
|
||||||||
September 30,
2010
|
September 30,
2009
|
|||||||
(Restated)
|
||||||||
Supplemental
disclosures of cash flow information:
|
||||||||
Income
taxes paid
|
$ | 800 | $ | 800 | ||||
Cash
paid for interest
|
$ | 121,501 | $ | 102,338 | ||||
Supplemental
schedule of non-cash investing and financing activities:
|
||||||||
Discount
on note payable
|
$ | 908,571 | $ | 178,601 | ||||
Property
and equipment acquired through capital lease obligations
|
$ | 336,600 | $ | - | ||||
Warrants
issued for placement fees
|
$ | - | $ | 18,197 | ||||
Conversion
of notes payable and accrued interest to common stock
|
$ | 2,313,139 | $ | 3,942,754 | ||||
Cumulative
effect of accounting change to additional paid-in capital for
derivative liabilities
|
$ | - | $ | 7,065,940 | ||||
Cumulative
effect of accounting change to retained earnings for derivative
liabilities
|
$ | - | $ | 723,930 | ||||
Value
of warrants and embedded conversion features recorded to derivative
liabilities
|
$ | - | $ | 906,805 | ||||
Reclassification
of derivatives to equity
|
$ | - | $ | 7,139,757 |
See
accompanying notes to condensed financial statements
4
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
1 - INTERIM FINANCIAL STATEMENTS
These
unaudited interim financial statements have been prepared by CyberDefender
Corporation (the “Company”) pursuant to the rules and regulations of the
Securities and Exchange Commission (“SEC”) for interim financial
statements. The information furnished herein reflects all adjustments
(consisting of normal recurring accruals and adjustments) that are, in the
opinion of management, necessary to fairly present the operating results for the
respective periods. Certain information and footnote disclosures
normally present in annual financial statements prepared in accordance with
accounting principles generally accepted in the United States of America
(“GAAP”) have been omitted pursuant to such rules and
regulations. These unaudited interim financial statements should
be read in conjunction with the audited financial statements and footnotes
for the Company for its year ended December 31, 2009 included in the Company’s
Annual Report on Form 10-K/A. The results for the nine-month interim
period ended September 30, 2010 are not necessarily indicative of the results to
be expected for the full year ending December 31, 2010.
NOTE
2 – RESTATEMENT
On
November 19, 2010, the Company’s Audit Committee concluded that the Company’s
financial statements for the year ended December 31, 2009 and the quarters ended
March 31, June 30 and September 30, 2009, and the quarters ended March 31 and
June 30, 2010, should be restated in order to make the following
adjustments: (i) the Black Scholes value of the warrants issued by
the Company in March 2009 pursuant to a certain Media and Marketing Services
Agreement should have been classified as an operating expense rather than
interest expense, and the Black Scholes value of the warrants should be measured
as of each monthly vesting date rather than the grant date starting from March
2009 through September 2010; (ii) certain warrants issued to consultants must be
revalued as of their respective vesting dates rather than the grant date, using
the Black Scholes method; and (iii) all of the Company’s advertising expenses
starting in the fourth quarter of 2009 should have been expensed as incurred
rather than capitalized and amortized against revenues for a period of 12 months
under ASC 340-20 (collectively, the “Adjustments”).
The
following tables set forth the effects of the restatement on certain line items
within our consolidated balance sheet at December 31, 2009 and our statement of
operations for the three and nine months ended September 30, 2009:
December 31, 2009
|
||||||||||||
Restated
|
Adjustments
|
As Filed
|
||||||||||
Deferred
charges, current
|
$ | 3,316,535 | $ | (2,312,753 | ) | $ | 5,629,288 | (1) | ||||
Total
Current Assets
|
$ | 9,223,207 | $ | (2,312,753 | ) | $ | 11,535,960 | |||||
Additional
paid-in capital
|
$ | 36,884,000 | $ | 3,825,872 | $ | 33,058,128 | (2)(3) | |||||
Accumulated
deficit
|
$ | (44,930,550 | ) | $ | (6,138,625 | ) | $ | (38,791,925 | )(2) | |||
Total
Stockholders’ Deficit
|
$ | (8,020,876 | ) | $ | (2,312,753 | ) | $ | (5,708,123 | ) |
Reference
(1)
Expensing of direct-response advertising costs as incurred rather than
capitalizing and amortizing per ASC 340-20.
(2) The
Adjustments as described above.
(3) Per
Note 2 above, there was a reclassification from common stock to additional
paid-in capital as a result of the merger.
For
the Three Months Ended
|
For
the Nine Months Ended
|
|||||||||||||||||||||||
September 30, 2009
|
September 30, 2009
|
|||||||||||||||||||||||
Restated
|
Adjustments
|
As Filed
|
Restated
|
Adjustments
|
As Filed
|
|||||||||||||||||||
Media
and marketing services
|
$ | 4,717,729 | $ | 1,172,588 | $ | 3,545,141 | $ | 13,363,588 | $ | 2,666,446 | $ | 10,697,142 | (1) | |||||||||||
General
and administrative
|
$ | 2,128,523 | $ | 25,916 | $ | 2,102,607 | (2) | $ | 6,477,178 | $ | (1,009,190 | ) | $ | 7,486,368 | (1)(2) | |||||||||
Total
Operating Expenses
|
$ | 7,319,993 | $ | 1,198,504 | $ | 6,121,489 | $ | 20,999,837 | $ | 1,657,256 | $ | 19,342,581 | ||||||||||||
LOSS
FROM OPERATIONS
|
$ | (3,910,959 | ) | $ | (1,198,504 | ) | $ | (2,712,455 | ) | $ | (12,145,557 | ) | $ | (1,657,256 | ) | $ | (10,488,301 | ) | ||||||
Interest
expense
|
$ | 445,458 | $ | (397,638 | ) | $ | 843,096 | $ | 2,164,189 | $ | (644,337 | ) | $ | 2,808,526 | (1) | |||||||||
NET
LOSS
|
$ | (4,356,417 | ) | $ | (800,666 | ) | $ | (3,555,751 | ) | $ | (14,200,688 | ) | $ | (1,012,319 | ) | $ | (13,188,369 | ) | ||||||
EPS
|
$ | (0.18 | ) | $ | (0.03 | ) | $ | (0.15 | ) | $ | (0.69 | ) | $ | (0.05 | ) | $ | (0.64 | ) |
Reference
(1)
Reclassification and revaluation of warrants.
(2) The
Company consolidated its 2009 investor relations and other related consulting
expense and income tax expense with general and administrative
expense.
5
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
3 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Organization and
Business
The
Company, based in Los Angeles, California, is a provider of Internet security
software, utilities and LiveTech support services to the consumer and small
business market. The Company markets its products directly to consumers through
multiple channels including television, radio, the Internet and print. The
Company’s goal is to be a leading provider of advanced solutions to protect
consumers and small businesses against threats such as Internet viruses, spyware
and identity theft, and to provide remote technical resolution
services.
Our
software products include CyberDefender Early Detection Center, a comprehensive
antispyware and antivirus suite, and CyberDefender Registry Cleaner, a PC
optimization suite. Both products are compatible with Windows XP,
Vista and 7.
CyberDefender
also provides LiveTech services 7 days a week and 365 days a year. Our
technicians are available to address PC problems that cannot be resolved with
simple do-it-yourself software. Our technicians connect to customers’
computers using a popular remote access software and provide our customers with
quick and reliable computer repair. Repair and optimization services
include (but are not limited to) malware removal, speed optimization, software
updates, file backup, privacy optimization and hardware
troubleshooting.
The
Company developed a collaborative Internet security network, which it refers to
as CyberDefender Argus Network (formerly known as the earlyNETWORK), based on
certain technology principles commonly found in a peer-to-peer network
infrastructure. A peer-to-peer network is not based upon traditional
clients and servers, but rather upon equal peer nodes that simultaneously
function as both “clients” and “servers” to the other nodes on the
network. This means that when a threat is detected from a computer
that is part of the CyberDefender Argus Network, the threat is relayed to our
Early Alert Center. The Early Alert Center tests, grades and ranks
the threat, automatically generates definition and signature files based on the
threat, and relays this information to the Alert Server, in some cases after a
human verification step. The Alert Server will relay the information
it receives from the Early Alert Center to other machines in the CyberDefender
Argus Network, and each machine that receives the information will, in turn,
relay it to other machines that are part of the CyberDefender Argus
Network. This protocol allows us to distribute rapidly alerts and
updates regarding potentially damaging viruses and other threats to members of
the CyberDefender Argus Network, without regard for the cost of the bandwidth
involved. Because cost is not a factor, updates can be continuous,
making our approach significantly faster than the client/server protocols used
by traditional Internet security companies that provide manual broadcast-updated
threat management systems. Computer users join the CyberDefender
Argus Network simply by downloading and installing our security
software.
During
May 2010, the Company entered into an Agreement and Plan of Merger with a
wholly owned Delaware subsidiary, pursuant to which the Company merged with and
into the Delaware subsidiary, with the Delaware subsidiary being the surviving
corporation, on the basis of one share of common stock of the Delaware
subsidiary to be exchanged for each outstanding share of common stock of the
Company, all as more particularly set forth in the Agreement and Plan of Merger.
The main purpose of the merger was to change the Company’s state of
incorporation from California to Delaware. Additionally, at the time of the
merger the Company increased the number of authorized shares of common stock to
100 million, changed the common stock from no par value to $0.001 par value and
authorized 10 million shares of preferred stock. As a result the Company
retroactively restated its December 31, 2009 common stock balance as if the
change in par value was effective for all periods presented.
Liquidity
The
Company has experienced operating losses since inception. Management
has implemented plans to continue to build its revenue base, expand sales and
marketing and improve operations, however, through September 2010, the Company
continued to operate at negative cash flow. For the nine months ended
September 30, 2010 and the year ended December 31, 2009, the Company has
incurred a net loss of $31.2 million and $19.8 million with negative cash flows
from operations of $4.4 million and $6.0 million, respectively. As of
September 30, 2010 and December 31, 2009, the Company had stockholders’ deficit
of $16.2 million and $8.0 million, respectively. To date, the
Company’s operations have been primarily financed through debt and equity
proceeds from private placement offerings. Management believes that
it has sufficient working capital from recent financings to fund operations
through at least March 31, 2011. As discussed in Note 9, the
Company entered into a Revolving Credit Loan Agreement with GRM effective
as of December 3, 2010. The credit facility permits the Company
to borrow up to $5 million, and the initial principal amount includes
$4,287,660 of outstanding trade payables owed by the Company to GRM on December
3, 2010 pursuant to a certain Media and Marketing Services Agreement described
in Note 5 below. All outstanding principal and accrued but unpaid
interest is due and payable in full at the earlier of either March 31, 2011 or
the closing of the Company’s sale and issuance of any debt or equity securities
of the Company in an aggregate amount exceeding $10 million. The Company intends
to obtain additional financing prior to March 31, 2011 to satisfy the
obligation. However, there can be no assurance that the Company will
secure the additional financing on terms acceptable to the Company, or at all.
In the event the Company is unable to obtain additional financing, the Company
expects it would be able to renegotiate the terms of the GRM revolving credit
facility, however, there is no assurance that this would
occur. Failure to obtain additional financing or an amendment to the
GRM revolving credit facility may require the Company to significantly curtail
its operations which could have a material
adverse impact on the Company’s results of operations and financial
position.
6
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Reclassification
To
conform to the current year's presentation, as a result of management's
continuing analysis of its financial reporting, the Company consolidated its
2009 investor relations and other related consulting expense and income tax
expense with general and administrative expense on the statement of operations.
These reclassifications had no effect on the previously reported net loss for
2009.
Use of
Estimates
The
preparation of financial statements in conformity with GAAP 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. Significant estimates made by management are, among
others, collectability of accounts receivable, recoverability of prepaid
expenses, deferred charges and property and equipment, value of shares and
options/warrants granted, valuation of deferred tax assets and recognition of
revenue. Actual results could differ from those estimates and
assumptions.
Accounts
Receivable
During
2010, the Company began offering a payment plan to its customers for the
purchase of multi-year technical support service plans. The payment plan allows
customers to pay in three installments over sixty days.
Property and
Equipment
Property
and equipment are recorded at cost. Expenditures for major additions and
improvements are capitalized and minor replacements, maintenance and repairs are
charged to expense as incurred. When equipment is retired or otherwise disposed
of, the cost and accumulated depreciation are removed from the accounts and any
resulting gain or loss is included in the results of operations for the
respective period. Depreciation is provided over the estimated useful lives of
the related assets ranging from three to seven years, using the straight-line
method. Amortization of leasehold improvements is provided over the shorter of
the estimated useful lives of the improvements or the term of the
lease.
Equipment under Capital
Lease
The
Company leases certain of its equipment under agreements accounted for as
capital leases. The assets and liabilities under capital lease are recorded at
the lesser of the present value of aggregate future minimum lease payments,
including estimated bargain purchase options, or the fair value of the assets
under lease. Assets under capital lease are depreciated using the straight-line
method over their estimated useful lives.
Internal Use
Software
Certain
costs related to computer software developed or obtained for internal use are
capitalized. The Company capitalizes only those direct costs incurred during the
application development and implementation stages for developing, purchasing or
otherwise acquiring software solely to meet the Company’s internal needs.
Capitalized costs will be amortized on a straight-line basis over the estimated
useful lives of the underlying software, which generally are three years. During
the third quarter of 2010 and for the nine month period ended, the Company
capitalized $0.7 million of costs which are included in property and equipment
on the accompanying condensed balance sheet.
Revenue
Recognition
The
Company sells off-the-shelf software products and technical support services and
packages that include both.
The
Company recognizes revenue from the sale of software licenses under the guidance
of the Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) Topic 985, “Software.”
Specifically,
the Company recognizes revenues from its software products when all of the
following conditions for revenue recognition are met:
|
i. |
persuasive
evidence of an arrangement exists,
|
|
ii. |
the
product or service has been delivered,
|
|
iii. |
the
fee is fixed or determinable, and
|
|
iv. |
collection
of the resulting receivable is reasonably
assured.
|
7
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
As part
of the sales price of some of its software licenses, the Company provides
renewable product support and content updates, which are separate components of
product licenses and sales. Term licenses allow customers to use the Company’s
products and receive product support coverage and content updates for a
specified period, generally twelve months. The Company invoices for product
support, content updates and term licenses at the beginning of the term. These
revenues contain multiple element arrangements where “vendor specific objective
evidence” (“VSOE”) may not exist for one or more of the elements. Certain of the
Company’s software licenses are in substance a subscription and therefore the
sale is deferred and recognized ratably over the term of the arrangement.
Revenue is recognized immediately for the sale of software products that are
utility products and that do not require product updates.
Revenue
is recognized immediately for the sale of our one-time technical support service
as it is performed when purchased. The Company recognizes a portion of the sale
of one of its annual services at the time of purchase when all of the elements
necessary for revenue recognition have occurred (i.e,. the initial technical
support call has occurred) and the remaining revenue is deferred over the annual
term. Revenue is deferred and recognized over the term of the service
agreements for the technical support services that are provided by third
parties.
The
Company recognizes revenue on the sale of bundled products based on the
individual components included in the bundle using the residual method. The
Company has established VSOE of fair value of the individual components based on
historical sales. The customer type (retail customer) and product are exactly
the same for all of these bundles. Revenue is recognized on the individual
components as detailed above.
The
Company also uses third parties to sell its software and therefore evaluates the
criteria of FASB ASC Topic 605, “Revenue Recognition,” in
determining whether it is appropriate to record the gross amount of revenue and
related costs or the net amount earned as commissions. The Company is the
primary obligor, is subject to inventory risk, has latitude in establishing
prices and selecting suppliers, establishes product specifications, and has the
risk of loss. Accordingly, the Company's revenue is recorded on a gross
basis.
The
Company still supports MyIdentityDefender Toolbar and CyberDefender FREE 2.0,
which were free to subscribers. Revenues are earned from advertising networks
which pay the Company to display advertisements inside the software or through
the toolbar search. The Company recognizes revenue from the advertising networks
monthly based on a rate determined either by the quantity of the ads displayed
or the performance of the ads based on the amount of times the ads are clicked
by the user. Furthermore, advertising revenue is recognized provided that no
significant Company obligations remain at the end of a period and collection of
the resulting receivable is probable. The Company’s obligations do not include
guarantees of a minimum number of impressions.
Deferred
Charges
The
Company uses a third party to provide technical support services associated with
the CyberDefenderULTIMATE product, which is no longer being sold but is still
supported. The costs associated with this service are deferred and
amortized against the recognition of the related sales revenue.
Advertising
Costs
The
Company expenses advertising costs as incurred. As described in detail in Note 5
below, the Company issued warrants for media and marketing
services. The non-cash value of those warrants is included in media
and marketing services on the accompanying statements of
operations. For the three months ended September 30, 2010 and 2009,
the Company recorded non-cash expense of $6.4 million and $1.2 million,
respectively. For the nine months ended September 30, 2010 and 2009, the Company
recorded non-cash expense of $18.3 million and $2.7 million,
respectively.
Reserve for
Refunds
The
Company’s policy with respect to refunds is to offer refunds within the first 30
days after the date of purchase. The Company may voluntarily issue refunds to
customers after 30 days of purchase, however the majority are issued within 30
days of the original sale and are charged against the associated sale or
deferred revenues (as applicable). Refunds were $2.2 million and $4.7 million
for the three and nine months ended September 30, 2010, respectively. Refunds
were $0.7 million and $2.0 million for the three and nine months ended September
30, 2009, respectively. As of September 30, 2010 and December 31, 2009, the
Company had $0 accrued for customer refunds, based on historical timing of
refunds.
Certain Risks and
Concentrations
As of
September 30, 2010, all of our cash was maintained at a major financial
institution in the United States. At times, deposits held with the financial
institution may exceed the amount of insurance provided on such deposits by the
Federal Deposit Insurance Corporation (“FDIC”) which provides deposit coverage
with limits up to $250,000 per owner through December 31, 2013. As of September
30, 2010, the Company had a balance of approximately $2.9 million in excess of
the FDIC limit.
8
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income
Taxes
The
Company has adopted the liability method of accounting for income taxes pursuant
to FASB ASC Topic 740, “Income
Taxes.” Deferred income taxes are recorded to reflect tax consequences on
future years for the differences between the tax basis of assets and liabilities
and their financial reporting amounts at each year-end. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statements carrying amounts of existing assets
and liabilities and their respective tax basis. Deferred tax assets, including
tax loss and credit carryforwards, and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
Deferred
income tax expense represents the change during the period in the deferred tax
assets and deferred tax liabilities. The components of the deferred tax assets
and liabilities are classified individually as current and non-current based on
their characteristics. Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized.
FASB ASC
Topic 740 prescribes recognition thresholds that must be met before a tax
position is recognized in the financial statements and provides guidance on
de-recognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. An entity may only recognize or continue to
recognize tax positions that meet a “more likely than not”
threshold.
The
Company does not have any unrecognized tax benefits as of September 30, 2010
that, if recognized, would affect the Company’s effective income tax
rate.
The
Company’s policy is to recognize interest and penalties related to income tax
issues as components of income tax expense. The Company did not recognize or
have any accrual for interest and penalties relating to income taxes as of
September 30, 2010.
Software Development
Costs
The
Company accounts for software development costs in accordance with FASB ASC
Topic 985, “Software.”
Such costs are expensed prior to achievement of technological feasibility and
thereafter are capitalized. There have been very limited software development
costs incurred between the time the software and its related enhancements have
reached technological feasibility and its general release to customers. As a
result, all software development costs have been charged to product development
expense.
Derivative
Instruments
Effective
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815,
“Derivatives and
Hedging,” that
applies to any freestanding financial instruments or embedded features that have
the characteristics of a derivative and to any freestanding financial
instruments that are potentially settled in an entity’s own common stock. As a
result, as of January 1, 2009, 7,134,036 of the Company’s issued and outstanding
common stock purchase warrants previously treated as equity pursuant to the
derivative treatment exemption were no longer afforded equity treatment. In
addition, amounts related to the embedded conversion feature of convertible
notes issued prior to January 1, 2009 and treated as equity pursuant to the
derivative treatment exemption were also no longer afforded equity treatment. As
such, effective January 1, 2009, the Company reclassified the fair value of
these common stock purchase warrants and the fair value of the embedded
conversion features, which both have exercise price reset features, from equity
to liability status as if these warrants and embedded conversion features were
treated as a derivative liability since the earliest date of issue in
September 2006. On January 1, 2009, the Company reclassified from
additional paid-in capital, as a cumulative effect adjustment, $7.1
million to beginning additional paid-in capital, $0.7 million to opening
retained earnings and $6.3 million to a long-term derivative liability to
recognize the fair value of such warrants and embedded conversion features on
such date.
During
the three and nine months ended September 30, 2009, the Company issued 0 and
1,192,000 common stock purchase warrants, respectively, that contained features
that required the Company to record their fair value as a derivative
liability. In addition, the value related to the embedded conversion
feature of convertible notes issued during the nine months ended September 30,
2009 was also recorded as a derivative liability. We recognized income of $0 and
$109,000 from the change in fair value of the outstanding warrants and embedded
conversion feature for the three and nine months ended September 30, 2009,
respectively.
The
Company obtained waivers from the warrant and note holders, pursuant to which
the warrant and note holders forever waived, as of and after April 1, 2009, any
and all conversion or exercise price adjustments that would otherwise occur, or
would have otherwise occurred on or after April 1, 2009, as a result of the
price reset provisions included in the warrants and notes. As a result of
obtaining the waivers, the warrants and notes are now afforded equity treatment
resulting in the elimination of the derivative liabilities of $7.1 million and a
corresponding increase in additional paid-in capital.
9
CYBERDEFENDER CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair Value
Measurements
FASB ASC
Topic 820, “Fair Value
Measurements and Disclosures,” defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value
measurements. The fair value hierarchy distinguishes between assumptions based
on market data (observable inputs) and an entity’s own assumptions (unobservable
inputs). The hierarchy consists of three levels:
•
|
Level
one — Quoted market prices in active markets for identical assets or
liabilities;
|
|||
•
|
Level
two — Inputs other than level one inputs that are either directly or
indirectly observable; and
|
|||
•
|
Level
three — Unobservable inputs developed using estimates and assumptions
which are developed by the reporting entity and reflect those assumptions
that a market participant would use.
|
Determining
which category an asset or liability falls within the hierarchy requires
significant judgment. The Company evaluates its hierarchy disclosures each
quarter. The Company has no assets or liabilities that are measured at fair
value on either a recurring or non-recurring basis.
All of
our financial instruments are recorded at fair value. For certain of the
Company’s financial instruments, including cash, restricted cash, accounts
receivable, accounts payable, other accrued liabilities and notes payable, the
carrying amounts approximate fair value due to their short
maturities.
Loss Per
Share
In
accordance with FASB ASC Topic 260, “Earnings Per Share,” the
basic loss per common share is computed by dividing net loss available to common
stockholders by the weighted average number of common shares outstanding.
Diluted loss per common share is computed similar to basic loss per common
share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potential
common shares had been issued and if the additional common shares were dilutive.
As of September 30, 2010 and 2009, there were 21,775,362 and 14,114,207 shares
of potentially dilutive securities outstanding, respectively. As the Company
reported a net loss, none of the potentially dilutive securities were
included in the calculation of diluted loss per share since their effect would
be anti-dilutive for that reporting period.
Stock Based
Compensation
The
Company applies FASB ASC Topic 718, “Compensation – Stock Compensation,”
which requires companies to measure and recognize the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value. For non-employee stock based compensation, the Company
recognizes an expense in accordance with FASB ASC Topic 505, “Equity,” and values the
equity securities based on the fair value of the security on the date of grant.
For stock-based awards the value is based on the market value of the stock on
the date of grant or the value of services, whichever is more readily available.
Stock option awards are valued using the Black-Scholes option-pricing
model.
The
Company accounts for equity instruments issued to consultants and vendors in
exchange for goods and services in accordance with the provisions of FASB ASC
Topic 505, “Equity.”
The measurement date for the fair value of the equity instruments issued is
determined at the earlier of (i) the date at which a commitment for performance
by the consultant or vendor is reached or (ii) the date at which the consultant
or vendor’s performance is complete. In the case of equity instruments issued to
consultants, the fair value of the equity instrument is recognized over the term
of the consulting agreement. An asset acquired in exchange for the issuance of
fully vested, non-forfeitable equity instruments should not be presented or
classified for accounting purposes as an offset to equity on the grantor’s
balance sheet once the equity instrument is granted. Accordingly, the Company
records the fair value of the fully vested, non-forfeitable common stock issued
for future consulting services as prepaid expense in its balance
sheet.
10
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Segment
Disclosures
The
Company operates in one segment and its chief operating decision maker is its
chief executive officer.
Subsequent
Events
The
Company has evaluated subsequent events through the filing date of this Form
10-Q, and determined that no subsequent events have occurred that would require
recognition in the condensed financial statements or disclosure in the notes
thereto other than as discussed in the accompanying notes (see Note
9).
Recently Issued Accounting
Pronouncements
The
Company has adopted all accounting pronouncements effective before September 30,
2010 which are applicable to the Company.
In
September 2009, the FASB issued an update to its accounting guidance
regarding multiple-deliverable revenue arrangements. The guidance addresses how
to measure and allocate consideration to one or more units of accounting.
Specifically, the guidance requires that consideration be allocated among
multiple deliverables based on relative selling prices. The guidance establishes
a selling price hierarchy of (1) vendor-specific objective evidence, (2)
third-party evidence and (3) estimated selling price. This guidance is effective
for annual periods beginning on or after June 15, 2010 but may be early adopted
as of the beginning of an annual period. The Company expects to adopt this
guidance on January 1, 2011 and does not expect this guidance to have a material
impact on its financial statements.
In
October 2009, the FASB issued an update to its accounting guidance
regarding software revenue recognition. The guidance changes the accounting
model for revenue arrangements that include both tangible products and software
elements. Under this guidance, tangible products containing software components
and non-software components that function together to deliver the tangible
product’s essential functionality are excluded from the software revenue
guidance in FASB ASC Topic 985, “Software.” In addition,
hardware components of a tangible product containing software components are
always excluded from the software revenue guidance. This guidance is effective
prospectively for revenue arrangements entered into or materially modified in
fiscal years beginning on or after June 15, 2010 but may be early adopted. The
Company expects to adopt this guidance on January 1, 2011 and does not expect
this guidance to have a material impact on its financial
statements.
In
January 2010, the FASB issued an update to its accounting guidance regarding
fair value measurement and disclosure. The guidance affects the disclosures made
about recurring and non-recurring fair value measurements. This guidance is
effective for annual reporting periods beginning after December 15, 2009, except
for the disclosures about purchases, sales, issuances and settlements in the
roll forward of activity in Level 3 fair value measurements. Those disclosures
are effective for fiscal years beginning after December 15,
2010. Early adoption is permitted.
In
February 2010, the FASB issued amended guidance on subsequent events. Under
this amended guidance, SEC filers are no longer required to disclose the date
through which subsequent events have been evaluated in originally issued and
revised financial statements. This guidance was effective immediately and we
adopted this new guidance in the quarter ended September 30, 2010. See Note
9 — Subsequent Events to our condensed financial statements.
NOTE
4 – RESTRICTED CASH
Under a
credit card processing agreement with a financial institution, the Company is
required to maintain a security reserve deposit as collateral. The
amount of the deposit is at the discretion of the financial institution and as
of September 30, 2010 and December 31, 2009 was $10,000. Under a separate credit
card processing agreement with a different financial institution, the Company is
also required to maintain a security reserve deposit as collateral. The amount
of the deposit is currently based on 10% of the six-month rolling sales volume
and was approximately $2.3 million and $1.3 million as of September 30, 2010 and
December 31, 2009, respectively. The security reserve deposit is funded by the
institution withholding a portion of daily cash receipts from Visa and
MasterCard transactions.
On
September 30, 2009, the Company entered into a second amendment to its premises
lease as more fully described in Note 7 below. As part of the amendment the
Company was required to issue a $250,000 letter of credit as a security deposit.
The letter of credit is collateralized by cash held in an account at the
Company’s bank. The account is interest bearing and the Company receives the
interest that is earned.
11
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - STOCKHOLDERS’ DEFICIT
Common
Stock
During
February 2009, the Company issued 94,628 shares of restricted common stock
valued at $1.10 per share to a vendor as settlement for past services
rendered.
During
the nine months ended September 30, 2009, eight investors exercised warrants to
purchase 387,954 shares of common stock exercisable at $1.00 to $1.01 per
share. The warrants were exercised pursuant to the cashless
provisions contained in the warrants and, as a result, the Company issued
230,706 shares to the investors.
On June
4, 2009, the Company issued 1,142,860 shares of common stock to GR Match, LLC
(“GRM”) for an aggregate purchase price of $2.0 million, of which $400,000 must
be used for the creation and production by GRM of television commercials
advertising the Company’s products and services (the “Commercial Funds”), and
the balance of which the Company will use for general working capital. Pursuant
to the terms of the Securities Purchase Agreement documenting the transaction,
GRM has demand and piggyback registration rights with respect to the
shares.
On June
10, 2009, the Company issued 632,500 shares of common stock to Shimski L.P. for
an aggregate purchase price of $1.1 million. Pursuant to the terms of the
Securities Purchase Agreement, Shimski L.P. has demand and piggyback
registration rights with respect to the shares.
On July
21, 2009, the Company issued 200,000 shares of common stock to twenty-eight
accredited investors for an aggregate purchase price of $0.5 million, the
proceeds of which the Company will use for general working capital. There were
no issuance costs related to this sale.
On July
30, 2009, one investor exercised warrants to purchase 15,000 shares of common
stock exercisable at $1.25 per share.
On August
17, 2009, the Company issued 1,838,952 shares of common stock for warrants that
were exercised in connection with a tender offer as more fully described in
“stock warrants” below.
During
the nine months ended September 30, 2010, seven investors exercised warrants to
purchase 159,150 shares of common stock exercisable at prices ranging from $1.00
to $2.25 per share.
See
“stock warrants” below for additional shares issued related to the exercise of
stock warrants.
See
“stock options” below for additional shares issued related to the exercise of
stock options.
See Note
6 for additional shares issued related to the convertible notes
payable.
Stock
warrants
On
November 11, 2008, the Company entered into a consulting agreement with Newview
Consulting L.L.C. (“Newview”) Pursuant to this agreement, Newview provided
investor relations services for a period of 6 months in exchange for warrants to
purchase 2,250,000 shares of common stock at a price of $1.25 per share. 900,000
warrants vested immediately and 270,000 warrants were to vest on the 1st of each
month beginning December 1, 2008 and ending April 1, 2009. At January
1, 2009, the Company amended the vesting schedule in the Newview warrant to vest
the remaining 1,080,000 warrants on the first of each month from January 1, 2009
to June 1, 2009 at the rate of 180,000 warrants per month. As such, 0
and 1,080,000 warrants vested during the three and nine month periods ended
September 30, 2009 and the value of $0 and $1.0 million, using the Black Scholes
pricing model, was expensed. As of September 30, 2009, all of the
warrants had vested.
12
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - STOCKHOLDERS’ DEFICIT (Continued)
On
January 17, 2009, the Company entered into a two-month consulting agreement with
a consultant for services relating to financial management and
reporting. As part of the agreement, the consultant was granted a
warrant to purchase 2,500 shares of common stock with a term of five years at an
exercise price of $1.25 per share, for each month of the term of the
agreement. The fair value of these warrants was $4,000, using a Black
Scholes pricing model, and was expensed to investor relations and other related
consulting expense during the nine months ended September 30, 2009. On April 24,
2009, the Company entered into a second agreement with the
consultant. As part of the agreement, the consultant was granted a
warrant to purchase 2,500 shares of common stock at an exercise price of $1.80
per share. The fair value of the warrant, which was computed as $3,000, was
expensed during the nine months ended September 30, 2009.
On
October 30, 2008, the Company executed a letter of intent with GRM to create,
market and distribute direct response advertisements to sell the Company’s
products. Pursuant to the letter of intent, GRM was responsible for
creating, financing, producing, testing and evaluating a radio commercial to
market the Company’s products in exchange for $50,000 and a fully vested,
non-forfeitable warrant to purchase 1,000,000 shares of common stock at a price
of $1.25 per share with an estimated fair value of $951,000 using the
Black-Scholes pricing model. The fair value of the warrant was
capitalized to prepaid expenses at the time of issuance and was expensed over
the five-month term of service. The Company expensed $0 and $571,000 to media
and marketing services during the three and nine months ended September 30,
2009. The warrant included an anti-dilutive provision that reduced the exercise
price of the warrant if the Company at any time while this warrant is
outstanding sells and issues any common stock at a price per share less than the
then exercise price. During August 2009, the Company received a waiver whereby
GRM permanently waived, as of and after April 1, 2009, any and all exercise
price adjustments that would otherwise occur, or would have occurred on or after
April 1, 2009, as a result of this provision.
On March
24, 2009, the Company entered into a Media and Marketing Services Agreement (the
“Media Agreement”) with GRM. Pursuant to the Media Agreement, GRM
will provide direct response media campaigns, including radio and television
direct response commercials, to promote the Company’s products and services and
will purchase media time on the Company’s behalf. During the term of
the Media Agreement, which is to continue until June 1, 2011, as amended,
subject to certain rights of termination, GRM will be the exclusive provider of
all media purchasing and direct response production services. The
Media Agreement was amended subsequent to September 30, 2010; see Note 9 Subsequent Events
below.
As
compensation for GRM’s services, the Company agreed to amend the warrant
described above so that the terms were consistent with the warrants described
below. None of the amended terms resulted in an accounting change to
the warrant. In conjunction with the execution of the Media Agreement
and for creating, financing, producing, testing and evaluating a television
commercial to market the Company’s products, the Company issued to GRM a second
five-year warrant for the purchase of 1,000,000 shares of the Company’s common
stock at a price of $1.25 per share valued at $712,000 using the Black-Scholes
pricing model. The fair value of the warrant was capitalized at the time of
issuance and was expensed over the five-month expected term of service. During
the three and nine months ended September 30, 2009, $142,000 and $712,000 was
expensed to media and marketing services expense. This warrant may be
exercised only for cash. Finally, the Company agreed to issue to GRM
a five-year warrant (“Media Services Warrant”) for the purchase of 8,000,000
shares of the Company’s common stock at an exercise price of $1.25 per
share. The Media Services Warrant may be exercised only with cash and
is subject to vesting as follows: for each $2 of media placement costs advanced
by GRM on the Company’s behalf, the right to purchase one share of the Company’s
common stock will vest. As of September 30, 2010, 7,875,968 Media
Services Warrant shares have vested and were valued at $23.0 million using the
Black-Scholes pricing model. During the three and nine months ended
September 30, 2010, 2.4 million and 6.0 million warrants vested, and $6.4
million and $18.3 million was expensed to media and marketing services expense.
During the three and nine months ended September 30, 2009, 0.6 million and 0.8
million warrants vested, and $1.0 million and $1.4 million was expensed to media
and marketing services expense. These warrants included an anti-dilutive
provision that would have resulted in a reduction of the exercise price of the
warrants if the Company at any time while the warrants were outstanding sold and
issued any common stock at a price per share less than the then exercise price.
During August 2009, the Company received a waiver whereby GRM permanently
waived, as of and after April 1, 2009, any and all exercise price adjustments
that would otherwise occur, or would have occurred on or after April 1, 2009, as
a result of this provision. On October 22, 2010, the Media Agreement was
extended, as more fully described below in Note 9 Subsequent
Events, to include payment of $75,000 per month to GRM as compensation for the
same services provided pursuant to the Media Agreement.
On April
1, 2009, the Company entered into an agreement with a consultant for management
consulting and business advisory services on an as needed basis. The
consultant was granted a warrant to purchase 850,000 shares of the Company’s
common stock for a period of five years at an exercise price of
$1.25. These warrants vested as follows: 300,000 immediately and
50,000 per month on the 1st day of
each month commencing May 1, 2009 and ending March 1, 2010. As of March 31,
2010, all of the warrant shares were vested. During the three and
nine months ended September 30, 2010, $0 and $0.5 million was expensed. During
the three and nine months ended September 30, 2009, $0.3 million and $0.7
million, was expensed.
13
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - STOCKHOLDERS’ DEFICIT (Continued)
On April
5, 2009, the Company entered into an agreement with a consultant for marketing
related services. The agreement had a term of three
months. The agreement provided compensation of $13,000 for month one,
$14,000 for month two and $15,000 for month three. In addition, the
consultant was granted a warrant to purchase 15,000 shares of the Company’s
common stock for a period of five years at an exercise price of $1.25. This
warrant was to vest 5,000 shares per month over the term of the agreement. On
May 15, 2009, the original agreement was terminated, along with the right to
purchase 8,387 shares of common stock that would have vested in June 2009, and
the Company entered into a second agreement with the consultant. The
second agreement had a term of three months and provided compensation of $17,500
for month one, of which 50% was to be deferred for 30 days, and $8,750 per month
thereafter. In addition, the consultant was granted a warrant to purchase 15,000
shares of the Company’s common stock for a period of five years at an exercise
price of $1.25. The warrant was to vest 5,000 shares per month over the term of
the second agreement. The second agreement also provided for a bonus of up to
50,000 additional warrant shares at an exercise price of $1.83 for achieving
certain goals. On June 15, 2009, the second agreement was terminated, along with
the right to purchase 10,000 shares of common stock that would have vested in
July and August 2009, and the Company entered into a third agreement with the
consultant. The third agreement had a term of two months. The third
agreement provided compensation of $12,500 per month. In addition, the
consultant was granted a warrant to purchase 10,000 shares of the Company’s
common stock for a period of five years at an exercise price of $1.25. This
warrant vested 5,000 shares per month over the term of the agreement.
Additionally, the consultant was granted a warrant to purchase 5,000 shares of
the Company’s common stock for a period of five years at an exercise price of
$1.83 for deferring 50% of the compensation due for May 2009 until July 30, 2009
and a warrant to purchase 5,000 shares of the Company’s common stock for a
period of five years at an exercise price of $1.83 as part of the bonus per the
second agreement. The third agreement also provided for a bonus of up to 45,000
additional warrant shares at an exercise price of $1.83 for achieving certain
goals. These goals were achieved and the Company issued the bonus warrant to the
consultant on August 15, 2009. The fair value of the 76,613 warrants that were
granted and vested of $128,000 was expensed to general and administrative
expense, $81,000 and $128,000 for the three and nine months ended September 30,
2009, respectively.
In May
2009, the Company began an offering to the holders of its warrants issued with
“cashless exercise” provisions and/or “down-round” provisions (together, the
“Released Provisions”). Pursuant to the offering, the warrant holders
were given the opportunity to increase by 10% the number of shares of common
stock covered by their warrants in exchange for extinguishing the Released
Provisions from their warrants. In order for the warrant holders to
take advantage of the offer, they were required to exercise a portion of their
warrant(s) and purchase for cash no less than 30% of the shares of common stock
covered by their warrant(s), after giving effect to the increase. On
June 29, 2009, the Company filed a Schedule TO with the SEC covering this
offering. Pursuant to the originally filed Schedule TO, the offering
was to expire on July 28, 2009. The Schedule TO was amended and the
offering was extended until August 17, 2009. The Company received $2.0 million
in proceeds, net of offering costs of $73,000, and issued 1.8 million shares of
common stock to warrant holders that participated in this
offer. Additionally, in accordance with the terms of the offering,
the Company issued warrants to purchase 270,000 shares of the Company’s common
stock in exchange for extinguishing the Released Provisions. The additional
warrants were valued at $549,000 using the Black Scholes pricing model, and
$48,000 and $549,000 was expensed to interest expense during the three and nine
months ended September 30, 2009, respectively.
On May
15, 2009, the Company entered into an agreement with a second consultant for
marketing related services. The agreement had a term of three months
and provided compensation of $17,500 for month one, of which 50% was to be
deferred for 30 days, and $8,750 per month thereafter. In addition, the
consultant was granted a warrant to purchase 15,000 shares of the Company’s
common stock for a period of five years at an exercise price of
$1.83. The warrant was to vest 5,000 shares per month over the term
of the second agreement. The agreement also provided for a bonus of up to 50,000
additional warrants at an exercise price of $1.83 for achieving certain goals.
On June 15, 2009, the agreement was terminated, along with the right to purchase
10,000 shares of common stock that would have vested in June and July 2009, and
the Company entered into a second agreement with the consultant. The
second agreement had a term of two months and provided compensation of $12,500
per month. In addition, the consultant was granted a warrant to purchase 10,000
shares of the Company’s common stock for a period of five years at an exercise
price of $1.83. This warrant vested 5,000 shares per month over the
term of the agreement. Additionally, the consultant was granted a warrant to
purchase 5,000 shares of the Company’s common stock for a period of five years
at an exercise price of $1.83 for deferring 50% of the compensation due for May
2009 until July 30, 2009 and a warrant to purchase 5,000 shares of the Company’s
common stock for a period of five years at an exercise price of $1.83 as part of
the bonus per the second agreement. The second agreement also provided for a
bonus of up to 45,000 additional warrants at an exercise price of $1.83 for
achieving certain goals. These goals were achieved and the Company issued the
bonus warrant to the consultant on August 15, 2009. The fair value of the 70,000
warrant shares that were granted and vested of $116,000 was expensed to general
and administrative expense, $86,000 and $116,000 for the three and nine months
ended September 30, 2009, respectively.
On August
1, 2009, the Company entered into an agreement with a consultant for business
development services related to the signing of the Wiley licensing
contract. The consultant was granted a warrant to purchase 55,000
shares of the Company’s common stock for a period of three years at an exercise
price of $2.18. The warrant was to vest 15,000 shares at the signing
of the Wiley contract, 15,000 shares at the Wiley launch and 25,000 shares at
the earlier of the first anniversary date of the agreement or when sales of the
Wiley branded products exceed 100,000 units. The fair value of the initial
15,000 warrant shares that were granted and vested of $26,000 was expensed
during the three and nine months ended September 30, 2009. The remaining 40,000
warrant shares vested during the nine months ended September 30, 2010 and
$69,000 was expensed.
14
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - STOCKHOLDERS’ DEFICIT (Continued)
See Note
6 for additional warrants issued during the three and nine months ended
September 30, 2009 related to the convertible notes payable.
The
following represents a summary of the warrants outstanding at September 30,
2010 and 2009 and changes during the nine months then ended:
Nine Months Ended
|
||||||||||||||||||||||||
September 30, 2010
|
September 30, 2009
|
|||||||||||||||||||||||
Weighted
|
Weighted
|
|||||||||||||||||||||||
Number
|
Average
|
Aggregate
|
Number
|
Average
|
Aggregate
|
|||||||||||||||||||
of
|
Exercise
|
Intrinsic
|
Of
|
Exercise
|
Intrinsic
|
|||||||||||||||||||
Warrants
|
Price
|
Value
|
Warrants
|
Prices
|
Value
|
|||||||||||||||||||
Outstanding,
beginning of period
|
13,026,657 | $ | 1.20 | 11,029,890 | $ | 1.14 | ||||||||||||||||||
Issued
|
6,038,636 | $ | 1.25 | 3,337,389 | $ | 1.28 | ||||||||||||||||||
Exercised
|
(159,150 | ) | $ | 1.23 | (2,241,906 | ) | $ | 1.11 | ||||||||||||||||
Outstanding,
end of period
|
18,906,143 | $ | 1.23 | $ | 49,828,886 | 12,125,373 | $ | 1.19 | $ | 15,903,284 | ||||||||||||||
Exercisable,
end of period
|
18,906,143 | $ | 1.21 | $ | 49,828,886 | 11,785,373 | $ | 1.18 | $ | 15,515,484 |
The
following table summarizes information about warrants outstanding at
September 30, 2010:
Weighted
|
||||||||
Average
|
||||||||
Number
of
|
Remaining
|
|||||||
Warrant
|
Contractual
|
|||||||
Exercise
Price
|
Shares
|
Life
(Years)
|
||||||
$ 1.00
|
2,702,440 | 1.11 | ||||||
$ 1.01
|
700,306 | 5.16 | ||||||
$ 1.20
|
324,875 | 2.26 | ||||||
$ 1.25
|
14,918,532 | 3.05 | ||||||
$ 1.80
|
2,500 | 3.56 | ||||||
$ 1.83
|
125,000 | 3.68 | ||||||
$ 2.05
|
77,490 | 3.98 | ||||||
$ 2.18
|
55,000 | 1.98 | ||||||
18,906,143 |
The
weighted average grant date fair value of warrants granted and vested during the
nine months ended September 30, 2010 and 2009 was $3.03 and $1.66 per share,
respectively. The weighted average remaining life of the vested warrants is 2.84
years.
15
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - STOCKHOLDERS’ DEFICIT (Continued)
Stock
options
In
January 2005, the Company adopted the CyberDefender Corporation 2005 Stock
Option Plan (sometimes called the CyberDefender Corporation 2005 Equity
Incentive Plan and referred to herein as the “2005 Plan”), which consists of
equity programs that provide for the granting of Incentive Stock Options or
Nonstatutory Stock Options, the issuance of stock purchase rights and awards of
stock. Under the terms of the 2005 Plan, the exercise price of options granted
may be equal to, greater than or less than the fair market value on the date of
grant, the options may have a maximum term of ten years and generally vest over
a period of service
or attainment of specified performance objectives. The maximum aggregate amount
of options that may be granted from the 2005 Plan is 931,734 shares, of
which awards for the purchase of 733,233 shares have been granted and are
outstanding, awards for the purchase of 198,125 shares have been exercised and
awards for the purchase of 376 shares are available for grant at September 30,
2010.
On
October 30, 2006, the Company adopted the Amended and Restated 2006 Equity
Incentive Plan (“2006 Plan”) that provides for the granting of Incentive Stock
Options or Nonstatutory Stock Options, the issuance of stock purchase rights and
awards of stock. Under the terms of the 2006 Plan, the exercise price of
options granted may be equal to, greater than or less than the fair market value
on the date of grant, the options may have a maximum term of ten years and
generally vest over a period of service or attainment of specified performance
objectives. The Company amended the 2006 Plan in June 2009 to increase the
maximum number of shares available to be granted by 1,500,000 shares. The
maximum aggregate amount of stock based awards that may be granted from the
2006 Plan is 2,875,000 shares, of which awards for the purchase of 1,918,986
shares have been granted and are outstanding, awards for the purchase of 326,691
shares have been exercised and awards for the purchase of 429,323 shares are
available for grant at September 30, 2010.
On
January 1, 2009, the Company entered into a three-month consulting agreement
with Unionway International, LLC, an entity controlled by Mr. Bing Liu, for
consulting services. As part of the agreement, Mr. Liu was granted
10-year options to purchase a total of 18,000 shares of common stock at an
exercise price of $1.00 per share vesting over the term of the agreement as
compensation for 2008 achievements. In addition, Mr. Liu was granted
10-year options to purchase 5,000 shares of common stock at an exercise price of
$1.00 per share vesting 2,500 shares on January 1, 2009, 1,250 shares on
February 1, 2009 and 1,250 shares on March 1, 2009.
On
January 17, 2009, the Company entered into a two-month consulting agreement with
a consultant for services relating to financial management and
reporting. As part of the agreement, the consultant was granted
options to purchase 2,500 shares of common stock at an exercise price of $1.25
per share, per month for the term of the agreement.
On April
1, 2009, the Company entered into a three-month consulting agreement with
Unionway International, LLC, an entity controlled by Mr. Bing Liu, for
consulting services. As part of the agreement, Mr. Liu was granted a
10-year option to purchase 15,000 shares of common stock at an exercise price of
$1.25 per share vesting over the term of the agreement.
During
the nine months ended September 30, 2009, the Company granted to employees
options to purchase a total of 650,000 shares of common stock under the 2006
Plan and the 2005 Plan at prices ranging from $1.00 to $3.30 per
share.
During
the nine months ended September 30, 2010, the Company granted to employees
options to purchase a total of 880,626 shares of common stock under the 2006
Plan and the 2005 Plan at prices ranging from $1.00 to $4.70 per
share.
16
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - STOCKHOLDERS’ DEFICIT (Continued)
A summary
of stock option activity for the 2005 Plan and 2006 Plan is as
follows:
Nine Months
|
||||||||||||||||||||||||||||||||
September 30, 2010
|
September 30, 2009
|
|||||||||||||||||||||||||||||||
Weighted
|
Weighted
|
|||||||||||||||||||||||||||||||
Weighted
|
Average
|
Weighted
|
Average
|
|||||||||||||||||||||||||||||
Number
|
Average
|
Remaining
|
Aggregate
|
Number
|
Average
|
Remaining
|
Aggregate
|
|||||||||||||||||||||||||
Of
|
Exercise
|
Contractual
|
Intrinsic
|
of
|
Exercise
|
Contractual
|
Intrinsic
|
|||||||||||||||||||||||||
Options
|
Price
|
Term
|
Value
|
Options
|
Prices
|
Term
|
Value
|
|||||||||||||||||||||||||
Outstanding,
beginning of year
|
1,856,293 | $ | 1.09 | 7.57 | 1,444,084 | $ | 0.83 | 7.66 | ||||||||||||||||||||||||
Granted
|
938,626 | $ | 3.65 | 9.55 | 693,000 | $ | 1.50 | 9.54 | ||||||||||||||||||||||||
Exercised
|
(73,200 | ) | $ | 0.85 | 5.71 | (75,106 | ) | $ | 1.11 | 8.58 | ||||||||||||||||||||||
Forfeited
|
(69,500 | ) | $ | 2.28 | (235,144 | ) | $ | 1.09 | ||||||||||||||||||||||||
Outstanding,
end of period
|
2,652,219 | $ | 1.97 | 7.77 | $ | 5,137,768 | 1,826,834 | $ | 1.04 | 7.60 | $ | 2,704,068 | ||||||||||||||||||||
Exercisable,
end of period
|
1,586,269 | $ | 1.11 | 6.84 | $ | 4,359,134 | 1,242,178 | $ | 0.78 | 6.81 | $ | 2,134,108 | ||||||||||||||||||||
Vested,
exercisable and expected to vest in the future
|
2,456,463 | $ | 1.78 | 7.65 | $ | 5,203,768 | 1,676,932 | $ | 0.97 | 7.44 | $ | 2,589,585 |
The
weighted-average grant date fair value of options granted during the nine months
ended September 30, 2010 and 2009 was $2.50 and $1.37 per option,
respectively.
As of
September 30, 2010 and 2009, 1,065,950 and 584,656 of the option shares granted
are not vested with an estimated remaining value of $1.8 million and $0.6
million, respectively. At September 30, 2010 and 2009, the remaining value of
non vested options granted is expected to be recognized over the weighted
average vesting period of 2.61 and 2.68 years, respectively.
The
Company recorded compensation expense associated with the issuance and
vesting of stock options of $310,000 and $701,000 in general and
administrative expense for the three and nine months ended September 30, 2010,
respectively. The Company recorded compensation expense associated with the
issuance and vesting of stock options of $59,000 and $200,000 in general
and administrative expense for the three and nine months ended September 30,
2009.
During
the nine months ended September 30, 2010 and 2009, options for the purchases of
73,200 and 75,106 shares were exercised for total proceeds to the Company of
$62,000 and $83,000, respectively. The aggregate intrinsic value of
the exercised options was $242,000 and $144,000 for the nine months ended
September 30, 2010 and 2009, respectively.
The
Company recognizes the fair value of options issued to employees and consultants
as stock-based compensation expense over the vesting period of the awards. The
estimated fair value of options is based on the Black-Scholes pricing
model.
17
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
6 - CONVERTIBLE NOTES PAYABLE
In
November and December 2008, the Company entered into a Securities Purchase
Agreement, which included registration rights, with certain accredited investors
to which it sold 10% Convertible Promissory Notes (“2008 Convertible Notes”),
due eleven months from the date of issuance and convertible into shares of
Common Stock in the aggregate principal amount of $845,000, which may be
converted at the price of $1.25 per share (subject to adjustment) into an
aggregate of 676,000 shares of common stock. In conjunction with the
sale of the 2008 Convertible Notes, the Company issued common stock purchase
warrants to purchase an aggregate of 338,000 shares of common stock at $1.25 per
share and paid its placement agent a total of $50,700 in commissions and issued
to its placement agent a five-year warrant to purchase an additional 50,700
shares of the Company’s common stock, at an exercise price of $1.25 per share,
valued at $47,000 using the Black-Scholes option pricing
model. In January 2009, the Company completed the sale and
issuance of the Company’s 2008 Convertible Notes. Accordingly, the Company
received additional gross proceeds of $355,000, which may be converted at the
price of $1.25 per share into an aggregate of 284,000 shares of common
stock. In conjunction with the sale of the 2008 Convertible Notes,
the Company issued common stock purchase warrants to purchase an aggregate of
142,000 shares of common stock at $1.25 per share and paid its placement agent a
total of $21,000 in commissions and issued to its placement agent a five-year
warrant to purchase an additional 21,300 shares of the Company’s common stock,
at an exercise price of $1.25 per share, valued at $18,000 using the
Black-Scholes option pricing model.
Under the
terms of the Registration Rights Agreement executed in connection with the
issuance of the 2008 Convertible Notes, the Company was obligated to
file a registration statement with the SEC covering the resale of the shares
issuable upon conversion of the 2008 Convertible Notes and the exercise of the
common stock purchase warrants The Company was required to file the
registration statement no later than 60 days following the final closing date of
the sale and issuance of the 2008 Convertible Notes and warrants, and to use its
best efforts to cause the registration statement to become effective no later
than 120 days thereafter. If the Company was delinquent in the filing deadline
or the effectiveness deadline of the registration statement, it would have been
obligated to pay the holders of the 2008 Convertible Notes liquidated damages
equal to 1% of the outstanding principal amount of the 2008 Convertible Notes
for every 30-day period of delinquency, up to a maximum of 10%. The Company
would have been required to pay any such liquidated damages in cash or its
common stock valued at the average volume weighted average price (“VWAP”) for
the five trading days preceding the applicable due date, provided such average
VWAP exceeds $1.00 per share. On May 1, 2009, the Company received a Consent and
Waiver from the holders of the 2008 Convertible Notes waiving all liquidated
damages under the Registration Rights Agreement.
The
warrants are redeemable at a price of $0.01 per share in the event (i) the
average VWAP of the Company’s common stock for 10 consecutive trading days
equals or exceeds 2.5 times the then current exercise price, (ii) the average
daily trading volume of the common stock during such 10-trading day period is at
least 50,000 shares and (iii) there is an effective registration statement
covering the resale of the shares issuable upon exercise of the
warrants.
The total
value of the 2008 Convertible Notes was allocated between the 2008 Convertible
Notes and the warrants, including the discount, which amounted to $596,000 and
$604,000, respectively. The discount of $604,000 ($159,000 was recorded in the
first quarter of 2009) related to the warrants is being amortized over the term
of the 2008 Convertible Notes. The Company amortized $218,000 and $548,000 to
interest expense related to the 2008 Convertible Notes for the three and nine
months ended September 30, 2009, respectively. At September 30, 2010 and
December 31, 2009, $0 and $109,000 of accrued interest on these notes is
included in accrued expenses on the accompanying condensed balance
sheets.
In
addition, as part of the transaction, the Company paid to the placement agent
$72,000 and issued common stock purchase warrants to purchase an aggregate of
72,000 shares of common stock at $1.25 per share. The warrants were valued at
$66,000 using the Black-Scholes pricing model. These costs, totaling $138,000
($39,000 was recorded in 2009), are being amortized over the term of the 2008
Convertible Notes. The Company recorded amortization of $50,000 and
$125,000 to interest expense during the three and nine months ended September
30, 2009, respectively.
18
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
6 - CONVERTIBLE NOTES PAYABLE (Continued)
On
September 30, 2009, all of the holders of the 2008 Convertible Notes converted
$1.2 million of principal into 960,000 shares of common stock at $1.25 per share
and all of the related note discount and debt issuance costs were amortized to
interest expense.
During
May 2009, the Company entered into a Securities Purchase Agreement pursuant to
which it sold to certain accredited investors $300,000 in aggregate principal
amount of the Company’s 10% Convertible Promissory Notes (“2009 10% Convertible
Notes”), due five months from the date of issuance and convertible into shares
of Common Stock at a conversion price of $1.75 per share. In
conjunction with the sale of the 2009 10% Convertible Notes, the Company paid
its placement agent a total of $12,000 in commissions, which was amortized in
full during 2009.
The total
value of the 2009 10% Convertible Notes was allocated between the 2009 10%
Convertible Notes and the discount, which amounted to $20,000. The discount was
amortized over the term of the 2009 10% Convertible Notes. At September 30, 2010
and December 31, 2009, $0 and $13,000 of accrued interest on these notes is
included in accrued expense on the accompanying condensed balance
sheets.
On
September 30, 2009, all of the holders of the 2009 10% Convertible Notes
converted $300,000 of principal into 171,429 shares of common stock at $1.75 per
share and all of the related note discount and debt issuance costs have been
amortized to interest expense.
On
November 4, 2009, the Company issued $2.2 million in aggregate principal amount
of its 8% Secured Convertible Promissory Notes (the “2009 8% Convertible
Notes”), convertible into common stock of the Company at a conversion price of
$2.05 per share. All outstanding principal and interest of the 2009
8% Convertible Notes was due April 1, 2011. Out of the total gross
proceeds of the offering, the Company paid its placement agent $155,000 in
commissions, equal to 7% of the gross proceeds of the offering, and issued to
its placement agent a three year warrant to purchase 77,490 shares of common
stock, equal to 3.5% of the number of shares of common stock into which the 2009
8% Convertible Notes initially may be converted, at an exercise price of $2.05
per share. The warrants were valued at $132,000 using the Black-Scholes pricing
model. These deferred financing costs, totaling $287,000, are being amortized
over the term of the 2009 8% Convertible Notes. The Company recorded
amortization of $0 and $239,000 to interest expense during the three and nine
months ended September 30, 2010.
The total
value of the 2009 8% Convertible Notes was allocated between the 2009 8%
Convertible Notes and the discount, which amounted to $745,200. The discount is
being amortized over the term of the 2009 8% Convertible Notes. The Company
amortized $0 and $621,000 to interest expense related to the 2009 8% Convertible
Notes for the three and nine months ended September 30, 2010. At September 30,
2010 and December 31, 2009, $0 and $33,000 of accrued interest on these notes is
included in accrued expenses on the accompanying condensed balance
sheets.
On May
15, 2010, all of the holders of the 2009 8% Convertible Notes converted $2.3
million of principal and accrued interest into 1.1 million shares of common
stock at $2.05 per share and all of the related note discount and debt issuance
costs have been amortized to interest expense.
On March
31, 2010, the Company issued in a private placement to GRM a 9% Secured
Convertible Promissory Note in the aggregate principal amount of $5.3 million
(the “GR Note”), due March 31, 2012. The Company received net
proceeds of $5.0 million after payment of an issuance fee of $300,000 to
GRM. The Company has recorded the $300,000 as a discount to the GR
Note as if the amount were an original issue discount. The GR Note will accrue
simple interest at the rate of 9% per annum, payable on the first day of each
calendar quarter in cash; provided, however, that GRM may elect to cause the
accrued unpaid interest for any applicable quarter to be added to the then
outstanding principal amount of the GR Note in lieu of a cash payment of
interest by delivering written notice of such election to the Company no later
than 15 days prior to the applicable interest payment date. The GR
Note was amended subsequent to September 30, 2010; see Note 9 Subsequent Events
below. GRM chose to have the first interest payment due July 1, 2010 added to
the aggregate principal amount of the GR Note. For the three and nine months
ended September 30, 2010 the Company recorded interest expense of $122,000 and
$241,000, respectively, under the GR Note.
19
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
6 - CONVERTIBLE NOTES PAYABLE (Continued)
Commencing
180 days after March 31, 2010, the outstanding principal amount of the GR Note
and accrued unpaid interest due thereon may be converted, at GRM’s election,
into the Company’s common stock at a conversion price of $3.50 per share (the
“Conversion Price”), subject to adjustment only in the event of stock splits,
dividends, combinations, reclassifications and the like. If at any
time after 180 days from the later of March 31, 2010 or such date when a
registration statement filed with the SEC covering the resale of the shares
issuable upon conversion of the GR Note becomes effective, the volume weighted
average price of the Company’s common stock for each of any 30 consecutive
trading days, which period shall have commenced after the effective date of such
registration statement, exceeds 250% of the then applicable Conversion Price,
and the daily trading volume for the common stock is at least 100,000 shares
(subject to adjustment for stock splits, combinations, recapitalizations,
dividends and the like) during such 30 trading day period, then the Company may
force GRM to convert all or part of the then outstanding principal amount of the
GR Note. GRM has piggyback and demand registration rights with
respect to the shares issuable upon conversion of the GR Note.
The
Company has the right to prepay the GR Note at any time without penalty upon 30
days written notice to GRM. GRM’s right to convert the GR Note
(commencing 180 days after its issuance date), remains active during the
prepayment notice period. Therefore, if the Company notifies GRM of
its election to prepay the GR Note sooner than 150 days from the issuance date
of the GR Note, then GRM would be obligated to accept repayment in
cash.
The
Company granted GRM a first lien priority security interest in all of the
Company’s assets securing the Company’s obligations under the GR Note, subject
to certain permitted indebtedness and liens permitted in connection with the
same.
The
Company agreed that on or before 90 days following March 31, 2010, the Company
shall: (i) cause each holder (each, a “Senior Debt Holder”) of the Company’s
outstanding 2009 8% Convertible Notes, dated on or about November 5, 2009, in
the aggregate principal amount of $2.2 million, to (A) be entirely converted,
along with accrued unpaid interest thereon, into shares of the Company’s common
stock in accordance with the terms thereof; or (B) expressly subordinate any
lien which the Senior Debt Holder holds in the Company's assets to
the GR Note and the security interest granted to GRM pursuant to a written
subordination agreement with GRM acceptable to GRM in its sole discretion; or
(C) prepay the entire outstanding principal balance of each 2009 8% Convertible
Note, and any accrued unpaid interest thereon and cause each of the 2009 8%
Convertible Notes to be cancelled. As described above all outstanding
principal of the 2009 8% Convertible Notes along with all accrued interest was
converted to shares of the Company’s common stock.
The total
value of the GR Note was allocated between the GR Note and the discount, which
amounted to $1.2 million including the $300,000 issuance fee. The discount will
be amortized over the term of GR Note. The Company amortized $151,000 and
$302,000 to interest expense related to the GR Note for the three and nine
months ended September 30, 2010.
As part
of the transaction, the Company incurred deferred financing costs of
approximately $51,000. These costs are being amortized over the term of the GR
Note. The Company recorded amortization of $6,000 and $13,000 to
interest expense during the three and nine months ended September 30,
2010.
Convertible
notes payable consist of the following:
September 30, 2010
|
December 31, 2009
|
|||||||
(In thousands)
|
||||||||
GR
Note
|
5,419 | - | ||||||
2009
8% Convertible Notes
|
- | 2,214 | ||||||
Unamortized
discount
|
(906 | ) | (621 | ) | ||||
Convertible
notes payable, net
|
$ | 4,513 | $ | 1,593 |
NOTE
7 - COMMITMENTS AND CONTINGENCIES
Royalty
Agreement
On July
24, 2009, the Company entered into a licensing agreement with Wiley Publishing,
Inc., owner of the For
Dummies® trademark, for use of the For
Dummies® trademark in connection with the manufacture, development,
operation, sale, distribution and promotion of the Company’s
products. The term of the agreement is five years with an option for
the Company to renew for an additional five years provided that the Company has
paid to Wiley a minimum royalty of $2.0 million during the initial term of the
agreement. The Company paid a $100,000 non-refundable royalty advance that is
recorded in prepaid expenses on the accompanying balance sheet. There
was no royalty expense for the three and nine months ended September 30,
2010.
20
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
7 - COMMITMENTS AND CONTINGENCIES (Continued)
Operating
Leases
The
Company's primary offices are in Los Angeles, California. The Company
entered into a lease on October 19, 2007 which commenced on March 24, 2008 for
approximately 4,742 rentable square feet of office space with a term of
sixty-two months. On October 9, 2009, the Company entered into a second
amendment of its lease with its current landlord to relocate and to occupy
approximately 16,000 square feet in the building to accommodate growth. The
lease calls for a base monthly rent of $35,060 with annual increases of 3% plus
common area expenses with a term of ten years. The Company’s rent on
its original space was abated beginning July 1, 2009 and the abatement continues
on the new space for a period of fourteen (14) months from the date the Company
began to occupy the new space, which was February 1, 2010, as long as the
Company abides by all the terms and conditions of the lease and if no event of
default occurs. Rent expense (including any rent abatements or escalation
charges) is recognized on a straight-line basis from the date the Company takes
possession of the property to the end of the lease term. In the event the
Company fails to abide by all the terms and conditions of the lease or an event
of default occurs the Company shall reimburse the landlord for the abated rent
along with interest. On August 9, 2010, the Company entered into a third
amendment to the lease for the Company’s premises. Pursuant to the third
amendment, the Company will occupy an additional 16,000 square feet in the
building to accommodate growth. The third amendment requires a base monthly rent
upon occupancy of $35,060 for the additional space, making the total base
monthly rent $70,120, with annual increases of 3%. The Company
expects to occupy the additional space on December 1, 2010. The third amendment
provides for six months of rent abatement on the additional space as long as the
Company occupies the space for the full lease term. In the event the Company
fails to abide by all the terms and conditions of the lease or an event of
default occurs the Company shall reimburse the landlord for the abated rent
along with interest. Aside from the monthly rent, the Company is required to pay
its share of common operating expenses.
Litigation
In the
ordinary course of business, the Company may face various claims brought by
third parties and the Company may, from time to time, make claims or take legal
actions to assert its rights. Any of these claims could subject the Company to
costly litigation and, while the Company generally believes that it has adequate
insurance to cover many different types of liabilities, the Company’s insurance
carriers may deny coverage or the Company’s policy limits may be inadequate to
fully satisfy any damage awards or settlements. If this were to happen, the
payment of any such awards could have a material adverse effect on the Company’s
operations, cash flows and financial position. Additionally, any such claims,
whether or not successful, could damage the Company’s reputation and business.
Management believes the outcome of currently pending claims and lawsuits are not
likely to have a material effect on the Company’s operations or financial
position.
Guarantees and
Indemnities
During
the normal course of business, the Company has made certain indemnities and
guarantees under which it may be required to make payments in relation to
certain transactions. The duration of these indemnities and guarantees varies
and, in certain cases, is indefinite. The majority of these indemnities and
guarantees do not provide for any limitation of the maximum potential future
payments the Company could be obligated to make. The Company hedges some of the
risk associated with these potential obligations by carrying insurance.
Historically, the Company has not been obligated to make significant payments
for these obligations and no liabilities have been recorded for these
indemnities and guarantees in the accompanying condensed balance
sheets.
The
Company has entered into, and will likely enter into in the future,
indemnification agreements with the individuals who serve as its officers and
directors. Pursuant to these agreements, the Company will indemnify
officers and directors who are made parties to, or threatened to be made parties
to, any proceeding by reason of the fact that they are or were officers or
directors of the Company, or are or were serving at the request of the Company
as a director, officer, employee, or agent of another entity. The
agreements require the Company to indemnify its officers and directors against
all expenses, judgments, fines and penalties actually and reasonably incurred by
them in connection with the defense or settlement of any such proceeding,
subject to the terms and conditions of the agreements.
Employment
Agreements
The
Company has an Amended and Restated Key Executive Employment Agreement with each
of Gary Guseinov, the Company’s Chief Executive Officer, Kevin Harris, the
Company’s Chief Financial Officer, and Igor Barash, the Company’s Chief
Information Officer. The details of these agreements have been
disclosed in the Company’s Form 10-Q for the period ended June 30, 2010 filed on
August 9, 2010.
21
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
8 - RELATED PARTY TRANSACTIONS
Unionway
International, LLC, an entity controlled by Bing Liu, a former officer, provided
software development services to the Company. During the three and nine months
ended September 30, 2009, the Company paid Unionway International, LLC $0 and
$50,000, respectively.
The
Company purchased promotional items with the Company’s name and logo on them
from VK Productions, an entity controlled by Mr. Guseinov’s spouse. During the
three and nine months ended September 30, 2010, VK Productions invoiced the
Company $0 and $6,000.
On April
1, 2010, the Company and GRM entered into a License Agreement (the “License
Agreement”) whereby the Company granted to GRM an exclusive royalty-bearing
license to market, sell and distribute, in the United States through retail
channels of distribution (such as retail stores, online retail storefronts,
kiosks, counters and other similar retail channels) and television shopping
channels (such as QVC and Home Shopping Network), and in certain foreign
countries through retail channels, television shopping channels, direct response
television and radio, and Internet websites associated with such marketing
channels (other than www.cyberdefender.com),
the Company’s line of antivirus and Internet security products or services (the
“License”).
In
consideration of the license granted to GRM in the License Agreement, GRM will
pay royalties to the Company on a product-by-product basis for each annual
subscription and each annual renewal by end users of the products covered by the
License Agreement. Upon the achievement of certain milestones or
conditions in the License Agreement, GRM will make annual advances of royalties
to the Company in the amount of $250,000 per year. If GRM fails to
pay an annual advance when due, and if certain other conditions are met, the
License shall become non-exclusive.
The
License Agreement provides that GRM and the Company will share costs associated
with localizing products and related material to comport to the language, laws
and/or customs of foreign countries, subject to certain caps on GRM’s expenses
with respect to such localization efforts.
Under the
License Agreement, the Company will provide customer service and all product and
technical support services to end users of the products in the United States and
will retain all revenue from such services. Additionally, with
respect to each foreign country in which GRM markets the products, the Company
will have the right to provide customer service and all product and technical
support services to end users of the products in such foreign
country.
The
License Agreement also provides that, after certain conditions are met, the
Company has the right to buy back and terminate the License (and the related
rights of GRM) as it relates to the territory of United States (the “Domestic
Buy-Out Right”) and/or to the collective territories outside of the United
States (the “International Buy-Out Right”). The price to be paid by
the Company in connection with the Domestic Buy-Out Right or International
Buy-Out Right, as applicable, will be based on a combination of factors,
including (i) the annualized gross revenue earned by GRM in connection with the
sale and distribution of products in the applicable territory being “bought out”
by the Company (the “Annualized Gross Revenue”), (ii) the enterprise value of
the Company, (iii) the gross revenue of the Company for the 12 months preceding
its exercise of such buy-out right and/or (iv) the fair market value of GRM’s
rights under the License Agreement (with respect to the territory being “bought
out” by the Company). In no case, however, will the buy-out
price be less than (a) 1.5 times the Annualized Gross Revenue, if the applicable
buy-out right is exercised within one year of such right becoming exercisable,
or (b) 3.0 times the Annualized Gross Revenue, if the applicable buy-out right
is exercised at any time after the one-year anniversary of such right becoming
exercisable. The buy-out price will be payable in cash or in shares
of the Company’s common stock, or any combination thereof, at GRM’s
discretion.
The
License Agreement may be terminated by mutual consent of the
parties. The License Agreement may also be terminated by either party
upon a default of the other party under the License Agreement that remains
uncured for 30 days following notice of such default. Additionally,
GRM may terminate the License Agreement at any time for convenience, provided
that GRM may not market any antivirus or Internet security products or services
that compete with the Company’s products or services in the distribution
channels covered by the License Agreement for one year following such a
termination for convenience. The License Agreement has been amended;
see Note 9 Subsequent
Events below.
See Note
5 for a detailed description of all warrants issued to GRM and the vesting of
those warrants in connection with the Media Agreement.
GRM
invoiced the Company $122,000 and $302,000 for the three and nine months ended
September 30, 2010 and $15,000 and $29,000 for the three and nine months ended
September 30, 2009 for their overhead expense reimbursement on media costs
incurred by GRM pursuant to the Media Agreement.
See Note
6 for a detailed description of the GR Note. See Note 9 for subsequent events
related to GRM.
22
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
9 - SUBSEQUENT EVENTS
On
October 22, 2010, the Company and GRM entered into a Third Amendment to the
Media and Marketing Services Agreement (“the Third Amendment”), effective as of
October 15, 2010. Pursuant to the Third Amendment, (i) GRM has the
right to appoint one observer to the Board of Directors at any time when there
is no GRM director on the board of directors, (ii) the Company shall pay GRM a
monthly creative management fee of $75,000, (iii) the Company shall pay directly
or reimburse GRM for all out-of-pocket costs incurred by GRM in connection with
the creation, development, and/or production of any television or radio direct
response commercials and (iv) the security interest granted to GRM is extended
to include the new monthly creative management fee as well as GRM’s
out-of-pocket production costs. The Third Amendment also extended the
term of the Media and Marketing Services Agreement until October 31, 2011,
unless earlier terminated in accordance with the provisions of the
Agreement.
On
October 22, 2010, the Company and GRM entered into a First Amendment to the
License Agreement (“the First Amendment”), effective as of October 15,
2010. Pursuant to the First Amendment, the royalties payable in
Schedule D to the License Agreement were amended and GRM was provided the one
time right to cause the eighteen months cutoff date (to which reference is made
in the definition of the International Roll-Out Date)to be delayed for a period
of up to 12 months in the event that GRM elects to delay its marketing of the
products in the International Territory for legitimate business reasons,
including, without limitation, delays in the development of the required
processes, systems or other aspects of GRM’s business.
Effective
as of December 3, 2010, the Company and GRM entered into a Revolving Credit Loan
Agreement (the “Loan Agreement”) pursuant to which GRM has made available to the
Company a secured revolving credit facility in the principal amount not to
exceed $5,000,000 (the “Credit Facility”). Pursuant to the terms and
conditions of the Loan Agreement, GRM will advance funds to the Company, and the
Company will use the funds solely for the Company’s payments of amounts owing to
GRM pursuant to the Media Services Agreement.
The
initial principal amount of the Credit Facility is $4,288,000, which is the
total amount of invoices owing by the Company to GRM pursuant to the Media
Services Agreement as of December 3, 2010, and will be repaid in accordance with
the terms of the Loan Agreement. Advances made by GRM under the
Credit Facility will not exceed $500,000 per week during the term of the Credit
Facility and will not exceed a maximum total amount of $5,000,000 unless
otherwise agreed to by GRM. All outstanding principal and accrued but
unpaid interest under the Credit Facility is due and payable in full on the
earlier of either March 31, 2011 or the closing of the Company’s sale and
issuance of any debt or equity securities of the Company in an aggregate amount
exceeding $10,000,000. Interest will accrue on the outstanding
principal amount advanced under the Credit Facility at an annual rate of 10%,
and will be calculated on a per diem basis and added to the principal amount
advanced. Upon an event of default, the interest rate will
increase to 15% per annum, and GRM may elect to: (1) terminate the Credit
Facility; (2) declare immediately due and payable in cash the entire outstanding
principal balance, together with any repayment fees, all accrued but unpaid
interest, and any and all other amounts due and owing; and (3) exercise any and
all rights and remedies available to GRM pursuant to the Loan Agreement or under
applicable law. Additionally, GRM also has the right, but not the
obligation, and at the Company’s sole cost and expense, to require the Company
to retain a consultant or hire a Company executive who would be senior to the
Company’s Chief Executive Officer and Chief Financial Officer
Simultaneously
with all repayments of outstanding amounts advanced under the Credit Facility,
including repayment of the Credit Facility on the due date, the Company will pay
GRM a repayment fee in an amount equal to 10% of the total amount being repaid.
Late payments, if any, will incur a fee in an amount equal to 10% of the amount
due.
Pursuant
to a security agreement, the Company granted to GRM a second lien priority
security interest in all of the Company’s assets subject only to liens existing
on the original issue date in favor of GRM under the GR Note. Subject to certain
limited exceptions, any future debt financing by the Company must be approved by
GRM and in all cases must be subordinate to the Credit Facility with respect to
both terms of payment and priority.
In
connection with the Credit Facility, and effective as of December 3, 2010, the
Company and GRM entered into a First Amendment to the GR Note, pursuant to which
the GR Note was amended to provide that the Company does not have the right to
repay the GR Note without the prior written consent of GRM.
In
connection with the Credit Facility, and effective as of December 3, 2010, the
Company and GRM entered into a First Amendment to the Loan and Securities
Purchase Agreement modifying certain loan covenants.
In
connection with the Credit Facility, and effective as of December 3, 2010, the
Company and GRM entered into a Fourth Amendment to the Media Services Agreement
(the “Fourth Amendment”), which amended the Media Services Agreement to reduce
payment terms to fifteen days for GRM invoices as long as there is a balance on
the Credit Facility. Second, the term of the Services Agreement was
extended to December 31, 2013.
23
FORWARD-LOOKING
STATEMENTS
This
Quarterly Report on Form 10-Q filed by CyberDefender Corporation (referred to as
“the Company”, “we”, “us” or “our”) contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. These are statements regarding financial and
operating performance and results and other statements that are not historical
facts. The words “expect,” “project,” “estimate,” “believe,” “anticipate,”
“intend,” “plan,” “forecast,” and similar expressions are intended to identify
forward-looking statements. Certain important risks could cause results to
differ materially from those anticipated by some of the forward-looking
statements. Some, but not all, of these risks include, among other
things:
·
|
changes
in local, state or federal regulations that will adversely affect our
business;
|
·
|
our
ability to market and distribute or sell our
products;
|
·
|
our
ability to protect our intellectual property and operate our business
without infringing upon the intellectual property rights of
others;
|
·
|
whether
we will continue to receive the services of certain officers and
directors; and
|
·
|
other
uncertainties, all of which are difficult to predict and many of which are
beyond our control.
|
We do not
intend to update forward-looking statements. You should refer to and carefully
review the risks identified in the Company’s Form 10-K/A for the year ended
December 31, 2009 and the information in future documents we file with the
Securities and Exchange Commission.
24
ITEM
2.
|
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
OVERVIEW
We are a
provider of security and PC optimization software and remote LiveTech services
to the consumer and small business market. We are located in Los Angeles,
California. Our mission is to bring to market advanced solutions to
protect computer users against Internet viruses, spyware, identity theft and
related security threats.
The
market in which we operate is highly competitive and rapidly changing. We
believe we can be successful in this market due to several factors.
|
·
|
Our
proprietary CyberDefender Argus Network (formerly known as the
“earlyNETWORK”) security platform uses a patented secure peer-to-peer
protocol and the power of user community, which we believe differentiates
our core anti-malware product and allows us to combat threats faster and
more cost effectively than our
competitors.
|
|
·
|
Our
security platform complements other security suites allowing our customers
to adopt multiple security products for increased
protection.
|
|
·
|
We
are expanding our technical support services (“LiveTech”) to provide our
customers with the technical expertise necessary to insure that their
technology is working properly, thereby providing them with a higher
degree of security.
|
|
·
|
We
are continuing our direct-response marketing efforts through our
partnership with GRM, a leader in the field, and expansion of our
marketing efforts with GRM to include retail and international
distribution.
|
|
·
|
We
are focusing on expanding our product offerings by creating new
products.
|
We
believe that providing a “software only” solution to computer security problems
is not as effective as our comprehensive solution, which includes security and
optimization software in conjunction with access to remote
technicians. Our customers benefit from having a technician analyze
their PCs and repair problems that they do not have the expertise to resolve.
While we still do not yet represent a significant presence in the security
software industry, we believe that the combination of our software security and
optimization solutions, our CyberDefender Argus Network platform, our remote
LiveTech capability and our direct response marketing focus, have improved our
ability to expand our presence in the security software market.
We
evaluate our financial performance utilizing a variety of indicators. Four of
the primary indicators that we utilize to evaluate the ongoing performance of
our business include gross sales (a non-GAAP measure), income/loss from
operations, net cash used in operating activities and renewal revenue and
renewal rates. See the “Reconciliation of GAAP to Non-GAAP Financial
Measures” below.
Gross
sales are a non-GAAP measure which we define as total sales before refunds and
before deferring revenue for GAAP purposes. We believe gross sales serves as an
appropriate measure to be used in evaluating the performance of our business as
it gives a better indication of our operating performance and the profitability
of our marketing initiatives. Gross sales for the three months ended
September 30, 2010 increased $11.9 million, or 178%, to $18.6 million from $6.7
million for the three months ended September 30, 2009. Gross sales
for the nine months ended September 30, 2010 increased $23.6 million, or 123%,
to $42.8 million from $19.2 million for the nine months ended September 30,
2009. As detailed in the table in the section below titled “Trends,
Events and Uncertainties,” service revenue more than tripled from the same
period in the prior year, while product and ancillary sales also increased for
the three and nine months ended September 30, 2010 as compared to 2009. The
increase was driven
by several factors: increased direct-response advertising efforts through
our partnership with GRM, increasing demand for our
software products and LiveTech services, and an increase in renewal revenues and
continued improvements related to infrastructure optimization including
SaaS-based CRM, IVR and eCommerce platforms.
25
Loss from
operations for the three months ended September 30, 2010 increased $6.7 million,
or 171%, to $10.6 million from $3.9 million for the three months ended September
30, 2009. This increase in operating loss is primarily attributable to the value
of the Media Services Warrant and other warrants issued to GRM. The increased
value of the warrants was due to two factors. The first, is the
increased number of warrants that vested due to an increase in the amount of
media spend per the Media Services Agreement and the second is the calculated
value of the warrants. During the three months ended September 30, 2010 and
2009, 2,448,652 and 558,245 warrants vested. The average value of the
warrants increased from $1.85 per warrant during the three months ended
September 30, 2009 to $2.60 per warrant during the three months ended September
30, 2010. During the nine months ended September 30, 2010 and 2009, 6,038,636
and 835,295 warrants vested. The average value of the warrants
increased from $1.66 per warrant during the nine months ended September 30, 2009
to $3.03 per warrant during the nine months ended September 30, 2010. The
warrants were valued using the Black-Scholes option-pricing model at each
vesting date. The calculated value of the warrants increased significantly at
each new vesting date as the stock price increased. The Black-Scholes
option-pricing model does not factor in the illiquidity of the underlying shares
when calculating the value of the warrants. The Company recorded non-cash
expense of $6.4 million to media and marketing services for the three months
ended September 30, 2010 as compared to $1.2 million for the three months ended
September 30, 2009. Additionally, operating loss increased in part because of
the deferral of revenues for GAAP purposes resulting from an increase in the
sale of two and three year LiveTech subscription plans during the third
quarter. Sales of multi-year technical support plans increased to
approximately 60% of the third quarter sales, up from 40% in the second quarter
of 2010. Loss from operations for the nine months ended September 30, 2010
increased $17.6 million, or 145%, to $29.7 million from $12.1 million for the
nine months ended September 30, 2009. This increase in operating loss is
primarily attributable to the value of the Media Services Warrant and other
warrants issued to GRM as detailed above. The Company recorded
non-cash expense of $18.3 million to media and marketing services for the nine
months ended September 30, 2010 as compared to $2.7 million for the nine months
ended September 30, 2009.
Net cash
used in operating activities for the nine months ended September 30, 2010
decreased $1.1 million, or 20%, to $4.4 million from $5.5 million for the nine
months ended September 30, 2009. The decrease is primarily attributable to an
increase in accounts payable and accrued expenses, an increase in deferred
revenue due to increased sales and a decrease in deferred charges due to
amortization offset by an increase in accounts receivable due to the
introduction of a two month payment plan to our customers, an increase in
restricted cash due to increased sales and increased costs from scaling our
infrastructure.
There are
challenges and risks associated with our recent growth and the many initiatives
that we are focused on implementing. Our growth may not continue as
expected or at all. Any one or all of our new initiatives may not
produce the expected results including; (i) our contract with Vindicia to
increase renewal rates, (ii) our new international and retail distribution
licensing agreement with GRM, and (iii) the new products that we expect to
launch under our brand. If our growth does not continue or does not
meet our expectations the costs incurred to scale our infrastructure may not produce a return
on our investment and our costs may continue to exceed our revenues.
Additionally, as described below, we received a $5 million short-term credit
facility from GRM that is due on March 31, 2011. The facility was
designed to provide bridge financing to us while we secure long-term
financing. Management is currently pursuing several financing options
including both debt and equity transactions.
On March
31, 2010, we received net proceeds of $5.0 million from a promissory note issued
to GRM. This investment will be used to continue the expansion of our
business. In addition to this investment, we signed a license agreement granting
GRM certain international and domestic distribution rights which we believe will
allow us to leverage GRM’s powerful international sales and distribution
channels as well as augment our domestic retail marketing
initiatives. Effective as of December 3, 2010, we entered into a
secured revolving credit facility with GRM described in Note 9 above in the
principal amount not to exceed $5,000,000 due March 31,
2011. Pursuant to the terms and conditions of the revolving credit
facility, GRM will advance funds to us and we will use the funds solely for our
payments of amounts owing to GRM pursuant to the Media Services
Agreement.
Effective
June 6, 2010, the Company’s common stock was listed on the NASDAQ Global
Market.
Critical Accounting Policies and
Estimates
During
the three months ended September 30, 2010, the Company chose to capitalize
certain costs related to computer software developed or obtained for internal
use. The Company capitalizes only those direct costs incurred during the
application development and implementation stages for developing, purchasing or
otherwise acquiring software solely to meet the Company’s internal needs.
Capitalized costs will be amortized on a straight-line basis over the estimated
useful lives of the underlying software, generally three years. During the third
quarter and nine months of 2010, the Company capitalized $0.7 million of
costs.
26
Contractual
Obligations
We are
committed under the following contractual obligations:
Contractual Obligations
|
Payments Due By Period
|
|||||||||||||||||||
Total
|
Less than 1 year
|
1 to 3 Years
|
3 to 5 Years
|
Over 5 Years
|
||||||||||||||||
Debt
obligations
|
$ | 5,419,250 | $ | - | $ | 5,419,250 | $ | - | $ | - | ||||||||||
Capital
lease obligations
|
$ | 325,313 | $ | 139,377 | $ | 185,936 | $ | - | $ | - | ||||||||||
Operating
lease obligations
|
$ | 8,879,019 | $ | 365,042 | $ | 1,766,982 | $ | 1,862,363 | $ | 4,884,633 |
Off-Balance
Sheet Arrangements
We do not
have off-balance sheet arrangements. As part of our ongoing business,
we do not participate in transactions that generate relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, often established
for the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes.
Indemnities
During
the normal course of business, we have agreed to certain
indemnifications. In the future, we may be required to make payments
in relation to these commitments. These indemnities include
agreements with our current and former officers and directors which may require
us to indemnify these individuals for liabilities arising by reason of the fact
that they were or are officers or directors. The duration of these
indemnities varies and, in certain cases, is indefinite. There is no
limit on the maximum potential future payments we could be obligated to make
pursuant to these indemnities. We hedge some of the risk associated
with these potential obligations by carrying general liability
insurance. Historically, we have not been obligated to make any
payments for these obligations and no liabilities have been recorded for these
indemnities in our condensed financial statements.
Trends,
Events and Uncertainties
As
described above in the discussion of revenue recognition, we generally receive
payment upon the sale of our products and services and defer the revenue over
the life of the license agreement or service plan, which ranges from one to
three years.
The
following table summarizes our GAAP revenue and deferred revenue for each of the
last eight quarters.
Quarter Ended
|
Net
Revenue
|
Cumulative
Deferred
Revenue
|
||||||
31-Dec-08
|
$ | 2,467,136 | $ | 4,552,953 | ||||
31-Mar-09
|
$ | 3,191,630 | $ | 6,687,198 | ||||
30-Jun-09
|
3,686,644 | $ | 8,139,384 | |||||
30-Sep-09
|
4,427,404 | $ | 9,656,352 | |||||
31-Dec-09
|
7,536,215 | $ | 10,779,146 | |||||
Fiscal
Year 2009 Total
|
$ | 18,841,893 | ||||||
31-Mar-10
|
$ | 9,477,330 | $ | 11,619,760 | ||||
30-Jun-10
|
9,712,586 | $ | 12,081,434 | |||||
30-Sep-10
|
12,746,103 | $ | 14,163,271 | |||||
Fiscal
Year to date 2010 Total
|
$ | 31,936,019 |
27
The
following table summarizes our gross sales by category for the last eight
quarters. Gross sales are a non-GAAP measure that we use in assessing our
operating performance. We define gross sales as total sales before refunds and
chargebacks and before deferring revenue for GAAP purposes. We use this non-GAAP
financial measure because we believe it provides a better indication of our
operating performance and the profitability of our marketing initiatives. We
include this non-GAAP financial measure in our earnings announcements in order
to provide transparency to our investors and to enable investors to better
understand our operating performance. However, we do not recommend using gross
sales alone to assess our financial performance or to formulate investment
decisions.
Quarter Ended
|
Software
|
Services
|
Ancillary
|
Renewals
|
Total
|
|||||||||||||||||||||||||||||||
31-Dec-08
|
2,107,307 | 49 | % | 1,493,234 | 35 | % | 669,477 | 16 | % | - | 0 | % | 4,270,018 | |||||||||||||||||||||||
31-Mar-09
|
$ | 2,475,095 | 40 | % | $ | 2,645,857 | 43 | % | $ | 606,051 | 10 | % | $ | 463,948 | 7 | % | $ | 6,190,951 | ||||||||||||||||||
30-Jun-09
|
2,501,266 | 40 | % | 2,678,978 | 43 | % | 584,1444 | 9 | % | 466,747 | 8 | % | 6,231,135 | |||||||||||||||||||||||
30-Sep-09
|
2,666,274 | 40 | % | 2,915,731 | 43 | % | 461,120 | 7 | % | 699,068 | 10 | % | 6,742,193 | |||||||||||||||||||||||
31-Dec-09
|
4,401,569 | 45 | % | 3,705,830 | 38 | % | 982,460 | 10 | % | 717,949 | 7 | % | 9,807,808 | |||||||||||||||||||||||
Fiscal
Year 2009 Totals
|
$ | 12,044,204 | 42 | % | $ | 11,946,396 | 41 | % | $ | 2,633,775 | 9 | % | $ | 2,347,712 | 8 | % | $ | 28,972,087 | ||||||||||||||||||
31-Mar-10
|
$ | 4,092,152 | 35 | % | $ | 5,802,486 | 49 | % | $ | 856,297 | 7 | % | $ | 1,062,473 | 9 | % | $ | 11,813,408 | ||||||||||||||||||
30-Jun-10
|
3,504,147 | 28 | % | 6,967,067 | 56 | % | 568,525 | 5 | % | 1,389,064 | 11 | % | 12,428,803 | |||||||||||||||||||||||
30-Sep-10
|
4,155,264 | 22 | % | 11,706,203 | 63 | % | 501,721 | 3 | % | 2,196,572 | 12 | % | 18,559,760 | |||||||||||||||||||||||
Fiscal
Year to date 2010 Totals
|
$ | 11,751,563 | 27 | % | $ | 24,475,756 | 57 | % | $ | 1,926,543 | 5 | % | $ | 4,648,109 | 11 | % | $ | 42,801,971 |
The
tables above indicate an upward trend in gross sales, GAAP revenue and deferred
revenue resulting from our focus on promoting our new products and services and
the addition of our new marketing channels. We cannot guarantee that
this upward trend will continue, even with increased spending on
advertising.
Reconciliation
of GAAP to Non-GAAP Financial Measures
The
following is a reconciliation of gross sales to net revenue for the three and
nine months ended September 30, 2010 and 2009:
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Gross
Sales
|
$ | 18,559,760 | $ | 6,742,192 | $ | 42,801,971 | $ | 19,164,278 | ||||||||
Less:
Refunds
|
(3,731,821 | ) | (797,820 | ) | (7,481,828 | ) | (2,755,201 | ) | ||||||||
Less:
Change in deferred revenue
|
(2,081,836 | ) | (1,516,968 | ) | (3,384,124 | ) | (5,103,399 | ) | ||||||||
Net
revenue
|
$ | 12,746,103 | $ | 4,427,404 | $ | 31,936,019 | $ | 11,305,678 |
Other
trends, events and uncertainties that may impact our liquidity are included in
the discussion below.
28
RESULTS
OF OPERATIONS
Three
and Nine Months Ended September 30, 2010 Compared to Three and Nine Months Ended
September 30, 2009
Net
Sales
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Net
sales
|
$ | 12,746,103 | $ | 4,427,404 | $ | 8,318,699 | 188 | % | $ | 31,936,019 | $ | 11,305,678 | $ | 20,630,341 | 182 | % |
The
increase in net revenue was driven by several factors: increased direct-response
advertising efforts through our partnership with GRM, increasing demand for our
software products and remote LiveTech services, an increase in renewal revenues
and continued improvements related to infrastructure optimization including
SaaS-based CRM, IVR and eCommerce platforms. See the discussion of advertising
expenses below.
Revenue
from product sales increased $1.5 million, or 65%, to $3.8 million for the three
months ended September 30, 2010 from $2.3 million for the three months ended
September 30, 2009. Revenue from services increased $5.9 million, or 393%, to
$7.4 million for the three months ended September 30, 2010 from $1.5 million for
the three months ended September 30, 2009. Revenue from renewals increased $1.0
million, or 250%, to $1.4 million for the three months ended September 30, 2010
from $0.4 million for the three months ended September 30, 2009.
Revenue
from product sales increased $5.7 million, or 93%, to $11.8 million for the nine
months ended September 30, 2010 from $6.1 million for the nine months ended
September 30, 2009. Revenue from services increased $12.7 million, or 363%, to
$16.2 million for the nine months ended September 30, 2010 from $3.5 million for
the nine months ended September 30, 2009. Revenue from renewals increased $2.2
million, or 220%, to $3.2 million for the nine months ended September 30, 2010
from $1.0 million for the nine months ended September 30, 2009.
Cost
of Sales
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Cost
of Sales
|
$ | 5,833,897 | $ | 1,018,370 | $ | 4,815,527 | 473 | % | $ | 13,002,748 | $ | 2,451,398 | $ | 10,551,350 | 430 | % |
The
increase in cost of sales was primarily attributable to the expansion of our
internal and external call center operations to support the increase in sales of
our remote LiveTech services. Additionally, we have reduced our use of an
offshore call center that was on a revenue share basis and increased our use of
a U.S. based third-party call center that is invoiced on a usage
basis. The revenue share arrangement allowed us to defer the cost of
the offshore call center for GAAP accounting. Cost of sales includes
compensation related expenses of our internal sales and technical support staff,
as well as the cost of outsourced call centers. Compensation-related expenses
for our internal sales and technical support staff totaled $2.8 million for the
three months ended September 30, 2010 as compared to $0 for the three months
ended September 30, 2009. Expenses related to outsourced call centers totaled
$2.8 million for the three months ended September 30, 2010 as compared $0.9 for
the three months ended September 30, 2009. Compensation-related expenses for our
internal technical support staff totaled $5.5 million for the nine months ended
September 30, 2010 as compared to $0 for the nine months ended September 30,
2009. Expenses related to outsourced call centers totaled $6.8 million for the
nine months ended September 30, 2010 as compared $2.0 for the nine months ended
September 30, 2009.
Operating
Expenses
Media
and marketing services
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Media
and marketing services
|
$ | 12,455,307 | $ | 4,717,729 | $ | 7,737,578 | 164 | % | $ | 34,662,346 | $ | 13,363,588 | $ | 21,298,758 | 159 | % |
Media and
marketing services expense is comprised primarily of non-cash expense related to
the Media Services Warrant and other warrants issued to GRM. Media
and marketing services costs also include media and channel fees, including
online and offline advertising and related functional resources. This increase
was primarily attributable to the non-cash expense related to the Media Services
Warrant and other warrants issued to GRM. Direct advertising costs
were $5.8 million and $3.2 million for the three months ended September 30, 2010
and 2009, respectively. Direct advertising costs were $15.4 million and $10.0
million for the nine months ended September 30, 2010 and 2009,
respectively.
29
Product
Development
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Product
Development
|
$ | 742,207 | $ | 464,761 | $ | 277,446 | 60 | % | $ | 2,457,726 | $ | 1,129,995 | $ | 1,327,731 | 117 | % |
Product
development expenses are primarily comprised of research and development costs
associated with the ongoing support and improvement of current products. This
increase is primarily attributable to increased salaries and compensation paid
to contractors. Certain costs related to computer software developed or obtained
for internal use have been capitalized. The Company capitalizes only those
direct costs incurred during the application development and implementation
stages for developing, purchasing or otherwise acquiring software solely to meet
the Company’s internal needs. During the third quarter and for the nine months
of 2010, the Company capitalized $0.7 million of costs.
General
and Administrative
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
G
& A
|
$ | 4,252,866 | $ | 2,128,523 | $ | 2,124,343 | 100 | % | $ | 11,402,399 | $ | 6,477,178 | $ | 4,925,221 | 76 | % |
General
and administrative expenses are primarily comprised of salaries and wages, third
party credit card processing fees, legal and professional fees, rent and other
normal operating expenses.
The
increase in G & A was primarily attributable to an increase in salaries and
wages and related compensation expenses, including benefits and payroll taxes,
due to the increase in staffing across all departments required as a result of
the increase in sales and scaling of infrastructure. The largest increase was
seen in our call center operations. There was also an overall increase in
expenses in all G & A categories due to the increased staffing and sales
activities in the current period. Additionally, there was an increase in
professional fees related to listing the Company’s common stock on the NASDAQ
Global Market and an increase in third party credit card processing fees as a
direct result of increased sales.
Loss
From Operations
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Loss
from operations
|
$ | 10,590,041 | $ | 3,910,959 | $ | 6,679,082 | 171 | % | $ | 29,716,212 | $ | 12,145,557 | $ | 17,570,655 | 145 | % |
The
increase in operating loss was primarily attributable to the non-cash expense
related to the Media Services Warrant and other warrants issued to GRM. The
Company recorded non-cash expense of $6.4 million to media and marketing
services for the three months ended September 30, 2010 as compared to $1.2
million for the nine months ended September 30, 2009. The Company recorded
non-cash expense of $18.3 million to media and marketing services for the nine
months ended September 30, 2010 as compared to $2.7 million for the nine months
ended September 30, 2009.
30
Other
Income/(Expense)
Interest
expense, net
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Interest
expense
|
$ | 291,279 | $ | 445,458 | $ | (154,179 | ) | (35 | )% | $ | 1,501,196 | $ | 2,164,189 | $ | (662,993 | ) | (31 | )% |
The
decreased interest expense was primarily attributable to the decrease in
interest and amortization expense from the 10% Convertible Promissory Notes and
the 10% Secured Debentures that were converted during 2009.
Net
Loss
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Net
loss
|
$ | 10,881,320 | $ | 4,356,417 | $ | 6,524,903 | 150 | % | $ | 31,217,408 | $ | 14,200,688 | $ | 17,016,720 | 120 | % |
The
increase in net loss was primarily attributable to the non-cash expense related
to the Media Services Warrant and other warrants issued to GRM. The Company
recorded non-cash expense of $6.4 million to media and marketing services for
the three months ended September 30, 2010 as compared to $1.2 million for the
three months ended September 30, 2009. The Company recorded non-cash expense of
$18.3 million to media and marketing services for the nine months ended
September 30, 2010 as compared to $2.7 million for the nine months ended
September 30, 2009.
31
Liquidity
and Capital Resources
As
detailed in the section above titled “Trends, Events and Uncertainties,” our
revenues have been increasing on a quarterly basis for the last eight
quarters.
To help
with our cash flow, we occasionally sell our debt or equity
securities. At September 30, 2010 we had outstanding $5.4 million in
principal amount of a 9% convertible promissory note issued to GRM.
At
September 30, 2010, we had cash totaling $2.8 million. In the nine
months ended September 30, 2010, we used $0.6 million in cash.
Cash
provided/(used) during the nine months ended September 30, 2010 and 2009
included:
Operating
Activities
Net cash
used in operating activities during the nine months ended September 30, 2010 was
primarily the result of our net loss of $31.2 million. Net loss was
adjusted for non-cash items such as amortization of debt discount of $0.9
million, compensation expense for vested stock options of $0.7 million,
amortization of deferred financing costs of $0.2 million, warrants issued for
media and marketing services of $18.3 million and shares and warrants issued for
services, interest and penalties of $0.6 million. Other changes in working
capital accounts include an increase in restricted cash of $1.0 million, an
increase in accounts receivable of $1.5 million, a decrease in deferred charges
of $1.7 million, an increase in accounts payable and accrued expenses of $3.6
million and an increase of $3.4 million in deferred revenue resulting from
higher new customer and renewal sales.
Net cash
used in operating activities during the nine months ended September 30, 2009 was
primarily the result of our net loss of $14.2 million. Net loss was adjusted for
non-cash items such as amortization of debt discount and deferred financing
costs, depreciation and amortization, shares issued for penalties, interest and
services, compensation expense from the issuance of stock options, warrants
issued in connection with a warrant tender offer and the change in the value of
derivative liabilities. Other changes in working capital accounts include an
increase in restricted cash, decreases in accounts receivables and prepaid
expenses, and increases in accounts payable, deferred charges and deferred
revenue as a result of an increase in the sales of our new
products.
Our
primary source of operating cash flow is the collection of sales receipts from
our customers and the timing of payments to our vendors and service
providers. During the nine months ended September 30, 2010, we began
offering payment plans to our customers for the purchase of multi-year technical
support service plans. We expect this change to increase gross sales but to also
impact operating cash flow because sales receipts will be spread over two months
instead of being received at the time of sale.
The
increase in cash related to accounts payable and accrued expenses was $3.6
million. Our operating cash flows, including changes in accounts
payable and accrued liabilities, are impacted by the timing of payments to our
vendors for accounts payable. We typically pay our vendors and
service providers in accordance with invoice terms and
conditions. The timing of cash payments in future periods will be
impacted by the nature of accounts payable arrangements. We did not
make any significant changes to the timing of payments to our vendors during the
nine months ended September 30, 2010. Subsequent to September 30, 2010, as
described in Note 9 of the accompanying notes to the condensed financial
statements we amended the Media Services Agreement that allows for the
modification of the payment terms to GRM under the Media Services
Agreement.
Our
working capital deficit at September 30, 2010, defined as current assets minus
current liabilities, was $10.2 million as compared to a working capital deficit
of $6.2 million at December 31, 2009. The decrease in working
capital of approximately $4.0 million from December 31, 2009 to September 30,
2010 was primarily attributable to an increase in restricted cash of $1.0
million and, an increase in accounts receivable of $1.5 million offset by a
decrease in cash of $0.6 million, a decrease in current portion of deferred
charges of $1.5 million, an increase in accounts payable and accrued expenses of
$3.6 million and an increase in current portion of deferred revenue of $1.1
million, resulting from increased sales.
Investing
Activities
Net cash
used in investing activities during the nine months ended September 30, 2010 was
$1.3 million, which was used for property and equipment purchases and
capitalization of internal use software. We expect to continue to
purchase property and equipment in the normal course of our business and develop
software for both internal and external use. The amount and timing of
these purchases and the related cash outflows in future periods is difficult to
predict and is dependent on a number of factors, including but not limited to
any increase in the number of our employees and changes in computer hardware and
software used in our business. Net cash used in investing activities
during the nine months ended September 30, 2009 was $7,000.
32
Financing
Activities
Cash
provided by financing activities during the nine months ended September 30, 2010
was $5.1 million, which was primarily the result of the net proceeds of $4.9
million from the issuance of a convertible note and the exercise of common stock
warrants and stock options totaling $0.2 million. Cash provided by
financing activities during the nine months ended September 30, 2009 was
primarily from the proceeds that we received from the sale of our common stock
of approximately $3.2 million, proceeds from the exercise of warrants to
purchase our common stock, net of offering costs, of approximately $2.0 million
and proceeds of approximately $0.6 million from the issuance of convertible
notes payable, net of offering costs.
Subsequent
to September 30, 2010, we received a $5 million short-term credit facility from
GRM that is due on March 31, 2011 as described in Note 9 of the accompanying
notes to the condensed financial statements. We currently anticipate that our
available capital resources, including our operating cash flows, will be
sufficient to meet our expected working capital and capital expenditure
requirements through the period March 31, 2011. However, such resources will not
be sufficient to fund the repayment of the obligation to GRM due on March 31,
2011. As such, we intend to raise additional funds through public or
private debt or equity financings if such financings become available on
favorable terms to fund the obligation coming due to GRM on March 31, 2011.
However, we can provide no assurance that we will be able to complete any new
financing or offerings.
ITEM
3.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
The
registrant is a smaller reporting company and is not required to provide this
information.
ITEM
4.
|
CONTROLS
AND PROCEDURES
|
We
conducted an evaluation, with the participation of our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange
Act”) as of September 30, 2010, to ensure that information required to be
disclosed by us in the reports filed or submitted by us under the Exchange Act
is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission’s rules and
forms. Based on that evaluation, our Chief Executive Officer and
Chief Financial Officer have concluded that as of September 30, 2010, our
disclosure controls and procedures were not effective at the reasonable
assurance level due to the material weakness described below.
A
material weakness is a control deficiency (within the meaning of the Public
Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. Management has
identified the following material weakness which has caused management to
conclude that, as of September 30, 2010, our disclosure controls and procedures
were not effective at the reasonable assurance level:
We have
become aware that in applying accounting standards, our control environment is
dependent upon a review function and the ability to recognize and obtain
assistance for transactions. Because of the failure of this control,
we were required to adjust (i) the Black Scholes value of the warrants issued by
us in March 2009 pursuant to a Media and Marketing Services Agreement which
should have been classified as an operating expense rather than interest expense
and that the Black Scholes value of such warrants should have been measured as
of each monthly vesting date rather than the grant date starting from March 2009
through September 2010; (ii) certain warrants issued to consultants which must
be revalued as of their respective vesting dates rather than the grant date,
using the Black Scholes method; and (iii) all of our advertising expenses
starting in the fourth quarter of 2009 which should have been expensed as
incurred rather than capitalized and amortized against revenues for a period of
12 months under ASC 340-20.
Changes
in Internal Control over Financial Reporting
There
were no changes in our internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15 (f) under the Exchange Act) during the
third quarter of 2010 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
Limitations
on Effectiveness of Controls
Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure controls and procedures or our internal
controls will prevent all errors and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within our Company have been detected.
33
PART
II - OTHER INFORMATION
ITEM 1.
|
LEGAL
PROCEEDINGS
|
Not
applicable.
ITEM 1A.
|
RISK
FACTORS
|
As a
smaller reporting company we are not required to provide this
information.
ITEM
2.
|
UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|
During
the three months ended September 30, 2010, one investor exercised a warrant to
purchase 2,400 shares of common stock exercisable at $1.00 per share. We relied
on section 4(2) of the Securities Act of 1933 to issue the common stock inasmuch
as the securities were issued to an accredited investor without any form of
general solicitation or general advertising.
ITEM
3.
|
DEFAULTS
UPON SENIOR SECURITIES
|
None.
ITEM 4.
|
REMOVED AND
RESERVED
|
ITEM 5.
|
OTHER
INFORMATION
|
None.
34
ITEM 6.
|
EXHIBITS
|
3.1
|
Certificate
of Incorporation (1)
|
|
3.2
|
Bylaws
(1)
|
|
10.1
|
Third
Amendment dated August 9, 2010 to Lease between the registrant and 617
7th Street Associates, LLC (2)
|
|
31.1
|
Certification
Pursuant to Rule 13a-14(a) and 15d-14(a) *
|
|
31.2
|
Certification
Pursuant to Rule 13a-14(a) and 15d-14(a) *
|
|
32
|
Certification
Pursuant to Section 1350 of Title 18 of the United States
Code*
|
_____________________________________
(1)
Incorporated by reference from the Registration Statement on Form S-3, File No.
333-167910, filed with the Securities and Exchange Commission on June 30,
2010.
(2)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on August 11, 2010.
*Filed
herewith.
35
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
CYBERDEFENDER
CORPORATION
|
||
By:
|
/s/ Gary Guseinov
|
|
Date:
December 20, 2010
|
Gary
Guseinov, President and
|
|
Chief
Executive Officer
|
||
By:
|
/s/ Kevin Harris
|
|
Date:
December 20, 2010
|
Kevin
Harris, Chief Financial
Officer
|
36