UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549-1004

 

Form 10-Q

 

(Mark One)

S Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange

Act of 1934

 

FOR THE QUARTERLY PERIOD ENDED September 30, 2012

 

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 Number 000-26455

 

ISECURETRAC CORP.

(Exact name of registrant as specified in its charter)

 

DELAWARE		87-0347787
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

 

5078 S. 111^th Street

OMAHA, NEBRASKA 68137

(Address of principal executive offices, Zip Code)

 

(402) 537-0022

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x            No ¨

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x            No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See 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 ¨            No x

 

The number of shares of issuer’s common stock outstanding as of November 5, 2012 was 48,807,249.

 

 

iSecureTrac Corp.

Table of Contents 

 

		Page
	PART I
Item
1	Financial Statements	01
2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
3.	Quantitative and Qualitative Disclosures About Market Risk	23
4.	Controls and Procedures	23
	PART II
1.	Legal Proceedings	23
1A.	Risk Factors (Not Required for SRC)	23
2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
3.	Defaults Upon Senior Securities	24
4.	Mine Safety Disclosures	24
5.	Other Information	24
6.	Exhibits	24

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

iSECUREtrac Corp. and SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 

		(Unaudited)
		September 30, 2012				December 31, 2011
ASSETS
Current Assets
Cash and cash equivalents		$	274,297			$	505,500
Accounts receivable, net of allowance for doubtful accounts of $184,495 in 2012 and $727,754 in 2011			1,303,371				1,428,265
Inventories			351,520				324,919
Prepaid expenses and other			121,919				124,355
Total current assets			2,051,107				2,383,039
Leasehold improvements and equipment, net of accumulated depreciation of $14,493,998 in 2012 and $13,610,392 in 2011			3,376,696				3,806,381
Goodwill			2,302,179				2,302,179
Other assets			18,059				18,059
Total assets		$	7,748,041			$	8,509,658
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable		$	217,202			$	847,076
Accrued expenses			305,358				555,884
Current maturities of long-term debt			664,914				538,206
Deferred revenues			61,238				63,063
Accrued interest, current			1,919				-
Total current liabilities			1,250,631				2,004,229
Long-term debt, less current maturities, including accrued interest on long-term debt			1,179,010				2,498,692
Total liabilities			2,429,641				4,502,921
Commitments and contingencies
Stockholders' equity
Common stock			48,808				10,930
Nonredeemable exchangeable Series C preferred stock			141				15,882
Nonredeemable exchangeable Series D preferred stock			-				13,318
Additional paid-in capital			91,250,511				88,203,493
Accumulated deficit			(85,981,060	)			(84,236,886	)
Total stockholders' equity			5,318,400				4,006,737
Total liabilities and stockholders' equity		$	7,748,041			$	8,509,658

 

See Notes to Consolidated Financial Statements.

 

 

iSECUREtrac Corp. and SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2012				2011				2012				2011
Revenues:
Equipment leasing		$	1,394,189			$	2,299,640			$	4,971,427			$	6,829,887
Administrative, field & support service revenues			136,666				117,941				399,943				354,870
Equipment sales			118,308				60,869				160,210				211,672
Total revenues			1,649,163				2,478,450				5,531,580				7,396,429
Operating expenses:
Cost of revenues			603,871				726,345				1,987,407				2,325,166
Research and development			156,158				176,049				475,429				635,544
Sales, general and administrative			998,094				1,371,261				3,262,339				4,599,794
Total operating expenses			1,758,123				2,273,655				5,725,175				7,560,504
Operating income (loss)			(108,960	)			204,795				(193,595	)			(164,075	)
Interest income (expense):
Interest income			-				-				-				2
Interest expense			(88,786	)			(84,710	)			(266,465	)			(830,637	)
Total interest expense, net			(88,786	)			(84,710	)			(266,465	)			(830,635	)
Income (loss) before provision for income taxes			(197,746	)			120,085				(460,060	)			(994,710	)
Provision for income taxes			-				-				-				-
Net income (loss)		$	(197,746	)		$	120,085			$	(460,060	)		$	(994,710	)
Preferred stock dividends and accretion			(2,889	)			(647,652	)			(1,284,114	)			(1,389,052	)
Net loss available to common stockholders		$	(200,635	)		$	(527,567	)		$	(1,744,174	)		$	(2,383,762	)
Basic and diluted loss per common share		$	(0.02	)		$	(0.05	)		$	(0.15	)		$	(0.22	)
Weighted average shares of common stock outstanding			12,175,853				10,930,117				11,350,239				10,929,673

 

See Notes to Consolidated Financial Statements.

 

  

iSECUREtrac Corp. AND SUBSIDIARY

STATEMENT OF STOCKHOLDERS' EQUITY

For the Nine Months Ended September 30, 2012

(Unaudited)

 

																										Additional
		Common Stock								Preferred Series C								Preferred Series D								Paid -in				Accumulated
		Shares				Amount				Shares				Amount				Shares				Amount				Capital				Deficit				Total
Balance, December 31, 2011			10,930,117			$	10,930				1,588,163			$	15,882				1,331,814			$	13,318			$	88,203,493			$	(84,236,886	)		$	4,006,737
Shares issued for directors' fees			14,648				15				-				-				-				-				3,985				-				4,000
Stock based compensation			-				-				-				-				-				-				62,665				-				62,665
Series C preferred stock issued in satisfaction of accrued dividends			-				-				127,053				1,271				-				-				(1,271	)			-				-
Accrual of Series C preferred stock dividends			-				-				-				-				-				-				699,753				(699,753	)			-
Series D preferred stock issued in satisfaction of accrued dividends			-				-				-				-				106,545				1,065				(1,065	)			-				-
Accrual Series D preferred stock dividends			-				-				-				-				-				-				584,361				(584,361	)			-
Shares issued in connection with debt conversion			-				-				-				-				156,066				1,561				1,703,497				-				1,705,058
Conversion of Series C preferred stock to common stock			8,135,916				8,136				(1,701,146	)			(17,012	)			-				-				8,876				-				-
Conversion of Series D preferred stock to common stock			29,726,568				29,727				-				-				(1,594,425	)			(15,944	)			(13,783	)			-				-
Net loss			-				-				-				-				-				-				-				(460,060	)			(460,060	)
Balance, September 30, 2012			48,807,249			$	48,808				14,070			$	141				-			$	-			$	91,250,511			$	(85,981,060	)		$	5,318,400

 

See Notes to Consolidated Financial Statements.

 

 

iSECUREtrac CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2012 and 2011

(Unaudited)

 

		2012				2011
Cash Flows From Operating Activities
Net loss		$	(460,060	)		$	(994,710	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization			883,606				896,686
Stock based compensation			66,665				224,117
Provision for Doubtful Accounts			10,000				256,756
Changes in operating assets and liabilities:
Accounts receivable			114,894				(92,442	)
Inventories			(26,601	)			(64,904	)
Prepaid expenses and other assets			2,436				(1,012	)
Accounts payable			(208,490	)			32,620
Accrued expenses			(250,526	)			37,015
Deferred revenues			(1,825	)			(5,013	)
Accrued interest payable			146,530				589,567
Net cash provided by operating activities			276,629				878,680
Cash Flows From Investing Activities
Purchases of leasehold improvements and equipment			(875,305	)			(620,182	)
Capitalization of software development costs			-				(163,850	)
Net cash used in investing activities			(875,305	)			(784,032	)
Cash Flows From Financing Activities
Principal proceeds from notes			-				50,000
Principal proceeds from long-term debt			990,000				750,000
Proceeds from revolving line of credit, net			-				575,000
Principal payments on long-term debt			(610,863	)			(1,092,476	)
Payments in connection with Series D Preferred Stock and debt conversion agreement			(11,664	)			(10,000	)
Net cash provided by financing activities			367,473				272,524
Increase (decrease) in cash			(231,203	)			367,172
Cash and cash equivalents at beginning of period			505,500				88,956
Cash and cash equivalents at end of period		$	274,297			$	456,128
Supplemental Non-cash Disclosure
Issuance of 1,331,814 of Series D Preferred Stock in connection with:
Conversion of long-term debt pursuant to debt conversion agreement dated June 30, 2011		$	-			$	14,108,972
Accrued interest payable on related long-term debt converted			-				540,178
Issuance of 156,066 of Series D Preferred Stock in connection with:
Conversion of long-term debt pursuant to debt conversion agreement dated September 28, 2012			1,475,000				-
Accrued interest payable on related long-term debt converted, including $97,111 of Accrued Interest  included in long-term debt at December 31, 2011			241,722				-
Equipment purchases included in accounts payable			27,567				-

 

See Notes to Consolidated Financial Statements.

 

 

iSECUREtrac CORP. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three and nine months ended September 30, 2012 and 2011

(Unaudited)

 

Note 1. General

 

The unaudited interim condensed consolidated financial statements as of September 30, 2012 and for the three and nine month periods ended September 30, 2012 and 2011, included herein, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X.

 

The consolidated balance sheet of iSECUREtrac Corp. (“iSECUREtrac”, or the “Company”) and its wholly-owned subsidiary, iSt Services, Inc., at December 31, 2011, has been taken from the audited consolidated financial statements at that date. The condensed consolidated financial statements for the three and nine months ended September 30, 2012 and September 30, 2011 are unaudited and reflect all normal and recurring accruals and adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position, operating results and cash flows for the interim periods presented in this quarterly report. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2011. The results of operations and cash flows for the three and nine months ended September 30, 2012 are not necessarily indicative of the results for the entire fiscal year ending December 31, 2012. Where appropriate, items of an insignificant nature within the condensed consolidated financial statements have been reclassified from the previous periods’ presentation.

 

The Company believes that its current working capital combined with the amounts available for additional working capital via the Business Loan Agreement with Access Bank and through lease financing for its monitoring equipment through AHK are sufficient to meet its liquidity needs through 2012.

 

Note 2. Debt Conversion and Recapitalization Agreement

 

During the three months ended September 30, 2012 the Company completed a series of transactions involving the Company’s long-term debt, preferred stock and common stock as summarized and outlined below.

 

In August 2012 a group of investors including three of the Company’s directors, Roger Kanne, Joseph Schwaller and Thomas Burlin, as well as the Company’s CEO, Lincoln Zehr, formed IST Holdings, LLC, (“Holdings”) a Nebraska based limited liability company.

 

On August 29, 2012, Holdings acquired the following:

 

·

$2,000,000 Note Payable (“Original Note”) held by Crestpark LP, Inc including all accrued interest, and

 

·

1,470,799 shares of the Series C 8% Cumulative, Compounding, Exchange Preferred Stock (“Series C Preferred Stock”) from MH Imports constituting approximately 85% of all outstanding Series C Preferred and the related warrants to purchase 564,251 shares of common stock, and

 

·

1,438,359 shares of the Series D 8% Cumulative Compounding, Exchangeable Preferred Stock (“Series D Preferred Stock”) from Crestpark, LP, Inc constituting 100% of all outstanding Series D Preferred.

 

 

On September 28, 2012 the Company entered into a Debt Conversion and Recapitalization Agreement (“Conversion Agreement”) with Holdings and certain individual holders of the Series C Preferred. Pursuant to that agreement:

 

·

$1,475,000 of the $2,000,000 long-term debt plus $241,722 of accrued interest thereon was converted into 156,066 additional shares of the Company’s Series D Preferred, and

 

·

The repayment terms of the remaining $525,000 of long-term debt were revised to reduce the interest rate from 9.5% to 6.0%, requiring interest only payments for 12 months and then equal principal and interest payments through maturity on March 31, 2017, and

 

·

37,862,484 shares of common stock were issued in exchange for all outstanding shares of the Company’s Series D Preferred, including the 156,066 issued above, and 1,701,146 of the 1,715,216 outstanding shares of the Company’s Series C Preferred. The exchange of Series C Preferred and Series D Preferred were made in accordance with the terms of their respective Amended and Restated Certificate of Designation, Preferences and Rights except that the issuance of warrants for the purchase of common stock issuable upon exchange of the Series C Preferred was waived by the holders of the Series C Preferred, and

 

·

All warrants for the purchase of common stock, held by the individuals who were a party to the Conversion Agreement, were cancelled.

 

The exchange of all but 14,070 shares of the Series C Preferred Stock and all shares of the Series D Preferred Stock for shares of the Company’s common stock has eliminated the liquidation preference that would have been payable to the holders of such exchanged shares of Series C Preferred Stock and Series D Preferred Stock in the event of a sale or similar strategic transaction by the Company as well as future accrual of dividends on the exchanged shares of Series C Preferred Stock and Series D Preferred Stock. In addition, the right of the holders of the Series C Preferred Stock and Series D Preferred Stock to collectively appoint a majority of the Company’s directors has terminated as a result of the exchange transaction since the remaining shares of Series C Preferred Stock outstanding do not have this right under the terms of the Series C Certificate of Designation.

 

The shares of common stock were issued pursuant to the terms of the Conversion Agreement and were issued without registration under the Securities Act of 1933, as amended (the “Securities Act”) in reliance on an exemption from such registration requirements. Holdings and the Company have entered into a Registration Rights Agreement, dated September 28, 2012, pursuant to which Holdings has been granted certain rights to have the shares of common stock issued to Holdings under the Conversion Agreement registered for sale pursuant to the Securities Act.

 

Note 3. Common Stock, Common Stock Options and Warrants

 

The Company is authorized to issue up to 75,000,000 shares of common stock with a stated par value of $0.001.

 

The Company may issue stock options and other types of equity-based compensation under its 2006 Omnibus Equity Incentive Plan (the “2006 Plan”) which was implemented on May 31, 2006 and its 2011 Omnibus Equity Incentive Plan which was implemented on May 4, 2011. These are the only plans under which the Company may issue additional equity-based compensation. The Company also has outstanding stock options that were issued under its 2001 Omnibus Equity Incentive Plan (the “2001 Plan”) and which were issued under employment agreements with executive officers.

 

 

During the nine months ended September 30, 2012, the Company granted options to purchase a total of 58,000 shares of common stock to eight employees pursuant to the 2006 Plan. No options were granted during the three months ended September 30, 2012. During the three and nine months ended September 30, 2012, 17,792 and 147,126 options issued under the 2006 Plan were forfeited, 625 options issued under the 2001 Plan were forfeited and no options issued under employment agreements outside the 2006 Plan and the 2001 Plan were forfeited. No options were exercised during the three and nine months ended September 30, 2012. The following table shows stock option activity during the nine month period ended September 30, 2012:

 

Options		Number of Shares				Weighted Average Exercise Price Per Share				Aggregate Intrinsic Value
Outstanding at December 31, 2011			3,028,632			$	1.33			$	875
Granted			58,000				0.18
Exercised			-				-
Forfeited			(147,751	)			0.75
Outstanding at September 30, 2012			2,938,881			$	1.34			$	55
Exercisable at September 30, 2012			2,895,944			$	1.36			$	43

 

During the three and nine month period ended September 30, 2012, no warrants expired or were granted by the Company or exercised by warrant holders. However, as part of Conversion Agreement described in Note 2, substantial changes were made to warrants outstanding.

 

At September 30, 2012, the Company had 2,938,881 outstanding stock options, and 51,554 shares issuable upon exercise of warrants to be issued upon exchange of Preferred Stock, collectively, that were not included in the computation of diluted EPS because to do so would have been anti-dilutive for the periods presented.

 

The Company accounts for its stock-based compensation by recognizing compensation costs relating to share-based compensation awards, including grants of employee stock options as these awards become vested based on the grant date fair value of the equity instruments issued.

 

The Company estimated the grant date fair value of each option granted during the periods set forth below using the Black-Scholes option pricing model with the following weighted average assumptions:

 

		Nine Months Ended  September 30, 2012				Year Ended  December 31, 2011
Risk free interest rate			1.36	%			1.93	%
Expected volatility factor			80.74	%			74.82	%
Expected option term in years			6				6
Dividends		$	0.00			$	0.00
Forfeitures for senior executives and non-senior executives			0% and 3%				0% and 3%

 

The risk-free interest rate is determined on the date the grant is issued. This rate is equal to the rates based on yields from U.S. Treasury zero-coupon issues with maturity of 3.5 years to 6.5 years. Expected volatilities are based upon looking back at historical stock prices of the Company over the two years prior to the stock option award.

 

 

The Company estimates forfeitures of stock options. The forfeiture rate is the rate at which options are expected to be forfeited prior to full vesting. The forfeiture rate is determined based on actual forfeiture rate experience as follows: For each historical year of option issuance, the total options issued for the year is compared to the options forfeited prior to having vested. For option years in which the two year vesting period has not passed, past experience is used to project future forfeitures. The total of pro forma forfeitures is then compared to total options awarded and the resultant percentage is used as the forfeiture rate. This rate is recalculated on an annual basis.

 

The annual rate of quarterly dividends is 0% since iSECUREtrac has historically not paid dividends on its common stock and currently does not expect to pay dividends on its common stock.

 

The Company recorded stock compensation expense for the three and nine months ended September 30, 2012 and September 30, 2011 as follows:

 

		Three Months Ended September 30, 2012				Three Months Ended September 30, 2011				Nine Months Ended September 30, 2012				Nine Months Ended September 30, 2011
Employee expense		$	19,349			$	69,898			$	62,665			$	222,117
Non-employee expense			2,000				-				4,000				2,000
Total stock-based compensation expense		$	21,349			$	69,898			$	66,665			$	224,117

 

As of September 30, 2012, there was approximately $12,183 of total unrecognized compensation costs related to non-vested stock option agreements granted to the Company’s executives and employees. The future compensation expense the Company will recognize if and as these options vest according to their contractual terms is as follows:

 

2012		$	7,122
2013			4,144
2014			917
Total		$	12,183

 

Note 4. Leasehold Improvements and Equipment

 

The cost and accumulated depreciation of our leasehold improvements and equipment as of September 30, 2012 and December 31, 2011 are as follows: 

 

		September 30, 2012												December 31, 2011
		Cost				Accumulated Depreciation				Net Book Value				Cost				Accumulated Depreciation				Net Book Value
Equipment		$	1,106,824			$	1,012,416			$	94,408			$	1,093,531			$	952,623			$	140,908
Leasehold improvements			175,819				129,424				46,395				175,819				117,268				58,551
Components held for future monitoring equipment builds			209,020				-				209,020				210,000				-				210,000
Software development costs			726,049				331,765				394,284				726,049				236,227				489,822
Monitoring equipment			15,652,982				13,020,393				2,632,589				15,211,374				12,304,274				2,907,100
Total leasehold improvements and equipment		$	17,870,694			$	14,493,998			$	3,376,696			$	17,416,773			$	13,610,392			$	3,806,381

 

The Company recorded depreciation expense of $883,606 and $896,686 for the nine months ended September 30, 2012 and 2011, respectively.

 

During the period ending September 30, 2011, the Company capitalized software development costs of $163,850. No software development costs were capitalized during the period ending September 30, 2012.

 

  

Note 5. Goodwill

 

Goodwill is the excess of the cash paid over the fair value of the net assets acquired and liabilities assumed in an acquisition, less the amount of identifiable intangible assets.  Goodwill is not amortized, but is tested for impairment on an annual basis at the end of each calendar year or if certain events or circumstances occur.  The Company determined that there was no impairment of goodwill as of December 31, 2011. No events transpired in the nine months ended September 30, 2012 that required a reevaluation of this conclusion.

 

Note 6. Credit Agreements

 

As of September 30, 2012, the Company has in place a line of credit with Access Bank as outlined below. Prior to the establishment of this line of credit, the Company had available credit facilities through Crestpark LP, Inc as outlined below.

 

Access Bank Line of Credit – On December 29, 2011, the Company entered into a Business Loan Agreement (the “Loan Agreement”) with Access Bank of Omaha, Nebraska, (the “Bank”) pursuant to which the Bank has made available to the Company an asset-based revolving line of credit of up to $750,000 through December 31, 2012 (the “Line of Credit”). Borrowings under the Line of Credit are evidenced by a Promissory Note of the Company, dated December 29, 2011 (the “Note)), and are secured by a first priority security interest in substantially all of the assets of the Company pursuant to a Commercial Security Agreement by and between the Company and the Bank, dated December 29, 2011 (the “Security Agreement”). Borrowings against the Line of Credit will be used, if needed, to meet the Company’s working capital needs from time to time and will be limited to a borrowing base equal to 75% of the Company’s eligible accounts receivable. Interest expense to Access Bank for the nine months ending September 30, 2012 was $11,704, including the unused commitment fee. As of September 30, 2012, the Company had $711,000 available under the Line of Credit. The Company has not borrowed any funds under the Line of Credit.

 

Outstanding borrowings against the Line of Credit will bear interest at a variable rate equal to 2.5% over an index rate representing the prime rate on corporate loans posted by at least 70% of the nation’s largest banks. Accordingly, on September 30, 2012, the interest rate on the Line of Credit would have been 5.75%. The Company is also required to pay the Bank a quarterly non-use fee of 0.50% per annum on the average funds available under the Line of Credit, but will be waived by the Bank for any quarter during which the average borrowings exceed 60% of the funds available. As a condition to entering the Loan Agreement, the Bank required Crestpark, LP, Inc. (“Crestpark”) to enter into an Intercreditor agreement with the Bank under which Crestpark agreed to subordinate its security interest in the assets of the Company that collateralized the then $2,000,000 long-term loan made by Crestpark to the Company. This subordination remains a condition of the note acquired and restructured by Holdings as described in Note 2.

 

Crestpark Credit Facilities - On November 10, 2008, the Company entered into a loan agreement (the “Loan Agreement”) with Crestpark LP, Inc. (“Crestpark”) and in connection with the Loan Agreement executed two separate promissory notes. The first note was for $750,000 for working capital via a Revolving Credit Commitment and the second note for $1,750,000 for equipment financing via an Equipment Term Loan. As of December 29, 2011 these facilities were cancelled.

 

Revolving Credit Commitment - The proceeds of the Revolving Credit Commitment of $1,468,788 were to be used for working capital needs. The Revolving Credit Commitment had a term ending on January 1, 2015, was unsecured and bore interest at a fixed noncompounded rate of 12% per annum, payable quarterly. The Company was also required to pay Crestpark an unused fee of 0.25% per annum on the average daily unused amount of the Revolving Credit Commitment.

 

 

On June 30, 2011, the Company entered into a debt conversion agreement with Crestpark pursuant to which Crestpark converted the balance outstanding on the Revolving Credit Commitment of $1,217,086 into 110,717 shares of the Company's Series D 8% Cumulative, Compounding Exchangeable Preferred Stock (the "Series D Preferred Stock").

 

On July 22, 2011, the Revolving Credit Commitment was terminated and replaced with a short-term note payable to Crestpark in the amount of $250,000 which was available to the Company to draw upon and matured September 20, 2011. This short-term note payable was subsequently extended and terminated on December 29, 2011.

 

Note 7. Long-Term Debt and Lease Obligations

 

The Company had the following long-term debt at September 30, 2012 and December 31, 2011:

 

		September 30, 2012				December 31, 2011
Crestpark LP, Inc
One secured note payable maturing on January 1, 2015
Fixed Tranche ~ bearing interest at 9.5%		$	-			$	2,000,000
IST Holdings, LLC
One secured note payable maturing on March 31, 2017, bearing interest at 6.0%			525,000				-
AHK Leasing, LLC
Eleven separate capital leases with related parties that are carrying interest rates at 8.50% to 10.25% and maturing December 2012 to August 2016.			1,318,923				939,787
Total long-term debt		$	1,843,923			$	2,939,787
Less current maturities			(664,914	)			(538,206	)
Total long-term debt less current maturities		$	1,179,010			$	2,401,581
Accrued interest on long-term debt related to the note payable to Crestpark LP, Inc			-				97,111
Total long-term debt less current maturities, including accrued interest on long-term debt		$	1,179,010			$	2,498,692

 

Crestpark LP, Inc.

 

On June 30, 2011, the Company entered into a debt conversion agreement with Crestpark, pursuant to which Crestpark converted $7,891,086 of the Fixed Tranche and the outstanding balance of $5,000,000 of the Floating Tranche, along with $540,978 of related accrued interest into 1,221,097 shares of the Company's Series D 8% Cumulative, Compounding Exchangeable Preferred Stock (the "Series D Preferred Stock").

 

As of December 31, 2011, the Company had outstanding a Note Payable (“Note”) with Crestpark for $2,000,000, under a Credit and Security Agreement originally dated December 18, 2007 and subsequently amended. Outstanding borrowings were due and payable on the earlier of (i) January 1, 2015 or (ii) the first date on which the Company either issues equity securities or arranges for additional indebtedness (other than trade indebtedness incurred in the ordinary course of business) in a transaction or series of transactions which generates aggregate net proceeds to the Company of not less than the then current principal amount outstanding under this Note, plus all accrued but unpaid interest. The Company could prepay the Note at any time without premium or penalty.

 

The Note provided, among other things, that the borrowings thereunder shall bear interest at 9.5% per annum and that such interest will be due and payable at maturity of the Note. Accrued interest on the Note was $97,111 at December 31, 2011. At September 30, 2012, there was no accrued interest on the Note.

 

 

The borrowings under the Note are secured by a first priority security interest in all of the assets of the Company except that Crestpark’s security interest in certain monitoring equipment is subordinate to the interest of AHK Leasing, LLC under its sale leaseback arrangements and to the interest of Access Bank under the December 29, 2011 Line of Credit.

 

This note was sold to Holdings on August 29, 2012 as outlined in Note 2.

 

IST Holdings, LLC

 

Holdings is a Nebraska based limited liability whose principals are two shareholders who also serve as directors of the Company. As described in Note 2, on September 28, 2012, the Company entered into a Conversion Agreement with Holdings under which all but $525,000 of the $2,000,000 principal balance of the promissory note dated December 31, 2010 plus the interest accrued thereon of $241,722 through September 30, 2012 was converted into 156,066 shares of the Company’s Series D Preferred Stock.

 

Under the Conversion Agreement, the $525,000 remaining principal balance of the Original Note has been exchanged by Holdings for a new promissory note in the principal amount of $525,000 (the “Substitute Note”) carries a fixed rate of 6.0% per annum. The Substitute Note provides for monthly payments of interest only for twelve months and then requires monthly amortizing payments of principal and interest through maturity of the Substitute Note on March 31, 2017. In all other respects, the indebtedness evidenced by the Substitute Note remains subject to the terms and conditions of that certain Credit and Security Agreement originally entered into by and between the Company and Crestpark dated October 29, 2007, as subsequently amended including a first priority security interest in the assets of the Company granted thereby.

 

The borrowings under the Substitute Note are secured by a first priority security interest in all of the assets of the Company except that Holdings’ security interest in certain monitoring equipment is subordinate to the interest of AHK Leasing, LLC under its sale leaseback arrangements and to the interest of Access Bank under the December 29, 2011 Line of Credit.

 

Capital Leases - AHK Leasing, LLC.

 

AHK Leasing, LLC (“AHK”) is a company controlled by three stockholders, one of which is a current director. These loans were in the form of capital leases with 36 month terms and bearing interest at a rate of 8.50% to 10.25% per annum and mature between December 2012 and August 2016. There was no accrued interest payable to AHK at September 30, 2012.

 

Total interest expense, including unused commitment fees, for the three months and nine months ended September 30, 2012 and September 30, 2011 is as follows: 

 

		Three Months Ended September 30, 2012				Three Months Ended September 30, 2011				Nine Months Ended September 30, 2012				Nine Months Ended September 30, 2011
AHK interest on long term debt		$	31,769			$	31,791			$	89,779			$	108,567
Crestpark LP interest on long-term debt			51,356				49,756				149,812				655,768
Crestpark LP credit agreements			-				863				-				61,762
Other			5,661				2,300				26,874				4,540
Total interest expense		$	88,786			$	84,710			$	266,465			$	830,637

 

 

 

Interest expense paid during the three and nine months ended September 30, 2012 and 2011 was $33,325 and $112,548, respectively, as compared to $34,955 and $203,322 for the same periods of 2011.

 

Note 8. Series C 8% Cumulative, Compounding Exchangeable Preferred Stock

 

As of September 30, 2012 and December 31, 2011, the Company has authorized 5,000,000 shares of preferred stock, of which 2,800,000 are designated as its $0.01 par value Series C 8% Cumulative, Compounding Exchangeable Preferred Stock (the “Series C Preferred Stock”). As of December 31, 2011 and September 30, 2012, the Company has outstanding 1,588,163 and 14,070 shares of Series C Preferred Stock, respectively. The Series C Preferred Stock outstanding at September 30, 2012 is exchangeable for 67,291 shares of common stock and warrants to acquire 51,554 shares of common stock at an exercise price of $2.30 per share at anytime at the discretion of the preferred stockholder.

 

Dividends on the Series C Preferred Stock shall be payable in additional shares of Series C Preferred Stock, rather than cash, in an amount per share equal to 0.08 shares of Series C Preferred Stock per annum compounded annually.

 

Prior to the transactions described in Note 2, the holders of the Series C Preferred Stock voted with the holders of the Series D Preferred Stock, as single class, with respect to the appointment of four of the seven directors of the Company until the earliest date on which either (i) less than an aggregate of 500,000 shares of Series C Preferred Stock and Series D Preferred Stock remain outstanding or (ii) the holders of record of a majority of the outstanding shares of Series C Preferred Stock and Series D Preferred Stock, voting as a single class, elect to eliminate their right to appoint such directors.  As a result of the transactions described in Note 2, effective September 28, 2012 the rights described above have been eliminated.

 

Upon any liquidation of the Company, no distribution can be made to the holders of shares of common stock or other stock ranking junior to the Series C Preferred Stock unless, prior thereto, the holders of shares of Series C Preferred Stock have received an amount per share equal to the per share original issue price of $11.00 per share plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, multiplied by a factor of 105%.

 

The Company had $2,889 accrued Series C Preferred Stock dividends at September 30, 2012.

 

Note 9. Series D 8% Cumulative, Compounding Exchangeable Preferred Stock

 

As of September 30, 2012 and December 31, 2011, the Company has authorized 5,000,000 shares of preferred stock, of which 2,200,000 are designated as its $0.01 par value Series D 8% Cumulative, Compounding Exchangeable Preferred Stock (the “Series D Preferred Stock”). As of December 31, 2011, the Company had outstanding 1,331,814 shares of Series D Preferred Stock. There was no Series D Preferred Stock outstanding at September 30, 2012.

 

Prior to the transactions described in Note 2, the dividends on the Series D Preferred Stock were payable in additional shares of Series D Preferred Stock, rather than cash, in an amount per share equal to 0.08 shares of Series D Preferred Stock per annum compounded annually.

 

Also prior to the transactions described in Note 2, the holders of the Series D Preferred Stock voted with the holders of the Series C Preferred Stock, as single class, with respect to the appointment of four of the seven directors of the Company until the earliest date on which either (i) less than an aggregate of 500,000 shares of Series C Preferred Stock and Series D Preferred Stock remain outstanding or (ii) the holders of record of a majority of the outstanding shares of Series C Preferred Stock and Series D Preferred Stock, voting as a single class, elect to eliminate their right to appoint such directors.  

 

 

The Series D Preferred Stock ranked on parity with the Series C Preferred Stock, and ranked senior to all other series of preferred stock and to the common stock as to the payment of dividends and as to the distribution of assets upon liquidation, dissolution or winding up.

 

As described in Note 2, all Series D Preferred Stock was converted to common stock as of September 30, 2012.

 

Note 10. Related Party Transactions

 

The Company has incurred debt with related parties through several lending arrangements as further described in Note 6 Credit Agreements and Note 7 Long-Term Debt and Lease Obligations. The terms of each of these related party transactions were approved by a Special Committee of the Board of Directors consisting solely of a disinterested director for each transaction.

 

In addition, the Company had previously issued preferred stock to related parties as further described in Note 8 Series C 8% Cumulative, Compounding Exchangeable Preferred Stock and Note 9 Series D 8% Cumulative, Compounding Exchangeable Preferred Stock.

 

In November 2011, Mykonos 6420 LP (“Mykonos”), previous to this time, the sole holder of the Company’s Series C Preferred Stock, re-distributed the ownership of the Series C Preferred Stock to the individual investors in Mykonos 6420 LP. MH Imports was an 85.75% owner of Mykonos and directly owned 85.75% of the Company’s Series C Preferred Stock prior to the transactions described in Note 2.

 

Crestpark was the sole holder of the Company’s Series D Preferred Stock prior to the transactions described in Note 2.

 

Crestpark and MH Imports are wholly owned subsidiaries of Consolidated Investment Services, Inc. which is wholly owned by Sammons Enterprises, Inc. 

 

Note 11. Subsequent Events

 

The Company evaluates all subsequent events and transactions for potential recognition or disclosure in our consolidated financial statements. There are no matters which require disclosure.

 

Note 12. Recent Accounting Pronouncements

 

On January 1, 2012, we adopted Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU") No. 2011-08, "Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment”. ASU 2011-08 amends existing guidance by giving an entity the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than the carrying amount. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then it is necessary to perform the two-step goodwill impairment test, as currently prescribed by ASC Topic 350. Otherwise, the two-step goodwill impairment test is not required. The adoption of this standard did not have a material effect on our consolidated financial statements.

 

 

Note 13. Commitments and Contingencies

 

During the quarter ended June 30, 2012, the Company was named as a defendant in a lawsuit seeking damages for injuries suffered by the victim of a shooting allegedly perpetrated by an individual who was under electronic monitoring by the State of Maryland using the Company’s GPS-based monitoring system. The Company’s management believes the plaintiff’s allegations and legal basis for recovery are without merit and accordingly has estimated that the maximum net exposure to the Company is $50,000 which is the amount of the Company’s liability insurance deductible. As of September 30, 2012, no expense has been recorded or accrued for relating to this lawsuit.

 

Note 14. Fair Value of Financial Instruments

 

The following methods and assumptions were used to estimate fair value of each class of financial instruments for which it is practicable to estimate that value;

 

Accounts receivable: The carrying amount approximates fair value.

 

Long-term debt: Based on the borrowing rates available to the Company for bank loans with similar terms and maturities, the carrying value approximates fair value.

 

Accounts payable and accrued expenses: The carrying amount approximates fair value.

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including statements regarding guidance, industry prospects and future results of operations or financial position, made in this Quarterly Report on Form 10-Q are forward-looking. We use words such as anticipates, believes, expects, future, intends, and similar expressions to identify forward-looking statements. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Actual results could differ materially for a variety of reasons, including , among others without limitation the risks set forth in Item 1A of Part I, “Risk Factors” contained in the Company’s 2011 Annual Report on Form 10-K.

 

General

 

The following discussion is intended to provide a better understanding of the significant changes in trends relating to the Company’s financial condition and results of operations. Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto.

 

Overview

 

iSECUREtrac develops, markets, leases and services products that assist in “monitoring compliance and modifying behavior” of individuals who are under the supervision of the criminal justice system and social service agencies, primarily in the United States.

 

The Company’s principal sources of revenue are daily leasing of electronic monitoring equipment including access to the corresponding web-based monitoring software, and providing administrative, field and support services, generally charged on a per offender basis.

 

 

Operating Summary and Future Outlook

 

As outlined in our Form 10-Q for the first quarter of 2012, the Company has implemented clear strategies with respect to technology and software platform as well as sales and marketing which were designed to improve both the competitive position and financial performance of the Company in light of industry trends and the loss of revenues from our largest client, the Commonwealth of Massachusetts.  Through the nine months ended September 30, 2012, the implementation of those strategies has gone nearly as planned and the Company is where we expected to be.

 

The decline in revenue for the three months and nine months ended September 30, 2012 in comparison to 2011 is primarily the result of the loss of revenues from the Commonwealth of Massachusetts as it transitioned to a new vendor in 2012.  At this time, we do not anticipate that any significant existing customers will terminate their agreements with us.  In addition, none of our current customers represent the percentage of our total revenues that were attributable to our Massachusetts contract.  Offsetting the loss of revenue from Massachusetts are additional revenues resulting from new electronic monitoring contracts signed during the quarter ended June 30, 2012.  While these additional revenues were moderate during the third quarter, we anticipate the revenues from these new contracts will grow throughout the remainder of 2012 as we continue to deploy units to these customers.   The Company continued to sign new contracts during the third quarter, some of which contributed revenue during the period and all of which are expected to provide additional revenues as they are more fully implemented throughout the remainder of 2012 [and into 2013].  Our sales and marketing staff is focused on finding additional opportunities and we continue to win new contracts by providing high quality products and services at competitive prices.  None of our new contracts or identified opportunities are individually or collectively of sufficient size to offset the revenue previously generated by the Commonwealth of Massachusetts, and as such, the Company expects it will take time for revenue to return to the levels reported during the first quarter of 2012.

 

While revenues have declined as we expected, we have taken several significant steps to keep our operating expenses in line with operating revenues.  Among other things, we have made notable reductions to our compensation expense and interest expense.  The expense reductions initiated during the quarter ended March 31, 2012, which were projected to decrease annual operating expenses by more than $1 million, began to take effect during the quarter ended June 30, 2012 and the decline in expenses for the quarter ended September 30, 2012 was the continued result of those actions.

 

The Company expects the fourth quarter of 2012 to be cash flow neutral.   The November elections have delayed or even stalled the rollout of a number of opportunities during the third quarter, thus it is likely that total revenue for the quarter ended December 31, 2012 will decline as compared to the revenue reported for the quarter ended September 30, 2012, nevertheless, the Company expects to be cash flow neutral for the quarter ended December 31, 2012.

 

The Company continues to pursue strategic partnerships with third parties that offer propriety, innovative technologies that fit well with the Company’s own proprietary offerings.  During the quarter ended September 30, 2012, the Company executed an agreement with Omnilink Systems, Inc. to offer their proprietary one-piece GPS monitoring device.  The Company expects these third party product offerings to begin generating revenue in the near future.

 

The continued success in implementing the above strategies is expected to result in improving financial performance into 2013 as well as providing the ability to continue increasing revenue and cash flow well beyond 2013.

 

 

Summary of Financial Information

 

The following table provides a comparison of selected financial highlights, in thousands, for the three months ended September 30, 2012 and 2011:

 

CONDENSED CONSOLIDATED FINANCIAL HIGHLIGHTS

Three Months Ended September 30, 2012 and 2011

(In thousands)

 

										Fav / (Unfav)
		2012				2011				Change
Revenue:
Equipment revenue		$	1,512			$	2,360			$	(848	)
Services revenue			137				118				19
Total revenue			1,649				2,478				(829	)
Costs of revenue			604				726				122
Gross profit margin			1,045				1,752				(707	)
Gross profit margin % (a)			63.4	%			70.7	%
Research and development expenses (R&D)			156				176				20
Sales, general and administrative expenses (SG&A)			998				1,371				373
Total R&D and SG&A			1,154				1,547				393
Operating income (loss)			(109	)			205				(314	)
Interest expense, net			89				85				(4	)
Net income (loss)		$	(198	)		$	120			$	(318	)
Preferred stock dividends and accretion			3				648				645
Net loss available to common stockholders		$	(201	)		$	(528	)		$	327

 

(a) Gross proft margin percentage = Gross Profit Margin / Total Revenue

 

 

Quarterly Highlights

 

In addition to the selected financial highlights above, the following selected quarterly financial and non-financial data over the past 5 quarters is important in understanding the trend in the Company’s results of operations:

 

CONDENSED CONSOLIDATED QUARTERLY FINANCIAL HIGHLIGHTS

Quarterly Trend

(In Thousands) 

---

 

		Sept 30 2011				Dec 31 2011				Mar 31 2012				Jun 30 2012				Sept 30 2012
Revenue:
Equipment leasing		$	2,360			$	2,341			$	2,152			$	1,467			$	1,512
Service Revenue			118				126				129				134				137
Total Revenue			2,478				2,467				2,281				1,601				1,649
Costs of Revenue			726				798				700				684				604
Gross profit margin			1,752				1,669				1,581				917				1,045
Gross profit margin % (a)			70.7	%			67.7	%			69.3	%			57.2	%			63.4	%
Research & Development (R&D)			176				187				157				162				156
Selling General & Admin (SG&A)			1,371				1,613				1,182				1,082				998
Subtotal R&D and SG&A			1,547				1,800				1,339				1,244				1,154
Operating Income (Loss)			205				(131	)			242				(327	)			(109	)
Interest expense			85				81				89				88				89
Net Income (Loss)		$	120			$	(212	)		$	153			$	(415	)		$	(198	)
Total Full-Time Equivalent Employees			60				60				55				52				48

 

 

CONDENSED CONSOLIDATED QUARTERLY FINANCIAL HIGHLIGHTS

QuarterlyTrend

(In Thousands) 

---

Cash Flows From Operating Activities		Sept 30 2011				Dec 31 2011				Mar 31 2012				Jun 30 2012				Sept 30 2012
Net income (loss)		$	120			$	(212	)		$	153			$	(415	)		$	(198	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization			283				285				324				281				279
Stock based compensation			70				51				23				22				22
Provision for doubtful accounts			1				-				10				-				-
Changes in operating assets and liabilities:
Accounts receivable			111				124				(393	)			652				(144	)
Inventories			(17	)			(36	)			(45	)			38				(20	)
Prepaid expenses			(28	)			85				(9	)			44				(33	)
Accounts payable			(12	)			(150	)			(16	)			(167	)			(25	)
Accrued expenses			(78	)			221				(154	)			(62	)			(35	)
Deferred revenue			9				(3	)			(6	)			(7	)			11
Accrued interest payable			15				47				48				49				50
Net cash provided by (used in) operating activities			474				412				(65)	1			434	1			(93	)
Principal payments on long-term debt			(309	)			(279	)			(237	)			(183	)			(192	)
Adjusted Net cash provided by (used in) operating activities less principal payments on long-term debt		$	165			$	133			$	(302	)		$	251			$	(285	)

 

(1)

As of March 31, 2012, the Company had an outstanding receivable balance from the Commonwealth of Massachusetts totaling approximately $748,000. This Agency has historically paid invoices within 25 days. As a result of administrative delays in processing the various extensions to the contract with the Commonwealth of Massachusetts, the Commonwealth did not continue this payment pattern. Had the Commonwealth paid invoices in a manner consistent with their historical pattern the Company would have received approximately an additional $500,000 of cash during the three months ended March 31, 2012, as of March 31, 2012 invoices totaling $525,291 were outstanding and past the normal payment patter of the Commonwealth of Massachusetts, and Net cash provided by (used in) operating activities would have been approximately $435,000 for the three months ended March 31, 2012. This outstanding receivable payment was received during the three months ended June 30, 2012. Without this receipt of payment during the three months ended June 20, 2012, that would have normally been received during the three months ended March 31, 2012, Net cash provided by (used in) operating activities would have been approximately ($66,000) for the three months ended June 30, 2012.

 

 

For the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011

 

Revenue

 

Equipment Revenue

Equipment revenue consists of the daily leasing of electronic monitoring equipment and periodic charges for lost or damaged equipment. For the three and nine month periods ended September 30, 2012, the Company had equipment revenue of $1,512,000 and $5,132,000 compared with $2,360,000 and $7,042,000 for the same periods in 2011 which represents a decline of 36% and 27%, which was due to a net decline in the number of units deployed. Virtually the entire decline in revenues is the result of the transition of the Commonwealth of Massachusetts to a new vendor early in the second quarter of 2012.

 

Revenue from the Commonwealth of Massachusetts aggregated $801,000 for the nine month period ended September 30, 2012. There were no revenues from the Commonwealth of Massachusetts for the three month period ended September 30, 2012. For the three and nine month periods ended September 30, 2011, revenue from the Commonwealth of Massachusetts was $731,000 and $2,043,000, respectively.

 

Service Revenues

Service revenues consist of daily charges for Monitoring Center Intervention, in connection with the leasing of GPS equipment outlined above. For the three and nine months ended September 30, 2012 the Company reported service revenue of $137,000 and $400,000 compared to $118,000 and $355,000 for the same periods in 2011. The increase was due to an increased number of deployed units utilizing this service offering. We did not provide Monitoring Center Intervention services under our contract with the Commonwealth of Massachusetts.

 

Cost of Revenue

 

Cost of revenue represents all direct costs related to delivery of proprietary and third-party monitoring equipment including amortization of the acquisition costs, lease costs on third-party equipment, repairs and maintenance of the monitoring equipment, royalty expenses, transportation costs, communication costs associated with the equipment, as well as costs to upgrade existing units for advancements in technology.

 

For the three and nine month periods ended September 30, 2012 the Company reported cost of revenue of $604,000 and $1,987,000 compared to $726,000 and $2,325,000 for the same periods in 2011 which represent decreases of approximately 17% and 15%, respectively.

 

For the three months ended September 30, 2012 the $122,000 decrease in cost of revenue is attributable to the following: 

 

·

$50,000 decrease in communications costs resulting from the renegotiation of our contract with our wireless service provider during the three months ended June 30, 2012

·

$32,000 decrease in co-location facility costs resulting from the transition of our backup facilities to a new location during the fourth quarter of 2011

·

$36,000 decrease in freight costs due to the wrap up of the Commonwealth of Massachusetts contract during the three months ended June 30, 2012

·

$4,000 decrease in various other costs including supply and repair costs

 

 

For the nine months ended September 30, 2012 the $338,000 decrease in cost of revenue is attributable to the following:

·

$138,000 decrease in communication costs resulting from the renegotiation of our contract with our wireless service provider during the three months ended June 30, 2011 and again during the three months ended June 30, 2012

·

$67,000 decrease in co-location facility costs resulting from the transition of our backup facilities to a new location during the fourth quarter of 2011

·

$94,000 decrease in freight costs due to the wrap up of the Commonwealth of Massachusetts contract during the three months ended June 30, 2012

·

$36,000 decrease in 3rd party equipment costs driven by the Company’s decision to terminate its reseller relationship with STOP, L.L.C. under which the Company deployed STOP, L.L.C.’s one piece device

·

$3,000 decrease in various other costs including supply and repair costs

 

Management anticipates that Cost of Revenue through the remainder of 2012 to remain similar relative to the levels reported for the three months ended September 30, 2012.

 

Research and Development Expenses

 

Research and Development (R&D) expenses represent the on-going direct costs associated with the development of the Company’s proprietary hardware and software including staffing expenses for the Company’s own engineers and software developers, the cost of outside contracted engineering and design, and the actual costs of components, prototypes, and testing equipment and services used in the product development functions.

 

R&D expenses for the three and nine months ended September 30, 2012 were $156,000 and $475,000 compared to $176,000 and $636,000 for the same periods in 2011, a decrease of $20,000 and $161,000, respectively. R&D expenses decreased largely as a result of restructuring of the R&D team during 2011 resulting in the elimination of administrative positions. In the short term, overall R&D expenses are expected to continue at or about the current levels reported for the three months ended September 30, 2012.

 

Sales, General and Administrative Expenses

 

Sales, General and Administrative (SG&A) expenses are all the expenses associated with the operations of the Company, other than the expenses described above. These expenses include payroll, taxes and benefits and related travel for executive, sales, administrative, customer support and accounting staff. In addition these costs include rent on property, corporate communications, office leases and supplies, marketing, advertising, trade shows, recruiting and training expenses, professional fees and bad debt expense.

 

For the three month period ended September 30, 2012, SG&A expenses decreased $373,000 from $1,371,000 reported in 2011 to $998,000 reported in 2012. Significant decreases of SG&A expense in the comparable periods are highlighted below: 

 

·

Personnel related expenses included salaries, benefits, incentive compensation, and travel decreased approximately $209,000 as a result of the elimination of certain executive and management positions during the quarter ended March 31, 2012

 

·

Office & Computer Supplies expense decreased $17,000

 

 

·

Stock option expenses decreased $51,000

 

·

Consulting expenses decreased $47,000

 

·

Various other expenses including advertising, insurance, communications, and other expenses decreased an aggregate of $49,000

 

For the nine month period ended September 30, 2012, SG&A expenses decreased $1,338,000 from $4,600,000 reported in 2011 to $3,262,000 reported in 2012. Significant decreases of SG&A expense in the comparable periods are highlighted below:

 

·

Personnel related expenses included salaries, benefits, incentive compensation, and travel decreased approximately $628,000 as a result of the elimination of certain executive and management positions during the quarter ended March 31, 2012

 

·

Communication expenses decreased $43,000

 

·

Office & Computer Supplies decreased $35,000

 

·

Consulting expenses decreased $88,000

 

·

Stock option expenses decreased $159,000

 

·

Bad debt expense decreased $247,000

 

·

Legal expense decreased $59,000

 

·

Various other expenses including advertising, insurance, communications, and other expenses decreased an aggregate of $79,000

 

Management expects that SG&A expenses will continue at or about the same levels reported for the three months ended September 30, 2012. The Company remains strategically positioned to support material revenue growth without requiring a corresponding increase in SG&A expenses.

 

Interest Expense, Net

 

Net interest expense represents the total interest expense incurred by the Company reduced by the interest income earned by the Company during the year. During the three and nine months ended September 30, 2012 the Company reported net interest expense of $89,000 and $266,000, as compared to $85,000 and $831,000 reported for the three and nine months ended September 30, 2011. The nine month decrease of $565,000 is attributable to the financial restructuring completed June 30, 2011 as well as the maturation of certain capital leases, offset by the addition of new leases. The addition of new leases during the second and third quarters of 2012 resulted in the $4,000 increase in net interest expense for the three months ended September 30, 2012 as compared to the same period of 2011.

 

The debt conversion completed on September 28, 2012 is expected to decrease future interest expense by approximately $40,000 per quarter.

 

 

Net Loss

 

For the reasons described above, the Company’s net loss for the three months ended September 30, 2012 was $198,000 in comparison to net income of $120,000 for the comparable period in 2011. Similarly, the Company’s net loss for the nine months ended September 30, 2012 was $460,000, in comparison to a net loss of $995,000 for the comparable period in 2011.

 

Preferred Stock Dividends and Accretion

 

For the three and nine month periods ended September 30, 2012, preferred stock dividends totaled $3,000 and $1,284,000 as compared to $648,000 and $1,289,000 for the three and nine month periods ended September 30, 2011. Additionally, accretion on the Series C was $100,000 for the nine months ended September 30, 2011, with no accretion on the Series C for the three months ended September 30, 2011. There was no accretion for the three and nine months ended September 30, 2012 due to the financial restructuring completed June 30, 2011.

 

The increase in dividends was due to compounding interest on accrued but unpaid dividends on our Series C Preferred Stock and the addition of the Series D Preferred Stock. As a result of the amendment to the terms of the Series C Preferred Stock on June 30, 2011, which allows it to be recorded as stockholders’ equity rather than debt, the periodic accretion noted above, which was increasing the carrying amount of the Series C Preferred Stock, is no longer required, as of July 1, 2011. For similar reasons, no accretion to carrying value is required on the Company’s Series D Preferred Stock. Additionally, while future dividends on both the Series C Preferred Stock and the Series D Preferred Stock will continue to accrue at a cumulative compounded rate of 8.0% per annum, such dividends and interest are payable only in additional shares of Preferred Stock.

 

Liquidity and Capital Resources

 

The Company’s principal uses of cash are the payment of operating expenses and debt service payments on its debt obligations, including its capital lease financing. In general, the Company expects to meet these liquidity needs by generating positive cash flow from operating activities. The Company also uses cash to repay long-term capital lease obligations incurred in connection with the acquisition of monitoring equipment that it leases or sells to its customers. For the nine months ended September 30, 2012, the Company generated $277,000 of cash in operating activities. Investing activities used $875,000 of cash and financing activities generated cash of $367,000. The total of all cash flow activities resulted in a decrease in the balance of cash for the nine months ended September 30, 2012 of $231,000. For the same period of 2011, the Company generated $879,000 of cash from operating activities, used $784,000 in investing activities, and generated $273,000 in cash from financing activities. The total of all cash flow activities in the nine months ended September 30, 2011 resulted in an increase in the balance of cash of $367,000.

 

The Company is currently working with Access Bank to renew the current Business Loan Agreement and expects that the current agreement will be renewed under essentially the same terms as are currently in place. Management believes that cash on hand at September 30, 2012 combined with expected future cash flow and the amounts available for additional working capital via the Business Loan Agreement with Access Bank and through lease financing for its monitoring equipment through AHK are sufficient to meet its liquidity needs through 2013.

 

 

Application of Critical Accounting Estimates

 

Management uses estimates and assumptions in preparing our financial statements in accordance with accounting principles generally accepted in the United States. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. On an on-going basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. Management believes that our estimates and assumptions are reasonable under the circumstances; however, actual results may vary from these estimates and assumptions under different future circumstances. We do not believe that any of the accounting estimates are critical at this time, however we expect to continue to review our accounting estimates in order to determine if any of these accounting estimates are critical. For further discussion of our significant accounting policies, refer to Note 1 – “Nature of Business and Significant Accounting Policies” in the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Not required for smaller reporting companies.

 

Item 4. Controls and Procedures

 

The Company maintains disclosure controls and procedures designed to ensure that the information the Company must disclose in its filings with the Securities and Exchange Commission is recorded, processed, summarized and reported on a timely basis. The Company's principal executive officer and principal financial officer have reviewed and evaluated the Company's disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in bringing to their attention on timely basis material information relating to the Company required to be included in the Company's periodic filings under the Exchange Act.

 

The Company’s principal executive officer and principal financial officer determined that there have not been any changes in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

The Company has been named as a defendant in a lawsuit filed in United States District Court in Maryland (Northern Division) on June 11, 2012 seeking recovery of damages for injuries suffered by the victim of a shooting allegedly perpetrated by an individual who was under electronic monitoring by the State of Maryland using the Company’s GPS-based monitoring system. The Company’s liability insurance carrier will assume defense of this claim should the suit be served. The Company’s management believes the plaintiff’s allegations and legal basis for recovery are without merit and accordingly has estimated that the maximum net exposure to the Company is $50,000 which is the amount of the Company’s liability insurance deductible. 

 

Item 1A. Risk Factors.

 

Not required for smaller reporting companies.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

On August 6, 2012, the Company issued an aggregate of 9,092 shares of common stock to four directors in partial payment of directors’ fees. The shares had a market value on June 30, 2012 of $2,000. The issuance of these shares is exempt from registration under Section 4(2) of the Securities Act of 1933.

 

Item 3. Defaults Upon Senior Securities.

 

None

 

Item 4. Mine Safety Disclosures.

 

Not applicable 

 

Item 5. Other Information.

 

None

 

Item 6. Exhibits.

 

3.1

Amended and Restated Certificate of Incorporation of the Company, as amended (3)

 

3.2

Restated Bylaws of the Company (1)

 

3.3

Amended and Restated Certificate of Designation, Preferences and Rights of Preferred Stock Designated Series C 8% Cumulative, Compounding Exchangeable Preferred Stock (2)

 

3.4

Certificate of Designation, Preferences and Rights of Preferred Stock Designated Series D 8% Cumulative, Compounding Exchangeable Preferred Stock of the Company (2)

 

4.1

Form of Common Stock Certificate (1)

 

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

	32	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101

The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 are furnished herewith, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011, (ii) Consolidated Statements of Operations for the three and nine months ended September 30, 2012 and 2011, (iii) Statements of Stockholders’ Equity for the nine months ended September 30, 2012, (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011, and (v) Notes to Condensed Consolidated Financial Statements.

 

(1)

Incorporated by reference from the registrant’s registration statement on Form 10-SB, filed on June 22, 1999 (Commission File No. 0-26455).

 

(2)

Incorporated by reference from the registrant’s current report on Form 8-K, filed on July 1, 2011 (Commission File No. 0-26455).

 

(3)

Incorporated by reference from the registrant’s current report on Form 8-K, filed on December 14, 2006 (Commission File No. 0-26455).

 

 

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.

 

	iSECUREtrac Corp.
	By:	/s/ Lincoln Zehr
		Lincoln Zehr
		Chief Executive Officer
	Dated: November 13, 2012
	By:	/s/Kimberly R. Reed
		Kimberly Reed
		Principal Accounting Officer
	Dated: November 13, 2012