UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 for the quarterly period ended September 30, 2004.
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
for the transition period from _______ to _______.
Commission file number: 333-54822
STRONGHOLD TECHNOLOGIES, INC.
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(Exact name of small business issuer as specified in its charter)
Nevada 22-3762832
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
106 Allen Road, Basking Ridge, NJ 07920
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(Address of principal executive offices)
(908) 903-1195
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(Issuer's telephone number)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 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 |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: as of November 19, 2004, 15,936,655
shares of the Registrant's common stock, (par value, $0.0001), were outstanding.
Transitional Small Business Disclosure Format: (Check One): Yes |_| No |X|
TABLE OF CONTENTS
Page
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PART I - Financial Information
Item 1. Financial Statements...................................................................................2
Consolidated Balance Sheet
as of September 30, 2004 (unaudited)...................................................................2
Consolidated Statements of Operations
For the Three Months Ended September 30, 2004 and 2003 and the nine
months ended September 30, 2004 and 2003
(unaudited)............................................................................................3
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2004 and 2003
(unaudited)............................................................................................4
Notes to Consolidated Financial Statements.............................................................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................11
Item 3. Controls and Procedures...............................................................................24
PART II - Other Information
Item 1. Legal Proceedings.....................................................................................25
Item 2. Changes in Securities and Use of Proceeds.............................................................25
Item 3. Defaults Upon Senior Securities.......................................................................27
Item 4. Submission of Matters to a Vote of Security Holders...................................................27
Item 6. Exhibits and Reports on Form 8-K......................................................................27
-i-
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEET
STRONGHOLD TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2004 (UNAUDITED)
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ASSETS
CURRENT ASSETS
Cash $ 10,795
Accounts receivable, less allowance for returns and
doubtful accounts of $181,750 362,170
Other receivables 37,220
Inventories 79,167
Prepaid expenses 134,697
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Total current assets 624,049
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PROPERTY AND EQUIPMENT, NET 101,037
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OTHER ASSETS
Software development costs, net of amortization 855,774
Other 132,994
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Total other assets 988,768
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$ 1,713,854
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 633,163
Accrued expenses and other current liabilities 1,110,435
Interest payable, stockholders 443,920
Notes payable, stockholders, current portion 360,000
Notes payable 656,667
Deferred revenue 468,756
Obligations under capitalized leases, current portion 40,061
------------
Total current liabilities 3,713,002
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LONG-TERM LIABILITIES
Notes payable, stockholders, less current portion 1,860,131
Note payable, convertible debt, net of issuance costs of $276,160 and beneficial
conversion feature of $1,484,449 239,391
Obligations under capitalized leases, less current portion 7,813
Payroll taxes payable, long term 535,000
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Total long term liabilities 2,642,335
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COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT
Preferred stock, Series A, $.0001 par value; authorized 5,000,000
shares, 2,002,750 issued and outstanding (aggregate liquidation preference of $3,004,125)
and preferred stock, Series B, $.0001 par value; authorized 2,444,444 shares,
2,444,444 issued and outstanding (aggregate liquidation preference $2,200,000) 445
Common stock, $.0001 par value, authorized 50,000,000
shares, 14,687,072 issued and outstanding 1,469
Additional paid-in capital 9,437,413
Stock subscription receivable (3,000)
Accumulated deficit (14,077,810)
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Total stockholders' deficit (4,641,483)
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$ 1,713,854
============
See accompanying notes to consolidated financial statements.
- 2 -
STRONGHOLD TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
================================================================================
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEP 30, SEP 30, SEP 30, SEPT 30,
2004 2003 2004 2003
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
SALES $ 475,969 $ 904,254 $ 1,819,896 $ 2,450,043
COST OF SALES 175,863 336,611 627,728 937,499
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GROSS PROFIT 300,106 567,643 1,192,168 1,512,544
SELLING, GENERAL AND
ADMINISTRATIVE 946,913 1,401,070 2,779,361 3,703,924
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LOSS FROM OPERATIONS (646,807) (833,427) (1,587,193) (2,191,380)
INTEREST EXPENSE 339,472 223,196 433,728 421,062
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NET LOSS APPLICABLE TO COMMON
STOCKHOLDERS $ (986,279) $ (1,056,623) $ (2,020,921) $ (2,612,442)
================================== ==================================
BASIC AND DILUTED LOSS PER
COMMON SHARE $ (0.07) $ (0.10) $ (0.15) $ (0.26)
================================== ==================================
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 14,024,528 10,460,333 13,603,903 10,206,182
================================== ==================================
See accompanying notes to consolidated financial statements.
- 3 -
STRONGHOLD TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
==================================================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 2004 2003
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(Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(2,020,921) $(2,612,442)
Adjustments to reconcile net loss to
net cash used in operating activities:
Provision for returns and allowances (recoveries) (8,128) 63,000
Depreciation and amortization 334,077 106,216
Amortization of debt discount and debt issuance costs 259,946
Interest expense for issuance of warrants 71,250
Changes in operating assets and liabilities:
Accounts receivable 232,746 (425,082)
Inventories 92,579 142,612
Prepaid expenses (123,056) 7,165
Other receivables (29,485) (18,548)
Accounts payable (48,312) (240,829)
Interest payable, stockholders 36,016 168,249
Accrued expenses and other current liabilities (366,840) 872,753
Deferred revenue 126,335 286,262
Other (66,520) (43,047)
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NET CASH USED IN OPERATING ACTIVITIES (1,581,563) (1,622,441)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES,
Payments for purchase of property and equipment (3,749) (10,859)
Payments for software development costs (355,260) (500,008)
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NET CASH USED IN INVESTING ACTIVITIES (359,009) (510,867)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock, net of financing costs 29,750 1,887,968
Proceeds from notes payable, stockholders 899,500 616,200
Principal repayments of notes payable, stockholders (57,850) (127,089)
Proceeds from notes payable, convertible debt, net of debt issuance costs 1,682,004 (238,332)
Principal repayments of notes payable (575,000) (15,594)
Principal payments for obligations under capital leases (32,198)
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NET CASH PROVIDED BY FINANCING ACTIVITIES 1,943,206 2,123,153
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NET INCREASE (DECREASE) IN CASH 2,634 (10,155)
CASH, BEGINNING OF PERIOD 8,161 13,384
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CASH, END OF PERIOD $ 10,795 $ 3,229
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION,
cash paid during the period for interest $ 45,198 $ 93,197
=========== ===========
- 4 -
STRONGHOLD TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission
(the "SEC"). These statements are unaudited and, in the opinion of management,
include all adjustments (consisting of normal recurring adjustments and
accruals) necessary to present fairly the results for the periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted pursuant to applicable SEC
rules and regulations. Operating results for the three-month and nine-month
periods ended September 30, 2004 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2004. These financial
statements should be read in conjunction with the financial statements and the
notes thereto included in the Company's Annual Report of Form 10-KSB for the
fiscal year ended December 31, 2003.
2. INVENTORIES
Inventories, which are comprised of hardware for resale, are stated at
cost, on an average cost basis, which does not exceed market value.
3. LOSS PER COMMON SHARE
Loss per common share is based on the weighted average number of common
shares outstanding. The Company complies with SFAS No. 128, "Earnings Per
Share," which requires dual presentation of basic and diluted earnings (loss)
per share. Basic earnings (loss) per share excludes dilutions and is computed by
dividing net loss applicable to common stockholders by the weighted average
number of common shares outstanding for the year. Diluted earnings (loss) per
share reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
entity. Since the effect of the outstanding options and warrants are
anti-dilutive, they have been excluded from the Company's computation of diluted
loss per common share..
4. STOCK-BASED COMPENSATION
In December 2002, FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure," which amended SFAS No. 123, "Accounting
for Stock-Based Compensation." This Statement provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based compensation. It also amends the disclosure provisions to
require more prominent disclosure about the effects on reported net income
(loss) of an entity's accounting policy decisions with respect to stock-based
employee compensation. As permitted by the Statement, the Company does not plan
to adopt the fair value recognition provisions of SFAS No. 123 at this time.
However, the Company has adopted the disclosure provisions of the Statement.
- 5 -
The Company accounts for its stock-based employee compensation plans under
Accounting Principles Board Opinion No. 25, under which no compensation cost has
been recognized in the accompanying consolidated statements of operations, as
all options granted under those plans had an exercise price equal to or in
excess of the market value of the underlying common stock at the date of grant.
Had compensation cost for these options been determined consistent with
the fair value method provided by SFAS No. 123, the Company's net loss and net
loss per common share would have been the following pro forma amounts for the
three-month and nine-month periods ended September 30, 2004 and 2003.
Three months ended Nine months ended
September 30, September 30,
-------------------------- ----------------------------
2004 2003 2004 2003
----------- ----------- ----------- -------------
NET LOSS APPLICABLE TO COMMON
STOCKHOLDERS, as reported $ (986,279) $(1,056,623) $(2,020,921) $ (2,612,442)
----------- ----------- ----------- -------------
DEDUCT
Total stock-based compensation
expense determined under fair
value method for all awards,net
of related tax effect 11,131 23,430 34,832 63,033
----------- ----------- ----------- -------------
PRO FORMA NET LOSS $ (997,410) $(1,080,053) $(2,055,753) $ (2,675,475)
----------- ----------- ----------- -------------
BASIC AND DILUTED EPS
As reported $ (0.07) $ (0.10) $ (0.15) $ (0.26)
----------- ----------- ----------- -------------
Pro forma $ (0.07) $ (0.10) $ (0.15) $ (0.26)
----------- ----------- ----------- -------------
The fair value of issued stock options is estimated on the date of grant
using the Black-Scholes option-pricing model including the following
assumptions: expected volatility of 2.06%, expected dividend yield rate of 0%,
expected life of 10 years, and a risk-free interest rate of 4.13% and 4.91% for
September 30, 2004 and 2003, respectively.
5. GOING CONCERN
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. Since the beginning
of the fiscal year, the Company has incurred a net loss of $2,020,921 and has
negative cash flows from operations of $1,581,563 for the nine months ended
September 30, 2004, and has a working capital deficit of $3,088,953 and a
stockholders' deficit of $4,641,483 as of September 30, 2004. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. During 2004 and 2005, management of the Company will rely on raising
additional capital to fund its future operations. If the Company is unable to
generate sufficient revenues or raise sufficient additional capital, there could
be a material adverse effect on the consolidated financial position, results of
operations and cash flows of the Company. The accompanying consolidated
financial statements do not include any adjustments that might be necessary if
the Company is unable to continue as a going concern.
- 6 -
6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the following at
September 30, 2004:
Sales tax $ 93,824
Payroll taxes (Federal, State & Local) 520,956
Compensation 289,807
Commissions 145,859
Other accrued expenses 59,989
TOTAL $1,110,435
Payroll Tax Payment Agreement with IRS
On April 30, 2004, the Company entered into an installment agreement with
the United States Internal Revenue Service ("IRS") to pay overdue payroll taxes
and penalties of totaling $1,233,101 under the terms of which the Company will
pay a minimum of $35,000 each month, commencing June 28, 2004, until it has paid
the withholding taxes due in full, to be completed in thirty-six month period by
April 30, 2007. The Company has recorded the portion of the payroll taxes of
$535,000 to be paid in the remaining monthly periods of 13 through 29 within the
agreed upon payment plan in the long term liabilities section under the heading
"Payroll taxes payable-long term" section of the balance sheet.
- 7 -
7. NOTES PAYABLE, STOCKHOLDERS
On March 15, 2004, the Company entered into a note payable with one of its
stockholders for approximately $900,000. The note bears interest at 8% per annum
and is due on March 15, 2007. The balance of this note is located in the
long-term portion of notes payable, stockholders.
8. COMMITMENTS AND CONTINGENCIES
Warrants
On June 16, 2004, in connection with the issuance of the 12% callable
secured convertible notes (the "AJW Notes")the Company issued to Stanford a
warrant (the "Stanford Warrants") to purchase 2,000,000 shares of Common Stock,
expiring in five years, at an exercise price of $.0001,in consideration i)
agreeing to a waiver of existing registration rights that included a lock up
period for one year after the effective date of a registration statement
prohibiting the registration and sale of Stanford's securities and ii) agreeing
as holder of Stronghold's Series A $1.50 Convertible Preferred Stock ("Series A
Stock") and Series B $.90 Convertible Preferred Stock ("Series B Stock"), to
waive any dilution issuances required by the Series A Stock and the Series B
Stock as a result of the conversion of the AJW Notes or exercise of the Stanford
Warrants into the Company's common stock. This issuance of the Stanford Warrants
has been accounted for as an adjustment of capital for the waiving of the
dilution protection for the Series A and Series B preferred stock. The Stanford
Warrants were valued at approximately $360,000 using the Black-Scholes option
pricing model including the following assumptions: exercise price of $0.0001,
expected volatility of 2.06%, expected dividend yield rate of 0%, expected life
of 5 years, and a risk free interest rate of 4.73%.
Callable Secured Convertible Notes
To obtain funding for its ongoing operations, the Company" entered into a
Securities Purchase Agreement (the "Securities Purchase Agreement") with New
Millennium Capital Partners II, LLC, AJW Qualified Partners, LLC, AJW Offshore,
Ltd. and AJW Partners, LLC (collectively, the "Investors") on June 18, 2004 for
the sale of (i) $3,000,000 of the AJW Notes and (ii) stock purchase warrants to
buy 3,000,000 shares of the Company's common stock (the "AJW Warrants").
On June 18, 2004, the Investors purchased $1,500,000 in AJW Notes and received
Warrants to purchase 1,500,000 shares of the Company's common stock. On July,
28, 2004 the Investors purchased $500,000 in AJW Notes and received Warrants to
purchase 500,000 shares of common stock. On October 22, 2004 the Investors
purchased $350,000 in AJW Notes and received Warrants to purchase 350,000 shares
of common stock. In addition, provided that all of the conditions in the
Securities Purchase Agreement are satisfied, the Investors are obligated to
provide the Company with additional funds as follows:
- 8 -
o $650,000 will be funded within five business days of the
effectiveness of the registration statement.
The AJW Notes bear interest at 12%, mature two years from the date of
issuance, and are convertible into our common stock, at the Investors' option,
at the lower of (i) $0.70 or (ii) 50% of the average of the three lowest
intraday trading prices for the Company's common stock during the 20 trading
days before, but not including, the conversion date. The Company may prepay the
AJW Notes in the event that no event of default exists, there are a sufficient
number of shares available for conversion of the AJW Notes and the market price
is at or below $0.57 per share. The full principal amount of the AJW Notes is
due upon default under the terms of AJW Notes. In addition, the Company has
granted the Investors a security interest in substantially all of its assets and
intellectual property as well as registration rights.
The AJW Note payable, convertible debt is recorded at $2,000,000 less original
debt issuance costs of $317,917 and beneficial conversion feature of $1,682,083,
presently reported on the September 30, 2004 Balance Sheet net of amortization
at $276,160 and $1,484,449 respectively, and are reported in accordance with
Emerging Issues Task Force "EITF" 98-5 "Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios" and EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible
Instruments". The Debt Discount is reported at 100% of the net proceeds of the
Convertible Debt Financing in accordance with EITF 98-5 that specifies that the
beneficial conversion expense may not exceed the net proceeds. Additionally, the
debt discount is net of amortization charged to interest expense of $259,946
recorded for the quarter ended September 30, 2004.
The Warrants are exercisable until five years from the date of issuance at
a purchase price of $0.57 per share. In addition, the exercise price of the
Warrants is adjusted in the event the Company issues common stock at a price
below market. Since the Company does not intend to issue common stock at below
market price the warrants were valued at $NIL using the Black-Scholes option
pricing model including the following assumptions: exercise price of $0.57,
expected volatility of 2.06%, expected dividend yield rate of 0%, expected life
of 5 years, and a risk free interest rate of 4.73%.
The Investors have contractually agreed to restrict their ability to convert the
AJW Notes and exercise the Warrants and receive shares of the Company's common
stock such that the number of shares of the Company's common stock held by them
and their affiliates after such conversion or exercise does not exceed 4.99% of
the then issued and outstanding shares of the Company's common stock.
- 9 -
All shares of the Company's common stock associated with this private placement
are restricted securities in accordance with Rule 144 as promulgated under the
Securities Act of 1933.
9. SUBSEQUENT EVENTS
Callable Secured Convertible Notes
On October 22, 2004, the Investors purchased $350,000 in AJW Notes and received
Warrants to purchase 350,000 shares of the Company's common stock. This purchase
was made prior to the effective registration statement as required by the
agreements. Subsequently, the remaining $650,000 of the final $1,000,000 will be
funded within five business days of the effectiveness of the registration
statement.
- 10 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The following discussion should be read in conjunction with our financial
statements and the accompanying notes appearing subsequently under the caption
"Financial Statements", along with other financial and operating information
included elsewhere in this quarterly report. Certain statements under this
caption "Management's Discussion and Analysis and Results of Operation"
constitute "forward-looking statements" under the Private Securities Litigation
Reform Act of 1995.
The statements contained in this Quarterly Report on Form 10-QSB that are
not historical facts are forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934 ("the Securities Act"), as
amended and the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements may be identified by, among other things, the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should," or "anticipates" or the negative thereof or other variations thereon
or comparable terminology, or by discussions of strategy that involve risks and
uncertainties. In particular, our statements regarding the anticipated growth in
the markets for our technologies, the continued development of our products, the
approval of our Patent Applications, the successful implementation of our sales
and marketing strategies, the anticipated longer term growth of our business,
and the timing of the projects and trends in future operating performance are
examples of such forward-looking statements. The forward-looking statements
include risks and uncertainties, including, but not limited to, the timing of
revenues due to the uncertainty of market acceptance and the timing and
completion of pilot project analysis, and other factors, including general
economic conditions, not within our control. The factors discussed herein and
expressed from time to time in our filings with the SEC could cause actual
results to be materially different from those expressed in or implied by such
statements. The forward-looking statements are made only as of the date of this
filing and we undertake no obligation to publicly update such forward-looking
statements to reflect subsequent events or circumstances.
OUR HISTORY
We were incorporated as a Nevada corporation on September 8, 2000, under
the name TDT Development, Inc. On May 16, 2002 we acquired Stronghold
Technologies, Inc., a New Jersey corporation referred to herein as our
"Predecessor Entity", pursuant to a merger of the Predecessor Entity into our
wholly-owned subsidiary, TDT Stronghold Acquisition Corp., referred to herein as
"Acquisition Sub". As consideration for the merger, we issued 7,000,000 shares
of our common stock, par value $0.0001 per share, to the stockholders of the
Predecessor Entity in exchange for all of the issued and outstanding shares of
the Predecessor Entity. Following the merger, Acquisition Sub, the survivor of
the merger, changed its name to Stronghold Technologies, Inc. (NJ) and remains
our only wholly-owned subsidiary. On July 11, 2002, we changed our name from TDT
Development, Inc. to Stronghold Technologies, Inc. On July 19, 2002, we
exchanged all of the shares that we held in our two other wholly-owned
subsidiaries, Terre di Toscana, Inc. and Terres Toscanes, Inc., which conducted
an import and distribution business specializing in truffle-based food product,
for 75,000 shares of our common stock held by Mr. Pietro Bortolatti, our former
president.
-11-
OVERVIEW OF OUR HANDHELD TECHNOLOGY BUSINESS
On May 16, 2002, we entered the handheld wireless technology business via
our acquisition by merger of the Predecessor Entity. The Predecessor Entity was
founded on August 1, 2000 to develop proprietary handheld wireless technology
for the automotive dealer software market. Since the merger of the Predecessor
Entity into our subsidiary, we continue to conduct the Predecessor Entity's
handheld wireless technology business.
OUR REVENUES
Stronghold's revenues are primarily received from system installation,
software licenses and system maintenance. The approximate average selling
package price of the system and installation is $70,000. Additional revenues are
derived from monthly system maintenance agreements that have a monthly fee of
$850 per month and a total contract value of $30,600. The revenues derived from
these categories are summarized below:
o SOFTWARE LICENSE REVENUES: This represents the software license
portion of the Dealer Advance Service Solution purchased by
customers of the Company. The software and intellectual property of
Dealer Advance has been developed and is owned by the Company.
o SYSTEM INSTALLATION REVENUES: This represents the installation and
hardware portion of the Dealer Advance Service Solution. All project
management during the installation is performed by us. The
installation and hardware portions include cable wiring
subcontracting services and off the shelf hardware and handheld
computers ("PDA"s).
o MONTHLY RECURRING MAINTENANCE REVENUE: This represents the
maintenance and support contract for the Dealer Advance Service
Solution that the customer executes with the system installation.
The typical maintenance contract is for 36 months. In the three year
operating history of the Company, approximately 50% of all the
Company's customers have prepaid the maintenance fees through a
third party leasing finance company. The third part leasing
arrangements are commitments by the dealer client directly with a
financing company with no recourse to the Company. These prepaid
maintenance fees have provided additional cash flow to us and have
generated a deferred revenue liability on or balance sheet.
-12-
Cost of sales for software licensing with the installation are estimated
at 10% of revenue for reproduction, minor customer specific configurations and
the setup cost of interface with the customers' DMS. Cost of sales for the
system installation includes direct labor and travel, subcontractors and third
party hardware.
GENERAL AND ADMINISTRATIVE OPERATING EXPENSES:
The general operating expenses of the Company are primarily comprised of:
o Marketing and Selling;
o General and Administrative;
o Development & Operations;
Our marketing and selling expenses include all labor, sales commissions
and non-labor expenses of selling and marketing of our products and services.
These include the salaries of two Vice Presidents of Sales and the Business
Development Manager ("BDM") staff.
Our general and administrative expenses include expenses for all
facilities, insurance, benefits, telecommunications, legal and auditing expenses
are included as well as the executive management group wage expense.
Our development & operations expenses include the expenses for the Client
Consultant group which advises and supports the installations of our Dealer
Advance(TM) clients.
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND THREE MONTHS ENDED SEPTEMBER 30, 2003.
REVENUE
For the quarter ended September 30, 2004, we had revenue of $475,969
compared with revenue of $904,254 for the quarter ended September 30, 2003. This
decrease in revenue of $428,285 or 47.36% is primarily attributed to the
following:
o the steps we made to address the Company's limited funding that
included reductions of our sales, marketing and client consultant
staffs,
o a strategic decision to allocate resources to establish the
Company's first sales efforts through third party distributors and
o a loss of momentum in the late part of the second quarter and the
early part of the third quarter resulting from concerns regarding
closure of the Company's pending funding that was needed to maintain
operations.
The Company's decision to conserve capital, reduce head count and embark
on a strategy of third party distribution resulted in the Company's revenue
reduction for the quarter ended September 30, 2004 as compared to the quarter
ended September 30, 2003.
-13-
GROSS PROFITS
We generated $300,106 in gross profits from sales for the quarter ended
September 30, 2004, which was a decrease of $267,537 from the quarter ended
September 30, 2003, when we generated $567,643 in gross profits. Our gross
profit margin percentage was unchanged at 63% in both the quarter ended
September 30, 2003 and the quarter ended September 30, 2004. The Company's
ability to maintain its gross profit margin despite the reduction in revenue is
due to the Company's ability to maintain prices and eliminate excess labor
capacity present in 2003.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Total Selling, General and Administrative expenses in the quarter ended
September 30, 2004 were $946,913, a decrease of 32.41% or $454,157 from the
quarter ended September 30, 2003 of $1,401,070. The significant reduction in
expense is primarily attributable to efficiencies gained through the reduction
of staff from 44 in September 30, 2003 to 22 in the quarter ended September 30,
2004. The significant reduction in staffing resulted in a reduction of payroll
expenses of $350,420, which was the largest portion of the $454,157 reduction.
Other significant expense reductions within selling, general and administrative
expenses for the quarter ended September 30, 2004 and September 30, 2003
included reductions as follows:
o legal expenses of $48,410,
o printing and reproduction expenses of $17,069 and
o Travel and automobile expenses reductions of $37,172.
Our interest and penalty expense increased from $223,196 in the quarter
ended September 30, 2003 to $339,472 in the quarter ended September 30, 2004.
This increase of $116,276 is primarily due a new non-cash category of interest
expense called Beneficial Conversion Expense. This new non-cash category expense
is attributed to the Company's adherence to EITF 98-5 "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios" and EITF 00-27 "Application of Issue No. 98-5 to
Certain Convertible Instrument". The Company recorded $218,650 of Beneficial
Conversion Expense in the third quarter of 2004 for the closing of the first two
tranches of $2,000,000 of convertible debt detailed in the notes to financials.
OPERATING LOSS
The Company's operating losses decreased by $186,620 in comparing the
quarter ended September 30, 2004 to the quarter ended September 30, 2003, which
were $646,807 and $833,427, respectively. This improvement in operating loss
despite the significant reduction in revenues is attributable to the maintenance
of gross profit margins of 63% and the significant reductions of selling,
general and administrative expenses of $454,157.
-14-
NET LOSS
We had a net loss of $986,279 for the quarter ended September 30, 2004
compared to $1,056,623 for the quarter ended September 30, 2003, a decrease in
net losses of $70,344. This reduction of net losses of 6.66% despite the
decrease of revenue and increased interest expense is also primarily
attributable to the maintenance of gross profit margins of 63% and the
significant reductions of selling, general and administrative expenses of
$454,157
Our loss per share also reduced to $.07 loss per share with a weighted
average of 14,024,528 shares outstanding in the quarter ended September 30, 2004
as compared to $0.10 loss per share in the quarter ended September 30, 2003 with
a weighted average of 10,460,333 shares outstanding.
We have never declared or paid any cash dividends on our common stock. We
anticipate that any earnings will be retained for development and expansion of
our business and we do not anticipate paying any cash dividends in the
foreseeable future. Our board of directors, subject to any restrictions or
prohibitions that may be contained in our loan or preferred stock agreements,
has sole discretion to pay dividends based on our financial condition, results
of operations, capital requirements, contractual obligations and other relevant
factors.
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND NINE MONTHS ENDED SEPTEMBER 30, 2003.
REVENUE
For the nine-month period ended September 30, 2004, we had revenue of
$1,819,896 compared with revenue of $2,450,043 for the nine month period ended
September 30, 2003. This decrease in revenue of $630,147 or 25.72% is primarily
attributed to the following:
o the steps we made to address the Company's limited funding that
included reductions of our sales, marketing and client consultant
staffs,
o a strategic decision to allocate resources to establish the
Company's first sales efforts through third party distributors; and
o a loss of momentum in the late part of the second quarter and the
early part of the third quarter resulting from concerns regarding
closure of the Company's pending funding that was needed to maintain
operations.
The Company's decision to conserve capital, reduce head count and embark
on a strategy of third party distribution resulted in the Company's revenue
reduction for the nine-month period ended September 30, 2004 as compared to the
nine-month ended September 30, 2003.
GROSS PROFITS
We generated $1,192,168 in gross profits from sales for the nine-month
period ended September 30, 2004, which was a decrease of $320,376 from the
nine-month period ended September 30, 2003, in which we generated $1,512,544 in
gross profits. Our gross profit margin percentage increased 4% from 62% in the
nine-month period ended September 30, 2003 to 66% in the nine-month period ended
September 30, 2004. The Company's ability to increase its gross profit margin
despite the reduction in revenue is due to the Company's ability to maintain
prices, eliminate excess labor capacity present in 2003 and reducing the unit
cost of third party hardware.
-15-
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Total Selling, General and Administrative expenses in the nine-month
period ended September 30, 2004 were $2,779,361, a decrease of 24.96% or
$924,563 from the nine-month period ended September 30, 2003 of $3,703,924. The
significant reduction in expense is primarily attributable to efficiencies
gained through the reduction of staff from 44 as of September 30, 2003 to 22 as
of September 30, 2004. The significant reduction in staffing resulted in a
reduction of payroll expenses of $794,314, which was the largest portion of the
net reduction of $924,563. Other significant expense reductions within selling,
general and administrative expenses for the nine-month period ended September
30, 2004 as compared to September 30, 2003 included the following:
o legal expenses of $121,000
o printing and reproduction expenses of $30,738 and
o travel and automobile expenses reductions of $59,495.
o Recruiting expenses of $45,611
o Marketing expenses of 54,475.
These reductions were also offset by an increase of amortization expenses
of $247,674 of which $218,000 were attributed to the non cash interest expense
associated with the convertible debt discount amortization discussed in the
notes to the financial statements.
Our interest and penalty expense increased $12,666 from $421,062 in the
nine-month period ended September 30, 2003 to $433,728 in the nine-month period
ended September 30, 2004. The nine-month period expense in 2003 of $421,062
included a one-time penalty of $130,000. After adjusting the nine-month period
expense for the one time penalty, the increase for the nine-month period is
$142,665 and is primarily due a new non-cash category of interest expense called
Beneficial Conversion Expense. This new non-cash category expense is attributed
to the Company's adherence to EITF 98-5 "Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios" and EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible
Instrument". The Company recorded $218,650 of Beneficial Conversion Expense in
the third quarter of 2004 for the closing of the first two tranches of
$2,000,000 of convertible debt detailed in the notes to financials.
-16-
OPERATING LOSS
The Company's operating losses decreased by $604,186 in comparing the
nine-month period ended September 30, 2004 to the nine-month period ended
September 30, 2003, which were $1,587,194 and $2,191,380, respectively. This
improvement in operating loss despite the significant reduction in revenues is
attributable to the increase of gross profit margins of 4% and the significant
reductions of selling, general and administrative expenses of $924,563.
NET LOSS
We had a net loss of $2,020,921 for the quarter ended September 30, 2004
compared to $2,612,442 for the quarter ended September 30, 2003, a decrease in
net losses of $591,521. This reduction of net losses of 22.64 % despite the
decrease of revenue and increased interest expense is also primarily
attributable to the increase of gross profit margins of 4% and the significant
reductions of selling, general and administrative expenses of $924,563.
Our loss per share also reduced to $.15 loss per share with a weighted
average of 13,603,303 shares outstanding in the nine-month period ended
September 30, 2004 as compared to $0.26 loss per share in the nine-month period
ended September 30, 2003 with a weighted average of 10,206,182 shares
outstanding.
We have never declared or paid any cash dividends on our common stock. We
anticipate that any earnings will be retained for development and expansion of
our business and we do not anticipate paying any cash dividends in the
foreseeable future. Our board of directors, subject to any restrictions or
prohibitions that may be contained in our loan or preferred stock agreements,
has sole discretion to pay dividends based on our financial condition, results
of operations, capital requirements, contractual obligations and other relevant
factors.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
As of September 30, 2004, our cash balance was $10,795. We had a net loss
of $986,279 for the quarter ended September 30, 2004. We had a net operating
loss of approximately $10,000,000 for the period from May 17, 2002 through
September 30, 2004 to offset future taxable income. Losses incurred prior to May
17, 2002 were passed directly to the shareholders and, therefore, are not
included in the loss carry-forward. There can be no assurance, however, that we
will be able to take advantage of any or all tax loss carry-forwards, in future
fiscal years. Our accounts receivable as of September 30, 2004 was $543,920
(less allowance for returns of $181,750), and $1,554,533 (less allowances for
returns of $170,172) for the quarter ended September 30, 2003. Accounts
receivable balances represent amounts owed to Stronghold for new installations
and maintenance, service, training services, software customization and
additional systems components.
-17-
As of September 30, 2004, the Company had the following financing
arrangements:
DEBT LIABILITY SUMMARY TABLE
CURRENT DEBT LIABILITIES
IRS Payment Plan 420,000
Interest payable, stockholders (founding shareholder) 443,920
Notes payable, stockholders, current portion (founding shareholder) 360,000
Notes payable, current portion (PNC Bank) 656,667
Total Debt current liabilities 1,880,587
-------------
LONG-TERM DEBT LIABILITIES
Notes payable, stockholders, less current portion (founding shareholder and Stanford) 1,860,131
Note payable, convertible debt, net of debt issuance costs of $1,760,609 239,391
IRS Payment Plan (Long term portion) 535,000
-------------
Total long term Debt liabilities 2,634,522
-------------
With respect to liabilities for real property leases, the following table
summarizes these obligations:
--------------- ------------- ---------------- ---------------- ------------------
MONTHS BALANCE
LOCATION DATE TERM REMAINING ON LEASE
--------------- ------------- ---------------- ---------------- ------------------
NJ 8/1/2003 55 months 42 $ 291,380
--------------- ------------- ---------------- ---------------- ------------------
VA 6/1/2004 24 months 20 $ 38,188
--------------- ------------- ---------------- ---------------- ------------------
Grand Total $ 329,568
--------------- ------------- ---------------- ---------------- ------------------
FINANCING NEEDS
To date, we have not generated revenues in excess of our operating
expenses. We have not been profitable since our inception, we expect to incur
additional operating losses in the future and will require additional financing
to continue the development and commercialization of our technology. We have
incurred a net loss of approximately $2,000,000 and have negative cash flows
from operations of approximately $1,580,000 for the nine months ended September
30, 2004, and have a working capital deficit of approximately $3,100,000 and a
stockholders' deficit of approximately $4,600,000 as of September 30, 2004.
These conditions raise substantial doubt about our ability to continue as a
going concern. During 2004, our management will rely on raising additional
capital to fund its future operations. If we are unable to generate sufficient
revenues or raise sufficient additional capital, there could be a material
adverse effect on the consolidated financial position, results of operations and
we may be unable to continue our operations.
The Company has a current commitment for an additional $650,000 of
financing, which will be closed on the fifth business day following the
effective date of the our registration statement becoming effective. The
$650,000 financing is the fourth tranche of the $3 Million callable convertible
debt financing. The Company expects that this funding will provide the necessary
cash to support operations throughout the first quarter of 2005. Prior to this
funding we will operate with cash on hand and cash generated from operations. We
do not have further commitments and we will need to raise additional funds after
the first quarter of 2005.
-18-
We expect our capital requirements to increase significantly over the next
several years as we continue to develop and market the DealerAdvance(TM) suite
and as we increase marketing and administration infrastructure and develop
capabilities and facilities. Our future liquidity and capital funding
requirements will depend on numerous factors, including, but not limited to, the
levels and costs of our research and development initiatives, the cost of hiring
and training additional sales and marketing personnel and the cost and timing of
the expansion of our marketing efforts.
FINANCINGS
The Company has entered into the following financing transactions:
LOANS FROM CHRISTOPHER J. CAREY, AN EXECUTIVE OFFICER, DIRECTOR AND SHAREHOLDER
OF THE COMPANY
On July 31, 2000, the Predecessor Entity entered into a line of credit
with Mr. Chris Carey, our President and Chief Executive Officer and the
President and Chief Executive Officer of Stronghold. The terms of the line of
credit made available $1,989,500, which the Predecessor Entity could borrow from
time to time, until August 1, 2001. The outstanding amounts accrued interest at
the per annum rate equal to the floating base rate, as defined therein, computed
daily, for the actual number of days elapsed as if each full calendar year
consisted of 360 days. The first interest payment under the line of credit was
due on August 1, 2001. On such date, the parties agreed to extend the line of
credit for one more year, until August 1, 2002.
On April 22, 2002, the Predecessor Entity issued 500,000 shares of its
common stock to Mr. Carey (which converted into 1,093,750 shares of our common
stock when we acquired the Predecessor Entity on May 16, 2002) in exchange for
cancellation of $1 million of outstanding indebtedness under the July 31, 2000
line of credit from Mr. Carey.
On May 16, 2002, the total amount outstanding under the July 31, 2000 line
of credit with Mr. Carey was $2.2 million. On such date, we issued 666,667
shares of our common stock to Mr. Carey in exchange for the cancellation of $1
million of the then outstanding amount under the line of credit. We agreed to
pay Mr. Carey the remaining $1.2 million according to the terms of a
non-negotiable promissory note, which was issued on May 16, 2002.
On September 30, 2002, we renegotiated the $1,200,000 promissory note with
Mr. Carey pursuant to a requirement contained in the promissory note with
UnitedTrust Bank. According to the new terms of the loan, Mr. Carey extended the
repayment of the principal amount until December 1, 2005. Until such time as the
principal is paid, we will pay an interest only fee of 12% per year. Mr. Carey's
promissory note is expressly subordinated in right of payment to the prior
payment in full of all of the Company's senior indebtedness. Subject to the
payment in full of all senior indebtedness, Mr. Carey is subrogated to the
rights of the holders of such senior indebtedness to receive principal payments
or distribution of assets. As of December 31, 2002, $970,749 was outstanding
under the promissory note issued to Mr. Carey.
On September 30, 2002, we entered into a loan agreement with CC Trust Fund
to borrow an amount up to $355,128. Christopher Carey Jr., Mr. Carey's son, is
the beneficiary of the trust, and Mary Carey, Mr. Carey's wife, is the trustee
of the trust. This bridge loan was for a period of twelve months, with all
principal due and payable on September 30, 2003. The 12.5% interest on the
outstanding principal is due each year. At the end of the loan period, the CC
Trust Fund will be entitled to exercise 25,000 warrants at $1.50 per share. On
September 30, 2003, the CC Trust Fund agreed to extend the term of their loan to
December 30, 2003. On December 30, 2003, the CC Trust Fund agreed to extend the
term of their loan to June 30, 2004. On March 30, 2004, the CC Trust Fund agreed
to extend the term of their loan to March 31, 2005. On May 1, 2005, the AC Trust
Fund agreed to extend the term of their loan to November 1, 2005. As of December
31, 2003, $355,128 was outstanding under the CC Trust Fund loan agreement.
-19-
On September 30, 2002, we entered into a loan agreement with AC Trust Fund
to borrow an amount up to $375,404. Amie Carey, Mr. Carey's daughter, is the
beneficiary of the trust, and Mary Carey, Mr. Carey's wife, is the trustee of
the trust. This bridge loan is for a period of twelve months, with all principal
due and payable on September 30, 2003. The 12.5% interest on the outstanding
principal is due each year. At the end of the loan period, the Fund will be
entitled to exercise 25,000 warrants at $1.50 per share. On September 30, 2002,
the AC Trust Fund agreed to extend the term of their loan to December 30, 2003.
On December 30, 2003, the AC Trust Fund agreed to extend the term of their loan
to June 30, 2004. On March 30, 2004, the AC Trust Fund agreed to extend the term
of their loan to March 31, 2005. On May 1, 2005, the AC Trust Fund agreed to
extend the term of their loan to November 1, 2005. As of December 31, 2003,
$375,404 was outstanding under the AC Trust Fund loan agreement.
In October 2002, in connection with a loan to the Company in the amount of
$165,000, we issued a promissory note to Christopher J. Carey for $165,000. Such
promissory note was due on or before December 31, 2003. On December 30, 2003,
Mr. Carey agreed to extend the term of his loan to June 30, 2004. On March 30,
2004, Mr. Carey agreed to extend the term of his loan to March 31, 2005. As of
December 31, 2003, the amount outstanding on this promissory note was $10,000.
Until such time as the principal is paid, interest on the note will accrue at
the rate of 12.5% per year.
On March 18, 2003, we entered into a bridge loan agreement with
Christopher J. Carey, for a total of $400,000. The agreement stipulates that the
Company will pay an 8% interest rate on a quarterly basis until the loan becomes
due and payable on June 30, 2004. We also issued to Mr. Carey 391,754 warrants
exercisable for common stock for 10 years at a price of $0.97 per share. On
December 30, 2003, Christopher J. Carey agreed to extend the term of the
promissory note to June 30, 2004. As of December 31, 2003, $360,000 was
outstanding under this bridge loan agreement. On May 1, 2004, Christopher J.
Carey agreed to extend the term of the loan to June 1, 2005.
On April 24, 2003, our President and Chief Executive Officer, Christopher
J. Carey, agreed to convert outstanding loans of $543,000 to 603,333 shares of
our common stock at a price of $.90 per share in conjunction with the Series B
Convertible Stock Financing detailed below.
FINANCINGS FROM PNC BANK (FORMERLY UNITED TRUST BANK)
On November 1, 2001, the Predecessor Entity entered into a line of credit
with UnitedTrust Bank (now PNC Bank) pursuant to which the Predecessor Entity
borrowed $1.5 million. This line of credit was due to expire by its terms, and
all outstanding amounts were due to be paid, on September 30, 2002. On September
30, 2002, the line of credit came due and the bank granted a three-month
extension. On September 30, 2002, we converted the outstanding line of credit
with UnitedTrust Bank into a $1,500,000 promissory note. Such promissory note is
to be paid in 36 monthly installments, which commenced in February 2003 and is
due to terminate on January 1, 2006. Interest accrues on the note at the prime
rate, adjusted annually, which is the highest New York City prime rate published
in The Wall Street Journal. The initial prime rate that applied to the
promissory note was 4.750%.
-20-
On August 7, 2003, we entered into a modification of the loan agreement
with UnitedTrust Bank, of which the principal balance was $1,291,666 at the time
of closing of the modification. Pursuant to the modification agreement,
UnitedTrust Bank agreed to subordinate its lien against our assets to a new
lender and reduce the monthly payments from $41,666 per month principal plus
accrued interest as follows: (a) from the date of closing through December 15,
2003, $10,000 per month plus accrued interest (b) from January 15, 2004 through
December 15, 2004, $15,000 per month plus accrued interest, (c) from January 15,
2005 through December 15, 2005, $20,000 per month plus interest and (d) on the
maturity date of January 1, 2006, a balloon payment equal to all the outstanding
principal and accrued interest. We are current with our payment of $15,000 per
month.
On January 9, 2004, we were served with a notice of an event of default by
United Trust Bank, now PNC Bank, a successor by merger effective January 2004
with United Trust Bank, ("the Bank"), under its Loan Agreement. Pursuant to
section 6.01(d) of the Loan Agreement, an Event of Default exists due to the
Company's failure to pay Payroll Tax Obligations aggregating in the amount of
$1,089,897 as of December 31, 2003 (including estimated penalties and interest).
The Company continues to make timely scheduled payments pursuant to the terms of
the loan and is in forbearance negotiations with the Bank with respect to the
default. On April 1, 2004, the Company received a second Notice of Event of
Default stating that the Bank had accelerated the maturity of the Loan and
declared all principal, interest, and other outstanding amounts due and payable.
However, if the Company is unable to reach a forbearance agreement with the
Bank, we may be required to pay off the amounts outstanding under the loan, and
if we are unable to pay off the amounts outstanding, the Bank could seize the
assets of the Company pledged as security for the Loan. If either of these
actions occur, we may be unable to continue our operations.
Because we were in default under the terms of the loan due primarily to
our payroll tax default, the Bank has instituted the default rate of interest
which is 5% above the "highest New York City prime rate" stated above. We have
entered into an installment agreement with the United States Internal Revenue
Service to pay the withholding taxes, under the terms of which we will pay
$100,000 by May 31, 2004 and $35,000 each month, commencing June 28, 2004, until
we have paid the withholding taxes due in full.
On April 27, 2004, PNC Bank, N.A., as successor by merger to UnitedTrust
Bank filed a complaint in the Superior Court of New Jersey, Law Division, Union
County (Docket No. UNN-L_001522-04) against our company and Christopher J.
Carey, in his capacity as guarantor, to collect the sums outstanding under the
Loan Agreement, dated as of September 30, 2002.
-21-
On July 15, 2004, we entered into a fully executed forbearance agreement
with PNC Bank, N.A. We made an initial principal payment of $420,000 with the
execution of the forbearance. Additionally, we are required to make four
consecutive monthly installments of $50,000.00 on August 15, 2004, September 15,
2004, October 15, 2004 and November 15, 2004 followed by the remaining principal
on or before December 15, 2004. Failure to adhere to this schedule may cause the
suit to be reinstated and PNC Bank may resume collection of the sum under the
suit.
On November 12, 2004, the Company and PNC Bank agreed upon terms of an
amendment to the forbearance agreement whereby by the payment schedule will
change to include interest only payments on November 15, 2004, December 15, 2004
and January 15, 2005 with the final principal payment being made on or before
January 31, 2005.
FINANCINGS BY STANFORD VENTURE CAPITAL HOLDINGS, INC.
On May 15, 2002, we entered into a Securities Purchase Agreement with
Stanford Venture Capital Holdings, Inc., referred to herein as Stanford, in
which we issued to Stanford (i) such number of shares of our Series A $1.50
Convertible Preferred Stock, referred to herein as Series A Preferred Stock,
that would in the aggregate equal 20% of the total issued and outstanding shares
of our common stock, and (ii) such number of warrants for shares of our common
stock that would equal the number of shares of Series A Preferred Stock issued
to Stanford. The total aggregate purchase price for the Series A Preferred Stock
and warrants paid by Stanford was $3,000,000. The issuance of the Series A
Preferred Stock and warrants took place on each of four separate closing dates
from May 16, 2002 through and July 19, 2002, at which we issued an aggregate of
2,002,750 shares of our Series A Preferred Stock and warrants for 2,002,750
shares of our common stock to Stanford.
On April 24, 2003, we entered into a Securities Purchase Agreement with
Stanford Venture Capital Holdings, Inc. for the issuance of 2,444,444 shares of
our Series B $0.90 Convertible Preferred Stock. The issuance of the Series B
Preferred Stock took place on six separate closing dates beginning on May 5,
2003 through September 15, 2003. In connection with the Securities Purchase
Agreement, we agreed to modify the previously issued five-year warrants to
purchase 2,002,750 shares of our common stock: (i) to reduce the exercise price
to $.25 per share; and (ii) to extend the expiration date through August 1,
2008. In addition, our President and Chief Executive Officer, Christopher J.
Carey, agreed to convert outstanding loans of $543,000 to 603,333 shares of our
common stock at a price of $.90 per share. In addition, the Company and Stanford
entered into a Registration Rights Agreement, dated April 30, 2003, in which the
Company agreed to register the shares of the Company's common stock issuable
upon conversion of the Series A and Series B Preferred Stock with the Securities
and Exchange Commission, no later than November 15, 2003. The Company and
Stanford agreed to extend the date of the filing requirements of the
Registration Rights Agreement to March 14, 2004. We have not yet filed a
registration statement, and are in negotiations with Stanford regarding an
extension of the registration filing date.
On March 3, 2004 and March 15, 2004 we received loans in the amount of
$437,500 each from Stanford. The Company has agreed to pay Stanford an 8% annual
dividend on the funds invested and to redeem the securities not later than three
years from the date of funding.
-22-
PRIVATE PLACEMENTS WITH ACCREDITED PRIVATE INVESTORS
During August and September 2002, we entered into 9 subscription
agreements with accredited private investors, as defined in Rule 501 of the
Securities Act, pursuant to which we issued an aggregate of 179,333 shares of
our common stock at $1.50 per share. These private investments generated total
proceeds to us of $269,000.
In October 2003, the Company commenced offerings to accredited investors
in private placements of up to $3,000,000 of the Company's common stock. In the
period of October 2003 through January 9, 2004 the Company raised $225,000 under
the terms of these private placements. The shares offered in the private
placement are priced at the 5 trading day trailing average closing price of the
common stock on the OTCBB, less 20%. For each share purchased in the private
placements, purchasers received a warrant to purchase one half (0.5) share of
common stock at 130% of the purchase price. A minimum of $25,000 was required
per investor. The number shares issued under this placement total 509,559, at an
average price of $0.44/share.
CALLABLE SECURED CONVERTIBLE NOTES
On June 16, 2004, to obtain funding for its ongoing operations, the
Company entered into the Securities Purchase Agreement the Investors on June 18,
2004 for the sale of (i) $3,000,000 in AJW Notes and (ii) Warrants to buy
3,000,0000 shares of the Company's common stock.
On June 18, 2004, the Investors purchased $1,500,000 in AJW Notes and received
Warrants to purchase 1,500,000 shares of the Company's common stock. On July 28,
2004 the Investors purchased $500,000 in AJW Notes and received Warrants to
puchase 500,000 shares of common stock. On October 22, 2004 the Investors
purchased $350,000 in AJW Notes and received Warrants to purchase 350,000 shares
of common stock. In addition, provided that all of the conditions in the
Securities Purchase Agreement are satisfied, the Investors are obligated to
provide the Company with additional funds as follows:
o $650,000 will be funded within five business days of the
effectiveness of the registration statement.
The AJW Notes bear interest at 12%, mature two years from the date of issuance,
and are convertible into our common stock, at the Investors' option, at the
lower of (i) $0.70 or (ii) 50% of the average of the three lowest intraday
trading prices for the Company's common stock during the 20 trading days before,
but not including, the conversion date. The Company may prepay the AJW Notes in
the event that no event of default exists, there are a sufficient number of
shares available for conversion of the Notes and the market price is at or below
$.57 per share. The full principal amount of the Notes is due upon default under
the terms of Notes. In addition, the Company has granted the investors a
security interest in substantially all of its assets and intellectual property
as well as registration rights.
-23-
The Warrants are exercisable until five years from the date of issuance at a
purchase price of $0.57 per share. In addition, the exercise price of the
Warrants is adjusted in the event the Company issues common stock at a price
below market.
The Investors have contractually agreed to restrict their ability to convert the
Notes and exercise the Warrants and receive shares of the Company's common stock
such that the number of shares of the Company's common stock held by them and
their affiliates after such conversion or exercise does not exceed 4.99% of the
then issued and outstanding shares of the Company's common stock.
All shares of the Company's common stock associated with this private placement
are restricted securities in accordance with Rule 144 as promulgated under the
of the Securities Act of 1933.
To enable us to fund our research and development and commercialization
efforts, during the next several months, we may enter into additional debt
and/or equity transactions with individual investors.
CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES
Financial Reporting Release No. 60, recently released by the Securities
and Exchange Commission, requires all companies to include a discussion of
critical accounting policies or methods used in the preparation of financial
statements. The notes to the consolidated financial statements include a summary
of significant accounting policies and methods used in the preparation of our
Consolidated Financial Statements. In addition, Financial Reporting Release No.
61 was recently released by the SEC requires all companies to include a
discussion which addresses, among other things, liquidity, off-balance sheet
arrangements, contractual obligations and commercial commitments. The following
is a brief discussion of the more significant accounting policies and methods
used by us.
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of financial statements in accordance with
generally accepted accounting principles in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, including the recoverability of tangible and intangible
assets, disclosure of contingent assets and liabilities as of the date of the
financial statements and the reported amounts of revenues and expenses during
the reported period.
On an on-going basis, we evaluate our estimates. The most significant
estimates relate to our recognition of revenue and the capitalization of our
software development.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
-24-
REVENUE RECOGNITION POLICY
Revenue related to the sale of products is comprised of one-time charges
to dealership customers for hardware (including server, wireless infrastructure,
desktop PCs, printers, interior/exterior access points/antennas and handheld
devices), software licensing fees and installation/training services. Stronghold
charges DealerAdvance Sales Solution(TM) dealers for all costs associated with
installation. The most significant variable in pricing is the number of handheld
devices purchased. Stronghold has not determined pricing for DealerAdvance
Service Solution(TM).
Once DealerAdvance Sales Solution(TM) is installed, Stronghold provides
hardware and software maintenance services for a yearly fee equal to
approximately 10% of the one-time implementation fees. All dealerships are
required to purchase maintenance with installations and pay maintenance fees on
a monthly basis. Stronghold provides our customers with services, including
software and report customization, business and operations consulting, and sales
training services on an as needed basis and typically are charged on a time and
expenses basis.
Stronghold offers all new customers a sixty-day performance trial period
during which time performance targets are set. Stronghold installs the system
and agrees to remove the system at no charge if the performance targets are not
met. If performance is met, a large portion of the dealerships enter into a
third party lease generally with lessors introduced by us. We have entered into
a number of relationships with leasing companies in which the leasing company
finances the implementation fees for the dealership in a direct contractual
relationship with the dealership. The lease is based solely on the
creditworthiness of the dealership without recourse to us. The leasing company
receives an invoice from us, and remits funds upon acceptance by the dealership.
We receive all funds as invoiced, with interest costs passed to the dealership.
These leases typically run 36 months in duration, during which time we contract
for service and maintenance services. Stronghold charges separately for future
software customization after the initial installation, for additional training,
and for additions to the base system (e.g., more handheld devices for additional
sales people). Depending upon the dealership arrangement, the support and
maintenance contracts are either billed monthly and recorded as revenue monthly,
or are recorded up front to unearned maintenance fees at the present value of
the 36-month revenue stream and amortized monthly to revenue over the life of
the agreement.
REVENUE RESTATEMENT
On December 26, 2002, we reclassified our consolidated financial
statements for the first three quarters of 2002. This step was taken on the
advice of Rothstein, Kass & Company, P.C., our accounting firm, to reflect
accounting changes in accordance with revenue recognition guidelines released by
the SEC.
Accordingly, our revenue was reclassified such that it may be recognized
in future quarters. For the nine months ended September 30, 2002, revenue was
reclassified from $2,952,076 to $1,898,884 with the difference treated as
deferred revenue.
Historically, we recorded revenue as a three-stage process: at the time
the equipment and software were delivered, installed and the personnel trained.
We will now recognize each sale with an additional stage as outlined in the
analysis provided by our accounting firm, which includes a fourth stage defined
as, "the system is handed over to the customer to run on their own." This
four-stage delivery process results in current sales revenues being carried into
future quarters. We estimate that this change delays our recognition of revenue
by approximately 20-50 days.
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SOFTWARE DEVELOPMENT CAPITALIZATION POLICY
Software development costs, including significant product enhancements
incurred subsequent to establishing technological feasibility in the process of
software production, are capitalized according to Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software to
Be Sold, Leased, or Otherwise Marketed." Costs incurred prior to the
establishment of technological feasibility are charged to research and
development expenses. For the quarter ended September 30, 2004, we capitalized
$77,739 of development costs in developing enhanced functionality of our
DealerAdvance(TM) products. This compares with $171,945 for the quarter ended
September 30, 2003. For the nine month period ended September 30, 2004 we
capitalized $342,596 of developments costs as compared to $500,007 for the nine
month period ended September 30, 2003. We capitalized a total of $683,052 of
development costs for the twelve month period ended December 31, 2003.
ITEM 3. CONTROLS AND PROCEDURES
Our management, with the participation of our chief executive officer and
chief financial officer, evaluated the effectiveness of our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act) as of September 30, 2004. Based on this evaluation, our chief executive
officer and Chief financial officer concluded that as of September 30, 2004, our
disclosure controls and procedures were (1) designed to ensure that material
information relating to us, including its consolidated subsidiaries, is made
known to our chief executive officer and chief financial officer by others
within those entities, particularly during the period in which this report was
being prepared and (2) effective, in that they provide reasonable assurance that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms.
No change in our internal controls over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal
quarter ended September 30, 2004 that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
From time to time, we may become involved in various lawsuits and
legal proceedings which arise in the ordinary course of business. However,
litigation is subject to inherent uncertainties, and an adverse result in these
or other matters may arise from time to time that may harm our business. Except
as disclosed below, we are currently not aware of any such legal proceedings or
claims that we believe will have, individually or in the aggregate, a material
adverse affect on our business, financial condition or operating results.
On April 27, 2004, PNC Bank, N.A., as successor by merger to UnitedTrust
Bank filed a complaint in the Superior Court of New Jersey, Law Division, Union
County (Docket No. UNN-L_001522-04) against our company and Christopher J.
Carey, in his capacity as guarantor, to collect the sums outstanding under the
Loan Agreement, dated as of September 30, 2002. On July 15, 2004, we entered
into a fully executed forbearance agreement with PNC Bank, N.A. We made an
initial principal payment of $420,000 with the execution of the forbearance.
Additionally, we are required to make four consecutive monthly installments of
$50,000.00 on August 15, 2004, September 15, 2004, October 15, 2004 and November
15, 2004 followed by the remaining principal on or before December 15, 2004.
Failure to adhere to this schedule may cause the suit to be reinstated and PNC
Bank may resume collection of the sum under the suit. The Company has made all
the required payments as of the balance sheet date of September 30, 2004 and the
subsequent payment on October 15, 2004.
On November 12, 2004, the Company and PNC Bank agreed upon terms of an
amendment to the forbearance agreement whereby by the payment schedule will
change to include interest only payments on November 15, 2004, December 15, 2004
and January 15, 2005 with the final principal payment being made on or before
January 31, 2005.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-27-
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
See Exhibit Index.
-28-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 this 19th day of
September, 2004.
STRONGHOLD TECHNOLOGIES, INC.
BY: /s/ Christopher J. Carey
------------------------------------------------------
Name: Christopher J. Carey,
Title: President and Chief Executive Officer
(principal executive officer)
BY: /s/ Robert M. Nawy
------------------------------------------------------
Name: Robert M. Nawy
Title: (principal financial officer)
BY: /s/ Karen S. Jackson
------------------------------------------------------
Name: Karen S. Jackson
Title: Controller (principal accounting officer)
Dated: As of November 20, 2004
ITEM 6. EXHIBIT INDEX
Exhibit Description
Number
10.1 Lease Agreement entered between the Company and APA Properties
No. 2, LP
10.2 Sublease Agreement between Clark/Bardes Consulting, Inc. and the
Company
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.
32.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, 18 U.S.C. 1350.
32.2 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, 18 U.S.C. 1350.