NOTE 3. - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Accounts Receivable
-
Credit is granted to substantially all customers throughout the United States. The Company carries its accounts receivable at invoice amount, less an allowance for doubtful accounts. On a periodic basis, the Company evaluates its accounts receivable and establishes
an allowance for doubtful accounts, based on a history of past write-offs and collections and current credit conditions. The Company’s policy is to not accrue interest on past due receivables. Management determined that an allowance of $70,000 for doubtful accounts was reasonably stated at December 31, 2015 and 2014.
Concentration of Credit Risk
-
Financial instruments that potentially subject the Company to concentration of credit risk consist of cash accounts in financial institutions. The cash accounts occasionally exceed the federally
insured deposit amount; however, management does not anticipate nonperformance by financial institutions. Management reviews the financial viability of these institutions on a periodic basis.
Loan Origination Fees
–
The Company capitalizes the costs of loan origination fees and amortizes the fees as interest expense over the contractual life of each agreement.
Sale of Certain Accounts Receivable
-
The Company has available a financing line with a financial institution (the Purchaser). In connection with this line of credit the Company adopted FASB ASC 860 “
Transfers
and Servicing
”. FASB ASC 860 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The Company has a factoring line with the Purchaser which enables the Company to sell selected accounts receivable invoices to the Purchaser with full recourse against the Company.
These transactions qualify for a sale of assets since (1) the Company has transferred all of its right, title and interest in the selected accounts receivable invoices to the financial institution, (2) the Purchaser may pledge, sell or transfer the selected accounts receivable invoices, and (3) the Company has no effective control over the selected accounts receivable
invoices since it is not entitled to or obligated to repurchase or redeem the invoices before their maturity and it does not have the ability to unilaterally cause the Purchaser to return the invoices. Under FASB ASC 860, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished.
Pursuant to the provisions of FASB ASC 860, the Company reflects the transactions as a sale of assets and establishes an accounts receivable from the Purchaser for the retained amount less the costs of the transaction and less any anticipated future loss in the value of the retained asset. In April 2014, the Company completed a revised financing agreement with the Purchaser.
The retained amount was revised to 15% of the total accounts receivable invoice sold to the Purchaser. Previously the retained amount was 20%. The fee for the initial purchase is .466% of the invoice. The fee is charged at prime plus 4% (effective rate of 7.5% at December 31, 2015) against the average daily outstanding balance of funds advanced. Previously, the fee for the first 30 days was 1% and additional fees were charged against the average daily balance of net outstanding funds at the prime rate, which
was 3.25% per annum at that time. The estimated future loss reserve for each receivable included in the estimated value of the retained asset is based on the payment history of the accounts receivable customer and is included in the allowance for doubtful accounts, if any. As collateral, the Company granted the Purchaser a first priority interest in accounts receivable and a blanket lien, which may be junior to other creditors, on all other assets.
The financing line provides the Company the ability to finance up to $2,000,000 of selected accounts receivable invoices, which includes a sublimit for one of the Company’s customers of $1,500,000. During the year ended December 31, 2015, the Company sold approximately $7,065,000 ($8,299,000 - 2014) of its accounts receivable to the Purchaser. As of
December 31, 2015, $566,561 ($874,458 - 2014) of these receivables remained outstanding. Additionally, as of December 31, 2015, the Company had approximately $20,000 available under the financing line with the financial institution ($140,000 – 2014). After deducting estimated fees and advances from the Purchaser, the net
receivable from the Purchaser amounted to $82,341 at December 31, 2015 ($149,573 - 2014), and is included
in accounts receivable in the accompanying balance sheets as of that date.
There were no gains or losses on the sale of the accounts receivable because all were collected. The cost associated with the financing line totaled approximately $79,000 for the year ended December 31, 2015 ($144,000 - 2014). These financing line fees are classified on the statements of operations as interest expense.
Property and Equipment
-
Property and equipment are recorded at cost and are depreciated over their estimated useful lives for financial statement purposes. The cost of improvements to leased properties is amortized over the shorter of the lease term or the life of the improvement. Maintenance
and repairs are charged to expense as incurred while improvements are capitalized.
Accounting for the Impairment or Disposal of Long-Lived Assets
-
The Company follows provisions of FASB ASC 360 “
Property, Plant and Equipment
” in accounting for the impairment of disposal of long-lived assets. This standard specifies,
among other things, that long-lived assets are to be reviewed for potential impairment whenever events or circumstances indicate that the carrying amounts may not be recoverable. The Company determined that there was no impairment of long-lived assets during 2015 and 2014.
Revenue Recognition
-
The Company’s revenues are generated under both time and material and fixed price agreements. Consulting revenue is recognized when the associated costs are incurred, which coincides with the consulting services being provided. Time and materials service
agreements are based on hours worked and are billed at agreed upon hourly rates for the respective position plus other billable direct costs. Fixed price service agreements are based on a fixed amount of periodic billings for recurring services of a similar nature performed according to the contractual arrangements with clients. Under both types of agreements, the delivery of services occurs when an employee works on a specific project or assignment as stated in the contract or purchase order.
Based on historical experience, the Company believes that collection is reasonably assured.
During 2015, sales to one client, including sales under subcontracts for services to several entities, accounted for 60.1% of total sales (60.2% - 2014) and 29.1% of accounts receivable at December 31, 2015 (27.8% - 2014). Sales to another client, which consisted of sales under subcontracts, accounted for 25.7% of sales in 2015 (30.7% - 2014) and 36.2% of accounts receivable
at December 31, 2015 (49.6% - 2014).
Equity Instruments -
For equity instruments issued to consultants and vendors in exchange for goods and services the Company follows the provisions of FASB ASC 718 “
Compensation – Stock Compensation
.” The measurement date for the fair value of the equity instruments issued
is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.
Stock Options -
The Company recognizes compensation expense related to stock based payments over the requisite service period based on the grant date fair value of the awards. The Company uses the Black-Scholes option pricing model to determine the estimated fair value of the awards.
Income Taxes -
The Company accounts for income tax expense in accordance with FASB ASC 740 “
Income Taxes
.” Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences, operating loss and tax credit
carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date
of enactment.
The Company reviews tax positions taken to determine if it is more likely than not that the position would be sustained upon examination resulting in an uncertain tax position. The Company did not have any material unrecognized tax benefit at December 31, 2015 or 2014. The Company recognizes interest accrued and penalties related to unrecognized tax benefits in tax
expense. During the years ended December 31, 2015 and 2014, the Company recognized no interest and penalties.
The Company files U.S. federal tax returns and tax returns in various states. The tax years 2012 through 2015 remain open to examination by the taxing jurisdictions to which the Company is subject.
Fair Value of Financial Instruments
-
The Company has determined the fair value of debt and other financial instruments using a valuation hierarchy. The hierarchy, which prioritizes the inputs used in measuring fair value, consists of three levels.
Level 1 uses observable inputs such as quoted prices in active markets;
Level 2 uses inputs other than quoted prices in active markets that are either directly or indirectly observable; and
Level 3, which is defined as unobservable inputs in which little or no market data exists, requires the Company to develop its own assumptions.
The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).
The carrying amounts of cash, accounts receivable and accounts payable and accrued expenses are reasonable estimates of their fair value due to their short maturity. Based on the borrowing rates currently available to the Company for loans similar to its term debt and notes payable, the fair value approximates its carrying amount.
Earnings Per Share -
Basic earnings per share is based on the weighted average number of common shares outstanding during the periods presented. Diluted earnings per share is based on the weighted average number of common shares outstanding, as well as dilutive potential common shares which, in the Company’s case, comprise
shares issuable under convertible notes payable and stock options. The treasury stock method is used to calculate dilutive shares, which reduces the gross number of dilutive shares by the number of shares purchasable from the proceeds of the options and warrants assumed to be exercised. In a loss year, the calculation for basic and diluted earnings per share is considered to be the same, as the impact of potential common shares is anti-dilutive.
The following table sets forth the computation of basic and diluted loss per share as of December 31, 2015 and 2014:
|
|
|
|
|
Numerator for basic net loss per share:
|
|
|
Net loss
|
$
(811,082
)
|
$
(498,000
)
|
Denominator for basic net loss per share:
|
|
|
Weighted average common shares outstanding
|
26,561,883
|
26,012,842
|
Basic net loss per share
|
$
(.03
)
|
$
(.02
)
|
|
|
|
Numerator for diluted net loss per share:
|
|
|
Net loss
|
$
(811,082
)
|
$
(498,000
)
|
Denominator for diluted net loss per share:
|
|
|
Weighted average common shares outstanding
|
26,561,883
|
26,012,842
|
Diluted net loss per share
|
$
(.03
)
|
$
(.02
)
|
|
|
|
Anti-dilutive
shares excluded from net loss share calculation
|
28,286,546
|
30,566,892
|
Certain common shares issuable under stock options and convertible notes payable have been omitted from the diluted net loss per share calculation because their inclusion is considered anti-dilutive because the exercise prices were greater than the average market price of the common shares or their inclusion would have been anti-dilutive.
Equity Investments
-
The Company accounts for investments in equity securities of other entities under the cost method of accounting if investments in voting equity interests of the investee are less than 20%. The
equity method of accounting is used if the Company’s investment in voting stock is greater than or equal to 20% but less than a majority. In considering the accounting method for investments less than 20%, the Company also considers other factors such as its ability to exercise significant influence over operating and financial policies of the investee. If certain factors are present, the Company could account for investments for which it has less than a 20% ownership under the equity
method of accounting.
Use of Estimates -
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recent Accounting Pronouncements
-
In May 2014, the FASB issued new accounting guidance on revenue from contracts with customers. The new guidance requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services
to customers. The updated guidance will replace most existing revenue recognition guidance in GAAP when it becomes effective and permits the use of either a retrospective or cumulative effect transition method. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company will evaluate the effect
that the updated standard will have on its financial statements and related
disclosures and select a transition method.
In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern." The guidance requires an entity to evaluate whether there are conditions or events, in the aggregate, that raise substantial doubt about the entity’s ability
to continue as a going concern within one year after the date that the financial statements are issued and to provide related footnote disclosures in certain circumstances. The guidance is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. Early application is permitted. The Company adopted the standard as of December 31, 2015. See Note 2.
In April 2015, the FASB issued new accounting guidance on the presentation of debt issuance costs. The new guidance requires that debt issuance costs related to a note be presented as a direct deduction from that note. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015 and interim periods within those fiscal
years. We do not believe this guidance will have a material effect on our financial statements when adopted.
In November 2015, the FASB issued new accounting guidance on the classification of deferred taxes. The new guidance requires that all deferred tax asset and liabilities be classified as noncurrent in a classified statement of financial position. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2016 and interim
periods within those fiscal years. Early application is permitted. When the guidance is effective all deferred tax assets and liabilities will be presented as noncurrent. We do not believe this guidance will have a material effect on our financial statements when adopted.
In February 2016, the FASB issued amended guidance for lease arrangements in order to increase transparency and comparability by providing additional information to users of financial statements regarding an entity's leasing activities. The revised guidance seeks to achieve this objective by requiring reporting entities to recognize lease assets and lease liabilities
on the balance sheet for substantially all lease arrangements. The guidance, which is required to be adopted in the first quarter of 2019, will be applied on a modified retrospective basis beginning with the earliest period presented. Early adoption is permitted. We are currently evaluating the impact of adopting this guidance on our financial statements.
NOTE 4. - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
|
3
|
to
|
5 years
|
$
29,004
|
$
29,004
|
Equipment
|
3
|
to
|
10 years
|
158,851
|
155,039
|
Furniture and fixtures
|
5
|
to
|
7 years
|
17,735
|
17,735
|
Leasehold improvements
|
|
3 years
|
|
5,874
|
5,874
|
|
|
|
|
211,464
|
207,652
|
Accumulated depreciation
|
|
|
|
(172,191
)
|
(147,613
)
|
|
|
|
|
$
39,273
|
$
60,039
|
Depreciation expense was $24,578 and $25,047 for the years ended December 31, 2015 and 2014, respectively.
NOTE 5. – SOFTWARE
On February 6, 2015, the Company purchased all rights to cyber security network vulnerability assessment software (the “Software”) from UberScan, LLC (the “Seller”). Under the purchase agreement, the Company agreed to pay the Seller the base purchase price of $180,000, of which $100,000 was paid in cash at the closing and the remaining $80,000
of which was paid by delivery at the closing of the Company’s secured promissory note. After April 7, 2015, the note began to accrue interest at 10% per annum. Subsequently, the Company and the Seller amended the note to extend the maturity date to March 31, 2016. As security for its obligations under the promissory note, the Company granted the Seller a security interest in the Software.
The cost of $180,000 is being amortized over the estimated useful life of five years
beginning on the date the asset is placed in service. Annual amortization expense was $27,000 in 2015 and is estimated to be $36,000 in 2016 to 2019 and $9,000 in 2020.
Under the purchase agreement, in addition to the base purchase price, the Company also agreed to pay the Seller: (i) a percentage of the licensing fees paid to the Company within three years after the closing date; provided, that the maximum amount payable to the Seller with respect to that three-year period is $800,000; plus (ii) a percentage of the licensing fees
paid to the Company during the three years beginning on the date, if any, on which the aggregate amount of the licensing fees paid to Seller with respect to the initial three-year period equals $800,000. The royalties are payable quarterly within 30 days after the end of each calendar quarter. There were no royalties paid or earned during the year ended December 31, 2015.
The purchase agreement also provides that the Company will pay the Seller one half of the amount by which the total software development costs incurred by the Company in connection with upgrading the Software to include specific functional specifications
is less than $500,000. The amount is payable when the total licensing fees paid
to the Company less the licensing fee payments made to the Seller equals
the difference between $500,000 and the
total software development cost. The Company has determined the potential obligation is not probable and accordingly no liability was recorded at December 31, 2015 or 2014.
To finance the portion of the base purchase price paid in cash at the closing under the purchase agreement, the Company borrowed $100,000 under an
unsecured line of credit financing agreement
(the “LOC Agreement”)
with a member of its board of directors.
In
connection with the closing, the Company entered into an employment agreement with one of the Seller’s principals to employ him as Director of CyberSecurity for three years.
NOTE 6. - INVESTMENT
During 2014 and 2013, the Company purchased an aggregate of 300,000 shares of the authorized but unissued shares of Series A Convertible Preferred Stock (“Series A stock”), $.001 par value, of Sudo.me Corporation (goSudo) for an aggregate purchase price of $300,000 pursuant to the terms and conditions of a preferred stock purchase agreement. goSudo is a
customer of the Company. As a result, at December 31, 2015 and December 31, 2014, the Company owns approximately 9.4% of the total outstanding shares of goSudo.
The investment is accounted for using the equity method since Company management
exercises significant influence over the operating and financial policies of goSudo.
Beginning in 2012 certain officers and directors of the Company made loans to goSudo and converted loans to Series A stock.
In
addition, one former Company employee, whose employment extended through June 30, 2014, is one of four members of the board of directors of goSudo and was active in managing goSudo's business. The Company’s chief executive officer is a member of the board of directors and is President of goSudo. As a result of the foregoing, the Company is deemed to have significant influence upon goSudo's policy and operating decisions.
The Series A stock votes together with all other classes of stock as a single class on all actions to be taken by the stockholders. Series A stock dividends accrue at the rate of $.10 per year on each share from the date of issuance. Each Series A share entitles the holder to such number of votes per share based on the number of shares of common stock it is convertible
into. At the option of the holder, each share and accrued and unpaid dividends are convertible into shares of common stock at a rate of the quotient of (i) preferred shares plus unpaid dividends divided by (ii) the number of preferred shares. Shares of Series A stock are automatically converted to shares of common stock upon a firm commitment underwritten public offering of common stock yielding gross proceeds of at least $10 million at a minimum price of $3 per share.
During 2015,
the investment
was written down using the equity method because of the net losses recorded by goSudo. In addition, the remaining carrying value of the investment was considered impaired at December 31, 2015 due to continued net losses of goSudo.
During 2015, the accounts receivable balance of $110,000 due from goSudo was converted to a demand note with interest at 10% and was fully reserved upon conversion, due to continued net losses of goSudo. As a result, a loss on investment of $109,000 and bad debt expense of $110,000 were recorded during 2015. During the year 2014,
the
investment
was written down by $168,000 consisting of $68,000 equity interest in the loss of goSudo and an impairment loss of $100,000.
Unaudited financial information for goSudo as of and for the year ended December 31, 2015 reflects total assets of $38,868 ($10,639 – 2014), total liabilities of $867,105 ($753,305 - 2014), and a net loss of $152,808 ($781,300 – 2014). goSudo is a development stage enterprise and had $122,786 of revenues earned by providing services to the Company for the
year ended December 31, 2015 ($0 – 2014).
NOTE 7. - LOAN ORIGINATION FEES
On December 1, 2014, the Company entered into an unsecured line of credit financing agreement with a member of its board of directors. The Company paid an origination fee consisting of (i) 600,000 shares of its common stock valued at $30,000 and (ii) options to purchase 600,000 shares of its common stock at an exercise price of $.05 valued at $23,400 using the Black-Scholes
option-pricing model all of which were immediately vested. At December 31, 2015, the Company has deferred origination fees of $53,400 less accumulated amortization expenses of $18,762 with a net carrying value of $34,638 ($51,957 -2014). The Company will amortize the remaining balance at the rate of $17,319 annually in 2016 and 2017.
NOTE 8. - NOTES PAYABLE – CURRENT
Notes payable consists of the following:
|
|
|
|
|
|
|
|
Note payable, 10%, unsecured
|
$
30,000
|
$
30,000
|
Note payable, 10%, secured by Software (A)
|
42,000
|
0
|
|
$
72,000
|
$
30,000
|
(A)
Note payable, 10%, secured by Software
- During 2015, the Company issued a note in connection with the purchase of Software (see note 5). The note is due on June 30, 2016.
Notes payable - related parties consist of:
|
|
|
|
|
|
|
|
Convertible demand note payable to employee, 11% (A)
|
$
49,776
|
$
59,000
|
Demand note payable to former director, 10%, unsecured
|
30,000
|
30,000
|
Convertible demand note payable to former director, 12%, unsecured (B)
|
40,000
|
40,000
|
|
$
119,776
|
$
129,000
|
(A)
Convertible demand note payable to employee, 11% -
At December 31, 2015 and 2014, the Company was obligated to an employee for $49,776 and $59,000, respectively, with interest at 11%. The note is secured by a subordinate lien on all of the Company's assets. The principal and accrued interest are convertible at the option of the holder into shares of common stock
at $.16 per share.
(B) Convertible demand note payable to former director, 12%,
-
At December 31, 2015 and 2014, the Company was obligated to a former director for $40,000 with interest at 12%. The note is unsecured and the principal is convertible at the option of the holder into shares of common stock at
$.11 per share.
NOTE 9. - LONG-TERM OBLIGATIONS
Notes Payable - Banks and Other
Term notes payable - banks and other consist of:
|
|
|
|
|
|
|
|
Note payable, 10%, secured, due January 1, 2018
|
$
265,000
|
$
265,000
|
Convertible term note payable,12%, secured, due August 31, 2018
|
175,000
|
175,000
|
Convertible notes payable, 6%, due December 31, 2016
|
150,000
|
150,000
|
Term note payable - PBGC, 6%, secured
|
249,000
|
261,000
|
Obligation to PBGC based on free cash flow
|
569,999
|
569,999
|
Convertible term note payable, 7%, secured, due October 3, 2016
|
100,000
|
100,000
|
Term notes payable - banks, secured
|
0
|
2,407
|
|
1,508,999
|
1,523,406
|
Less: current maturities
|
262,000
|
14,388
|
|
$
1,246,999
|
$
1,509,018
|
Note payable, 10%, secured, due January 1, 2018 -
During the years ended December 31, 2004 and 2003, the Company issued secured notes payable aggregating $265,000. All of these borrowings bear interest at 10% and are due, as modified on January 1, 2018. The notes are secured by a first lien on accounts receivable that are not
otherwise used by the Company as collateral for other borrowings and by a second lien on accounts receivable.
Convertible term note payable, 12%, secured, due August 31, 2018
-
The Company entered into a secured loan agreement during 2008 for working capital. The loan bears interest at 12%, which is payable monthly and is due, as modified on August 31, 2018 for an aggregate of $175,000. During 2009,
the note was modified for its conversion into common shares at $.25 per share, which was the closing price of the Company’s common stock on the date of the modification. The note is secured by a subordinate lien on all assets of the Company.
Convertible notes payable, 6%, due December 31, 2016
-
At December 31, 2015, the Company was obligated to unrelated third parties for $150,000 ($150,000 - 2014). The principal is convertible at the option of the holder into shares of common stock at $.05 per share. The notes bear interest
at 6.0% at December 31, 2015 (6.0% - 2014). The Notes are convertible into shares of common stock subject to the following limitations. The Notes are not convertible to the extent that shares of common stock issuable upon the proposed conversion would result in a change in control of the Company which would limit the use of its net operating loss carryforwards; provided, however if the Company closes a transaction with another third party or parties that results in a change of control which will limit the use
of its net operating loss carryforwards, then the foregoing limitation shall
lapse. Prior to any conversion by a requesting note holder, each note holder holding a note which is then convertible into 5% or more of the Company’s common stock shall be entitled to participate on a pari passu basis with the requesting note holder and upon any such participation the requesting note holder shall proportionately adjust his conversion request such
that, in the aggregate, a change of control, which will limit the use of the Company’s net operating loss carryforwards, does not occur.
Term note payable - PBGC, 6%, secured
-
On October 17, 2011, in accordance with of the Settlement Agreement dated September 6, 2011 (the “Settlement Agreement”), the Company issued a secured promissory note in favor of the Pension Benefit Guaranty Corporation (the “PBGC”)
for $300,000 bearing interest at 6% per annum amortizing in quarterly payments over a seven-year period with a balloon payment of $219,000 due on September 15, 2018.
Obligation to PBGC based on free cash flow
-
On October 17, 2011, in accordance with the Settlement Agreement, the Company became obligated to make annual future payments to the PBGC through December 31, 2017 equal to a portion of the Company’s “Free Cash Flow” as defined
in the Settlement Agreement, not to exceed $569,999. The annual obligation is contingent upon the Company earning free cash flow in excess of defined amounts which vary by year. The annual amount is due fifteen days after the issuance of the Company’s audited financial statements relating to the previous year. The Settlement Agreement contains specific events of default and provisions for remedies upon default. No amounts have been owed or paid on this obligation as of December 31, 2015 or 2014.
Convertible term note payable, 7%, secured
-
In accordance with the Settlement Agreement, the Company repurchased 500,000 shares of its common stock from the previously terminated defined benefit retirement plan for $130,000 which was funded from the proceeds of a convertible note in the
principal amount of $100,000 to a non-affiliated accredited investor on October 4, 2011 and $30,000 of the Company's working capital. The note bears interest at the rate of 7% per annum, payable monthly, matures on October 3, 2016 and is secured by a subordinate lien on all of the Company’s assets. The note's principal is convertible at the option of the holder into shares of the Company’s common stock at $.10 per share, which was the price of the Company's common stock on the closing date of the
agreement.
Term notes payable - banks, secured
-
The Company entered into capital lease agreements during 2012 and 2010 for the secured financing of office and technology equipment. The remaining capital lease bore interest at 14.9% and was due in monthly installments of $318 through August 2015.
Notes Payable - Related Parties
Notes payable – related parties consist of the following:
|
|
|
|
|
|
|
|
Convertible notes payable, 6%, due January 1, 2017
|
$
419,300
|
$
473,000
|
Note payable, line of credit, 6.35%, unsecured
|
394,028
|
200,000
|
Convertible note payable, 7%, due March 31, 2018
|
25,000
|
0
|
|
838,328
|
673,000
|
Less current maturities
|
16,979
|
8,172
|
|
$
821,349
|
$
664,828
|
F-11
Convertible notes payable, 6%, due January 1, 2017 -
The Company has various notes payable to related parties totaling $419,300 at December 31, 2015 ($473,000 – 2014) which mature, as amended, on January 1, 2017 with principal and accrued interest convertible at the option of the holder into shares of common stock at $.05
per share. The notes bear interest at 6.0% at December 31, 2015 (6.0% - 2014). The interest rate is adjusted annually, on January 1
st
of each year, to a rate equal to the prime rate in effect on December 31
st
of the immediately preceding year, plus one and one quarter percent, and in no event, shall the interest rate be less than 6% per annum.
The Company executed collateral security agreements with the note holders providing for a subordinate security interest in all of the Company’s assets. Generally, upon notice, prior to the note maturity date, the Company can prepay all or a portion of the outstanding notes.
The Notes are convertible into shares of common stock subject to the following limitations. The Notes are not convertible to the extent that shares of common stock issuable upon the proposed conversion would result in a change in control of the Company which would limit the use of its net operating loss carryforwards; provided, however, if the Company closes a transaction
with another third party or parties that results in a change of control which will limit the use of its net operating loss carryforwards, then the foregoing limitation shall lapse. Prior to any conversion by a requesting note holder, each note holder holding a note which is then convertible into 5% or more of the Company’s common stock shall be entitled to participate on a pari passu basis with the requesting note holder and upon any such participation the requesting note holder shall proportionately adjust
his conversion request such that, in the aggregate, a change of control, which will limit the use of the Company’s net operating loss carryforwards, does not occur.
Note payable, line of credit, 6.35%, unsecured -
On December 1, 2014, the Company entered into an unsecured line of credit financing agreement with a member of its board of directors. The LOC Agreement provides for working capital of up to $400,000 through December 31, 2017. The Company is required to provide the lender with a
report stating the use of proceeds for each pending draw under the line of credit. Borrowings of $100,000 or more bear interest at the prime rate plus 2.85% (effective rate of 6.35% at December 31, 2015).
Principal and interest are paid monthly using an amortization schedule for a fifteen year fully amortizing loan with all outstanding amounts due on December 31, 2017.
Convertible note payable, 6%, due March 31, 2018 -
On February 12, 2015, the Company borrowed $25,000 from a Company officer. The note is unsecured and matures on March 31, 2018 with principal convertible at the option of the holder into shares of common stock at $.10 per share.
Long-Term Obligations
Minimum future annual payments of long-term obligations as of December 31, 2015 are as follows:
2016
|
$
278,979
|
2017
|
1,378,348
|
2018
|
690,000
|
Total long-term obligations
|
$
2,347,327
|
NOTE 10. - STOCKHOLDERS' DEFICIENCY
Preferred Stock -
The Company’s certificate of incorporation authorizes its board of directors to issue up to 1,000,000 shares of preferred stock. The stock is issuable in series that may vary as to certain rights and preferences, as determined upon issuance, and has a par value of $.01 per share. As of December 31,
2015 and 2014 there were no preferred shares issued or outstanding.
Common Stock -
On December 1, 2014, as payment of a portion of an origination fee under the LOC Agreement, the Company issued 600,000 shares of its common stock at $.05 per share.
NOTE 11. - STOCK OPTION PLANS AND AGREEMENTS
The Company’s board of directors and stockholders have approved stock option plans adopted in 1996, 1997, 1998, 1999, and 2005, which have authority to grant options to purchase up to an aggregate of 581,473 common shares at December 31, 2015 (3,937,833 – 2014). No further grants may be made from these plans.
2009 Plan -
During 2009, the Company’s board of directors approved the 2009 stock option plan, which grants options to purchase up to an aggregate of 4,000,000 common shares. As of December 31, 2015, 768,000 (470,500 – 2014) options to purchase shares remain unissued under the 2009 plan. Options issued to date
are nonqualified since the Company has decided not to seek stockholder approval of the 2009 Plan.
Option Agreements -
During 2014 and 2013, the Company's board of directors approved stock option agreements with consultants and a member of the board of directors of which options for an aggregate of 2,175,000 common shares are outstanding at December 31, 2015 with an average exercise price of $.15 per share. At December 31,
2015, options for 525,000 shares are vested; options for 1,650,000 shares vest based on achieving specific sales performance criteria for the Company.
Origination Fee -
On December 1, 2014, as payment of a portion of an origination fee under the LOC Agreement, the Company issued options to purchase 600,000 shares of its common stock at an exercise price of $.05, all of which were immediately vested.
The Company grants stock options to its key employees and independent service providers as it deems appropriate. Employee stock options are exercisable as long as the optionee continues to be an employee of the Company and for thirty days subsequent to employee termination.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model based on the following assumptions.
Volatility is based on the Company’s historical volatility. The expected life of the options was assumed to be 3.25 or 5.75 years using the simplified method for plain vanilla options as stated in FASB ASC 718 to improve the accuracy of this assumption while simplifying record keeping requirements until more detailed information about the Company’s exercise
behavior is available. The risk-free rate for the life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
F-12
The following assumptions were used for the years ended December 31, 2015 and 2014.
|
2015
|
2014
|
Risk-free interest rate
|
1.49% - 1.78%
|
.77% - 1.98%
|
Expected dividend yield
|
0%
|
0%
|
Expected stock price volatility
|
100%
|
100%
|
Expected life of options
|
5.75 years
|
3.25 - 5.75 years
|
The following is a summary of stock option activity, including qualified and non-qualified options for the years ended December 31, 2015 and 2014:
|
Number of Options Outstanding
|
Weighted Average Exercise Price
|
Remaining Contractual Term
|
Aggregate Intrinsic Value
|
Outstanding at December 31, 2013
|
9,220,500
|
$
.18
|
|
|
Granted
|
3,030,000
|
$
.09
|
|
|
Expired
|
(517,667
)
|
$
.15
|
|
|
Forfeited
|
(833,333
)
|
$
.13
|
|
|
Outstanding at December 31, 2014
|
10,899,500
|
$
.16
|
|
|
Granted
|
150,000
|
$
.05
|
|
|
Expired
|
(1,954,333
)
|
$
.13
|
|
|
Forfeited
|
(651,667
)
|
$
.13
|
|
|
Outstanding at December 31, 2015
|
8,443,500
|
$
.16
|
4.8 years
|
$
0
|
|
|
|
|
|
Vested or expected to vest at
|
|
|
|
|
December 31, 2015
|
6,693,500
|
$
.17
|
5.4 years
|
$
0
|
Exercisable at December 31, 2015
|
6,073,500
|
$
.17
|
5.2 years
|
$
0
|
At December 31, 2015, there was approximately $22,000 of total unrecognized compensation cost related to outstanding non-vested options, which excludes non-vested options which are performance based for which the option expense cannot be presently quantified. This cost is expected to be recognized over a weighted average period of approximately one year. The total fair
value of shares vested during the year ended December 31, 2015 was approximately $89,000.
The weighted average fair value of options granted was $.03 and $.07 per share for the years ended December 31, 2015 and 2014, respectively. The exercise price for all options granted equaled or exceeded the market value of the Company’s common stock on the date of grant.
NOTE 12. - INCOME TAXES
The components of income tax expense (benefit) consists of the following:
|
|
|
|
|
Deferred:
|
|
|
Federal
|
$
(255,000
)
|
$
(135,000
)
|
State
|
(31,000
)
|
90,000
|
|
(286,000
)
|
(45,000
)
|
Change in valuation allowance
|
286,000
|
45,000
|
|
$
0
|
$
0
|
At December 31, 2015, the Company had federal net operating loss carryforwards of approximately $7,300,000 ($6,800,000 – 2014) and various state net operating loss carryforwards of approximately $2,500,000 ($2,200,000 – 2014) which expire from 2018 through 2035. These carryforwards exclude federal net operating loss carryforwards from inactive subsidiaries
of approximately $6,600,000 ($6,600,000 – 2014), as well as net operating loss carryforwards from states that the Company does not presently operate in. Utilization of the net operating loss carryforwards may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenues Code and similar state provisions. The annual limitation may result in the expiration of the net operating loss carryforwards before utilization.
At December 31, 2015, a net deferred tax asset, representing the future benefit attributed primarily to the available net operating loss carryforwards and defined benefit pension plan expenses, in the amount of approximately $3,431,000 ($3,145,000 - 2014), had been fully offset by a valuation allowance because management believes that the statutory limitations on utilization
of the operating losses and concerns over achieving profitable operations diminish the Company’s ability to demonstrate that it is more likely than not that these future benefits will be realized before they expire.
The following is a summary of the Company's temporary differences and carryforwards which give rise to deferred tax assets and liabilities.
|
|
|
|
|
Deferred tax assets (liabilities):
|
|
|
Net operating loss carryforwards
|
$
2,614,000
|
$
2,423,000
|
Defined benefit pension liability
|
325,000
|
331,000
|
Reserves and accrued expenses payable
|
492,000
|
391,000
|
Gross deferred tax asset
|
3,431,000
|
3,145,000
|
Deferred tax asset valuation allowance
|
(3,431,000
)
|
(3,145,000
)
|
Net deferred tax asset
|
$
0
|
$
0
|
The differences between the U.S. statutory federal income tax rate and the effective income tax rate in the accompanying statements of operations are as follows:
|
|
|
|
|
Statutory U.S. federal tax rate
|
34.0
%
|
34.0
%
|
State income taxes
|
3.8
|
(18.0
)
|
Change in valuation allowance
|
(35.3
)
|
(9.1
)
|
Stock-based compensation expense
|
(1.7
)
|
(4.5
)
|
Expired stock-based compensation
|
(.4
)
|
(1.8
)
|
Other permanent non-deductible items
|
(.4
)
|
(.6
)
|
Effective income tax rate
|
0.0
%
|
0.0
%
|
NOTE 13. - EMPLOYEE RETIREMENT PLANS
Simple IRA Plan
-
Through December 31, 2012, the Company offered a simple IRA plan as a retirement plan for eligible employees who earned at least $5,000 of annual compensation. Eligible employees could elect to contribute
a percentage of their compensation up to a maximum of $11,500. The accrued liability for the simple IRA plan, including interest, was $216,913 and $208,449, as of December 31, 2015 and 2014, respectively.
401(k) Plan -
Effective, January 1, 2013, the Company began offering a defined contribution 401(k) plan in place of the simple IRA plan. For 2015, 401(k) employee contribution limits are $18,000 plus a catch up contribution for those over age 50 of $6,000. The Company can elect to make a discretionary contribution to the Plan.
No discretionary contribution was approved for 2015 or 2014.
NOTE 14. - COMMITMENTS
Lease Commitments -
The Company leases its headquarters facility under an operating lease agreement that expires in May 2016. Rent expense under the operating lease was approximately $64,900 less amounts received from a sublease to a related party of $18,097 for
each of the years ended December 31, 2015 and 2014. Future minimum payments required under the lease are $26,945 in 2016 less amounts due from a sublease to a related party of $7,530.
NOTE 15. - RELATED PARTY ACCOUNTS RECEIVABLE AND ACCRUED INTEREST PAYABLE
Accounts Receivable –
Certain officers or directors of the Company have made loans to goSudo, a customer of the Company, and can influence the management of this company. At December 31, 2015, there are no accounts receivable due from this related party ($66,885 - December 31, 2014).
Accrued Interest Payable –
Included in accrued interest payable is accrued interest payable to related parties of $411,303 at December 31, 2015 ($378,731 - 2014).
NOTE 16. - SUPPLEMENTAL CASH FLOW INFORMATION
On February 6, 2015, the Company originated a secured promissory note in the principal amount of $80,000 in connection with the acquisition of the UberScan software (See Note 5). During 2015, the Company made principal payments of $38,000.
During 2015, the accounts receivable balance of $110,000 due from goSudo was converted to a demand note with interest at 10% and was fully reserved upon conversion. The note is on non-accrual status and the net carrying value is $0 at December 31, 2015.
On December 1, 2014, as payment of an origination fee under the LOC Agreement, the Company issued 600,000 shares of its common stock at $.05 per share valued at $30,000 and issued options to purchase 600,000 shares of its common stock at an exercise price of $.05 valued at $23,400.
NOTE 17. - SUBSEQUENT EVENTS
Subsequent to year end and through April 14, 2016
,
the Company issued options for 315,000 common shares at an exercise price of $.10; 315,000 common shares at an exercise price of $.25; and 308,000 common shares at an exercise price of $.34 to a former Company officer. The options become exercisable as authorized by the board
of directors.
On March 14, 2016, the Company entered into an
unsecured financing agreement with a third party lender. The agreement provides for $500,000 of working capital with draws of $200,000 which occured on April 13, 2016, $200,000 to occur on July 1, 2016 and $100,000 to occur on October 1, 2016. Borrowings bear interest at 6% with
interest payments due quarterly. Principal is due on December 31, 2021. Principal and interest may become immediately due and payable upon the occurrence of customary events of default. In consideration for providing the financing, the Company paid the lender a fee consisting of 2,500,000 shares of its common stock valued at $37,500 on the date of the agreement based upon the closing bid quotation of its common stock on the OTC Bulletin Board on that date. The lender has piggy back registration rights for these
shares. The Company’s Chief Executive Officer and President agreed to guarantee the loan obligations if he is no longer an “affiliate” of the Company as defined by Securities and Exchange Commission rules.