10-Q 1 f10q093012_10q.htm FORM 10-Q QUARTERLY REPORT SEPTEMBER 30 2012 FORM 10-Q Quarterly Report September 30 2012

UNITED STATES

SECURITIES EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q


  X .

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2012


      .

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from   to   


STRIKEFORCE TECHNOLOGIES, INC.

(Exact name of registrant as specified in its Charter)


WYOMING

333-122113

22-3827597

(State or other jurisdiction of  incorporation or organization)

(Commission file number)

(I.R.S. Employer Identification No.)


1090 King Georges Post Road, Suite 603

Edison, NJ  08837

(Address of Principal Executive Offices)


(732) 661-9641

(Issuer’s telephone number)


Securities registered pursuant to Section 12(b) of the Exchange Act:


Title of each class

Name of each exchange on which registered

N/A

N/A


Securities registered pursuant to Section 12(g) of the Exchange Act:


Common stock, $0.0001 par value

Title of Class


Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the 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      .


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such a shorter period that the registrant was required to submit and post such files).  Yes   X  . No      .


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

      .

Accelerated filer

      .

Non-accelerated filer

      . (Do not check if a smaller reporting company)

Smaller reporting company

  X .


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


Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


 

 

 

Class

 

Outstanding at November 11, 2012

Common stock, $0.0001 par value

 

305,793,299


Indicate the number of shares outstanding of each of the issuer’s classes of preferred stock, as of the latest practicable date.


 

 

 

Class A

 

Outstanding at November 11, 2012

Preferred stock, no par value

 

3


Transitional Small Business Disclosure Format  Yes      . No   X  .


Documents Incorporated By Reference

None





STRIKEFORCE TECHNOLOGIES, INC.

FORM 10-Q

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011

TABLE OF CONTENTS


 

 

 

Page

Number

PART I - FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

3

 

 

Balance Sheets

4

 

 

Statements of Operations

5

 

 

Statement of Stockholders’ Deficit

6

 

 

Statements of Cash Flows

7

 

 

Notes to the Financial Statements

8

 

Item 2.

Management Discussion & Analysis of Financial Condition and Results of Operations

34

 

Item 3

Quantitative and Qualitative Disclosures About Market Risk

44

 

Item 4.

Controls and Procedures

44

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

Item1.

Legal Proceedings

46

 

Item1A.

Risk Factors

46

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

46

 

Item 3.

Defaults Upon Senior Securities

47

 

Item 4.

Mine Safety Disclosures

47

 

Item 5

Other information

47

 

Item 6.

Exhibits

48

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CERTIFICATIONS

 

 

 

 

 

Exhibit 31 – Management certification

 

 

 

Exhibit 32 – Sarbanes-Oxley Act

 




2




PART I

 

ITEM 1.  FINANCIAL STATEMENTS AND NOTES TO INTERIM FINANCIAL STATEMENTS


The accompanying unaudited interim financial statements have been prepared in accordance with the instructions to Form 10-Q.  Therefore, they do not include all information and footnotes necessary for a complete presentation of financial position, results of operations, cash flows, and stockholders' equity in conformity with generally accepted accounting principles.  Except as disclosed herein, there has been no material change in the information disclosed in the notes to the financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2011, filed April 16, 2012.  In the opinion of management, all adjustments considered necessary for a fair presentation of the results of operations and financial position have been included and all such adjustments are of a normal recurring nature.  Operating results for the three months and nine months ended September 30, 2012 are not necessarily indicative of the results that can be expected for the year ending December 31, 2012.




3




STRIKEFORCE TECHNOLOGIES, INC.

CONDENSED BALANCE SHEETS

 

 

 

 

 

 

 

 

 

September 30, 2012

 

December 31, 2011

 

 

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 ASSETS

 

 

 

 

 

 

 Current Assets:

 

 

 

 

 

 

 Cash

 

$

228,884

 

$

-

 Accounts receivable

 

 

137,929

 

 

75,323

 Prepayments and other current assets

 

 

10,287

 

 

12,421

 Total current assets

 

 

377,100

 

 

87,744

 

 

 

 

 

 

 

 Property and equipment, net

 

 

4,996

 

 

6,838

 Website, net

 

 

8,250

 

 

-

 Patents, net

 

 

4,138

 

 

4,329

 Security deposit

 

 

8,684

 

 

8,684

 Total Assets

 

$

403,168

 

$

107,595

 

 

 

 

 

 

 

 LIABILITIES AND STOCKHOLDERS' DEFICIT

 

 

 

 

 

 

 Current Liabilities:

 

 

 

 

 

 

 Bank overdraft

 

$

-

 

$

4,520

 Current maturities of convertible notes payable, net of

discount of $272,825

and $85,511, respectively

 

 

 

 

 

 

 

 

1,278,942

 

 

1,153,756

 Convertible notes payable - related parties

 

 

360,500

 

 

360,500

 Current maturities of notes payable, net of discount of

$1,598 and $14,915, respectively  

 

 

2,374,765

 

 

2,391,849

 Notes payable - related parties

 

 

722,638

 

 

722,638

 Accounts payable

 

 

883,477

 

 

943,642

 Accrued expenses

 

 

3,854,322

 

 

3,542,099

 Advance license billing

 

 

-

 

 

-

 Derivative liabilities

 

 

568,867

 

 

334,605

 Convertible secured notes payable

 

 

542,588

 

 

542,588

 Capital leases payable

 

 

5,532

 

 

5,532

 Payroll taxes payable

 

 

53,901

 

 

53,901

 Due to factor

 

 

209,192

 

 

209,192

 Total current liabilities

 

 

10,854,724

 

 

10,264,822

 

 

 

 

 

 

 

 Common stock to be issued

 

 

-

 

 

25,000

 Convertible notes payable, net of current maturities

 

 

30,000

 

 

30,000

 Notes payable, net of current maturities

 

 

-

 

 

50,000

 Total Liabilities

 

 

10,884,724

 

 

10,369,822

 

 

 

 

 

 

 

 Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 Stockholders' Deficit

 

 

 

 

 

 

 Series A Preferred stock, no par value; 100 shares

authorized; 3 shares issued and outstanding

 

 

 

 

 

 

 

 

987,000

 

 

987,000

 Series B Preferred stock at $0.10 par value; 100,000,000

shares authorized;  none issued or outstanding

 

 

 

 

 

 

 

 

-

 

 

-

 Preferred stock series not designated, at $0.10 par value;

10,000,000 shares authorized;  none issued or

outstanding

 

 

 

 

 

 

 

 

-

 

 

-

 Common stock at $0.0001 par value; 500,000,000 shares

authorized;  294,253,293 and 221,388,354 shares issued

and outstanding, respectively

 

 

 

 

 

 

 

 

29,425

 

 

22,139

 Additional paid-in capital

 

 

17,918,115

 

 

17,249,713

 Accumulated deficit

 

 

(29,416,096)

 

 

(28,521,079)

 Total Stockholders' Deficit

 

 

(10,481,556)

 

 

(10,262,227)

 Total Liabilities and Stockholders' Deficit

 

$

403,168

 

$

107,595




4




STRIKEFORCE TECHNOLOGIES, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months

 

 

For the Nine Months

 

 

 

Ended

 

 

Ended

 

 

 

September 30,

2012

 

September 30,

2011

 

 

September 30,

2012

 

September 30,

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Revenues

 

$

289,515

$

137,535

 

$

642,596

$

286,695

 

 

 

 

 

 

 

 

 

 

 

 Cost of sales

 

 

1,029

 

5,179

 

 

13,050

 

19,038

 

 

 

 

 

 

 

 

 

 

 

 Gross profit

 

 

288,486

 

132,356

 

 

629,546

 

267,657

 

 

 

 

 

 

 

 

 

 

 

 Operating expenses:

 

 

 

 

 

 

 

 

 

 

 Compensation

 

 

77,011

 

58,500

 

 

258,418

 

217,800

 Professional fees

 

 

105,875

 

97,178

 

 

380,648

 

870,039

 Selling, general and administrative expenses

 

 

75,692

 

910,214

 

 

216,475

 

3,209,796

 Research and development

 

 

78,000

 

97,500

 

 

253,500

 

260,669

 Total operating expenses

 

 

336,578

 

1,163,392

 

 

1,109,041

 

4,558,304

 

 

 

 

 

 

 

 

 

 

 

 Loss from operations

 

 

(48,092)

 

(1,031,036)

 

 

(479,495)

 

(4,290,647)

 

 

 

 

 

 

 

 

 

 

 

 Other (income) expense:

 

 

 

 

 

 

 

 

 

 

 Interest and financing expense

 

 

203,468

 

154,449

 

 

515,707

 

441,062

 Change in fair value of derivative liabilities

 

 

8,503

 

(52,860)

 

 

(102,224)

 

(40,516)

 Forgiveness of debt

 

 

-

 

(790)

 

 

-

 

(4,251)

 Other (income) expenses

 

 

2,039

 

-

 

 

2,039

 

-

 Total other expense

 

 

214,010

 

100,799

 

 

415,522

 

396,295

 

 

 

 

 

 

 

 

 

 

 

 Income tax provision  

 

 

-

 

-

 

 

-

 

-

 

 

 

 

 

 

 

 

 

 

 

 Net loss

 

$

(262,102)

$

(1,131,835)

 

$

(895,017)

$

(4,686,942)

 

 

 

 

 

 

 

 

 

 

 

 Net loss per common share - basic and diluted  

 

$

(0.001)

$

(0.01)

 

$

(0.004)

$

(0.03)

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding   - basic and diluted

 

 

276,144,686

 

166,012,047

 

 

254,046,590

 

136,155,784




5




STRIKEFORCE TECHNOLOGIES, INC.

CONDENSED STATEMENT OF STOCKOLDERS' DEFICIT

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Series A Preferred

stock, no par value

 

 Common stock at

$0.0001 par value

 

Additional

Paid-in

 

Accumulated

 

Total

Stockholders'

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Deficit

 

Deficit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2011

 

3

 

$

987,000

 

221,388,354

 

$

22,139

 

$

17,249,713

 

$

(28,521,079)

 

$

(10,262,227)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sale of shares of common stock including warrants

 

-

 

 

-

 

50,555,451

 

 

5,055

 

 

397,795

 

 

-

 

 

402,850

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of shares of common stock for consulting services

 

-

 

 

-

 

3,146,867

 

 

315

 

 

51,915

 

 

-

 

 

52,230

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of shares of common stock for settlement and transfer of debt

 

-

 

 

-

 

8,356,274

 

 

835

 

 

130,596

 

 

-

 

 

131,431

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of shares of common stock for financing

 

-

 

 

-

 

562,500

 

 

56

 

 

8,944

 

 

-

 

 

9,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of shares of common stock for conversions of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

convertible notes payable

 

-

 

 

-

 

10,243,847

 

 

1,025

 

 

67,284

 

 

-

 

 

68,309

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of warrants for consulting services

 

-

 

 

-

 

-

 

 

-

 

 

11,868

 

 

-

 

 

11,868

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

-

 

 

-

 

-

 

 

-

 

 

-

 

 

(895,017)

 

 

(895,017)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2012

 

3

 

$

987,000

 

294,253,293

 

$

29,425

 

$

17,918,115

 

$

(29,416,096)

 

$

(10,481,556)




6




STRIKEFORCE TECHNOLOGIES, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

 

 

 

 

 

 

 

For the Nine

 

 

For the Nine

 

 

 

Months Ended

 

 

Months Ended

 

 

 

September 30, 2012

 

 

September 30, 2011

Cash flows from operating activities:

 

 

 

 

 

 

Net loss

 

$

(895,017)

 

$

(4,686,942)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

 

5,474

 

 

3,182

Forgiveness of debt

 

 

-

 

 

(4,251)

Amortization of discount on notes payable

 

 

(213,982)

 

 

61,977

Change in fair value of derivative financial instruments

 

 

275,406

 

 

(40,516)

Issuance of preferred stock for employee services

 

 

-

 

 

987,000

Issuance of stock options for employee and non-employee services

 

 

-

 

 

1,960,875

Issuance of common stock and warrants for consulting services

 

 

64,096

 

 

684,141

Financing expense paid through the issuance of common stock

 

 

9,000

 

 

26,200

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

(62,606)

 

 

9,493

Prepaid expenses

 

 

2,134

 

 

(802)

Accounts payable

 

 

(33,165)

 

 

(43,351)

Accrued expenses

 

 

346,656

 

 

403,313

Net cash used in operating activities

 

 

(502,004)

 

 

(639,681)

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Investment in website

 

 

(9,000)

 

 

-

Purchases of property and equipment

 

 

(2,691)

 

 

(6,399)

Net cash used in investing activities

 

 

(11,691)

 

 

(6,399)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Bank overdraft repayment

 

 

(4,520)

 

 

-

Proceeds from sale of common stock

 

 

405,000

 

 

210,000

Sale of warrants for cash

 

 

-

 

 

570,313

Proceeds from the exercise of warrants

 

 

-

 

 

20,000

Proceeds from notes payable

 

 

-

 

 

107,500

Repayment of notes payable

 

 

(10,401)

 

 

(29,415)

Proceeds from convertible notes payable

 

 

353,000

 

 

-

Repayment of convertible notes payable

 

 

(500)

 

 

-

Proceeds from notes payable - related parties

 

 

-

 

 

2,800

Repayment of notes payable - related parties

 

 

-

 

 

(6,600)

Repayment of secured convertible notes payable

 

 

-

 

 

(129,041)

Net cash provided by financing activities

 

 

742,579

 

 

745,557

 

 

 

 

 

 

 

Net change in cash

 

 

228,884

 

 

99,477

 

 

 

 

 

 

 

Cash at beginning of the period

 

 

-

 

 

45,925

 

 

 

 

 

 

 

Cash at end of the period

 

$

228,884

 

$

145,402

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

         Interest paid

 

$

-

 

$

-

         Income tax paid

 

$

-

 

$

-

 

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

 

 

Conversion of convertible notes payable into common stock

 

$

68,309

 

$

235,084

Issuance of common stock in settlement of debt

 

$

131,433

 

$

-

Issuance of common stock for common stock to be issued

 

$

25,000

 

$

-




7



StrikeForce Technologies, Inc.

September 30, 2012 and 2011

Notes to the Financial Statements

(Unaudited)


Note 1 - Nature of Operations


StrikeForce Technical Services Corporation was incorporated in August 2001 under the laws of the State of New Jersey. On September 3, 2004, the stockholders approved an amendment to the Certificate of Incorporation to change the name to StrikeForce Technologies, Inc. (the “Company”). On November 15, 2010, the Company was redomiciled under the laws of the State of Wyoming. The Company’s operations are based in Edison, New Jersey.


The Company is a software development and services company.  The Company owns the exclusive right to license and develop various identification protection software products that were developed to protect computer networks from unauthorized access and to protect network owners and users from identity theft.  The Company has developed a suite of products based upon the licenses and its strategy is to develop and exploit the products for customers in the areas of financial services, e-commerce, corporate, government, healthcare and consumer sectors. In November 2010, the Company received notice that the United States Patent Office (“USTPO”) issued an official Notice of Allowance for the patent application for the technology relating to its ProtectID® product, titled "Multi-Channel Device Utilizing a Centralized Out-of-Band Authentication System". In January 2011, the Company received notice that the United States Patent Office issued the Company Patent No. 7,870,599.  The “Out-of-Band Patent” went through a USTPO Re-Examination process starting on August 16, 2011 and concluded on December 27, 2011, with all of the Company's patent claims remaining intact and seven additional Company patent claims being added. In 2011, the Company also submitted an additional continuation patent on the “Out-of-Band” Patent, with another sixty-six additional Company claims now pending. The technology developed by the Company and used in the Company’s GuardedID® product is the subject of a pending patent application.  


In December 2011, the Company executed an exclusive agreement with an agent to represent the Company in enforcing the ProtectID® patent. The agent will receive a commission of 50% of the net proceeds resulting from its services. The Company terminated that exclusive agreement in September 2012. The Company shall be enforcing its patent rights and management has taken the initial steps concerning such enforcement as recommended by its patent attorneys.


Note 2 - Summary of Significant Accounting Policies


Basis of Presentation -Unaudited Interim Financial Information


The accompanying condensed unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the rules and regulations of the United States Securities and Exchange Commission to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods have been included.  Interim results are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the financial statements of the Company for the year ended December 31, 2011 and notes thereto contained in the Annual Report on Form 10-K of the Company as filed with the United States Securities and Exchange Commission (“SEC”) on April 16, 2012.


Reclassification


Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation. These reclassifications had no effect on reported losses.




8




Fair Value of Financial Instruments


The Company follows applicable accounting guidance for disclosures about fair value of its financial instruments. U.S. GAAP establishes a framework for measuring fair value, and requires disclosures about fair value measurements.  To provide consistency and comparability in fair value measurements and related disclosures, U.S. GAAP establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels.  The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The three levels of fair value hierarchy are described below:


Level 1

 

Quoted market prices available in active markets for identical assets or liabilities as of the reporting date.

 

 

 

Level 2

 

Pricing inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date.

 

 

 

Level 3

 

Pricing inputs that are generally not observable inputs and not corroborated by market data.


Financial assets are considered Level 3 when their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable.


If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.


The carrying amounts of the Company’s financial assets and liabilities, such as cash, accounts receivable, prepayments and other current assets, accounts payable, accrued expenses, payroll taxes payable, and due to factor, approximate their fair values because of the short maturity of these instruments.  


The Company’s notes payable, convertible notes payable, convertible secured notes payable, and capital leases payable approximate the fair value of such instruments based upon management’s best estimate of interest rates that would be available to the Company for similar financial arrangements at September 30, 2012 and December 31, 2011.


The Company’s Level 3 financial liabilities consist of the derivative financial instruments for which there is no current market for these securities such that the determination of fair value requires significant judgment or estimation.  The Company valued the automatic conditional conversion, re-pricing/down-round, change of control; default and follow-on offering provisions using a lattice model, with the assistance of a valuation specialist, for which management understands the methodologies. These models incorporate transaction details such as Company stock price, contractual terms, maturity, risk free rates, as well as assumptions about future financings, volatility, and holder behavior as of the date of issuance and each balance sheet date.


Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist.


Fair Value of Financial Assets and Liabilities Measured on a Recurring Basis


Level 3 Financial Liabilities – Derivative Financial Instruments


The Company uses Level 3 of the fair value hierarchy to measure the fair value of the derivative liabilities and revalues its derivative liability at the end of every reporting period and recognizes gains or losses in the Statements of Operations that are attributable to the change in the fair value of the derivative liability.


Discount on debt


The Company allocates the proceeds received from convertible debt instruments between the liability component and equity component, and records the conversion feature as a liability. The conversion feature and certain other features that are considered embedded derivative instruments, such as a conversion reset provision, a penalty provision and redemption option, have been recorded at their fair value as its fair value can be separated from the convertible note and its conversion is independent of the underlying note value. The conversion liability is marked to market each reporting period with the resulting gains or losses shown in the Statement of Operations. The Company has also recorded the resulting discount on debt related to the warrants and conversion feature and is amortizing the discount using the effective interest rate method over the life of the debt instruments.



9




Derivative Financial Instruments


Derivative instruments are required to be recognized as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of a derivative instrument depends on: (i) whether the derivative has been designated and qualifies as part of a hedging relationship, and (ii) the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument based upon the exposure being hedged as either a fair value hedge, cash flow hedge or hedge of a net investment in a foreign operation. The Company evaluates its convertible debt, options, warrants or other contracts to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for under applicable accounting guidance. The result of this accounting treatment is that the fair value of the embedded derivative is marked-to-market each balance sheet date and recorded as a liability, and the change in fair value is recorded in the Statement of Operations as other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity.


In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument.


The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. Equity instruments that are initially classified as equity that become subject to reclassification are reclassified to liability at the fair value of the instrument on the reclassification date. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument is expected within 12 months of the balance sheet date.


The fair value model utilized to value the various compound embedded derivatives in the secured convertible notes comprises multiple probability-weighted scenarios under various assumptions reflecting the economics of the secured convertible notes, such as the risk-free interest rate, expected Company stock price and volatility, likelihood of conversion and or redemption, and likelihood of default status and timely registration.  At inception, the fair value of the single compound embedded derivative was bifurcated from the host debt contract and recorded as a derivative liability which resulted in a reduction of the initial notional carrying amount of the secured convertible notes (as unamortized discount which is being amortized over the term of the notes under the effective interest method).


Embedded Beneficial Conversion Feature of Convertible Instruments


The Company recognizes and measures the embedded beneficial conversion feature of applicable convertible instruments by allocating a portion of the proceeds from the convertible instruments equal to the intrinsic value of that feature to additional paid-in capital. The intrinsic value of the embedded beneficial conversion feature is calculated at the commitment date as the difference between the conversion price and the fair value of the securities into which the convertible instruments are convertible. The Company recognizes the intrinsic value of the embedded beneficial conversion feature of the convertible notes so computed as interest expense.


From time to time, the Company transfers the liability under the indenture instrument to a third party in certain circumstances.


Related Parties


Related parties include a. affiliates of the Company; b. entities for which investments in their equity securities would be required to be accounted for by the equity method by the investing entity; c. trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management; d. principal owners of the Company; e. management of the Company; f. other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests; and g. other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.


Stock-Based Compensation for Obtaining Employee Services


The Company accounts for share-based employee compensation plans under the fair value recognition and measurement provisions of GAAP. Those provisions require all share-based payments to employees, including grants of stock options, to be measured based on the grant-date fair value of the awards, with the resulting expense generally recognized in statements of income over the period during which the employee is required to perform service in exchange for the award.


The fair value of each option award is estimated on the date of grant using a Black-Scholes option-pricing valuation model.



10




The ranges of assumptions for inputs are as follows:


·

Expected term of share options and similar instruments.


·

Expected volatility of the entity's shares and the method used to estimate it. The Company uses historical data to estimate holder's expected exercise behavior.


·

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods within the contractual life of the option and similar instruments.


·

The expected dividend yield is based on the Company's current dividend yield as the best estimate of projected dividend yield for periods within the expected contractual life of the option and similar instruments The Company has not declared any dividends since inception.


The Company's policy is to recognize compensation cost for awards with only service conditions and a graded vesting schedule on a straight-line basis over the requisite service period for the entire award. Additionally, the Company's policy is to issue new shares of common stock to satisfy stock option exercises.


Equity instruments issued to parties other than employees for acquiring goods or services


The Company accounts for equity instruments issued to parties other than employees for acquiring goods or services under applicable accounting guidance. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable.  The measurement date used to determine the fair value of the equity instrument issued is the earlier of the date on which the performance is complete or the date on which it is probable that performance will occur. The fair value of the option or warrant award is estimated on the date of grant using a Black-Scholes option-pricing valuation model.  


The Company may grant fully vested, non-forfeitable equity instruments that are exercisable by the grantee only after a specified period of time if the terms of the agreement provide for earlier exercisability if the grantee achieves specified performance conditions. Any measured cost of the transaction is recognized in the same period(s) and in the same manner as if the entity had paid cash for the goods or services or used cash rebates as a sales discount instead of paying with, or using, the equity instruments. A recognized asset, expense, or sales discount is not reversed if a stock option that the counterparty has the right to exercise expires unexercised.


If the Company receives a right to receive future services in exchange for unvested, forfeitable equity instruments, those equity instruments are treated as unissued for accounting purposes until the future services are received (that is, the instruments are not considered issued until they vest). Consequently, in such cases, there is no recognition at the measurement date and no entry is recorded.


Income Tax Provision


The Company accounts for income taxes under the liability method.  Deferred income tax assets and liabilities are determined based upon differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.  Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of operations in the period that includes the enactment date.


For interim periods, the income tax provision (benefit) is based on the estimated annual effective tax rate.  Due to losses sustained, the applicable estimated tax rate is zero in each period.


The Company adopted the uncertainty in income taxes accounting standard which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  Under this guidance, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.  The standard also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.



11




Uncertain Tax Positions


The Company’s operations are based in New Jersey and it is subject to federal and New Jersey state income tax. Tax years subsequent to 2007 are open to examination by United States and state tax authorities. The Company had no material adjustments to its liabilities for unrecognized income tax benefits. On classification of all interest and penalties related to income tax, if any, the Company records them under other expenses in the Statement of Operations.


Net (Loss) per Common Share


Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period.  Diluted net income per common share is computed by dividing net income by the weighted average number of shares of common stock and potentially outstanding shares of common stock during the period to reflect the potential dilution that could occur from common shares issuable through contingent share arrangements, stock options and warrants.


The following table shows the potentially outstanding dilutive common shares excluded from the diluted net loss per common share calculation for the interim periods ended September 30, 2012 and 2011 as they were anti-dilutive:


 

 

 

Potentially Outstanding

Dilutive Common Shares

 

 

 

For the Nine

Months Ended

September 30,

2012

 

 

For the Nine

Months Ended

September 30,

2011

Warrants issued in connection with debentures

 

 

 

2,773,157

 

 

 

2,925,267

 

 

 

 

 

 

 

 

 

Warrants sold for cash

 

 

 

222,350,000

 

 

 

223,550,000

 

 

 

 

 

 

 

 

 

Warrants issued in consideration of services provided

 

 

 

7,325,000

 

 

 

11,743,200

 

 

 

 

 

 

 

 

 

Warrants issued in connection with the sale of common stock

 

 

 

26,777,727

 

 

-

 

 

 

 

 

 

 

 

 

Sub-total - Warrants

 

 

 

259,225,884

 

 

 

238,218,467

 

 

 

 

 

 

 

 

 

Options issued from 5/20/03 to 4/21/11 to employees to purchase common shares exercisable at $0.0025 to $10.00 per share expiring 3 years to 10 years from the date of issuance

 

 

 

140,027,309

 

 

 

140,027,309

 

 

 

 

 

 

 

 

 

Options issued from 12/2/04 to 12/23/10 to consultants to purchase common shares exercisable at $0.006 to $9.00 per share expiring 5 years to 10 years from the date of issuance

 

 

 

2,761,889

 

 

2,761,889

 

 

 

 

 

 

 

 

 

Sub-total – Options

 

 

 

142,789,198

 

 

 

142,789,198

 

 

 

 

 

 

 

 

 

Shares of common stock issuable under the conversion feature of convertible notes payable

 

 

 

57,762,800

 

 

17,654,755

 

 

 

 

 

 

 

 

 

Total potentially outstanding dilutive common shares

 

 

 

459,777,882

 

 

398,662,420


Subsequent Events


The Company has evaluated subsequent events through the date when the financial statements were issued.  


Recently Issued Accounting Pronouncements




12




FASB Accounting Standards Update No. 2011-08


In September 2011, the FASB issued the FASB Accounting Standards Update No. 2011-08 “Intangibles—Goodwill and Other: Testing Goodwill for Impairment” (“ASU 2011-08”). This Update is to simplify how public and nonpublic entities test goodwill for impairment. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. Under the amendments in this Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.


The Company has adopted this amended guidance and adoption of these updates has not had a material impact on the financial statements or results of operations.. 


FASB Accounting Standards Update No. 2011-11


In December 2011, the FASB issued the FASB Accounting Standards Update No. 2011-11 “Balance Sheet: Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”). This Update requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of IFRS.


The amended guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods.


FASB Accounting Standards Update No. 2012-02


In July 2012, the FASB issued the FASB Accounting Standards Update No. 2012-02 “Intangibles—Goodwill and Other (Topic 350) Testing Indefinite-Lived Intangible Assets for Impairment” (“ASU 2012-02”).


 This Update is intended to reduce the cost and complexity of testing indefinite-lived intangible assets other than goodwill for impairment. This guidance builds upon the guidance in ASU 2011-08, entitled Testing Goodwill for Impairment. ASU 2011-08 was issued on September 15, 2011, and feedback from stakeholders during the exposure period related to the goodwill impairment testing guidance was that the guidance also would be helpful in impairment testing for intangible assets other than goodwill. 


The revised standard allows an entity the option to first assess qualitatively whether it is more likely than not (that is, a likelihood of more than 50 percent) that an indefinite-lived intangible asset is impaired, thus necessitating that it perform the quantitative impairment test. An entity is not required to calculate the fair value of an indefinite-lived intangible asset and perform the quantitative impairment test unless the entity determines that it is more likely than not that the asset is impaired.


This Update is effective for annual and interim impairment tests performed in fiscal years beginning after September 15, 2012. Earlier implementation is permitted.


Other Recently Issued, but Not Yet Effective Accounting Pronouncements


Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.


Note 3 - Going Concern


The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates continuity of operations, realization of assets, and liquidation of liabilities in the normal course of business.


As reflected in the accompanying financial statements, the Company has an accumulated deficit at September 30, 2012, and net loss and net cash used in operating activities for the nine months ended. These factors raise substantial doubt about the Company’s ability to continue as a going concern.




13




Currently, management is attempting to increase revenues and improve gross margins by a revised sales strategy. The Company is redirecting its sales focus from direct sales to domestic and international channel sales, where the Company is primarily selling through a channel of Distributors, Value Added Resellers, Strategic Partners and Original Equipment Manufacturers. While the Company believes in the viability of its strategy to increase revenues and in its ability to raise additional funds, there can be no assurances to that effect.  The ability of the Company to continue as a going concern is dependent upon the Company’s ability to continually increase its customer base and realize increased revenues from recently signed contracts.


The financial statements do not include any adjustments related to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.


Note 4 - Convertible Notes Payable


Convertible notes payable at September 30, 2012 and December 31, 2011 consisted of the following:


 

 

September

30,

2012

 

December

31,

2011

(1) Convertible note bearing interest at 8% per annum, originally scheduled to mature on March 28, 2008, with a conversion price of $9.00 per share. As of September 30, 2012, the Company has not received a response from the note holder regarding a settlement agreement.

$

235,000

$

235,000

(2) Convertible notes bearing interest at 8% per annum with a conversion price of $9.00 per share which was originally scheduled to mature on December 31, 2010.  As of September 30, 2012, the Company has not received a response from the note holder regarding a settlement agreement.

 

50,000

 

50,000

(3)  Convertible note bearing interest at 9% per annum with a conversion price of $1.40 per share which was originally scheduled to mature on December 9, 2010.  As of September 30, 2012, the Company has not received a response from the note holder regarding a settlement agreement.

 

200,000

 

200,000

(4)  Convertible note bearing interest at 9% per with a conversion price of $0.80 per share which was originally scheduled to mature on December 31, 2010.  As of September 30, 2012, the Company has not received a response from the note holder regarding a settlement agreement.



150,000

 

150,000

(5) Convertible note executed in May 2007 bearing interest at 9% per annum with a conversion price of $0.35 per share which was originally scheduled to mature December 31, 2010.  As of September 30, 2012, the Company has not received a response from the note holder regarding a settlement agreement.

 

100,000

 

100,000

(6) Convertible notes executed in June 2007 bearing interest at 8% per annum which was originally scheduled to mature on December 29, 2010.  As of September 30, 2012, the Company has not received a response from the note holder regarding a settlement agreement.

 

100,000

 

100,000

(7) Convertible note executed in July 2007 bearing interest at 8% per annum which was originally scheduled to mature on January 2, 2011.  As of September 30, 2012, the Company has not received a response from the note holder regarding a settlement agreement.

 

100,000

 

100,000

(8) Convertible notes executed in August 2007 bearing interest at 9% per annum which was originally scheduled to mature on August 9, 2010. The Company is pursuing extensions.

 

120,000

 

120,000

(9) Convertible notes executed in December 2009 bearing interest at 9% per annum maturing on December 1, 2012, with a conversion price of $0.105 per share. The Company issued 200,000 warrants with an exercise price of $0.10 per share and an expiration date of December 1, 2012 in connection with the notes.

 

50,000

 

50,000

(10) Convertible note bearing interest at 8% per annum, maturing on March 31, 2015.

 

30,000

 

30,000

(11) Convertible notes, bearing compound interest at 8% per annum, which were originally scheduled to mature on June 30, 2010, with a conversion price of $10.00 per share. Per the terms of a debt purchasing agreement formalized with a consultant in September 2011, the Company transferred one of the notes, in the amount of $10,000, including accrued interest, to the consultant in October 2011 (see Note 11). The Company is pursuing extensions. In September 2012, the Company repaid $500 of the balance of the notes.

 

48,255

 

48,755



14




(12) Four convertible notes bearing interest at 4% per annum, maturing on December 5, 2012, January 3, 2013, January 31, 2013 and March 2, 2013, respectively (see Note 10). On June 15, 2012, the note holder converted $15,000 of the December 5, 2011 note into 2,668,089 unrestricted shares of the Company's common stock at $0.005622 per share. On August 15, 2012, the note holder converted $25,000 of the December 5, 2011 note into 7,575,758 unrestricted shares of the Company's common stock at $0.0033 per share (see Note 11).

 

260,000

 

75,000

(13) Three convertible notes bearing interest at 8% per annum, maturing on January 6, 2013, February 8, 2013 and April 30, 2013, respectively (see Note 10). In October 2012, the note holder converted $26,000 of the April 11, 2012 note into 5,581,818 unrestricted shares of the Company’s common stock. The conversions were processed on October 19, 2012 for $12,000 into 2,400,000 shares at a conversion price of $0.005 per share and October 31, 2012 for $14,000 into 3,181,818 shares at a conversion price of $0.0044 per share. In November 2012, an additional note was issued for $32,500 (see Notes 10 and 14).

 

128,000

 

-

(14) Convertible non-interest bearing notes, with a conversion price of $9.00 per share which matured June 2006 and an 18% convertible note which matured November 2008 with a conversion price of $0.50 per share and 6,667 shares of the Company’s common stock. As of September 30, 2012, the Company has not received a response from the note holders regarding a settlement agreement.

 

10,512

 

10,512

 

 

1,581,767

 

1,269,267

Long term portion

 

(30,000)

 

(30,000)

 

 

1,551,767

 

1,239,267

Discount on convertible notes payable

 

(272,825)

 

(85,511)

Current maturities, net of discount

$

1,278,942

$

1,153,756


At September 30, 2012 and December 31, 2011, accrued interest due for the convertible notes was $623,583 and $534,174, respectively, and is included in accrued expenses in the accompanying balance sheets. Interest expense for the convertible notes payable for the interim period ended September 30, 2012 and 2011 was $89,409 and $73,024, respectively.


Note 5 - Convertible Notes Payable – Related Parties


Convertible notes payable – related parties at September 30, 2012 and December 31, 2011 consisted of the following:


 

 

September

30,

2012

 

December

31,

2011

(1) Convertible note with the VP of Technology bearing interest at the prime rate plus 2% per annum with a conversion price of $10.00 per share, which was originally scheduled to mature on September 30, 2010. The Company issued 500 warrants with an exercise price of $10.00 per share. In April 2012, the note was extended to December 31, 2012.

$

50,000

$

50,000

(2) Convertible note with the VP of Technology bearing interest at the prime rate plus 4% per annum with a conversion price of $10.00 per share, which matured on September 30, 2010. In April 2012, the note was extended to December 31, 2012.

 

7,500

 

7,500

(3) Convertible notes with the CEO bearing interest at 8% per annum with a conversion price of $10.00 per share, which was originally scheduled to mature on April 30, 2011. The Company issued 1,800 warrants with an exercise price of $10.00 per share and expiration dates of February 4, 2014, September 7, 2014 and August 16, 2015. In April 2012, the notes were extended to December 31, 2012.

 

230,000

 

230,000

(4) Convertible notes with an employee bearing interest at 8% per annum with a conversion price of $10.00 per share, which was originally scheduled to mature on June 30, 2010.The Company issued 150 warrants with an exercise price of $10.00 per share and expiration dates of August 26, 2015 and September 29, 2015. In April 2012, the notes were extended to December 31, 2012.

 

15,000

 

15,000



15




(5)  Convertible note with a relative of a director bearing interest at 8% per annum with a conversion price of $10.00 per share, which matured on June 30, 2010. The Company issued 50 warrants with an exercise price of $10.00 per share and an expiration date of December 7, 2015. In April 2012, the note was extended to December 31, 2012.

 

5,000

 

5,000

(6) Convertible note with an employee bearing interest at 8% per annum with a conversion price of $10.00 per share, which matured on June 30, 2010. The Company issued 100 warrants with an exercise price of $10.00 per share and an expiration date of December 6, 2015. In April 2007, the interest calculation was amended from simple to compound effective April 1, 2007. In April 2012, the note was extended to December 31, 2012.

 

10,000

 

10,000

(7)  Convertible notes with the CEO bearing compound interest at 8% per annum with a conversion price of $10.00 per share, which was originally scheduled to mature on April 30, 2011. The Company issued 380 warrants with an exercise price of $10.00 per share and expiration dates of January 18, 2016 and February 28, 2016. In April 2012, the notes were extended to December 31, 2012.

 

38,000

 

38,000

(8) Convertible note with an employee bearing compound interest at 8% per annum with a conversion price of $7.50 per share, which was originally scheduled to mature on June 30, 2010. The Company issued 50 warrants with an exercise price of $10.00 per share and an expiration date of March 6, 2016. In April 2012, the note was extended to December 31, 2012.

 

5,000

 

5,000

 

$

360,500

$

360,500


At September 30, 2012 and December 31, 2011, accrued interest due for the convertible notes – related parties was $241,368 and $211,228, respectively, and is included in accrued expenses in the accompanying balance sheets. Interest expense for convertible notes payable – related parties for the interim period ended September 30, 2012 and 2011 was $30,140 and $33,120, respectively.  


Note 6 - Notes Payable


Notes payable at September 30, 2012 and December 31, 2011 consisted of the following:


 

 

 September

30,

2012

 

December

31,

2011

(1) Seventy units, with each unit consisting of a 10% promissory note of $25,000, maturing from 1/22/11 to 12/18/11 and with a 10% discount rate, and 82,000 non-dilutable (for one year) restricted shares of the Company’s common stock, at market price. Per the terms of a debt purchasing agreement formalized with a consultant in September 2011, the Company transferred notes for $50,000 in July 2011 and $25,000 in August 2011, including accrued interest, to the consultant (see Notes 10 and 11). Per the terms of a settlement agreement that the Company executed with the estate of a deceased note holder in November 2011, the Company settled a $25,000, note for restricted shares of its common stock, in December 2011, issued to  two beneficiaries of the estate (see Note 10 and 11). The Company is pursuing extensions on the remaining notes.

$

1,650,000

$

1,650,000

(2) Promissory note bearing interest at 10% per annum, maturing on January 23, 2012, with a total of 738,000 shares of common stock (see Note 11). The Company is pursuing an extension.

 

225,000

 

225,000

(3) Two units with each unit consisting of a 10% promissory note of $25,000, maturing on April 20, 2012, and 50,000 restricted shares of the Company’s common stock, at market price. The 100,000 shares were issued in June 2009 (see Note 11). The Company is pursuing extensions.

 

50,000

 

50,000

(4) 10% promissory note of $50,000 and 82,000 shares of the Company’s common stock, valued at market price, for a total of 164,000 shares of common stock, issued in November 2009 (see Note 11).

 

50,000

 

50,000



16




(5) One unit consisting of a 10% promissory note of $25,000, maturing on June 8, 2012, and 50,000 restricted shares of the Company’s common stock, at market price. The shares were issued in June 2009 (see Note 11). The Company is pursuing an extension.

 

25,000

 

25,000

(6) Three units with each unit consisting of a 10% promissory note of $25,000, maturing on June 25, 2012, and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 150,000 shares of common stock. The shares were issued in August 2009 (see Note 11). The Company is pursuing extensions.

 

75,000

 

75,000

 (7) 1.4 units with each unit consisting of a 10% promissory note of $25,000, maturing on July 14, 2012 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 70,000 shares of common stock.  The shares were issued in August 2009 (see Note 11). The Company is pursuing an extension.

 

35,000

 

35,000

(8) One unit consisting of a 10% promissory note of $25,000, maturing on August 18, 2012 and 75,000 restricted shares of the Company’s common stock, at market price (see Note 11).

 

25,000

 

25,000

(9) Two units with each unit consisting of a 10% promissory note of $25,000, maturing on September 2, 2012 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 100,000 shares of common stock. The April 2009 agreement whereby the note shall be repaid from the proceeds of sales of the Company’s products sold by the note holder who is a distributor for the Company also applies to this note. For the nine months ended September 30, 2012 and 2011, sales proceeds of $10,401 and $185, respectively, were applied to the note balance (see Notes 10 and 11). In September 2012, the note was extended to September 30, 2013.

 

35,113

 

45,514

 (10)  Promissory note executed in October 2009 for $50,000, maturing on October 20, 2012. Per the terms of the promissory note, the Company sold 3/4 unit with each unit consisting of a 10% promissory note of $25,000 and 133,333 restricted shares of the Company’s common stock, at market price, for a total of 100,000 shares of common stock (see Note 11).

 

18,750

 

18,750

(11)  Promissory note executed in April 2010 for $80,000, bearing interest at 10% per annum, which matured on July 23, 2010, and 500,000 restricted shares of the Company’s common stock, at market price (see Note 11). In May 2011, the Company made a partial payment of $10,000. Per the terms of a settlement agreement that the Company executed with the note holder in January 2012, the Company settled the note, including accrued interest, for unrestricted shares of its common stock (see Note 11).

 

-

 

70,000

(12) Promissory note executed in May 2010 for $50,000, bearing interest at 10% per annum, maturing on May 21, 2013, and 200,000 restricted shares of the Company’s common stock, at market price. The April 2009 agreement whereby the note shall be repaid from the proceeds of sales of the Company’s products sold by the note holder who is a distributor for the Company also applies to this note. For the nine months ended September 30, 2012 and 2011, no sales proceeds were applied to the note balance (see Notes 10 and 11).

 

50,000

 

50,000

(13) Promissory notes executed in July 2011 bearing interest at 10% per annum, maturing on December 31, 2011. The Company issued 1,000,000 warrants with an exercise price of $0.50 per share and an expiration date of July 15, 2014. The fair value of the warrants issued was $26,200, all of which was expensed in 2011 as interest expense. The Company is pursuing extensions.

 

87,500

 

87,500

(14) Promissory note executed in August 2011 bearing interest at 10% per annum, maturing on December 31, 2011. The Company is pursuing an extension.

 

50,000

 

50,000

 

 

2,379,235

 

2,456,764

Long term portion

 

-

 

(50,000)

 

 

2,376,363

 

2,406,764

Discount on notes payable

 

(1,598)

 

(14,915)

Current maturities, net of discount

$

2,374,765

$

2,391,849


At September 30, 2012 and December 31, 2011, accrued interest due for the notes was $1,047,804 and $868,877, respectively, and is included in accrued expenses in the accompanying balance sheets. Interest expense for notes payable for the nine months ended September 30, 2012 and 2011 was $178,926 and $183,398, respectively.  


The total long term portion of all funded debt is due as follows: 2015-$30,000.



17




Note 7 - Notes Payable – Related Parties


Notes payable – related parties at September 30, 2012 and December 31, 2011 consisted of the following:


 

 

September

30,

2012

 

December

31,

2011

(1) Promissory notes executed with the CEO bearing interest at an amended rate of 8% per annum which matured on April 30, 2011. In April 2012, the notes were extended to December 31, 2012.

$

504,000

$

504,000

(2) Promissory note executed with the CEO bearing interest at 9% per annum which matured on April 30, 2011.  The Company issued 20,000 warrants with an exercise price of $1.30 per share and an expiration date of May 25, 2011. The fair value of the warrants issued was $24,300. In April 2012, the note was extended to December 31, 2012.

 

100,000

 

100,000

(3) Promissory note with the CEO bearing interest at 8% per annum which matured on April 30, 2011. The Company issued 8,800 warrants with an exercise price of $0.50 per share and an expiration date of February 21, 2012. The fair value of the warrants issued was $3,758. In April 2012, the note was extended to December 31, 2012.

 

22,000

 

22,000

(4) Two 10% promissory notes, with the CEO, of $25,000 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 100,000 shares, which matured on April 30, 2011. In April 2012, the note was extended to December 31, 2012.

 

50,000

 

50,000

(5) Promissory notes with the CEO, non-interest bearing, which matured on April 30, 2011. Partial payments of $6,580 were made against the notes in August and September 2010 and $2,700 in February 2011. In April 2012, the notes were extended to December 31, 2012.

 

31,420

 

34,120

(6) In October 2010, the Company assigned the proceeds of six open receivables invoices, totaling $20,761, to its CEO. The assignment was non-interest bearing and fee free with a due date of November 20, 2010. Partial repayments were made in October 2010 for $4,218 and November 2010 for $4,125. In April 2012, the note was extended to December 31, 2012 (see Note 10).

 

12,418

 

12,418

(7) Promissory note executed in March 2011 with the CEO, non-interest bearing, which matured on April 1, 2011. In April 2012, the note was extended to December 31, 2012.

 

2,800

 

2,800

 

$

722,638

$

722,638


At September 30, 2012 and December 31, 2011, accrued interest due for the notes – related parties was $366,278 and $324,179, respectively, and is included in accrued expenses in the accompanying balance sheets. Interest expense for notes payable - related parties for the interim period ended September 30, 2012 and 2011 was $42,098 and $41,965, respectively.


Note 8 – Derivative Financial Instruments


The Company accounts for derivative financial instruments in accordance with ASC 815, which requires that all derivative financial instruments be recorded in the balance sheets either as assets or liabilities at fair value.


As of September 30, 2012, the Company’s derivative financial instruments are embedded derivatives associated with the Company’s secured and unsecured convertible notes. The Company’s secured convertible debentures issued to YA Global and Highgate in 2005, further assigned to Citco Global (“Citco Global Notes”), and unsecured convertible debentures issued to two unrelated investor firms on December 5, 2011, January 3, 2012, January 31, 2012 and March 2, 2012 (“ICG Notes”) and April 11, 2012, May 4, 2012 and July 25, 2012 ("Asher Notes"), are hybrid instruments, which individually warrant separate accounting as a derivative instrument. In July 2012, the Company was notified by Citco Global that the custodian for the Citco Global Notes is D.A.R.T. Limited (“DART”). The Citco Global Notes are hereinafter referred to as the “DART Notes”. The embedded derivative feature has been bifurcated from the debt host contract, referred to as the "Compound Embedded Derivative Liability", which resulted in a reduction of the initial carrying amount (as unamortized discount) of the notes. The unamortized discount is amortized to interest expense using the effective interest method over the life of the notes, or 12 months. The embedded derivative feature includes the conversion feature within the notes and an early redemption option.  The compound embedded derivatives within the convertible notes have been recorded at fair value at the date of issuance; and are marked-to-market each reporting period with changes in fair value recorded to the Company’s statement of operations as Change in fair value of derivative liabilities.




18




Valuation of Derivative Financial Instruments


(1)

Valuation Methodology


The Company has utilized a third party valuation consultant to fair value the compound embedded derivatives using a multinomial lattice models that values the derivative liabilities within the convertible notes based on a probability weighted discount cash flow model.


(2)

Valuation Assumptions- Change in Fair Value of Derivative Liability Related to DART Notes


The following assumptions were used for the valuation of the derivative liability related to the Notes:


·

The principal balance of the DART Notes as of 9/30/12 is $532,395;

·

The stock price of $0.0095 is based on market data as of 9/30/12;

·

An event of default would occur 1% of the time, increasing 0.10% per month to a maximum of 10%;

·

Alternative financing would be initially available to redeem the note 10% of the time and increase monthly by .1% to a maximum of 20%.

·

The monthly trading volume would average $188,376 over a year and would increase at 1% per period;

·

The projected volatility curve for each valuation period was based on the Company’s historical volatility.

·

The Holder would automatically convert the notes at a stock price of $0.13 (the higher of: 2 times the conversion price or 1.5 times the stock price) if the registration was effective and the company was not in default.


As of September 30, 2012, the estimated fair value of derivative liabilities on secured convertible notes of DART was $142,612.The mark to market adjustment to decrease the derivative liabilities for the quarter ended September 30, 2012 was $10,192.


(3)

Valuation Assumptions- Change on Fair Value of Derivative Liabilities Related to ICG and Asher Notes


The existing derivative instruments were valued as of 9/30/12. The following assumptions were used for the valuation of the derivative liability related to the ICG and Asher Notes:


·

The notes face amount as of 9/30/12 is $388,000 with an initial conversion price for ICG of 60% of the lowest bid from of the 10 previous days (effective rates of 51.55%) and for Asher 58% of the average of the 5 or 3 lowest bid  from of the 10 previous days (effective rates of 48.65% for the 4/11/12 Asher Note; 54.00% for the 5/4/12 and 7/25/12 Asher Notes).

·

The projected volatility curve for each valuation period was based on the historical volatility of the company;

·

An event of default would occur 1% of the time, increasing 1.00% per month to a maximum of 10%;

·

The company would redeem the notes projected initially at 0% of the time and increase monthly by 2.0% to a maximum of 10.0% (from alternative financing being available for a Redemption event to occurred); and

·

The Holder would automatically convert the note at the maximum of 2 times the conversion price if the company was not in default. With the target exercise price dropping as maturity approaches.


As of September 30, 2012, the estimated fair value of derivative liabilities on the unsecured convertible notes from ICG and Asher was $426,255. The mark to market adjustment to decrease the derivative liabilities for the quarter ended September 30, 2012 was $18,695.


On June 15, 2012 and August 15, 2012, $15,000 and $25,000 of the ICG Notes were converted to common stock based on the conversion term.  As a result of conversion of the ICG Notes, the compound embedded derivative liabilities of $41,144 at those date were reclassified as additional paid in capital, and the unamortized discount, in the amount of $12,835, was credited as a reduction of additional paid in capital for the interim period ended September 30, 2012.




19




Summary of Fair Value of Financial Assets and Liabilities Measured on a Recurring Basis


Financial assets and liabilities measured at fair value on a recurring basis are summarized below and disclosed on the balance sheets:


 

 

 

 

Fair Value Measurement Using

 

 

 

Carrying Value

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Derivative warrant liabilities

 

$

568,867

 

 

 

$

-

 

 

 

$

-

 

 

$

568,867

 

 

 

$

568,867

 

 


Summary of the Changes in Fair Value of Level 3 Financial Liabilities


The table below provides a summary of the changes in fair value, including net transfers in and/or out, of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31, 2011 and the nine months ended September 30, 2012 :


 

 

Fair Value Measurement Using Level 3 Inputs

 


 

 

 

Derivative warrants

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2010 

 

 

 

 

 

 

 

$  

424,671

 

 

 

 

 

 

 

$  

424,671

 

 

Total gains or losses (realized/unrealized)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in net (income) loss

 

 

 

 

 

 

 

 

(163,745

)

 

 

 

 

 

 

 

(163,745

)

 

Included in other comprehensive income

 

 

 

 

 

 

 

 

-

 

 

 

 

 

 

 

 

-

 

 

Purchases, issuances and settlements

 

 

 

 

 

 

 

 

73,679

 

 

 

 

 

 

 

 

73,679

 

 

Transfers in and/or out of Level 3

 

 

 

 

 

 

 

 

-

 

 

 

 

 

 

 

 

-

 

 

Balance, December 31, 2011 

 

 

 

 

 

 

 

$  

334,605

 

 

 

 

 

 

 

$  

334,605

 

 

Total gains or losses (realized/unrealized)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in net (income) loss

 

 

 

 

 

 

 

 

(102,224

)

 

 

 

 

 

 

 

(102,224

)

 

Included in other comprehensive income

 

 

 

 

 

 

 

 

-

 

 

 

 

 

 

 

 

-

 

 

Purchases, issuances and settlements

 

 

 

 

 

 

 

 

336,486

 

 

 

 

 

 

 

 

336,486

 

 

Transfers in and/or out of Level 3

 

 

 

 

 

 

 

 

-

 

 

 

 

 

 

 

 

-

 

 

Balance, September 30, 2012

 

 

 

 

 

 

 

$

568,867

 

 

 

 

 

 

 

$

568,867

 

 


Note 9 - Convertible Secured Notes Payable


Convertible secured notes payable consisted of the following at September 30, 2012 and December 31, 2011:


 

 

September 30,

2012

 

 

December 31,

2011

 

DART Limited (custodian for Citco Global and as assigned from YA Global/Highgate)

 

$

542,588

 

 

$

    542,588

 

 

 

 

 

 

 

 

 

 

Total convertible secured notes payable

 

$

542,588

 

 

$

     542,588

 


At September 30, 2012, the Company's outstanding convertible secured notes payable are secured through the note holder's claim on the Company's intellectual property.


The DART secured convertible debentures are fully matured. The Company has been in contact with the note holder who has indicated that it has no present intention of exercising its right to convert the debentures into restricted shares of the Company's common stock. 

 

Conversions to Common Stock


For the nine months ended September 30, 2012 and 2011, DART and Citco Global had no conversions.



20




Note 10 - Commitments and Contingencies


Payroll Taxes


At December 31, 2011, the Company recorded $53,901 of payroll taxes, of which approximately $45,000 were delinquent from the year ended December 31, 2003. The Company had also recorded $32,462 of related estimated penalties and interest on the delinquent payroll taxes. In September 2012, the Company determined to re-examine the nature and amounts of this accrued liability.

 

Section 105 HRA Plan


In September 2011, the Company enacted a Section 105 HRA Plan, effective with the 2011 payroll year, with an outside plan administrator. Per the terms of the plan, the Company will contribute plan dollars of $1,500 per plan year for employees with single health plan coverage and $3,000 per plan year for employees with family health plan coverage into the plan. The plan dollars will be reimbursed to the employees to offset the cost of health care expenses.


For the nine months ended September 30, 2012 and 2011, the Company contributed plan dollars of $1,391 and $3,349, respectively.


Lease Agreements


The Company operates from a leased office in New Jersey. Per the terms of the lease agreement with the landlord, the Company pays a monthly base rent of $3,807 commencing on July 1, 2009 through the lease termination date of January 31, 2013. The landlord holds the sum of $8,684 as the Company’s security deposit.


Consulting Agreements


In December 2009, the Company entered into a retainer agreement with an attorney, whereby the attorney will act as house counsel for the Company with respect to all general corporate matters.  The agreement is at will and required a payment of 100,000 shares of common stock, valued at $0.05 per share, upon execution. Commencing on January 1, 2010, the fee structure also includes a monthly cash fee of $1,000 and the monthly issuance of 2,500 shares of common stock, valued at market (see Note 11).


In April 2011, the Company entered into a marketing advisory and financial agreement with a marketing firm whereby the consultant serves as a marketing and financial advisor to the Company. The agreement terminated on April 1, 2012. For acting in this role, the consultant received 5,000,000 shares of the Company’s common stock in April 2011. The consultant also received warrants to purchase 6,500,000 shares of the Company’s common stock in April 2011. The warrants are exercisable at $0.06 per share for 2,000,000 shares, $0.11 per share for 2,000,000 shares, $0.16 per share for 1,500,000 shares and $0.26 per share for 1,000,000 shares. The warrants are only exercisable if certain contractual thresholds are met as of June 1, 2012 (see Note 11).


In July 2011, the Company entered into a consulting agreement with an investor services firm whereby the consultant serves as an investment consultant to the Company. The term of the agreement is one year. For acting in this role, the consultant received 1,250,000 shares of the Company’s common stock in July 2011. The Company also agreed to issue warrants to purchase 625,000 shares of the Company’s common stock, exercisable at $0.06 per share, and warrants to purchase 625,000 shares of the Company’s common stock, exercisable at $0.11 per share, to the consultant. The warrants have a three year term (see Note 11). The warrants were issued in October 2011.


In November 2011, the Company entered into a consulting agreement with a firm whereby the consultant will receive a success fee, in the form of restricted shares of the Company’s common stock, of 6% of all monies invested in the Company as a result of a term sheet the Company executed with an investor firm in November 2011 (see Notes 10 below and 11).


In December 2011, the Company executed an exclusive agreement with an agent to represent the Company in enforcing its “Out-of-Band” patent No. 7,870,599. The agent will receive a commission of 50% of the net proceeds resulting from their services (see Note 2). As of September 30, 2012, no commissions were paid to the agent relating to the agreement. The Company terminated that exclusive agreement in September 2012. The Company shall be enforcing its patent rights and management has taken the initial steps concerning such enforcement as recommended by its patent attorneys.


In December 2011, the Company executed a joint venture agreement with a marketing firm whereby the parties will develop and execute marketing strategies for the Company’s products. The parties will share revenues resulting from the efforts of the joint venture at 50% each. As of September 30, 2012, no revenues were attributed to the agreement.



21




In December 2011, the Company executed a business development agreement with a consulting firm, which was amended in December 2011, having a six month term. In consideration of the agreement, the Company, at its sole discretion, will issue up to 5,000,000 restricted shares of its common stock, at the conclusion of the agreement, providing the Company is satisfied with the consultant’s performance relating to the agreement. At its sole discretion, the Company may issue half of the above shares after 90 days of the agreement date and the shares would be placed in escrow for the consultant. As of September 30, 2012, no shares were issued to the consultant relating to the agreement.


In January 2012, the Company entered into a consulting agreement with a firm whereby the consultant will assist the Company in obtaining clients and investors. The consultant will receive a fee of $5,000 per month and warrants to purchase 150,000 shares of the Company’s common stock, exercisable at $0.03 per share. The consultant also received warrants to purchase 150,000 shares of the Company’s common stock, exercisable at $0.03 per share, upon execution of the agreement. The warrants have a three year term. The term of the agreement was one month. The agreement was amended and extended for February, March, April, July, August and September 2012. The February 2012 amendment reduced the exercise price of the warrants to $0.02 per share. In July 2012, the agreement was amended for an additional one month extension and the monthly fee was increased to $5,500 and the issuance of warrants to purchase 165,000 shares of the Company’s common stock, exercisable at $0.02 per share, with a three year term. For the nine months ended September 30, 2012, the consultant received $45,500 in fees and warrants to purchase 1,065,000 shares of the Company's common stock at $0.02 per share for 765,000 warrants and $0.03 per share for 300,000 warrants. All of the warrants have a three year term. In October 2012, the consultant received bonus warrants to purchase 1,000,000 shares of Company's common stock, at $0.015 per share, with a three year term (see Notes 11 and 14).


In January 2012, the Company entered into a consulting agreement with a firm whereby the consultant will assist the Company in obtaining investors. The consultant will receive a commission of 5% of all financing raised as a result of the consultant’s efforts. The consultant will also receive, as a commission, 10% of all financing raised as a result of the consultant’s efforts in the form of warrants to purchase shares of the Company’s common stock, exercisable at $0.02 per share. The warrants have a three year term. The term of the agreement is two years. As of September 30, 2012, no financing was raised relating to the agreement.


In February 2012, the Company entered into a consulting agreement with a firm whereby the consultant will assist the Company in obtaining clients. The consultant will receive a commission of 50% of all contracted revenues and 50% of the first renewal of all contracted revenues, for new clients, and 25% of all contracted revenues for existing clients, recorded as a result of the consultant’s efforts. In March 2012, the agreement was amended to increase the 25% commission rate to 35%. The parties may elect to remit commissions in the form of restricted shares of the Company’s common stock, with a maximum amount of shares issued in one year not to exceed 5,000,000 shares. The agreement also includes performance incentives whereby the consultant will receive bonus restricted shares of the Company’s common stock at the end of the agreement term as follows: one million shares if contracted revenues exceed $1,000,000, two million shares if contracted revenues exceed $2,000,000, three million shares if contracted revenues exceed $3,000,000 and four million shares if contracted revenues exceed $4,000,000. At the end of the first year of the agreement, the consultant will also have the option to purchase restricted shares of the Company’s common stock directly from the Company at a 25% discount of the then current market price on the last day of the contract, up to a maximum of 5,000,000 shares. The term of the agreement is one year with automatic renewals. In July 2012, the parties extended the term of the agreement to October 31, 2013. As of September 30, 2012, no revenues were recorded relating to the agreement.


In April 2012, the Company entered into a consulting agreement with a firm whereby the consultant will provide public relations services to the Company. The consultant will receive a fee of $7,000 per month and $500 per month in the form of restricted shares of the Company's common stock valued on the closing market price of the first day of each month that the agreement is in effect. The agreement term is May 1, 2012 to October 31, 2012 and may be renewed upon mutual agreement (see Notes 11 and 14).


Term Sheet


In November 2011, the Company executed a term sheet with an investor firm whereby the firm would invest in the Company up to $450,000, in tranches of $75,000 per month for six months, in the form of convertible promissory notes, bearing interest at 4% per year, with maturity dates of 12 months from the date issuance (see Notes 4, 9 and 10 above). A broker fee of 12% will be deducted from each tranche and the notes will include a 15% prepayment penalty. The investor firm may process conversions after six months from the date of each closing. Conversions will include a 40% discount to the lower of (i) the average closing bid price of the Company’s common stock for the previous ten days of a conversion notice or (ii) the closing bid price on the date of the conversion notice. In December 2011, the Company received the first tranche of $66,000, net of the $9,000 broker fee, and executed a convertible promissory note and securities purchase agreement per the terms of the term sheet (see Note 4).  Additional closings, for the same amounts, were held in January (two closings) and March (one closing) 2012. The debentures contain an embedded derivative feature (see Note 9). In March 2012, the investor firm notified the Company that it has elected to terminate the term sheet and no further closings will occur.



22




In March 2012, the Company executed a term sheet with an investor firm whereby the firm would invest in the Company $53,000 in the form of a convertible promissory notes, bearing interest at 8% per year, with a maturity date 9 months from the date issuance. A closing fee of $3,000 would be deducted from the tranche and the note would include a tiered prepayment penalty. The investor firm may process conversions after six months from the date of the closing. Conversions would include a 42% discount to the average closing bid price of the Company’s common stock for the previous ten days of a conversion notice, using the average of the three lowest trading prices. In April 2012, the Company received the tranche of $50,000, net of the $3,000 closing fee, and executed a convertible promissory note and securities purchase agreement per the terms of the term sheet. In May 2012, the investor firm invested an additional $32,500 in the Company governed by the terms of the term sheet and in the form of a convertible promissory note for $32,500. The Company received the second tranche of $30,000, net of a $2,500 closing fee, in May 2012. In July 2012, the investor firm invested an additional $42,500 in the Company governed by the terms of a July 2012 term sheet and in the form of a convertible promissory note for $42,500. The Company received the third tranche of $40,000, net of a $2,500 closing fee, in July 2012 (see Note 4). The Company recorded all of the closing fees of $8,000 as deferred financing costs. For the nine months ended September 30, 2012, the Company expensed $3,714 of financing expenses related to the deferred financing costs. In November 2012, the Company executed a new term sheet with the investor firm and received $30,000, net of a $2,500 closing fee, and executed a convertible promissory note and securities purchase agreement per the terms of the term sheet (see Note 14).


Drawdown Equity Financing Agreement


On April 13, 2012, the Company entered into a Drawdown Equity Financing Agreement, together with a Registration Rights Agreement, with Auctus Private Equity Fund, LLC ("Auctus"), the selling stockholder. In October 2012, the Company elected to withdraw its Form S-1/A registration statement and terminate the Drawdown Equity Financing Agreement with Auctus.


Transfer of Aged Debt


In September 2011, the Company formalized a debt settlement agreement with a consultant whereby the Company transferred $1,000,000 of debentures and aged debt to the consultant. The Company satisfied the debt sold to the consultant by issuing shares of the Company’s common stock to the consultant at a price of $0.005 per share for the first $100,000, $0.01 per share for the next $100,000, $0.015 per share for the third $100,000 and $0.01 per share for the remainder of the $1,000,000 of aged debt. In July 2011, the Company satisfied promissory notes of $50,000, plus accrued interest, in August 2011, the Company satisfied promissory notes of $32,500, plus accrued interest and in October 2011, the Company satisfied a related party convertible note of $10,000, plus accrued interest (see Notes 4 and 6). In consideration of the debt transferred, the consultant received 6,500,000 shares, 4,112,500 shares and 3,133,746 shares of the Company’s unrestricted common stock in July, September and October 2011, respectively (see Note 11).


The Company also made available to the note holders the opportunity to offer financing to the Company through the sale of a total of 35,000,000 two year commitment warrants exercisable into shares of the Company's common stock at $0.02 per share for 15,000,000 warrants, $0.03 per share for 10,000,000 warrants and $0.04 per share for 10,000,000 warrants. For the year ended December 31, 2011, the Company sold warrants for cash in the amount of $43,000 in September 2011 and $20,000 in October 2011 (see Note 11).


The consultant had also agreed to purchase $100,000 of additional restricted shares of the Company’s common stock commencing in October 2011, at $20,000 per tranche. The Company plans to use the proceeds of the sale of the stock solely to reduce accrued payroll and related payroll taxes. As of September 30, 2012, no additional shares have been purchased.  


Settlement Agreements


In April 2009, the Company executed a settlement agreement with its former President whereby the Company agreed to make monthly payments of $7,500, beginning in June 2009, in order to repay promissory notes, accrued interest, deferred payroll and expenses in the amount of $139,575 owed to its former President. The Company paid an initial installment payment of $12,500 to its former President in April 2009. The company paid an installment payment of $7,500 to its former President in September 2009. In September 2009, the Company executed an amendment to the settlement agreement whereby the payment terms and amount were revised. Effective September 2009, the Company was to make a $2,500 payment to its former President per Company payroll period. In the event the Company does not process a full payroll, the Company is to pay a proportionate percentage of the payment owed equal to the percentage of the total Company net payroll amount paid. For the years ended December 31, 2011 and 2010, the Company paid $10,000 and $28,600, respectively, to its former President per the terms of the agreement and amendment. All of the 2010 payments and $3,900 in payments made in the year ended December 31, 2011, made in accordance with the agreement and subsequent amendment, were applied to the February 2008 promissory note balance owed to the Company’s former President. As of March 31, 2011, the note balance was paid in full. Payments made in the year ended December 31, 2011, made in accordance with the agreement and subsequent amendment, totaling $24,273 were applied to the open payables balance and $24,327 were applied to accrued interest owed to the Company’s former President. In January 2012, the Company and its former President agreed to settle the remaining balance due of $20,975 in exchange for the issuance of 1,498,214 restricted shares of the Company’s common stock, valued at $0.014 per share (see Note 11).



23




In August 2011, the Company executed a debt settlement agreement with a trade vendor whereby the Company has agreed to issue restricted shares of its common stock to the vendor, at market price, as settlement of the balance owed to the vendor of $54,000. The Company issued 900,000 shares of common stock, valued at $0.03 per share, in September 2011 for settlement of $27,000 of the balance owed. The remaining balance was settled by the issuance of shares in March 2012 (see Note 11).


Loan Repayment Agreement


In April 2009, the Company signed an agreement whereby two promissory notes executed with a distributor of its products were to be repaid from the proceeds of sales of the Company’s products sold by the distributor for the Company. In September 2009, the Company executed an additional promissory note with the distributor that is included in the loan repayment agreement. In May 2010, the Company executed an additional promissory note with the distributor that is included in the loan repayment agreement. For the nine months ended September 30, 2012 and 2011, sales proceeds of $10,401 and $19,415, respectively, were applied to the balance of the notes (see Notes 6 and 11). In September 2012, the Company and the distributor executed an amendment to the March and April 2009 promissory notes whereby the Company will remit the accrued interest due on the notes, in the amount of $10,388, to the distributor by November 1, 2012. The payment was made in October 2012.


Assignment


In October 2010, the Company assigned the proceeds of six of the Company’s open receivables invoices, in the total amount of $20,761, to its CEO. The assignment was non-interest bearing and fee free with a due date for repayment of November 20, 2010. Partial repayments of the assignment were made in October 2010 for $4,218 and November 2010 for $4,125. The due date of the assignment has been extended to December 31, 2012 (see Note 7).


Due to Factor


In March 2007, the Company entered into a sale and subordination agreement with a factoring firm whereby the Company sold its rights to two invoices, from February 2007 and March 2007, totaling $470,200 to the factor.  Upon signing the agreement and providing the required disclosures, the factor remitted 65%, or $144,440, of the February 2007 invoice and a certain percentage of $53,010 of the March 2007 invoice to the Company.  The Company paid a $500 credit review fee to the factor relating to the agreement.  Per the terms of the agreement, once the Company’s client remits the invoice amount to the factor, the factor deducts a discount fee from the remaining balance of the factored invoices and forwards the net proceeds to the Company.  The discount fee is computed as a percentage of the face amount of the invoice as follows: 2.25% fee for invoices paid within 30 days of the down payment date with an additional 1.125% for each 15 day period thereafter. In September 2007, the February 2007 factored invoice was deemed uncollectible and was written off as bad debt expense. In December 2007, the March 2007 factored invoice was deemed uncollectible and was written off as bad debt expense. In February 2008, the Company and the factor agreed to a total settlement amount of $75,000, which was scheduled to be paid by the Company to the factor in September 2008 unless both parties mutually agreed to extend the due date. In September 2008, the Company and the factor reached a verbal agreement to extend the due date to December 31, 2008. The Company is pursuing a further extension. As of September 30, 2012, the balance due to the factor by the Company was $209,192 including interest.


Note 11 - Stockholders’ Deficit


Preferred Stock


On October 21, 2010, the Company amended its Articles of Incorporation in New Jersey to authorize 10,000,000 shares of preferred stock, par value $0.10. The designations, rights, and preferences of such preferred stock are to be determined by the Board of Directors. On November 15, 2010, the Company changed its domicile from the state of New Jersey to the state of Wyoming.


In addition to the 10,000,000 shares of preferred stock authorized, on January 10, 2011, 100 shares of preferred stock were designated as Series A Preferred Stock and 100,000,000 shares were designated as Series B Preferred Stock. The bylaws under the Wyoming Incorporation were amended to reflect the rights and preferences of each additional new designation.


The Series A Preferred Stock collectively has voting rights equal to eighty percent of the total current issued and outstanding shares of common stock. If at least one share of Series A Preferred Stock is outstanding, the aggregate shares of Series A Preferred Stock shall have voting rights equal to the number of shares of common stock equal to four times the sum of the total number of shares of common stock issued and outstanding, plus the number of shares of Series B Preferred Stock (or other designated preferred stock) which are issued and outstanding.




24




The Series B Preferred Stock shall have preferential liquidation rights in the event of any liquidation, dissolution or winding up of the Company, such liquidation rights to be paid from the assets of the Company not delegated to parties with greater priority at $1.00 per share or, in the event an aggregate subscription by a single subscriber of the Series B Preferred Stock is greater than $100,000,000, $0.997 per share. The Series B Preferred Stock shall be convertible to a number of shares of common stock equal to the price of the Series B Preferred Stock divided by the par value of the Series B Preferred Stock. The option to convert the shares of Series B Preferred Stock may not be exercised until three months following the issuance of the Series B Preferred Stock to the recipient shareholder. The Series B Preferred Stock shall have ten votes on matters presented to the shareholders of the Company for one share of Series B Preferred Stock held. The initial price of the Series B Preferred Stock shall be $2.50, (subject to adjustment by the Company’s Board of Directors) until such time, if ever, the Series B Preferred Stock are listed on a secondary and/or public exchange.  As of September 30, 2012, no shares of Series B Preferred Stock have been issued.


Issuance of Series A Preferred Stock


In February 2011, the Company issued three shares of non-convertible Series A preferred stock valued at $329,000 per share, or $987,000 in aggregate, for voting purposes only, to the three members of the management team at one share each. The issued and outstanding shares of the Series A preferred stock have voting rights equal to eighty percent of the total issued and outstanding shares of the Company's common stock (see Note 10). This effectively provided them, upon retention of their Series A Preferred Stock, voting control on matters presented to the shareholders of the Company. They have each irrevocably waived their conversion rights relating to the Series A preferred shares issued. The Company expensed $987,000 in stock based compensation expense related to the issuance of the shares in 2011.


Common Stock


In February 2011, an  increase of the authorized shares of the Company’s common stock from one hundred million (100,000,000) to five hundred million (500,000,000), $0.0001 par value, was ratified, effective upon the filing of an amendment to the Company’s Certificate of Incorporation with the Wyoming Secretary of State.


Issuance of Common Stock for Services


In December 2009, the Company entered into a retainer agreement with an attorney, whereas the attorney acts as house counsel for the Company with respect to all general corporate matters.  The agreement is at will and required a payment of 100,000 shares of common stock, valued at $0.05 per share, due upon execution. Commencing on January 1, 2010, the fee structure also includes a monthly cash fee of $1,000 and the monthly issuance of 2,500 shares of common stock, valued at market. For the nine months ended September 30, 2012 and 2011, the Company issued 22,500 shares of common stock, valued at $230, and 22,500 shares of common stock, valued at $685, respectively, all of which have been expensed as legal fees, related to the agreement.


In November 2011, the Company entered into a consulting agreement with a firm whereby the consultant will receive a success fee, in the form of restricted shares of the Company’s common stock, of 6% of all monies invested in the Company as a result of a term sheet the Company executed with an investor firm in November 2011 (see Note 10). In December 2011, the consultant received 343,511 shares of the Company’s common stock, valued at $4,500 and all of which has been expensed as consulting fees, as a result of the first investor tranche of $75,000. In December 2011, the consultant received 343,511 shares of the Company’s common stock, valued at $4,500, as a result of the first investor tranche of $75,000. In January 2012, the consultant received 264,705 shares of the Company’s common stock, valued at $4,500, as a result of the second investor tranche of $75,000. In February 2012, the consultant received 276,073 shares of the Company’s common stock, valued at $4,500, as a result of the third investor tranche of $75,000. In March 2012, the consultant received 321,428 shares of the Company’s common stock, valued at $4,500, as a result of the fourth investor tranche of $75,000 (see Note 10). The value of all of the shares issued has been expensed as consulting fees.


In December 2011, the Company issued 2,000,000 restricted shares of its common stock to a consultant in consideration of the consultant’s past support of the Company through several areas of assistance. The shares were valued at $37,200, all of which has been expensed as consulting fees.  


In January 2012, the Company issued 2,000,000 restricted shares of its common stock to a consultant in consideration of the consultant’s past support of the Company through several areas of assistance. The shares were valued at $36,000, all of which has been expensed as consulting fees.




25




In May 2012, the Company entered into a consulting agreement with a firm whereby the consultant will provide public relations services to the Company. The consultant will receive a fee of $7,000 per month and $500 per month in the form of restricted shares of the Company's common stock valued on the closing market price of the first day of each month that the agreement is in effect. In May 2012, the consultant received 33,334 shares of the Company’s common stock, valued at $500. In June 2012, the consultant received 55,555 shares of the Company’s common stock, valued at $500. In July 2012, the consultant received 62,500 shares of the Company’s common stock, valued at $500. In August 2012, the consultant received 58,140 shares of the Company’s common stock, valued at $500. In September 2012, the consultant received 52,632 shares of the Company’s common stock, valued at $500. The value of all of the shares issued has been expensed as consulting fees (see Note 10). In October 2012, the consultant received 52,632 shares of the Company’s common stock, valued at $500 (see Note 14).


Issuance of Common Stock for Financing


In January 2009, the Company executed a promissory note for $225,000, bearing interest at 10% per annum, maturing on January 23, 2012. Per the terms of the promissory note, the note holder of a $100,000 convertible note, executed in July 2008, rolled the convertible note balance and accrued interest owed into a purchase of nine units with each unit consisting of a 10% promissory note of $25,000 for a total of $225,000 and 82,000 shares of the Company’s common stock, valued at $0.06, for a total of 738,000 shares of common stock. An additional loan to the Company, in January 2009, of $100,000 by the note holder was included as part of the purchase of the nine units (see Note 6). The shares were issued in February 2009. For the nine months ended September 30, 2012 and 2011, the Company expensed $0 and $16,605, respectively, of financing expenses related to the shares.


In March 2009, the Company executed a promissory note for $50,000, bearing interest at 10% per annum, maturing on March 20, 2012. Per the terms of the promissory note, the note holder purchased two units with each unit consisting of a 10% promissory note of $25,000 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 100,000 shares of common stock. The shares were issued in April 2009. For the nine months ended September 30, 2012 and 2011, the Company expensed $417 and $1,250, respectively, of financing expenses related to the shares (see Notes 6 and 10).


In April 2009, the Company executed a promissory note for $50,000, bearing interest at 10% per annum, maturing on April 10, 2012. Per the terms of the promissory note, the note holder purchased two units with each unit consisting of a 10% promissory note of $25,000 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 100,000 shares of common stock. For the nine months ended September 30, 2012 and 2011, the Company expensed $417 and $1,250, respectively, of financing expenses related to the shares (see Notes 6 and 10).


In May 2009, the Company executed a promissory note for $50,000, bearing interest at 10% per annum, maturing on May 27, 2012. Per the terms of the promissory note, the note holder purchased two units with each unit consisting of a 10% promissory note of $25,000 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 100,000 shares of common stock. The shares were issued in June 2009. For the nine months ended September 30, 2012 and 2011, the Company expensed $417 and $750, respectively, of financing expenses related to the shares (see Note 6).


In June 2009, the Company executed a promissory note for $25,000, bearing interest at 10% per annum, maturing on June 8, 2012. Per the terms of the promissory note, the note holder purchased one unit consisting of a 10% promissory note of $25,000 and 50,000 restricted shares of the Company’s common stock, at market price. The shares were issued in June 2009. For the nine months ended September 30, 2012 and 2011, the Company expensed $208 and $375, respectively, of financing expenses related to the shares (see Note 6).


In June 2009, the Company executed a promissory note for $75,000, bearing interest at 10% per annum, maturing on June 12, 2012. Per the terms of the promissory note, the note holder purchased three units with each unit consisting of a 10% promissory note of $25,000 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 150,000 shares of common stock. The shares were issued in August 2009. For the nine months ended September 30, 2012 and 2011, the Company expensed $1,167 and $1,500, respectively, of financing expenses related to the shares (see Note 6).


In July 2009, the Company executed a promissory note for $35,000, bearing interest at 10% per annum, maturing on July 14, 2012. Per the terms of the promissory note, the note holder purchased 1.4 units with each unit consisting of a 10% promissory note of $25,000 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 70,000 shares of common stock. The shares were issued in August 2009. For the nine months ended September 30, 2012 and 2011, the Company expensed $544 and $700, respectively, of financing expenses related to the shares (see Note 6).




26




In August 2009, the Company executed a promissory note for $25,000, bearing interest at 10% per annum, maturing on August 18, 2012. Per the terms of the promissory note, the note holder purchased one unit consisting of a 10% promissory note of $25,000 and 75,000 restricted shares of the Company’s common stock, at market price. The shares were issued in August 2009. For the nine months ended September 30, 2012 and 2011, the Company expensed $583 and $750, respectively, of financing expenses related to the shares (see Note 6).


In September 2009, the Company executed a promissory note for $50,000, bearing interest at 10% per annum, maturing on September 2, 2012. Per the terms of the promissory note, the note holder purchased two units with each unit consisting of a 10% promissory note of $25,000 and 50,000 restricted shares of the Company’s common stock, at market price, for a total of 100,000 shares of common stock. For the nine months ended September 30, 2012 and 2011, the Company expensed $1,222 and $1,375, respectively, of financing expenses related to the shares (see Notes 6 and 10).


In October 2009, the Company executed a promissory note for $50,000, bearing interest at 10% per annum, maturing on October 20, 2012. Per the terms of the promissory note, the note holder purchased two units with each unit consisting of a 10% promissory note of $25,000 and 82,000 restricted shares of the Company’s common stock, valued at $0.10 per share, for a total of 164,000 shares of common stock. The shares were issued in November 2009. For the nine months ended September 30, 2012 and 2011, the Company expensed $0 and $4,100, respectively, of financing expenses related to the shares (see Note 6).


In October 2009, the Company executed a promissory note for $18,750, bearing interest at 10% per annum, maturing on October 27, 2012. Per the terms of the promissory note, the note holder purchased three/fourths of one unit with each unit consisting of a 10% promissory note of $25,000 and 133,333 restricted shares of the Company’s common stock, valued at $0.10 per share, for a total of 100,000 shares of common stock. For the nine months ended September 30, 2012 and 2011, the Company expensed $0 and $2,500, respectively, of financing expenses related to the shares (see Note 6).


In December 2009, the Company executed a promissory note for $7,500, bearing interest at 10% per annum, maturing on December 4, 2012. As consideration for executing the note, the Company issued 150,000 shares of restricted common stock, valued at $0.10 per share, to the note holder. For the nine months ended September 30, 2012 and 2011, the Company expensed $1,250 and $3,750, respectively, of financing expenses related to the shares (see Note 6).


In May 2010, the Company executed a promissory note for $50,000, bearing interest at 10% per annum, maturing on May 21, 2013. As consideration for executing the note, the Company issued 200,000 shares of restricted common stock, valued at $0.009 per share, to the note holder. For the nine months ended September 30, 2012 and 2011, the Company expensed $450 and $450, respectively, of financing expenses related to the shares (see Notes 6 and 10).


In May 2012, the Company issued 562,500 restricted shares of its common stock, valued at $9,000, to an investor firm as consideration for entering into and structuring an Equity Facility Agreement. The shares were included in the Form S-1 the Company with the SEC in June 2012. The value of the shares has been expensed as financing expense (see Note 10).


Issuance of Common Stock for Settlement of Accounts Payable


In August 2011, the Company issued 900,000 shares of its common stock, valued at $0.03 per share, to a vendor for settlement of accounts payable. In March 2012, the remaining accounts payable balance was settled and the Company issued 1,800,000 shares of its common stock, valued at $0.015 per share, to the vendor (see Note 10).


Issuance of Common Stock for the Sale and Settlement of Aged Debt


Per the terms of a debt purchase agreement that the Company formalized with a consultant in September 2011, the Company issued 6,500,000 unrestricted shares of its common stock, valued at $0.005 per share, in July 2011, 4,112,500 unrestricted shares of its common stock, valued at $0.005 per share, in September 2011, and 3,133,746 unrestricted shares of its common stock, valued at $0.005 per share, in October 2011 to the consultant for the sale and retirement of certain promissory notes and convertible related party promissory notes (see Notes 4, 6 and 10).


Per the terms of a settlement agreement that the Company executed with the estate of a deceased note holder in November 2011, the Company issued 1,344,086 restricted shares of its common stock, valued at $0.0186 per share, in December 2011, to two beneficiaries of the estate for the settlement of a promissory note (see Notes 6 and 10).




27




Per the terms of a settlement agreement that the Company executed with its former President in January 2012, the Company issued 1,498,214 restricted shares of its common stock, valued at $0.014 per share to its former President for settlement of  accrued interest owed (see Note 10).


Per the terms of a settlement agreement that the Company executed with a note holder in January 2012, the Company issued 5,058,060 restricted shares of its common stock, valued at $0.0165 per share to the note holder for settlement of a promissory note (see Notes 6 and 10).


Conversions to Common Stock


For the nine months ended September 30, 2012, ICG converted $40,000 of the ICG note dated December 5, 2011 into 10,243,847 unrestricted shares of the Company’s common stock. The conversions were processed on June 15, 2012 for $15,000 into 2,668,089 shares at a conversion price of $0.005622 per share and August 15, 2012 for $25,000 into 7,575,758 shares at a conversion price of $0.0033 per share.


For the nine months ended September 30, 2011, ICG had no conversions.


In October 2012, Asher converted $26,000 of the Asher note dated April 11, 2012 into 5,581,818 unrestricted shares of the Company’s common stock. The conversions were processed on October 19, 2012 for $12,000 into 2,400,000 shares at a conversion price of $0.005 per share and October 31, 2012 for $14,000 into 3,181,818 shares at a conversion price of $0.0044 per share (see Notes 4 and 14).


Sale of Shares of Common Stock


In June 2011, the Company sold to two individuals certain units which contained common stock. The Company issued 3,000,000 shares of its common stock at $0.02 per share.


In August 2011, the Company sold to one individual certain units which contained common stock and warrants. The Company issued 1,000,000 shares of its common stock at $0.03 per share and warrants to purchase 500,000 shares of the Company’s common stock, exercisable at $0.04 per share that expire in August 2014.


In September 2011, the Company sold to three individuals certain units which contained common stock. The Company issued 5,000,000 shares of its common stock at $0.02 per share for 4,000,000 shares and $0.025 per share for 1,000,000 shares.


In October 2011, the Company sold subscriptions to one individual for certain units containing common stock and warrants. The units were for 1,000,000 shares of its common stock at $0.025 per share and warrants to purchase 500,000 shares of the Company’s common stock, exercisable at $0.04 per share that expire three years from the date of issuance. The shares and warrants were formally issued in March 2012. The Company recorded the value of the shares as common stock to be issued at December 31, 2011 and included them into loss per share purposes for 2011.


In November 2011, the Company sold to two individuals certain units which contained common stock and warrants. The Company issued 2,000,000 shares of its common stock at $0.025 per share, 1,000,000 shares to each individual, and warrants to purchase a total of 1,500,000 shares of the Company’s common stock, exercisable at $0.04 per share that expire in October 2014.


In January 2012, the Company sold subscriptions to one individual for certain units containing common stock and warrants. The Company issued 3,418,804 shares of its common stock at $0.017 per share and warrants to purchase a total of 1,709,402 shares of the Company’s common stock, exercisable at $0.03 per share that expire in January 2015.


In February 2012, the Company sold subscriptions to one individual for certain units containing common stock and warrants. The Company issued 4,444,444 shares of its common stock at $0.016 per share and warrants to purchase a total of 2,222,222 shares of the Company’s common stock, exercisable at $0.03 per share that expire in February 2015.


In March 2012, the Company sold subscriptions to one individual for certain units containing common stock and warrants. The Company issued 2,717,391 shares of its common stock at $0.015 per share and warrants to purchase a total of 1,358,696 shares of the Company’s common stock, exercisable at $0.03 per share that expire in February 2015.




28




In April 2012, the Company sold to three individuals certain units which contained common stock and warrants. The Company issued 6,973,640 shares of its common stock at $0.01 per share for 2,469,136 shares and $0.011 per share for 4,504,504 shares. The Company also issued warrants to purchase a total of 3,486,830 shares of the Company’s common stock, exercisable at $0.02 per share that expire in April 2015.


In June 2012, the Company sold subscriptions to one individual for certain units containing common stock and warrants. The Company issued 4,000,008 shares of its common stock at $0.007 per share and warrants to purchase a total of 2,000,004 shares of the Company’s common stock, exercisable at $0.02 per share that expire in June 2015.


In July 2012, the Company sold to two individuals certain units which contained restricted common stock and warrants. The Company issued 14,492,393 shares of its common stock at $0.0047 per share for 10,570,824 shares and $0.0064 per share for 3,921,569 shares. The Company also issued warrants to purchase a total of 7,246,197 shares of its common stock, exercisable at $0.02 per share, that expires in July 2015.


In August 2012, the Company sold subscriptions to one individual for certain units containing restricted common stock and warrants. The Company issued 5,555,556 shares of its common stock at $0.0045 per share and warrants to purchase a total of 2,777,778 shares of its common stock, exercisable at $0.02 per share that expire in August 2015.


In September 2012, the Company sold to two individuals certain units which contained restricted common stock and warrants. The Company issued 7,953,215 shares of its common stock at $0.0056 per share for 4,444,444 shares and $0.0071 per share for 3,508,771 shares. The Company also issued warrants to purchase a total of 3,976,608 shares of its common stock, exercisable at $0.02 per share that expire in September 2015.


Sale of Warrants for Cash and Exercise of Warrants


In January 2011, the Company sold warrants to purchase 5,333,333 shares of common stock to one unrelated individual for $14,000 in cash. The warrants are exercisable at $0.03 per share and expire in January 2016.


In February 2011, the Company sold warrants to purchase 37,714,285 shares of common stock to two unrelated individuals for $99,000 in cash. The warrants are exercisable at $0.03 per share and expire in February 2016.


In March 2011, the Company sold warrants to purchase 12,250,000 shares of common stock to four unrelated individuals for $76,563 in cash. The warrants are exercisable at $0.03 per share and expire in March 2016.


In April 2011, the Company sold warrants to purchase 5,000,000 shares of common stock to an unrelated party for $31,250 in cash. The warrants are exercisable at $0.03 per share and expire in April 2016.


In April 2011, in accordance with a warrant purchase agreement executed with a consulting group, the Company issued warrants to purchase 50,000,000 shares of common stock to three unrelated parties for cash considerations in the amount of $445,000, of which the company received $131,000 in April 2011, $57,500 in May 2011, $74,000 in June 2011 and $14,000 in July 2011. Each party received warrants exercisable at $0.02 per share for 10,000,000 shares, $0.04 per share for 10,000,000 shares, $0.08 per share for 10,000,000 shares, $0.12 per share for 10,000,000 and $0.15 per share for 10,000,000 shares. All of the warrants expire in April 2014.


In April 2011, the Company issued 800,000 restricted shares of its common stock, valued at $0.025 per share, to an individual for the exercise of warrants for cash.


In September 2011, in accordance with a debt settlement agreement executed with a consulting firm, the Company issued warrants to purchase 35,000,000 shares of common stock to the consultant for cash considerations in the amount of $315,000, of which the company received $43,000 in September 2011 and $20,000 in October 2011. The warrants are exercisable at $0.02 per share for 15,000,000 shares, $0.03 per share for 10,000,000 shares and $0.04 per share for 10,000,000 shares. All of the warrants expire in September 2013 (see Note 10).


Issuance of Warrants for Financing and Acquiring Services


In connection with consulting agreements, the Company issued warrants for 13,990,950 shares to consultants, all of which were deemed earned upon issuance, as of September 30, 2012. The fair value of these warrants granted, estimated on the date of grant using the Black-Scholes option-pricing model, was $996.678, which has been recorded as consulting expenses.




29




The table below summarizes the Company’s warrant activities through September 30, 2012:


 

 

Number of

 Warrant Shares

 

Exercise Price Range

 Per Share

 

Weighted Average Exercise Price

 

Fair Value

at Date of

Issuance

Contractual

Term

 

Intrinsic

 Value

 (in thousands)

 

Balance, January 1, 2011

 

 

122,968,467

 

 

 

$0.004  -  $ 10.00

 

 

 

$

 0.039

 

 

 $

1,312,645

 

 

 

$             ---

 

 

Granted

 

 

118,000,000

 

 

 

$0.02 - $ 0.50

 

 

 

$

 0.062

 

 

 $

1,430,013

 

 

 

$             ---

 

 

Exercised

 

 

-

 

 

 

-

 

 

 

$

 -

 

 

$

   -

 

 

 

$             ---

 

 

Balance,

     December 31, 2011

 

 

240,968,467

 

 

 

$0.004  - $ 10.00

 

 

 

$

0.05

 

 

 $

2,742,658

 

 

 

$            ---

 

 

Granted

 

 

  26,342,727

 

 

 

$0.02 - $0.04

 

 

 

$

0.02

 

 

$

81,650

 

 

 

$            ---

 

 

Expired

 

 

   (8,085,310)

 

 

 

$0.004  - $ 5.50

 

 

 

$

0.21

 

 

$

-

 

 

 

$            ---

 

 

Balance,

     September 30, 2012

 

 

259,225,884

 

 

 

$0.015 -  $ 10.00

 

 

 

$

0.049

 

 

 $

2,824,308

 

 

 

$            ---

 

 

Exercisable,

     September 30, 2012

 

 

259,225,884

 

 

 

$0.015 -  $ 10.00 

 

 

 

$

0.049

 

 

 $

2,824,308

 

 

 

$            ---

 

 


The following table summarizes information concerning outstanding and exercisable warrants as of September 30, 2012:


 

 

 

 

 

Warrants Outstanding

 

Warrants Exercisable

 

Range of Exercise Prices

 

 

 

 

Number Outstanding

 

Average Remaining Contractual Life (in years)

 

Weighted-Average Exercise Price

 

Number Exercisable

 

Weighted-Average Exercise Price

 

$10.00

 

 

 

 

 

8,050

 

 

1.96

 

$

10.000

 

 

8,050

 

$

10.000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$0.02 - $0.80

 

 

 

 

 

259,217,834

 

 

55

 

 

0.049

 

 

259,217,834

 

 

0.049

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

259,225,884

 

 

2.53

 

$

0.042

 

 

259,225,884

 

$

0.042

 


Note 12 - Stock Based Compensation


2004 Equity Incentive Plan


In September 2004, the stockholders approved the Equity Incentive Plan for the Company’s employees (“Incentive Plan”), effective April 1, 2004. The number of shares authorized for issuance under the Incentive Plan was increased to 10,000,000 in September 2006, 15,000,000 in March 2007, 20,000,000 in June 2007, 100,000,000 in December 2007 and 200,000,000 in April 2011, by unanimous consent of the Board of Directors prior to 2011 and by majority consent of the Board of Directors in 2011.


Options awarded in April 2011


On April 21, 2011, the Company awarded 70,000,000 stock options to the Company’s management team and employees exercisable at $0.01 per share expiring five (5) years from the date of grant vesting over an eight month period.


The Company estimated the fair value of 2011 options on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:


 

 

April 21,

2011

Risk-free interest rate

 

 2.14 %

Dividend yield

 

0.00%

Expected volatility

 

313%

Expected option life

 

5 years




30




The table below summarizes the Company’s Incentive Plan stock option activities through September 30, 2012:


 

 

Number

of

Option

Shares

 

Fair

Value

at the

Date of

Grant

Exercise

Price

Range

Per

Share

 

Weighted

Average

Exercise

Price

 

Weighted

Average

Remaining

(in years)

Contractual

Term

 

Aggregate

Intrinsic

Value

(in thousands)

 

Balance, January 1, 2011

 

 

70,027,309

 

 

$1,184,621

 

$0.0025 -  $ 10.00

 

 

 

$

0.018

 

 

 

3.7

 

 

 

$          ---

 

 

Granted

 

 

70,000,000

 

 

$2,030,000

 

$0.01

 

 

 

$

0.010

 

 

 

4.3

 

 

 

$          ---

 

 

Cancelled

 

 

-

 

 

-

 

-

 

 

 

$

-

 

 

 

-

 

 

 

$          ---

 

 

Balance,

     December 31, 2011

 

 

140,027,309

 

 


$3,214,621

 

$0.0025 - $10.00

 

 

 

$

0.014

 

 

 

4.0

 

 

 

$          ---

 

 

Granted

 

 

-

 

 

-

 

-

 

 

 

$

-

 

 

 

-

 

 

 

$          ---

 

 

Balance,

     September 30, 2012

 

 

140,027,309

 

 


$3,214,621

 

$0.0025 - $10.00

 

 

 

$

0.014

 

 

 

3.25

 

 

 

$          ---

 

 

Vested and Exercisable,

     September 30, 2012

 

 

140,027,309

 

 


$3,214,621

 

$0.0025-$10.00

 

 

 

$

0.014

 

 

 

3.25

 

 

 

$          ---

 

 


As of September 30, 2012, an aggregate of 140,027,309 options were outstanding under the incentive plan and 59,972,691 shares were available for future issuance.

 

The following table summarizes information concerning outstanding and exercisable Incentive Plan options as of September 30, 2012:


 

Options Outstanding

 

Options Exercisable

 

Range of Exercise Prices

Number Outstanding

 

Average Remaining Contractual Life (in years)

 

Weighted-Average Exercise Price

 

Number Exercisable

 

Weighted-Average Exercise Price

 

$10.000

 

37,500

 

 

  1.91

 

$

10.000

 

 

37,500

 

$

10.000

 

$1.000

 

105,000

 

 

3.76

 

 

1.000

 

 

105,000

 

 

1.000

 

$0.0025 - $0.375

 

139,884,809

 

 

3.25

 

 

0.011

 

 

139,884,809

 

 

0.011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

140,027,309

 

 

3.25

 

$

0.014

 

 

140,027,309

 

$

0.014

 


Non-Incentive Plan Stock Option Grants


As of September 30, 2012, an aggregate of 2,761,889 non-plan, non-qualified options for non-employees were outstanding. The exercise price for 2,000,000 options (granted in December 2010) is $0.006, for 760,000 options is $3.60 and for 1,889 options is $9.00, yielding a weighted average exercise price of $1.001.


At September 30, 2012, there were 2,761,889 vested non-plan, non-qualified stock options outstanding of which 2,000,000 options are exercisable at $0.006, 760,000 options are exercisable at $3.60 and 1,889 options are exercisable at $9.00.




31




Note 13 - Concentration of Credit Risk


Customers and Credit Concentrations


Revenue concentrations for the nine months ended September 30, 2012 and 2011 and the accounts receivables concentrations at September 30, 2012 and December 31, 2011 are as follows:


 

Net Sales

for the Nine months Ended

 

 

Accounts

Receivable At

 

 

September

30,

2012

 

 

September

30,

2011

 

 

September

30,

2012

 

 

December

31,

2011

 

Customer A

 

53.7

%

 

 

18.2

%

 

 

88.7

%

 

 

88.7

%

Customer B

 

18.7

%

 

 

34.9

%

 

 

-

%

 

 

-

%

Customer C

 

10.7

%

 

 

              18.5            

%

 

 

5.9

%

 

 

9.1

%

Customer D

 

6.2

%

 

 

-

%

 

 

-

%

 

 

-

%

 

 

89.3

%

 

 

71.6

%

 

 

94.6

%

     

 

97.8

%


A reduction in sales from or loss of such customers would have a material adverse effect on the Company’s results of operations and financial condition.


Note 14 - Subsequent Events


The Company has evaluated all events that occurred after the balance sheet date through the date when the financial statements were issued.  The Management of the Company determined that there were certain reportable subsequent events to be disclosed as follows:


Convertible Notes Payable


In November 2012, the Company executed a securities purchase agreement and convertible note for $32,500, bearing interest at 8% per annum, maturing on August 5, 2013, per a term sheet executed in November 2012 with an investor firm. A closing fee of $2,500 was deducted from the tranche and the note included a tiered prepayment penalty. The investor firm may process conversions after six months from the date of the closing. Conversions will include a 42% discount to the average closing bid price of the Company’s common stock for the previous ten days of a conversion notice, using the average of the three lowest trading prices (see Notes 4 and 10).


Term Sheet


In November 2012, the Company executed a term sheet with an investor firm whereby the firm would invest in the Company $27,750 in the form of a convertible promissory notes, bearing interest at 8% per year, with a maturity date 9 months from the date issuance. A closing fee of $2,750 would be deducted from the tranche and the note would include a tiered prepayment penalty. Conversions would include a 40% discount to the average closing bid price of the Company’s common stock for the previous ten days of a conversion notice, using the average of the three lowest trading prices.


Issuance of Common Stock for Services


In October 2012, the Company issued 52,632 shares of common stock, valued at $500, to a consultant related to a public relations agreement executed in May 2012 (see Notes 10 and 11).


In November 2012, the Company issued 350,000 restricted shares of common stock, valued at $0.0065 per share, to the five members of its Advisory Board in consideration to their services provided to the Company.


Conversions to Common Stock


In October 2012, Asher converted $26,000 of the Asher note dated April 11, 2012 into 5,581,818 unrestricted shares of the Company’s common stock. The conversions were processed on October 19, 2012 for $12,000 into 2,400,000 shares at a conversion price of $0.005 per share and October 31, 2012 for $14,000 into 3,181,818 shares at a conversion price of $0.0044 per share (see Notes 4 and 10).



32




Sale of Shares of Common Stock


In October 2012, the Company sold subscriptions to an individual for certain units containing common stock and warrants. The Company issued 5,555,556 shares of its common stock at $0.0045 per share and warrants to purchase a total of 2,777,778 shares of the Company’s common stock, exercisable at $0.02 per share that expire in October 2015.


Issuance of Warrants for Services


In October 2012, the Company issued bonus warrants to purchase 1,000,000 shares of the Company’s common stock, exercisable at $0.015 per share, to a consultant per the terms of a consulting agreement entered into in January 2012. The warrants have a three year term.





33




ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


CAUTION REGARDING FORWARD-LOOKING INFORMATION

 

Included in this Report are "forward-looking" statements, within the meaning of the Private Securities Litigation Reform Act of 1995 ("PSLRA") as well as historical information. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that the expectations reflected in these forward-looking statements will prove to be correct. Our actual results could differ materially from those anticipated in forward-looking statements as a result of certain factors, including matters described in the section titled "Risk Factors." Forward-looking statements include those that use forward-looking terminology, such as the words "anticipate," "believe," "estimate," "expect," "intend," "may," "project," "plan," "will," "shall," "should," and similar expressions, including when used in the negative. Although we believe that the expectations reflected in these forward-looking statements are reasonable and achievable, these statements involve risks and uncertainties and we cannot assure you that actual results will be consistent with these forward-looking statements. We claim the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA.  

 

Such risks include, among others, the following: demand for payment of our convertible notes outstanding under which we are currently in default, our inability to obtain adequate financing to repay the convertible notes, our ability to continue financing our operations either through debt or equity offerings, international, national and local general economic and market conditions: our ability to sustain, manage or forecast our growth; material costs and availability; new product development and introduction; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; the loss of significant customers or suppliers; prospective changes to financing options due to the Jobs Act of 2012, fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other factors referenced in this filing.

 

Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements and there can be no assurance that the actual results anticipated by management will be realized or, even if substantially realized, that they will have the expected consequences to or effects on our business operations. We undertake no obligation to update or revise these forward-looking statements, whether to reflect events or circumstances after the date initially filed or published, to reflect the occurrence of unanticipated events or except as required by the federal securities laws.


Unless otherwise noted, references in this Form 10-Q to “StrikeForce” “we”, “us”, “our”, “SFT”, and the “Company” means StrikeForce Technologies, Inc., a Wyoming corporation. 


Background


StrikeForce Technologies, Inc. is a software development and services company that offers a suite of integrated computer network security products using proprietary technology. StrikeForce Technical Services Corporation was incorporated in August 2001 under the laws of the State of New Jersey. On September 3, 2004, the stockholders approved an amendment to the Certificate of Incorporation to change the name to StrikeForce Technologies, Inc. On November 15, 2010, we redomiciled under the laws of the State of Wyoming. We initially conducted operations as an integrator and reseller of computer hardware and telecommunications equipment and services until December 2002.  In December 2002, and formally memorialized in September 2003, we acquired certain intellectual property rights and patent pending technology from NetLabs.com including the rights to further develop and sell their principal technology. In addition, certain officers of NetLabs.com joined our company as officers and directors of our company. We subsequently changed our name to StrikeForce Technologies, Inc., under which we have conducted our business since August 2003. Our strategy is to develop and market our suite of network security products to the corporate, financial, healthcare, government, technology, insurance, e-commerce and consumer sectors. We plan to grow our business primarily through our globally expanding network and internally generated sales, rather than by acquisitions. We have no subsidiaries and we conduct our operations from our corporate office in Edison, New Jersey.


We own the exclusive right to license and develop various identification protection software products to protect computer networks from unauthorized access and to protect network owners and users from identity theft.  We have developed a suite of products partly based upon this exclusive license that is targeted to the financial, e-commerce, corporate, government, healthcare, insurance,, technology and consumer sectors. 




34




We began our operations in 2001 as a reseller and integrator of computer hardware and iris biometric technology. From the time we started our operations through the first half of 2003, we derived the majority of our revenues as an integrator. In December 2002, upon the acquisition of the licensing rights to certain intellectual property and patent pending technology from NetLabs.com, we shifted the focus of our business to developing and marketing our own suite of security products. Based upon the acquired licensing rights and additional research and development, we have developed various identification protection software products to protect computer networks from unauthorized access and to protect network owners and users from identity theft. In November 2010, we received notice that the United States Patent Office (“USTPO”) had issued an official Notice of Allowance for the patent application for the technology relating to our ProtectID® product, titled "Multi-Channel Device Utilizing a Centralized Out-of-Band Authentication System". In January 2011, we received notice that the United States Patent Office issued the Company Patent No. 7,870,599.  The “Out-of-Band” Patent went through a USTPO Re-Examination process starting on August 16, 2011 and concluded on December 27, 2011, with all of our patent claims remaining intact and seven additional Company patent claims being added. In 2011, we submitted an additional continuation patent on the “Out-of-Band” Patent, with another sixty-six additional Company claims now pending. The technology we developed and use in our GuardedID® product is the subject of a pending patent application.  In December 2011, we executed an exclusive agreement with an agent to represent us in enforcing the “Out-of-Band” Patent. We terminated that exclusive agreement in September 2012. We shall be enforcing our patent rights and our management has taken the initial steps concerning such enforcement as recommended by our patent attorneys.


We completed the development of our ProtectID® platform at the end of June 2006 and we completed the core development of our keyboard encryption and anti-keylogger product, GuardedID®, in December 2006, with continuous enhancements, which is currently being sold and distributed. We seek to locate customers in a variety of ways. These include contracts primarily with value added resellers and distributors (both inside the United States and internationally), direct sales calls initiated by our internal staff, exhibitions at security and technology trade shows, through the media, through consulting agreements, and through our own and agent relationships. Our sales generate revenue either as an Original Equipment Manufacturer (“OEM”) model, through a Hosting/License agreement, bundled with other company’s products or through direct purchase by customers. We price our products for cloud consumer transactions based on the number of transactions in which our software products are utilized. We also price our products for business applications based on the number of users. We believe that these pricing models provide our company with one-time, monthly, quarterly and yearly recurring revenues. We are also generating revenues from annual maintenance contracts, renewal fees and expect, but cannot guarantee, an increase in revenues based upon the execution of various agreements that we have recently closed and are being implemented.


In October 2010, we executed an agreement to pursue a funding opportunity through a consulting company that, through an executed Memorandum of Understanding, purports to provide funding to us over time, necessary to sustain the Company while current contracts for business revenues develop and increase to a sustainable level. Other multiple alternative funding options had not progressed to viable proposals or did not close because of their expressed high risk level associated with our secured lenders, large debt positions and low revenues. A requirement of this funding source, utilizing an equity funding approach, required us to re-domicile in the State of Wyoming in order for this project to move forward in a necessary timeframe and at a necessary low cost to the Company. In November 2010, we received the corporate registration, amended articles of incorporation and by-laws as a result of our re-domiciling in the State of Wyoming.


We generated all of our revenues of $642,596, for the nine months ended September 30, 2012, compared to $286,695 for the nine months ended September 30, 2011, from the sales of our security products. We market our products globally to financial service firms, healthcare related companies, e-commerce companies, government agencies, the enterprise market in general and with virtual private network companies, as well as technology service companies that service all the above markets. We seek such sales through our own direct efforts and primarily through distributors, resellers and third party agents internationally. We are also seeking to license the technology as original equipment with computer hardware and software manufacturers. We are engaged in production installations and pilot projects with various distributors, resellers and direct customers, as well as having reached additional reseller agreements with strategic vendors internationally, including South America, Europe, Asia, Africa and the Pacific Rim. Our GuardedID® product is also being sold directly to consumers, primarily through the Internet as well as distributors, resellers, third party agents and potential OEM agreements by bundling GuardedID® with their products (providing a value-add to their own products and offerings).


We have incurred substantial losses since our inception. Our management believes that our products provide a cost-effective, more secure and technologically competitive solution to address the problems of network security and identity theft in general. However, there can be no assurance that our products will continue to gain increased acceptance and continue to grow in the commercial marketplace or that one of our competitors will not introduce technically superior products. 


Our executive office is located at 1090 King Georges Post Road, Suite 603, Edison, NJ 08837. Our telephone number is (732) 661-9641. We have 7 employees. Our Company’s website is www.strikeforcetech.com.  We are not including the information contained in our website as part of, or incorporating it by reference into, this Report on Form 10-Q. 



35




Business Model


We are focusing primarily on developing sales through “channel” relationships in which our products are offered by other manufacturers, distributors, value-added resellers and agents, internationally. In 2010, we added and publicly announced a major channel distributor who provides a presence for us in London, England, representing us in the European Union. We also sell our suite of security products directly from our Edison, NJ office, which also augments our channel partner relationships. It is our strategy that these “channel” relationships will provide the greater percentage of our revenues ongoing, as was the case in 2011. Examples of the channel relationships that we are seeking include already established original equipment manufacturer (“OEM”) and bundled relationships with other security technology and software providers that would integrate or bundle the enhanced security capabilities of ProtectID® and or GuardedID® into their own product lines, thereby providing greater value to their clients. These would include providers of networking software and manufacturers of computer and telecommunications hardware and software that provide managed services, as well as all markets interested in increasing the value of their products and packages, such as financial services software, anti-virus, government integrators and identity theft product companies.


Our primary target markets include financial services such as banks, insurance companies, e-commerce based services companies, telecommunications and cellular carriers, technology software companies, healthcare related companies, government agencies and consumers. For the near term, we are focusing our concentration on the identity theft and data breach strategic problem areas, such as where compliance with government regulations are key and stolen passwords are used to acquire private information illegally. In the fourth quarter of 2011, we executed a multi-year contract with a major US financial lender who utilizes our ProtectID® solution for its over 12,000,000 employees, administrators and consumers. The contract became revenue producing in the fourth quarter of 2011. In the first quarter of 2012, we executed a multi-year contract with a healthcare facility who utilizes our ProtectID® solution for its employees and administrators. The contract became revenue producing in the first quarter of 2012. In addition, we signed a major contract during the second quarter of 2012 with a branded digital signature service company with clients in financial services and technology services for the government, that is required to include two-factor authentication with a bias on Out-of-Band Authentication. This implementation is planned, but not guaranteed, to be revenue producing in 2012 with increasing recurring revenues.


Because we are now experiencing a continual recurring growing market demand, we are developing a sizeable global reseller and distribution channel as a strategy to generate, manage and fulfill demand for our products across market segments, minimizing the requirement for an increase in our staff. We have minimized the concentration on our initial direct sales efforts as our distribution and reseller channels continue to grow internationally and require appropriate levels of support.


We seek to generate revenue through fees for ProtectID® based on consumer usage in the financial and healthcare services markets, as well as enterprises in general, through our Cloud Service, plus one-time and annual per person fees in the enterprise markets which often are for local installations of our product, and set-up and recurring transaction fees when the product is accessed in our Cloud Service, along with yearly maintenance fees, and other one-time and recurring fees. We also intend to generate revenues through sales of our GuardedID® product. GuardedID® pricing is for an annual license and we discount for volume purchases. GuardedID® pricing models, especially when bundling through OEM contracts, include monthly and quarterly recurring revenues. As more agreements are reached by our distributors, we are experiencing monthly increasing sales growth, through the execution of GuardedID® bundled OEM agreements. We also provide our clients a choice of operating our ProtectID® software internally by licensing it or through our hosted Cloud Service or a hybrid that some clients have implemented. GuardedID® requires a download on each and every computer it protects, whether for employees or consumers. We have three GuardedID® products, (i) a standard version which protects browser data entry only, (ii) a premium version which protects almost all the applications running under Microsoft Windows on the desktop, including Microsoft Office Suite and (iii) an Enterprise version which provides the Enterprise administrative rights and the use of Microsoft’s Enterprise tools for the product’s deployment.  


Our management believes that our products provide a cost-effective and technologically competitive solution to address the problems of network security and identity theft in general. Updated guidance for the Federal Financial Institutions Examination Council (“FFIEC”) regulations include the requirement for solutions that have Two-Factor Out-of-Band Authentication and products that stop keylogging malware, real time, which our management believes our proprietary products uniquely and directly address. This new updated guidance went into effect as of January 1, 2012. Based on this new requirement in the latest FFIEC update that was published in June 2011 and now being enforced as of January 2012, we have recently experienced a growing increase in sales orders and inquiries. However, there can be no assurance that our products will continue to gain acceptance and continue to grow in the commercial marketplace or that one of our competitors will not introduce technically superior products. 




36




Marketing


Our multi-channel marketing strategy includes:


1. Direct sales to enterprise and commercial customers. In this effort, we are purchasing marketing programs, a new strategy for us, and we are looking at other inside sales alternatives in order to respond aggressively to inquiries relating to our products.


2. The global addition of resellers, agents & distributors (our strategic sales channel) who distribute and resell our products and services to enterprise and commercial customers (technology and software product distributors, systems integrators, managed service companies, other security technology and software vendors, telecom companies, identity theft related product companies, etc.).


3. Application Service Provider (ASP) Partners: Our certified SAS 70 third party service provides a hosting platform that facilitates faster implementations at competitive prices for our Cloud Service option.


4. Original Equipment Manufacturers (OEM): SFT products are sold to other security technology vendors that integrate ProtectID® and GuardedID® into their products (bundling) and services providing for monthly increasing recurring revenues.


5. Internet sites that sell GuardedID® to consumers and small enterprises, such as affiliates.


Our hosting service provider is Host My Site and we have been under contract with them since December 2007 when we executed an agreement with a nationwide premier data center and co-location services provider who functions as an Application Service Provider for our ProtectID product, which requires a secondary server used for the “Out-of-Band” two-factor authentication technology. We believe that this relationship improves the implementation time, reduces the cost and training requirements, and allows for ease of scalability on an as needed basis. The hosting site is also SAS 70 (Statement on Auditing Standards (SAS) No. 70,) certified, which is critical to providing a secure compliant service that is required by most of our clients. Our agreement with the services provider was for a one-year (1) term, initially ending in December 2008 and renewing automatically for one-year (1) terms, and is still in effect. The relationship can be terminated by either party on sixty days written notice. The hosting service is compensated by our Company based on a flat monthly fee per the terms of the contract that can increase as we require additional services.


Intellectual Property


In December 2011, we executed an exclusive agreement with an agent to represent us in enforcing the “Out-of-Band” patent. We terminated that exclusive agreement in September 2012. We shall be enforcing our patent rights and our management has taken the initial steps concerning such enforcement as recommended by our patent attorneys.


Our firewall product, which was in the research and design phase, is no longer being developed; therefore, the pending provisional patent application was allowed to expire. A fourth patent application relating to our ProtectID® product was combined into the first ProtectID® patent application and the fourth application was allowed to lapse.


We have three trademarks that have been approved and registered: ProtectID®, GuardedID® and CryptoColor®. We have two trademarks that are in the application process: ID Genie and MobileTrust. A portion of our software is licensed from third parties and the remainder is developed by our own team of developers while leveraging some limited external consultant expertise as necessitated. We rely upon confidentiality agreements signed by our employees, consultants and third parties to protect the intellectual property rights.


We license technology from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. We anticipate that we will continue to license technology from third parties in the future. Although we are not substantially dependent on any individual licensed technology, some of the software that we license from third parties could be difficult for us to replace. The effective implementation of our products depends upon the successful operation of third-party licensed products in conjunction with our suite of products, and therefore any undetected errors in these licensed products could create delays in the implementation of our products, impair the functionality of our products, delay new product introductions, damage our reputation, and/or cause us to provide substitute products.




37




Business Strategy


We expect to incur significant additional costs before we become profitable. We anticipate that most of the costs that we incur will be related to salaries, professional fees, marketing, sales and research & design. We anticipate that we will increase our sales force by approximately one full-time employee and our technology staff by approximately two employees during the next twelve months. At the present time, our monthly cash expenditure burn rate is approximately $110,000 per month. We expect that our monthly cash usage for operations will increase in the future due to contracted and anticipated increased volumes and the preceding additions. We anticipate that the area in which we will experience the greatest increase in operating expenses is in marketing, selling, advertising, payroll related to sales and product support, technology and global strategic business consulting subject to cash availability.


Our primary strategy over the next 12 months is to focus on the growth and support of our channel partners, including distributors, resellers and original equipment manufacturers (OEMs). Secondly, our internal sales team will target potential direct sales in industries that management believes provides the greatest potential for sales. These include small to medium sized financial institutions, government agencies, e-commerce, healthcare and enterprise businesses. We are also executing agreements with strategic resellers and distributors for marketing, selling and supporting our products internationally. It is our intention to ultimately utilize distributors, resellers and agents to generate the bulk of our sales internationally, realizing that this strategy will take time to nurture. There can be no assurance, however, that we will succeed in implementing our sales strategy. Although management believes that there is an increasingly strong market for our products, we have not generated substantial revenue from the sale of our principal products and there is no assurance we can secure a market sufficient to permit us to achieve profitability in the next twelve months.


Competition


The software development and services market is characterized by innovation and competition. There are several well-established companies within this market that offer network security systems and newer companies with emerging technologies. We believe that our patented “Out-of-Band” two-factor identity authentication product is an innovative, secure, adaptable, competitively priced, integrated network authentication system. The main features of ProtectID® include: an open architecture “Out-of-Band” platform for user authentication; operating system independence; biometric layering; mobile authentication; secure website logon; Virtual Private Network (“VPN”) access; domain authentication and multi-level authentication. Unlike other techniques for increased network security, ProtectID® does not rely on a specific authentication device or method (e.g., phone, tokens, smart cards, digital certificates or biometrics, such as a retinal or fingerprint scan). Rather ProtectID® has been developed as an “open platform” that incorporates many authentication devices and methods. For example, once a user has been identified to a computer network, a system deploying our ProtectID® authentication system permits the “Out-of-Band” authentication of that user by a telephone, iPhone, iPad, Blackberry, PDA, email, hard token, SSL client software, a biometric device such as a fingerprint scan, or others, before that user is permitted to access the network. By using “Out-of-Band” authentication methods, management believes that ProtectID® provides a competitive product for customers with security requirements greater than typical name and password schemes for virtual private networks and computer systems with multiple users at remote locations, as examples. We also believe that our keystroke encryption product, GuardedID®, offers an additional competitive edge for network security and e-commerce applications that should provide greater levels of security and the ability to evolve over time based on newer technologies when made available. Both products have limited competition based on our product’s ability to protect individual identities and computers/devices.


Although we believe that our suite of products offer competitive advantages, there is no assurance that any of these products will gain acceptance in the marketplace. Our competitors include established software and hardware companies that are likely to be better financed and to have established sales channels. Due to the high level of innovation in the software development industry, it is also possible that a competitor will introduce a product that provides a higher level of security than the ProtectID® products or which can be offered at prices that are more advantageous to the customer.




38




Results of Operations

 

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2011

 

Our revenues for the three months ended September 30, 2012 were $289,515 compared to $137,535 for the three months ended September 30, 2011, an increase of $151,980 or 111%. The increase in revenues was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® (“Out-of-Band”) technology.


Our revenues generated consisted of hardware and software sales, services and maintenance sales, revenues from sign on fees, and recurring transaction revenues. Hardware sales for the three months ended September 30, 2012 were $0 compared to $5,211 for the three months ended September 30, 2011, a decrease of $5,211. The decrease in hardware revenues was primarily due to the decrease in the sales of our one-time-password token key-fobs.  Software, services and maintenance sales for the three months ended September 30, 2012 were $289,515 compared to $132,324 for the three months ended September 30, 2011, an increase of $157,191. The increase in software, services and maintenance revenues was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® (“Out-of-Band”) technology.


Our cost of revenues for the three months ended September 30, 2012 was $1,029 compared to $5,179 for the three months ended September 30, 2011, a decrease of $4,150, or 80.1%. The decrease resulted primarily from the overall increase in our software product revenues which entail a reduced cost of sales as compared with revenues that include hardware purchases and the decrease in the sales of our one-time-password token key-fobs. Cost of revenues as a percentage of total revenues for the three months ended September 30, 2012 was 0.36% compared to 3.8% for the three months ended September 30, 2011. The decrease resulted primarily from the overall increase in our software product revenues which entail a reduced cost of sales as compared with revenues that include hardware purchases.

 

Our gross profit for the three months ended September 30, 2012 was $288,486 compared to $132,356 for the three months ended September 30, 2011, an increase of $155,950, or 118%. The increase in gross profit was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® (“Out-of-Band”) technology.

 

Our research and development expenses for the three months ended September 30, 2012 were $78,000 compared to $97,500 for the three months ended September 30, 2011, a decrease of $19,500, or 20.0%. The decrease was primarily attributable to the decrease in time expended by our research and development personnel. The salaries, benefits and overhead costs of personnel conducting research and development of our software products comprise research and development expenses.


Our selling, general and administrative (“SGA”) expenses for the three months ended September 30, 2012 were $258,578 compared to $1,065,892 for the three months ended September 30, 2011, a decrease of $807,314 or 75.7%. The decrease was due primarily to expenses in stock based compensation through the issuance of employee and non-employee stock options in the third fiscal quarter of 2011 in the amount of $823,875. Selling, general and administrative expenses consist primarily of salaries, benefits and overhead costs for executive and administrative personnel, insurance, fees for professional services, including consulting, legal, and accounting fees, plus travel costs and non-cash stock compensation expense for the issuance of stock to non-employees and other general corporate expenses.


Our other expense for the three months ended September 30, 2012 was $214,010 as compared to $100,799 for the three months ended September 30, 2011, representing an increase in other expense of $113,211, or 112%. The increase was primarily due to an increase in interest expense and the change in the fair value of the derivatives relating to a portion of our secured and unsecured convertible debenture balance.


Our net loss for the three months ended September 30, 2012 was $262,102 compared to a net loss of $1,131,835 for the three months ended September 30, 2011, a decrease of $869,733, or 76.8%. The decrease in our net loss was due primarily to expenses in stock based compensation through the issuance of employee and non-employee stock options in the third fiscal quarter of 2011, in addition to increased gross profit in the third fiscal quarter of 2012.




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FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2011

 

Our revenues for the nine months ended September 30, 2012 were $642,596 compared to $286,695 for the nine months ended September 30, 2011, an increase of $355,901 or 124%. The increase in revenues was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® (“Out-of-Band”) technology.


Our revenues generated consisted of hardware and software sales, services and maintenance sales, revenues from sign on fees, and recurring transaction revenues. Hardware sales for the nine months ended September 30, 2012 were $6,067 compared to $10,305 for the nine months ended September 30, 2011, a decrease of $4,238. The decrease in hardware revenues was primarily due to the decrease in the sales of our one-time-password token key-fobs.  Software, services and maintenance sales for the nine months ended September 30, 2012 were $636,529 compared to $144,066 for the nine months ended September 30, 2011, an increase of $492,463. The increase in software, services and maintenance revenues was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® (“Out-of-Band”) technology.


Our cost of revenues for the nine months ended September 30, 2012 was $13,050 compared to $19,038 for the nine months ended September 30, 2011, a decrease of $5,988, or 3.2%. The decrease resulted primarily from the overall increase in our software product revenues which entail a reduced cost of sales as compared with revenues that include hardware purchases and the decrease in the sales of our one-time-password token key-fobs. Cost of revenues as a percentage of total revenues for the nine months ended September 30, 2012 was 2.0% compared to 6.6% for the nine months ended September 30, 2011. The decrease resulted primarily from the overall increase in our software product revenues which entail a reduced cost of sales as compared with revenues that include hardware purchases.


Our gross profit for the nine months ended September 30, 2012 was $629,546 compared to $267,657 for the nine months ended September 30, 2011, an increase of $361,889, or 135%. The increase in gross profit was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® (“Out-of-Band”) technology. 


Our research and development expenses for the nine months ended September 30, 2012 were $253,500 compared to $260,669 for the nine months ended September 30, 2011, a decrease of $7,169, or 2.8%. The decrease was primarily attributable to the decrease in time expended by our research and development personnel. The salaries, benefits and overhead costs of personnel conducting research and development of our software products comprise research and development expenses.


Our selling, general and administrative (“SGA”) expenses for the nine months ended September 30, 2012 were $855,541 compared to $4,297,635 for the nine months ended September 30, 2011, a decrease of $3,442,094 or 80.1%. The decrease was due primarily to the non-recurrence of one-time expense in stock based compensation through the issuance of preferred stock in the first fiscal quarter of 2011 in the amount of $987,000 and expenses in stock based compensation through the issuance of employee and non-employee stock options in the first, second and third fiscal quarters of 2011 in the amount of $1,960,875. The parties receiving the irrevocably preferred stock waived all conversion rights to such preferred stock. Selling, general and administrative expenses consist primarily of salaries, benefits and overhead costs for executive and administrative personnel, insurance, fees for professional services, including consulting, legal, and accounting fees, plus travel costs and non-cash stock compensation expense for the issuance of stock to non-employees and other general corporate expenses.


Our other  expense for the nine months ended September 30, 2012 was $415,522 as compared to $396,295 for the nine months ended September 30, 2011, representing an increase in other expense of $19,227, or 4.9%. The increase was primarily due to an increase in interest expense and the change in the fair value of the derivatives relating to a portion of our secured and unsecured convertible debenture balance.


Our net loss for the nine months ended September 30, 2012 was $895,017 compared to a net loss of $4,686,942 for the nine months ended September 30, 2011, a decrease of $3,791,925, or 80.9%. The decrease in our net loss was due primarily to the non-recurrence of one-time expense in stock based compensation through the issuance of preferred stock in the first fiscal quarter of 2011 and expenses in stock based compensation through the issuance of employee and non-employee stock options in the first fiscal quarter of 2011, in addition to increased gross profit in fiscal 2012. The parties receiving the irrevocable preferred stock waived all conversion rights to such preferred stock.




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Liquidity and Capital Resources

 

Our total current assets at September 30, 2012 were $377,100, which included cash of $228,884, as compared with $87,744 in total current assets at December 31, 2011, which included cash of $0. Additionally, we had a stockholders’ deficit in the amount of $10,481,556 at September 30, 2012 compared to a stockholders’ deficit of $10,262,227 at December 31, 2011.  We have historically incurred recurring losses and have financed our operations through loans, principally from affiliated parties such as our directors, and from the proceeds of debt and equity financing. The liabilities include a computed liability for the fair value of derivatives of $568,867, which will only be realized on the conversion of the derivatives, or settlement of the debentures.  


We financed our operations during the nine months ended September 30, 2012 primarily through the sale and issuance of debt, in the amount of $353,000, through the sale of our common stock, in the amount of $430,000, and through recurring revenues from our ProtectID® hosting platform and license fees, and sales of our GuardedID® keystroke encryption technology, in the amount of $642,596. Management anticipates that we will continue to rely on equity and debt financing, at least in the near future, to finance our operations. While management believes that there will be a substantial percentage of our sales generated from our GuardedID® product and there are an increasing number of customers for our ProtectID® product, we will continue to have customer concentrations. Inherently, as time progresses and corporate exposure in the market continues to grow, with increasing marketing efforts, management believes, but cannot guarantee, we will continue to attain greater numbers of customers and the concentrations could decrease over time. Until this is accomplished, management will continue to attempt to secure additional financing through both the public and private market sectors to meet our continuing commitments of expenditures and until our sales revenue can provide greater liquidity.

  

Our number of common shares outstanding increased from 221,388,354 shares at the year ended December 31, 2011 to 294,253,293 at the nine months ended September 30, 2012, an increase of 32.9%. The increase in the number of common shares outstanding was due to common shares issued related to the issuance, conversion and settlement of debt, equity financing and consulting obligations, which, consequently, reduced our total debt.  


We have historically incurred losses and we anticipate that we will not generate any significant revenues until the fourth quarter of 2012 or later. Our operations presently require funding of approximately $110,000 per month. Management believes we will be cash flow positive by the end of 2012, or shortly thereafter, based on recently executed and announced contracts and potential contracts that we anticipate closing throughout 2012 in the financial industry, technology, insurance, enterprise, healthcare, government, and consumer sectors in the United States, Latin America, Europe, Africa and the Pacific Rim. There can be no assurance, however, that the sales anticipated will materialize or that we will achieve the profitability we have forecasted.  Management also recognizes the consequences of the current world economic developments and the possible volatile effect on currency rates resulting from revenues derived from foreign markets.


DRAWDOWN EQUITY FINANCING AGREEMENT


On April 13, 2012, we entered into a Drawdown Equity Financing Agreement, together with a Registration Rights Agreement, with Auctus Private Equity Fund, LLC ("Auctus"), the selling stockholder. In October 2012, we elected to withdraw our Form S-1/A registration statement and terminate the Drawdown Equity Financing Agreement with Auctus.


SUMMARY OF OUR OUTSTANDING SECURED CONVERTIBLE DEBENTURES


At September 30, 2012, $542,588 in aggregate principal amount of the DART Limited ("DART"), custodian for Citco Global Custody NV (“Citco Global”) as of July 2012, debentures, as assigned by YA Global and Highgate in April 2009, were issued and outstanding.


During the nine months ended September 30, 2012, DART had no conversions.


The DART secured convertible debentures are fully matured. We have been in contact with the note holder who has indicated that it has no present intention of exercising its right to convert the debentures into restricted shares of our common stock. The note holder has advised us that it currently is willing to wait until it receives a buyout offer from us. 




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During the nine months ended September 30, 2012, we issued unsecured convertible notes in an aggregate total of $353,000 to two unrelated parties per the terms of a term sheet executed with investor firms in November 2011, April 2012 and July 2012. Additionally, during the nine months ended September 30, 2012, an investor firm converted $40,000 of the convertible note dated December 5, 2011 into 10,243,847 unrestricted shares of our common stock pursuant to an exemption provided under Regulation D of the Securities Act of 1933, as discussed below. The conversion price was $0.005622 per share for 2,668,089 shares and $0.0033 per share for 7,575,758 shares. Since the unsecured convertible note arose greater than six months and, as no additional consideration was paid in the notice of conversion by the investor firm, the conversion was tacked back to the original date of the issuance of the note as the holding period under SEC Rule 144(d)(3)(ii) resulting in the issuance of unrestricted shares. Additionally, during the nine months ended September 30, 2012, we repaid a total of $500 of unsecured convertible notes to one unrelated party.


During the nine months ended September 30, 2012, we repaid a total of $10,401 of unsecured notes to one unrelated party and we settled a total of $70,000 of unsecured notes held by one unrelated party in exchange for unrestricted shares of our common stock.


Summary of Funded Debt


As of September 30, 2012, our Company’s open unsecured promissory note balance was $2,374,765, net of discount on promissory notes of $1,598, listed as follows:


·

$18,750 to an unrelated individual - current portion

·

$275,000 to an unrelated individual – current portion

·

$85,113 to an unrelated company - current portion

·

$210,000 to an unrelated company - current portion

·

$1,650,000 to twenty unrelated individuals through term sheet with the StrikeForce Investor Group – current portion

·

$137,500 to an unrelated company - current portion


As of September 30, 2012, our Company’s open unsecured related party promissory note balances were $722,638, listed as follows:


·

$722,638 to our CEO – current portion


As of September 30, 2012, our Company’s open convertible secured note balances were $542,588, listed as follows:


·

$542,588 to DART (custodian for Citco Global and as assigned in 04/09 by YA Global and Highgate House Funds, Ltd.)  


As of September 30, 2012 our Company’s open convertible note balances were $1,308,942, net of discount on convertible notes of $272,825, listed as follows:


·

$235,000 to an unrelated company (03/05 unsecured debenture) - current portion

·

$7,000 to an unrelated company (06/05 unsecured debenture) – current portion

·

$10,000 to an unrelated individual (06/05 unsecured debenture) - current portion

·

$40,000 to three unrelated individuals (07/05 unsecured debentures) - current portion

·

$48,255 to an unrelated individual (01/06 unsecured debenture) – current portion

·

$200,000 to an unrelated individual (06/06 unsecured debenture) – current portion

·

$150,000 to an unrelated individual (09/06 unsecured debenture) – current portion

·

$3,512 to an unrelated individual (02/07 unsecured debenture) – current portion

·

$100,000 to an unrelated individual (05/07 unsecured debenture) – current portion

·

$100,000 to an unrelated individual (06/07 unsecured debentures) – current portion

·

$100,000 to an unrelated individual (07/07 unsecured debenture) – current portion

·

$120,000 to three unrelated individuals (08/07 unsecured debentures) – current portion

·

$50,000 to two unrelated individuals (12/09 unsecured debentures) - current portion

·

$30,000 to an unrelated company (03/10 unsecured debenture) – long term portion

·

$35,000 to un unrelated company (12/11 unsecured debenture) - current portion

·

$150,000 to un unrelated company (01/12 unsecured debenture) - current portion

·

$75,000 to un unrelated company (03/12 unsecured debenture) - current portion

·

$53,000 to un unrelated company (04/12 unsecured debenture) - current portion

·

$32,500 to un unrelated company (05/12 unsecured debenture) - current portion

·

$42,500 to un unrelated company (07/12 unsecured debenture) - current portion




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As of September 30, 2012 our Company’s open convertible note balances - related parties were $360,500, listed as follows:


·

$268,000 to our CEO – current portion

·

$57,500 to our VP of Technical Services – current portion

·

$30,000 to a relative of our CTO & one of our Software Developers – current portion

·

$5,000 to a relative of our former CFO – current portion


Based on present revenues and expenses, we are unable to generate sufficient funds internally to sustain our current operations. We must raise additional capital or determine other borrowing sources to continue our operations.  It is management’s plan to seek additional funding through the sale of common stock, the sale and settlement of trade payables and debentures, and the issuance of notes and debentures, including notes and debentures convertible into common stock. If we issue additional shares of common stock, the value of shares of existing stockholders is likely to be diluted.


However, the terms of the convertible secured debentures issued to certain of the existing stockholders require that we obtain the consent of such stockholders prior to our entering into subsequent financing arrangements. No assurance can be given that we will be able to obtain additional financing, that we will be able to obtain additional financing on terms that are favorable to us or that the holders of the secured debentures will provide their consent to permit us to enter into subsequent financing arrangements.


Our future revenues and profits, if any, will primarily depend upon our ability, and that of our distributors and resellers, to secure sales of our suite of network security and anti-malware products. We do not presently generate significant revenue from the sales of our products. Although management believes that our products are competitive for customers seeking a high level of network security, we cannot forecast with any reasonable certainty whether our products will gain acceptance in the marketplace and if so by when.


Except for the limitations imposed upon us respective to the convertible secured debentures of DART (custodian for Citco Global and as assigned by YA Global and Highgate House Funds, Ltd.), there are no material or known trends that will restrict either short term or long-term liquidity.


Off-Balance Sheet Arrangements

 

We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, result of operations, liquidity or capital expenditures.

 

Going Concern

 

 The report of our independent registered public accounting firm on our annual financial statements contains explanatory language that substantial doubt exists about our ability to continue as a going concern


The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates continuity of operations, realization of assets, and liquidation of liabilities in the normal course of business.


As reflected in the accompanying financial statements, we had a working capital deficiency of $10,477,624 and $10,177,078 and deficits in stockholders’ equity of $10,481,556 and $10,262,227 at September 30, 2012 and December 31, 2011, respectively, and net losses of $895,017 and $4,686,942 and net cash used in operating activities of $502,004 and $639,681 for each of the nine-month periods  then ended. These factors raise substantial doubt about our ability to continue as a going concern.


Currently, management is attempting to increase revenues and improve gross margins by a revised sales strategy. In principle, we are redirecting our sales focus from direct sales to domestic and international channel sales, where we are primarily selling through a channel of Distributors, Value Added Resellers, Strategic Partners and Original Equipment Manufacturers. While we believe in the viability of our strategy to increase revenues and in its ability to raise additional funds, there can be no assurances to that effect.  Our ability to continue as a going concern is dependent upon our ability to continually increase our customer base and realize increased revenues from recently signed contracts.


The financial statements do not include any adjustments related to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.




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Critical Accounting Policies


See Notes to the Financial Statements.


Recently Issued Accounting Pronouncements


Refer to Note 2 in the accompanying interim financial statements.


Additional Information


You are advised to read this Form 10-Q in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Quarterly Reports on Form 10-Q, Annual Reports on Form 10-K, Registration Statement on Form S-1 and Current Reports on Form 8-K that we file from time to time. You may obtain copies of these reports directly from us or from the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E. Washington, D.C. 20549, and you may obtain information about obtaining access to the Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains information for electronic filers at its website http://www.sec.gov.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


We do not hold any derivative instruments and do not engage in any hedging activities.


ITEM 4.  CONTROLS AND PROCEDURES


Evaluation of Disclosure Controls and Procedures.  


Regulations under the Securities Exchange Act of 1934 (the “Exchange Act”) require public companies to maintain “disclosure controls and procedures,” which are defined as controls and other procedures that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.


We carried out an evaluation, with the participation of our management, including our Chief Executive Officer (“CEO”), of the effectiveness our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of September 30, 2012. Based upon that evaluation, our CEO concluded that our disclosure controls and procedures are not effective at the reasonable assurance level due to the material weaknesses described below.


In light of the material weaknesses described below, we performed additional analysis and other post-closing procedures to ensure our financial statements were prepared in accordance with generally accepted accounting principles.  Accordingly, we believe that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented.


A material weakness is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.  Management has identified the following three material weaknesses which have caused management to conclude that, as of September 30, 2012, our disclosure controls and procedures were not effective at the reasonable assurance level:


1. We do not have written documentation of our internal control policies and procedures.  Written documentation of key internal controls over financial reporting is a requirement of Section 404 of the Sarbanes-Oxley Act which is applicable to us as of and for the nine months ending September 30, 2012.  Management evaluated the impact of our failure to have written documentation of our internal controls and procedures on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.


2. The Company’s board of directors has no audit committee, independent director or member with financial expertise which causes ineffective oversight of our external financial reporting and internal control over financial reporting.



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3. We do not have sufficient segregation of duties within accounting functions, which is a basic internal control.  Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible.  However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals.  Management evaluated the impact of our failure to have segregation of duties on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.


To address these material weaknesses, management performed additional analyses and other procedures to ensure that the financial statements included herein fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented.


Remediation of Material Weaknesses


We intend to remediate the material weaknesses in our disclosure controls and procedures identified above by adding independent director or member with financial expertise or hiring a full-time CFO, with SEC reporting experience, in the future when working capital permits and by working with our independent registered public accounting firm and refining our internal procedures.  To date, we have not been successful in reducing the number of audit adjustments, but will continue our efforts in the coming fiscal year.


Changes in Internal Control over Financial Reporting


There were no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.




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PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS  

 

The Company is not currently a party to, nor is any of its property currently the subject of, any material legal proceeding. None of the Company’s directors, officers or affiliates is involved in a proceeding adverse to the Company’s business or has a material interest adverse to the Company’s business.

 

ITEM 1A. RISK FACTORS


Not required under Regulation S-K for “smaller reporting companies.”


Information about risk factors for the nine months ended September 30, 2012, does not differ materially from that set forth in Part I, Item 1A of the Company’s 2011 Annual Report on Form 10-K or the Form S-1/A registration Statement filed September 7, 2012.


ITEM 2. RECENT ISSUANCES OF UNREGISTERED SECURITIES  


In July 2012, we sold to two individuals certain units which contained restricted common stock and warrants. We issued 14,492,393 shares of our common stock at $0.0047 per share for 10,570,824 shares and $0.0064 per share for 3,921,569 shares. We also issued warrants to purchase a total of 7,246,197 shares of our common stock, exercisable at $0.02 per share, that expire in July 2015.


In July 2012, we issued 62,500 restricted shares of our common stock, valued at $500, to a consultant relating to a public relations agreement we executed with the consultant in May 2012.


In July 2012, we issued 7,500 restricted shares of our common stock, valued at $0.0063 per share, to a law firm as compensation for general counsel legal services rendered.


In July 2012, we issued warrants to purchase 165,000 shares of our common stock, exercisable at $0.02 per share, per the terms of a consulting agreement we executed in January 2012, and amended and extended in July 2012. The warrants expire in July 2015.


In August 2012, we sold to one individual certain units which contained restricted common stock and warrants. We issued 5,555,556 shares of our common stock at $0.0045 per share and warrants to purchase a total of 2,777,778 shares of our common stock, exercisable at $0.02 per share that expire in August 2015.


In August 2012, we issued 58,140 restricted shares of our common stock, valued at $500, to a consultant relating to a public relations agreement we executed with the consultant in May 2012.


In August 2012, we issued 7,575,758 unrestricted shares of our common stock to an investor firm that converted $25,000 of a convertible note, dated December 5, 2011, into shares of our common stock. The conversion price was $0.0033 per share. Since the note arose greater than six months and, as no additional consideration was paid in the notice of conversion by the investor firm, the conversion was tacked back to the original date of the issuance of the note as the holding period under SEC Rule 144(d)(3)(ii) resulting in the issuance of unrestricted shares as consequence of an exemption pursuant to Regulation D of the Securities Act of 1933.


In August 2012, we issued warrants to purchase 150,000 shares of our common stock, exercisable at $0.02 per share, per the terms of a consulting agreement we executed in January 2012, and amended and extended in August 2012. The warrants expire in August 2015.


In September 2012, we sold to two individuals certain units which contained restricted common stock and warrants. We issued 7,953,215 shares of our common stock at $0.0056 per share for 4,444,444 shares and $0.0071 per share for 3,508,771 shares. We also issued warrants to purchase a total of 3,976,608 shares of our common stock, exercisable at $0.02 per share, that expire in September 2015.


In September 2012, we issued 52,632 restricted shares of our common stock, valued at $500, to a consultant relating to a public relations agreement we executed with the consultant in May 2012.


In September 2012, we issued 7,500 restricted shares of our common stock, valued at $0.0093 per share, to a law firm as compensation for general counsel legal services rendered.



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All of the above offerings and sales, except the afore-mentioned shares issued pursuant to a conversion of convertible notes (originally exempt from registration pursuant to Regulation D of the Securities Act of 1933, were made in reliance upon the exemption from registration under Rule 506 of Regulation D promulgated under the Securities Act of 1933 and/or Section 4(2) of the Securities Act of 1933, based on the following: (a) the investors confirmed to us that they were “accredited investors,” as defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933 and had such background, education and experience in financial and business matters as to be able to evaluate the merits and risks of an investment in the securities; (b) there was no public offering or general solicitation with respect to the offering; (c) the investors were provided with certain disclosure materials and all other information requested with respect to our company; (d) where applicable, the investors acknowledged that all securities being purchased were “restricted securities” for purposes of the Securities Act of 1933, and agreed to transfer such securities only in a transaction registered under the Securities Act of 1933 or exempt from registration under the Securities Act; and (e) where applicable, a legend was placed on the certificates representing each such security stating that it was restricted and could only be transferred if subsequent registered under the Securities Act of 1933or transferred in a transaction exempt from registration under the Securities Act of 1933.


ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.


The Company has not made various principal and interest payments on many of its debt obligations. It continues to seek work-out arrangements and applicable refinancing with new or revised debt or equity instruments. See Notes 4, 6, and 9 to the condensed financial statements.


ITEM 4.  MINE SAFETY DISCLOSURES


Not applicable.


ITEM 5.  OTHER INFORMATION.


There is no information with respect to which information is not otherwise called for by this form.





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ITEM 6.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.   


Exhibit Number

Description

3.1

Amended and Restated Certificate of Incorporation of StrikeForce Technologies, Inc.(1)

3.2

Amended Articles of Incorporation of StrikeForce Technologies, Inc. (5)

3.3

By-laws of StrikeForce Technologies, Inc. (1)

3.4

Amended By-laws of StrikeForce Technologies, Inc. (5)

3.5

Amended By-laws of StrikeForce Technologies, Inc. (6)

3.6

Articles of Amendment of StrikeForce Technologies, Inc. (6)

10.1

2004 Stock Option Plan (1)

10.2

Securities Purchase Agreement dated December 20, 2004, by and among StrikeForce Technologies, Inc. and YA Global Investments, LP. (1)

10.3

Secured Convertible Debenture with YA Global Investments, LP. (1)

10.4

Investor Registration Rights Agreement dated December 20, 2004, by and between StrikeForce Technologies, Inc. and YA Global Investments, LP in connection with the Securities Purchase Agreement.(2)

10.5

Escrow Agreement, dated December 20, 2004, by and between StrikeForce Technologies, Inc. and YA Global Investments, LP in connection with the Securities Purchase Agreement. (2)

10.6

Security Agreement dated December 20, 2004, by and between StrikeForce Technologies, Inc. and YA Global Investments, LP in connection with the Securities Purchase Agreement. (1)

10.7

Secured Convertible Debenture with YA Global Investments, LP dated January 18, 2005. (1)

10.8

Royalty Agreement with NetLabs.com, Inc. and Amendments. (1)

10.9

Employment Agreement dated as of May 20, 2003, by and between StrikeForce Technologies, Inc. and Mark L. Kay. (1)

10.10

Amended and Restated Secured Convertible Debenture with YA Global Investments, LP dated April 27, 2005. (1)

10.11

Amendment and Consent dated as of April 27, 2005, by and between StrikeForce Technologies, Inc. and YA Global Investments, LP. (1)

10.12

Securities Purchase Agreement dated as of April 27, 2005 by and between StrikeForce Technologies, Inc. and Highgate House Funds, Ltd. (1)

10.13

Investor Registration Rights Agreement dated as of April 27, 2005 by and between StrikeForce Technologies, Inc. and Highgate House Funds, Ltd. (2)

10.14

Secured Convertible Debenture with Highgate House Funds, Ltd. dated April 27, 2005. (2)

10.15

Escrow Agreement dated as of April 27, 2005 by and between StrikeForce Technologies, Inc., Highgate House Funds, Ltd. and Gottbetter & Partners, LLP. (1)

10.16

Escrow Shares Escrow Agreement dated as of April 27, 2005 by and between StrikeForce Technologies, Inc., Highgate House Funds, Ltd. and Gottbetter & Partners, LLP. (1)

10.17

Security Agreement dated as of April 27, 2005 by and between StrikeForce Technologies, Inc. and Highgate House Funds, Ltd. (1)

10.18

Network Service Agreement with Panasonic Management Information Technology Service Company dated August 1, 2003 (and amendment). (1)

10.19

Client Non-Disclosure Agreement. (1)

10.20

Employee Non-Disclosure Agreement. (1)

10.21

Secured Convertible Debenture with Highgate House Funds, Ltd. dated May 6, 2005. (2)

10.22

Termination Agreement with YA Global Investments, LP dated February 19, 2005. (1)

10.23

Securities Purchase Agreement with WestPark Capital, Inc. (4)

10.24

Form of Promissory Note with WestPark Capital, Inc. (4)

10.25

Investor Registration Rights Agreement with WestPark Capital, Inc. (4)

10.26

Drawdown Equity Financing Facility with Auctus Private Equity Fund, LLC., dated April 13, 2012 (7)

10.27

Registration Rights Agreement with Auctus Private Equity Fund, LLC, dated April 13, 2012 (7)

10.28

StrikeForce Technologies Inc. WEBEX Presentation dated May 30, 2012 (8)

10.29

Irrevocable Waiver of Conversion Rights of Mark L. Kay (9)

10.30

Irrevocable Waiver of Conversion Rights of Ramarao Pemmaraju (9)

10.31

Irrevocable Waiver of Conversion Rights of George Waller (9)

10.32

CFO Consultant Agreement with Philip E. Blocker (9)

10.33

Resume of Philip E. Blocker (9)

10.34

Corporate Resolution for Issuance of Common Stock to Auctus Private Equity Fund, LLC (9)

10.35

Consent by Li & Company, P.C. (10)

10.36

Consent by Jill Arlene Robbins (10)

10.37

Termination of a Material Definitive Agreement. (11)

31.1

Certification by Chief Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act, promulgated pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (3)

31.2

Certification by Chief Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act, promulgated pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (3)

32.1

Certification by Chief Executive Officer, required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code, promulgated pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (3)

32.2

Certification by Chief Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code, promulgated pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (3)




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(1)

Filed as an exhibit to the Registrant’s Form SB-2 dated as of May 11, 2005 and incorporated herein by reference.

(2)

Filed as an exhibit to the Registrant’s Amendment No. 1 to Form SB-2 dated as of June 27, 2005 and incorporated herein by reference.

(3)

Filed herewith.

(4)

Filed as an exhibit to the Registrant’s Form 8-K dated August 1, 2006 and incorporated herein by reference.

(5)

Filed as an exhibit to the Registrant’s Form 8-K dated December 23, 2010 and incorporated herein by reference.

(6)

Filed as an exhibit to the Registrant’s Form 8-K dated February 4, 2011 and incorporated herein by reference.

(7)

Filed as an exhibit to the Registrant’s Form 8-K dated May 9, 2012 and incorporated herein by reference.

(8)

Filed as an exhibit to the Registrant’s Form 8-K dated May 30, 2012 and incorporated herein by reference.

(9)

Filed as an exhibit to the Registrant’s Form S-1/A dated July 31, 2012 and incorporated herein by reference.

(10)

Filed as an exhibit to the Registrant’s Form S-1/A dated September 7, 2012 and incorporated herein by reference.

(11)

Filed as an exhibit to the Registrant’s Form 8-K dated October 3, 2012 and incorporated herein by reference.





SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



 

STRIKEFORCE TECHNOLOGIES, INC.

 

  

  

Dated: November 14, 2012

By:  

/s/ Mark L. Kay

 

Mark L. Kay

 

Chief Executive Officer

 

 

 

 

 

Dated: November 14, 2012

By:  

/s/ Philip E. Blocker

 

Philip E. Blocker

 

Chief Financial Officer and

Principal Accounting Officer





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