-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KJjARP6b+G9h1oDE0ljOfJsVwWGiT4HiZb8DCylkdaUm4hk5jkwhS991ThkOWzMK NFrU+Bch2P2DlUttWuTO0Q== 0001144204-06-021241.txt : 20060517 0001144204-06-021241.hdr.sgml : 20060517 20060517145614 ACCESSION NUMBER: 0001144204-06-021241 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060517 DATE AS OF CHANGE: 20060517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL DESCRIPTOR SYSTEMS INC CENTRAL INDEX KEY: 0000927454 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 232770048 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-26604 FILM NUMBER: 06848817 BUSINESS ADDRESS: STREET 1: 2010F CABOT BLVD WEST CITY: LANGHORNE STATE: PA ZIP: 19047 BUSINESS PHONE: 2157520963 MAIL ADDRESS: STREET 1: 2010 F CABOT BLVD WEST CITY: LANGHORNE STATE: PA ZIP: 19047 10QSB 1 v043308_10qsb.txt FORM 10-QSB U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 |X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2006 OR |_| Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to _______________ DIGITAL DESCRIPTOR SYSTEMS, INC. -------------------------------- (Exact name of registrant as specified in its charter) Delaware 23-2770048 - ------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification number) 2150 Highway 35, Sea Girt, New Jersey 08750 ------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's Telephone number, including area code: (732) 359-0260 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| State the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock May 10, 2006 --------------------- -------------------- $.001 par value 7,868,016,065 Shares TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT YES |_| NO |X| Digital Descriptor Systems, Inc. and Subsidiary Condensed Consolidated Financial Statements For the Three Months Ended March 31, 2006 and 2005 (Restated) (Unaudited) Condensed Consolidated Unaudited Financial Statements: Condensed Consolidated Balance Sheets for the Three Months Ended March 31, 2006 and March 31, 2005 (restated) Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and March 31, 2005 (restated) Condensed Consolidated Statement of Cash Flows for the Three Months Ended March 31, 2006 and March 31, 2005 (restated) Notes to Condensed Consolidated Financial Statements 1 Digital Descriptor Systems, Inc. and Subsidiary CONDENSED CONSOLIDATED BALANCE SHEETS AT MARCH 31, 2006 AND 2005 (UNAUDITED) ASSETS
March 31 March 31 2006 2005 ------------ ------------ As Restated Current Assets: Cash and cash equivalents $ 100,709 $ 823,485 Restricted cash -- 50,000 Accounts receivable, less allowances of $60,583 and 38,084, respectively 535,958 98,432 Inventory 426,059 365,963 Prepaid expenses 6,325 1,794 ------------ ------------ Total Current Assets 1,069,051 1,339,674 Property and equipment, net 374,071 410,901 ------------ ------------ Other Assets Deposits 1,730 1,730 Goodwill 4,054,998 4,054,998 Intangible assets, net 179,681 202,178 Deferred financing costs, net 227,213 376,113 ------------ ------------ Total Other Assets 4,463,622 4,635,019 ------------ ------------ TOTAL ASSETS $ 5,906,744 $ 6,385,594 ============ ============ LIABILITIES AND STOCKHOLDERS' (DEFICIT) LIABILITIES Current Liabilities: Accounts payable $ 285,213 $ 202,193 Accrued expenses 316,598 305,634 Accrued interest 806,685 862,332 Due to Officer and director 0 20,115 Deferred income 188,968 169,204 Convertible debentures, net of debt discount 2,042,124 1,608,250 Derivative liabilities 7,220,088 7,328,441 ------------ ------------ Total Current Liabilities 10,859,676 10,496,169 Long Term Liabilities Note payable 3,500,000 3,500,000 Convertible debentures, net of debt discount 1,511,745 1,091,838 ------------ ------------ Total Long Term Liabilities 5,011,745 4,591,838 Total Liabilities 15,871,421 15,088,007 STOCKHOLDERS' (DEFICIT) Preferred stock, $.001 par value: authorized shares - 1,000,000; issued and outstanding shares - none Common stock, par value $.001; authorized 9,999,000,000 shares at; March 31,2006 and 9,999,000000 shares at March 31, 2005; 5,454,943,898 issued and outstanding at March 31, 2006 and 319,466,359 issued and outstanding at March 31, 2005 5,454,944 319,466 Additional paid in capital 11,983,209 19,373,934 Accumulated deficit (27,402,830) (28,395,813) ------------ ------------ Total Stockholders' (Deficit) (9,964,677) (8,702,413) ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) $ 5,906,744 $ 6,385,594 ============ ============
The accompanying notes are an integral part of the condensed consolidated financial statements. 2 Digital Descriptor Systems, Inc. and Subsidiary CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2006 2005 ------------- ------------- As Restated INCOME Net Sales $ 870,964 $ 148,875 Cost of Revenue 293,342 44,702 ------------- ------------- Gross Profit 577,622 104,173 OPERATING EXPENSES General and administrative 618,892 259,701 Sales and marketing 44,806 25,332 Research 26,524 3,848 ------------- ------------- Total Operating Expenses 690,222 288,881 LOSS BEFORE OTHER INCOME (EXPENSE) (112,600) (184,708) OTHER (EXPENSE) Interest (732,194) (457,531) Amortization of deferred financing cost (37,225) (37,225) Amortization of debt discount (323,029) (440,755) Change in fair market value of derivative liability (661,020) (630,702) Other income and expenses (31,804) (780) ------------- ------------- Total Other (Expense) ($ 1,785,272) ($ 1,566,993) NET (LOSS) APPLICABLE TO COMMON SHARES ($ 1,897,872) ($ 1,751,701) ============= ============= NET (LOSS) PER BASIC AND DILUTED SHARES $ (0.00) $ (0.01) ============= ============= WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 3,943,573,535 251,049,692 ============= =============
The accompanying notes are an integral part of the condensed consolidated financial statements. 3 Digital Descriptor Systems, Inc. and Subsidiary CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2006 2005 ------------- ------------- As Restated CASH FLOWS FROM OPERATING ACTIVITIES Net (loss) $ (1,897,872) $ (1,751,701) ------------- ------------- Adjustments to reconcile net (loss) to net cash (used in) operating activities: Depreciation and amortization 11,770 -- Amortization of deferred financing cost 37,225 37,225 Amortization of debt discount 323,029 440,755 Amortization of benefical interest 732,194 (217,126) Change in fair market value of derivatives 661,020 630,702 Bad debt expense 7,500 -- Changes in operating assets and liabilities: Accounts receivable (75,465) (29,903) Inventory (11,908) (31,211) Prepaid expense, deposits and other assets (2,435) (1,794) Accounts payable 60,216 64,611 Accured expenses (64,594) (4,140) Accured interest 7,723 182,265 Deferred Income 16,495 (20,249) ------------- ------------- Total adjustments 1,702,770 1,051,135 ------------- ------------- Net cash (used in) operating activities (195,102) (700,566) ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES Acquisition of Business Assets -- (1,500,000) ============= ============= Net cash provided by (used in) investing activities -- (1,500,000) ------------- -------------
The accompanying notes are an integral part of the condensed consolidated financial statements. 4 Digital Descriptor Systems, Inc. and Subsidiary CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2006 2005 ------------- ------------- As Restated CASH FLOWS FROM FINANCING ACTIVITES Due to officers and directors -- (6,285) Net cash provided by (used in) financing activities -- (6,285) ------------- ------------- NET (DECREASE) IN CASH AND CASH EQUIVALENTS (195,102) (2,206,851) CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 295,811 3,080,336 ------------- ------------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 100,709 873,485 ============= =============
The accompanying notes are an integral part of the condensed consolidated financial statements. 5 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) Note 1 - Description of Business Digital Descriptor Systems, Inc., incorporated in Delaware in 1994, develops, assembles and markets computer installations consisting of hardware and software, which capture video and scanned images, link the digitized images to test and store the images and text on a computer database and transmit this information to remote locations. The principal product of the Company is the Compu-Capture Law Enforcement Program, which is marketed to law enforcement agencies and jail facilities and generates the majority of the Company's revenues. Substantially all of the Company's revenues are derived from governmental agencies in the United States. CGM is a manufacturer and distributor of indicative and barrier security seals, security tapes and related packaging security systems, protective security products for palletized cargo, physical security systems for tractors, trailers and containers as well as a number of highly specialized authentication products. Note 2 - Summary of Significant Accounting Policies Significant accounting policies followed by the Company in the preparation of the accompanying financial statements are summarized below: Use of Estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Revenue Recognition The Company derives revenue from the sale of hardware, software, post customer support, and other related services. Post customer support includes telephone support, bug fixes, and rights to upgrades. Other related services include basic training. The Company recognizes revenue upon delivery of the product to the end-user, when the fee is determinable and collectibility is probable. Revenue allocable to post customer support is recognized on a straight-line basis over the period which the service is to be provided. Revenue collected for future services is recorded as deferred income and totaled $ 188,968 and $ 169,204 , respectively, for the three months ended March 31, 2006 and 2005. Revenue allocable to other services is recognized as the services are provided. Software Development Costs All costs incurred in the research and development of new software products and costs incurred prior to the establishment of a technologically feasible product are expensed as incurred. Research and development of software costs were $ 26,524 and $3,848, respectively, for the three months ended March 31, 2006 and 2005. Cash and Cash Equivalents For the purpose of the statement of cash flows, cash and cash equivalents include time deposits, certificates of deposits, restricted cash, and all highly liquid debt instruments with original maturities or three months or less. Accounts Receivable Accounts receivable are uncollateralized customer obligations due under normal trade terms requiring payment within 30 days from the invoice date. No interest is charged on any past due accounts. Accounts receivable are stated at the amount billed to the customer. Accounts receivable was $ 535,958 and $ 98,432, respectively, for the three months ended March 31, 2006 and 2005 . 6 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) The carrying amount of accounts receivable is reduced by a valuation allowance that reflects management's best estimate of the amount that will not be collected. Management reviews all accounts receivable balances that exceed 90 days from invoice date and based on assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected. The allowance for doubtful accounts was $ 60,583 and $38,084, respectively, for the three months ended March 31, 2006 and 2005. Income Taxes The Company provides for income taxes under the liability method. Deferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Such differences result from differences in the timing of recognition by the Company of net operating loss carry forwards, certain expenses, and differences in the depreciable lives and depreciation methods for certain assets. Accounting for Stock Options Financial Accounting Standards Board issued Statement No. 123 (SFAS 123), "Accounting for Stock-Based Compensation" which provides companies with a choice to follow the provisions of SFAS 123 in determination of stock-based compensation expense or to continue with the provisions of Accounting Principles Board Opinion No. 25 (APB 25). The Company has elected to follow the provisions of APB 25. Under APB 25, if the exercise price of the Company stock options equals or exceeds the market price of the underlying Common Stock on the date of grant, no compensation expense is recognized. The effect of applying SFAS 123 to the Company's stock-based awards results in net loss and net loss per common share that are disclosed on a pro forma basis in Note 8. Net Loss Per Common Share Basic loss per share is calculated by dividing the net loss by the weighted average common shares outstanding for the period. Diluted loss per share is calculated by dividing the net loss by the weighted average common shares outstanding of the period plus the dilutive effect of common stock equivalents. No exercises of common stock equivalents were assumed during any period because the assumed exercise of these securities would be anti-dilutive. Concentration of Credit Risk Financial instruments which potentially subject the company to a concentration of credit risk principally consist of cash and accounts receivable. Concentration of credit risk, with respect to accounts receivable, is limited due to the Company's credit evaluation process. The Company does not require collateral from its customers. The Company sells its principal products to end users and distributors principally in the United States. Fair Value of Financial Instruments The carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and convertible debentures approximates their fair value based on the liquidity of these financial instruments and based on their short-term nature. Reclassification Certain amounts at March 31, 2005 have been reclassified to conform to the March 31, 2006 statements. 7 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) Note 3 - Impact of Recent Accounting Pronouncements In December of 2004 the FASB issued a revision to Statement No. 123, Accounting for Stock-Based Compensation. This Statement supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for good or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement does not change the accounting guidance for share-based payment transactions with parties other than employees as provided in Statement 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with selling, Goods or Services." This Statement does not address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, Employers Accounting for Employee Stock Ownership Plans. The revisions of this statement did not have a material impact upon the Company's financial statements. The Company reviews the carrying value of intangibles and other long-lived assets for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets is measured by comparison of its carrying amount to the undiscounted cash flows that the asset or asset group is expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the property, if any, exceeds its fair market value. Goodwill represents the excess of the cost of the Company's acquired subsidiaries or assets over the fair value of their net assets at the date of acquisition. Under Statement of Financial Accounting Standards ("SFAS") No. 142, goodwill is no longer subject to amortization over its estimated useful life; rather, goodwill is subject to at least an annual assessment for impairment applying a fair-value based test. Note 4 - Convertible Debentures Based on the guidance in SFAS133 and EITF00-19, the Company concluded that the conversion features of it convertible debentures were required to be accounted for as derivatives. The imbedded derivative feature was bi-furcated and the fair market value was determined using a convertible bond valuation model. The derivative instruments are recorded at fair market value with changes in value recognized during the period of change. For further discussion, see footnote #12 regarding restatement. During May 2001, the Company issued three convertible notes for an aggregate amount of $20,000. The debentures are collateralized by substantially all of the company's assets. The debentures accrue interest at the rate of 10% per annum. The holders have the right to convert the principal amount plus accrued interest into shares of the Company's common stock. The conversion price in effect on any Conversion Date shall be an amount equal to 50% of the mean average price of the common stock for the ten trading days prior to notice of conversion. We recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 4,992 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. 8 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) During September 2001, the Company issued two convertible debentures for an aggregate amount of $400,000. The debentures are collateralized by substantially all of the company's assets. These debentures are in default as they were due on September 30, 2002. The debentures accrue interest at the rate of 12% per annum. A late fee equal to 15% of the accrued and unpaid interest is also assessed during the default period. Interest on the debentures was not paid quarterly, and accordingly accrued interest and late fees payable related to the notes totaling $187,600 is included in the accompanying financial statements. The holders have the right to convert the principal amount plus accrued interest into shares of the Company's common stock at anytime after issuance. The conversion price in effect on any Conversion Date shall be the lesser of $.08 per share or 50% of the average of the lowest three inter-day sales prices during the ten trading days immediately preceding the applicable Conversion Date. The Company also issued common stock purchase warrants for the right to purchase 800,000 shares of common stock of the Company at an exercise price per share equal to the lesser of $.36 or the average of the lowest three closing sales prices for the common stock during the twenty Trading Days immediately prior to exercise. The estimated fair value of the warrants of $48,000 was allocated to paid-in capital. This resulting debt discount plus $90,000 of financing charges were amortized on a straight-line basis over the term of the debentures, and were fully amortized at December 31, 2002. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 59,407 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. During 2004, $10,500 of the debenture was converted into 35,000,000 shares of common stock and during 2003, $3,164 of the debenture was converted into 15,818,010 shares of common stock. In December, 2001 the Company issued three convertible debentures for an aggregate amount of $500,000. The debentures are collateralized by substantially all of the company's assets. The debentures are in default as they were due December 31, 2002. Interest accrues at the rate of 12% per annum through maturity, and increased to 15% per annum during the default period. Quarterly interest payments were not made, and accordingly accrued interest payable related to the notes totaling $210,000 is included in the accompanying financial statements. The holders have the right to convert the principal amount plus accrued interest into shares of the Company's common stock at any time. The conversion price in effect on any Conversion Date shall be the lesser of $.043 per share or 50% of the average of the lowest three inter-day sales prices during the twenty Trading Days immediately preceding the applicable Conversion Date. The Company also issued common stock purchase warrants for the right to purchase 1,500,000 shares of common stock of the Company at an exercise price per share equal to the lesser of $.02 or the average of the lowest three inter-day sales prices during the twenty Trading Days immediately prior to exercise. The estimated fair value of the warrants of $90,000 was allocated to paid-in capital. This resulting debt discount plus $77,500 of financing charges were amortized on a straight-line basis over the term of the debentures, and were fully amortized at December 31, 2002. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 388,800 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. 9 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) In June 2002, a 12% convertible promissory note for $75,000 was issued to two investors. The debentures are collateralized by substantially all of the company's assets. The debentures are in default as they were due in August 2003. The debentures accrue interest at the rate of 12% per annum. A late fee equal to 15% of the accrued and unpaid interest is also assessed during the default period. Quarterly interest on the debentures was not paid, and accordingly accrued interest and late fees payable related to the notes totaling $29,071 is included in the accompanying financial statements. The holders have the right to convert the principal amount plus unpaid accrued interest into shares of the Company's common stock at any time through repayment. The conversion price is equal to fifty percent of the average of the lowest three (i) inter-day trading prices, or (ii) if the common stock is traded on the OTC Bulletin Board or Pink Sheets, the prices asked by any person or entity acting as a market maker in the common stock during the twenty trading days immediately preceding the relevant date upon which a conversion is effected. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 59,430 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In September 2002, the Company issued secured convertible debentures in the aggregate principal amount of $100,000. The debentures are collateralized by substantially all of the company's assets. The debentures are in default as they were due on September 30, 2003. The debentures accrue interest at the rate of 12% per annum. A late fee equal to 15% of the accrued and unpaid interest is also assessed during the default period. Quarterly interest on the debentures was not paid, and accordingly accrued interest and late fees payable related to the notes totaling $30,000 are included in the accompanying financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of common stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $0.005 or (2) 40% of the average of the lowest three inter-day sales prices of the common stock during the twenty Trading Days immediately preceding the applicable conversion date. The Company also issued common stock purchase warrants for the right to purchase 300,000 shares of common stock of the Company at an exercise price per share equal to $.01. The estimated fair value of the warrants was zero. Debt issuance costs of $27,500 were also amortized on a straight-line basis over the term of the debentures and were fully amortized at December 31, 2003. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 79,190 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In January, 2003 the Company issued three convertible debentures for an aggregate amount of $250,000, with simple interest accruing at the annual rate of 10%. The debentures are collateralized by substantially all of the company's assets. These debentures are in default as they were due January 10, 2004. Quarterly interest was not paid and accordingly, accrued interest of $61,415 is included in the financial statements. 10 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) The holders have the right to convert the principal amount and interest due under the debentures into shares of common stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $0.005 or (2) 40% of the average of the lowest three inter-day sales prices of the common stock during the twenty Trading Days immediately preceding the applicable Conversion Date. The Company also issued common stock purchase warrants for the right to purchase 750,000 shares of common stock of the Company at an exercise price per share equal to $0.01. The estimated fair value of the warrants was zero. Financing costs incurred of $56,750 were fully amortized at December 31, 2003. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 92,225 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In February, 2003, the Company issued three convertible debentures for an aggregate amount of $125,000, with simple interest accruing at the annual rate of 10%. The debentures are collateralized by substantially all of the company's assets. The debentures are in default as they were due February 27, 2004. Quarterly interest due was not paid and accordingly accrued interest of $28,125 is included in the financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of common stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $0.005 or (2) 40% of the average of the lowest three inter-day sales prices of the common stock during the twenty Trading Days immediately preceding the applicable Conversion Date. The Company also issued common stock purchase warrants for the right to purchase 375,000 shares of common stock of the Company at an exercise price per share equal to $0.01. The estimated fair value of the warrants was zero. Debt issuance costs of $10,843 were also amortized on a straight-line basis over the term of the debentures. Amortization expense during 2004 was $24,307 and the costs were fully amortized as of December31, 2004. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 47,850 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In April, 2003, The Company issued three convertible debentures for an aggregate amount of $125,000, with simple interest accruing at the annual rate of 10%. The debentures are collateralized by substantially all of the company's assets. The debentures are in default as they were due March 31, 2004. Quarterly interest was not paid and accordingly accrued interest of $15,834 is included in the financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of common stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $0.005 or (2) 40% of the average of the lowest three inter-day sales prices of the common stock during the twenty Trading Days immediately preceding the applicable Conversion Date. 11 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) The Company also issued common stock purchase warrants for the right to purchase 375,000 shares of common stock of the Company at an exercise price per share equal to $0.01. The estimated fair value of the warrants was zero. Debt issuance costs of $20,844 were also amortized on a straight-line basis over the term of the debentures. Amortization expense during 2004 was $38,591 and the costs were fully amortized as of December31, 2004. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 68,250 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In October, 2003, the Company issued two convertible debentures for an aggregate amount of $165,000, with simple interest accruing at the annual rate of 12%. The debentures are collateralized by substantially all of the company's assets. The debentures are in default as they were due October 1, 2004. Quarterly interest was not paid and accordingly accrued interest of $25,988 is included in the financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of the Company's common stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $.005 or (2) 40% of the average of the lowest three inter-day sales prices of the common stock during the twenty Trading Days immediately preceding the applicable Conversion Date. The debenture holders also received warrants to purchase 1,505,000 shares at an exercise price of $0.01 per share. The estimated fair value of the warrants was zero. Amortization expense during 2004 was $147,469 and the costs were fully amortized as of December31, 2004. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 326,733 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In November, 2003, the Company issued two convertible debentures for an aggregate amount of $45,000, with simple interest accruing at the annual rate of 10%. The debentures are in default as they were due November 27, 2004. Quarterly interest was not paid and accordingly accrued interest of $9,453 is included in the financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of the Company's common stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $.005 or (2) 40% of the average of the lowest three inter-day sales prices of the common stock during the twenty Trading Days immediately preceding the applicable Conversion Date. The Company also issued common stock purchase warrants for the right to purchase 315,000 shares of common stock of the Company at an exercise price per share equal to $0.01. The estimated fair value of the warrants was zero. Amortization expense during 2004 was $47,469 and the costs were fully amortized as of December 31, 2004. 12 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 72,572 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In December, 2003, the Company issued three convertible debentures for an aggregate amount of $45,000, with simple interest accruing at the annual rate of 12%. The debentures are collateralized by substantially all of the company's assets. These debentures are in default as they were due by December 3, 2004. Quarterly interest was not paid and accordingly accrued interest of $5,694 is included in the financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of the Company's common stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $.005 or (2) 40% of the average of the lowest three inter-day sales prices of the common stock during the twenty Trading Days immediately preceding the applicable Conversion Date. The Company also issued common stock purchase warrants for the right to purchase 750,000 shares of common stock of the Company at an exercise price per share equal to $0.01. The estimated fair value of the warrants was zero. . Amortization expense during 2004 was $42,349 and the costs were fully amortized as of December31, 2004. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 72,527 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In February, 2004, the Company issued two convertible debentures for an aggregate amount of $45,000, with simple interest accruing at the annual rate of 12%. The debentures are collateralized by substantially all of the company's assets. These debentures are due in February, 2005. Quarterly interest was not paid and accordingly accrued interest of $4,906 is included in the financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of the Company's common stock. The conversion price in effect on any conversion date shall be the lesser of (1) $.005 or (2) 67% of the average of the lowest three inter-day sales prices of the common stock during the twenty trading days immediately preceding the applicable conversion date. In addition the debenture holders also received warrants to purchase 315,000 shares at an exercise price of $0.005 per share anytime before February 28, 2009. The estimated fair value of the warrants was $504, which was also recorded as a debt discount. The total debt discount is being amortized on a straight line basis which approximates the effective interest method, over the life of the note. $20,317 of this amount was charged to interest expense during 2004. Additional costs of $12,819 incurred with the issuance of the convertible debentures were recorded as deferred financing cost and are being amortized on a straight-line basis, which approximates the effective interest method, over the term of the debentures. Unamortized costs as of December 31, 2004 amounted to $1,068. 13 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $172,265 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In May, 2004, the Company issued four convertible debentures for an aggregate amount of $250,000, with simple interest accruing at the annual rate of 12%. The debentures are collateralized by substantially all of the company's assets. These debentures are due in May 2005. Quarterly interest was not paid and accordingly accrued interest of $19,555 is included in the financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of the Company's common stock. The conversion price in effect on any conversion date shall be the lesser of (1) $.005 or (2) 67% of the average of the lowest three inter-day sales prices of the common stock during the twenty trading days immediately preceding the applicable conversion date. In addition the debenture holders also received warrants to purchase 750,000 shares at an exercise price of $0.005 per share anytime before May 31, 2009. The estimated fair value of the warrants was $5,175, which was also recorded as a debt discount. The total debt discount is being amortized on a straight line basis which approximates the effective interest method, over the life of the note. $35,911 of this amount was charged to interest expense during 2004. Additional costs of $55,244 incurred with the issuance of the convertible debentures were recorded as deferred financing cost and are being amortized on a straight-line basis, which approximates the effective interest method, over the term of the debentures. Unamortized costs as of December 31, 2004 amounted to $36,829. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $327,750 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In November, 2004, the Company issued four convertible debentures for an aggregate amount of $3,500,000, with simple interest accruing at the annual rate of 12%. The debentures are collateralized by substantially all of the company's assets. These debentures are due in November, 2005. Quarterly interest was not paid and accordingly accrued interest of $36,151 is included in the financial statements. The holders have the right to convert the principal amount and interest due under the debentures into shares of the Company's common stock. The conversion price in effect on any conversion date shall be the lesser of (1) $.0005 or (2) 67% of the average of the lowest three inter-day sales prices of the common stock during the twenty trading days immediately preceding the applicable conversion date.. In addition the debenture holders also received warrants to purchase 10,500,000 shares at an exercise price of $0.005 per share anytime before November 30, 2009. The estimated fair value of the warrants was $5,250, which was also recorded as a debt discount. The total debt discount is being amortized on a straight line basis which approximates the effective interest method, over the life of the note $71,828 of this amount was charged to interest expense during 2004. 14 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) Additional costs of $391,569 with the issuance of the convertible debentures were recorded as deferred financing cost and are being amortized on a straight-line basis which approximates the effective interest method, over the term of the debentures. Unamortized costs as of December 31, 2004 amounted to $376,509. In addition, we recorded a derivative liability related to this convertible debenture. The initial fair market value of the conversion option in the amount of $ 2,519,300 was recorded as a debt discount and is being amortized over the stated maturities of the notes using the effective interest method. The fair market value of the conversion feature is also shown as a derivative liability on the company's balance sheet and is being adjusted to fair market value each reporting period with the change being reported as "other income and expenses" in the statement of operations. In 2005 the Company converted $643,340 of accrued interest into convertible debentures, $97,402 was recorded as debt discount. In March 2005, $513,431 was repaid on convertible debentures. Note 5 - Deferred Financing Costs Deferred financing costs represent cost incurred in connection with the issuance of the convertible debentures. Deferred financing costs are being amortized over the life of the convertible debentures on the straight-line basis, which approximates the effective interest method. The net financing costs were $227,213 and $376,113 for the three months ended March 31, 2006 and 2005, respectively. Note 6 - Commitments and Contingencies Operating Lease The Company rents office facilities under a rental agreement that is automatically renewable every four months. The most recent renewal period expired on December 31, 2005. CGM leases two facilities, one in Somerset NJ and the other in Staten Island New York under non-cancelable lease agreements that end in December 2007 and December 2008, respectively. Employment Agreements Anthony R. Shupin, Chairman, President and Chief Executive Officer. Mr. Shupin was re-appointed as Chairman, President and Chief Executive Officer effective February, 2005. On February 25, 2005, DDSI entered into a five-year employment agreement with Mr. Shupin, which entitled him to a base salary of $215,000 per year, which may at the Board of Directors discretion adjust his base salary (but not below $215,000 per year). Mr. Shupin is also entitled to participate in the Annual Management Bonus Plan. As a participant in the Annual Management Bonus Plan, Mr. Shupin will be eligible to receive bonuses, based on performance, in any amount from 10% to 200% of the Base Salary. In addition, Mr. Shupin shall participate in the Management Equity Incentive Plan. As a participant in the Management Equity Plan, Mr. Shupin will be eligible to receive options, which vest over a period of time from the date of the option's issue, to purchase common shares of DDSI. The Company may grant Mr. Shupin, following the first anniversary of the date hereof and at the sole discretion of the Board of Directors, options to purchase common shares of the Company (subject to the vesting and the satisfaction of the other terms and conditions of such options). Mr. Shupin will be entitled to 25 vacations days per year at such times as may be mutually agreed with the Board of Directors. DDSI will provide Mr. Shupin a monthly car allowance of Six Hundred Dollars ($600.00) along with related car expenses. 15 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) Michael J. Pellegrino, Senior Vice President and Chief Financial Officer. Mr. Pellegrino was appointed as Senior Vice President and Chief Financial Officer effective February 25, 2005. On February 25, 2005, DDSI entered into a five-year employment agreement with Mr. Pellegrino, which entitled him to a base salary of $175,000 per year which may at the Board of Directors discretion adjust his base salary (but not below $175,000 per year). Mr. Pellegrino is also entitled to participate in the Annual Management Bonus Plan. As a participant in the Annual Management Bonus Plan, Mr. Pellegrino will be eligible to receive bonuses, based on performance, in any amount from 10% to 200% of the Base Salary. In addition, Mr. Pellegrino shall participate in the Management Equity Incentive Plan. As a participant in the Management Equity Incentive Plan, Mr. Pellegrino will be eligible to receive options, which vest over a period of time from the date of the option's issue, to purchase common shares of DDSI. DDSI may also grant to the Employee, following the first anniversary of the date of the Agreement and at the sole discretion of the Board of Directors, options to purchase common shares of the Company (subject to the vesting and the satisfaction of the other terms and conditions of such options). Mr. Pellegrino will be entitled to 25 vacation days per year at such times as may be mutually agreed with the Board of Directors. DDSI shall also furnish Mr. Pellegrino with monthly car allowance of Six Hundred Dollars ($600.00) and related car expenses. DDSI has an employment agreement with Erik Hoffer, pursuant to which Mr. Hoffer will be employed as Executive Vice President of the Company for an initial term of three years, which may be extended, and President of CGM Sub for an initial term of one year, which may be renewed for successive one-year terms. Pursuant to the Employment Agreement, Mr. Hoffer will receive a base salary of $200,000, a bonus of 5% of the gross margin sales increase over the prior year's gross margin sales of CGM products and customary benefits and reimbursements. Note 7 - Stock Option and Other Plans The Company maintains the 1994 Restated Stock Option Plan (the 1994 Plan) pursuant to which the Company reserved 5,000,000 shares of common stock. The options granted have a term of ten years and are issued at or above the fair market value of the underlying shares on the grant date. The Company also maintains the 1996 Director Option Plan (the Director Plan) pursuant to which the Company reserved 200,000 shares of common stock. Options granted under the Director Plan are issued at or above the fair market value of the underlying shares on the grant date. A portion of the first option vests at the six-month anniversary of the date of the grant and continues over a four-year period. Subsequent options vest on the first anniversary of the grant date. The options expire ten years from the date of the grant or 90 days after termination of employment, whichever comes first. The following is a summary of option activity under all plans:
Weighted 1996 Total Average Director Number of Exercise 1994 Plan Plan Nonqualified Options Price --------- --------- ------------ ---------- ------------ Outstanding at March 31, 2005 33,000 -- -- 33,000 $.10 - $.365 ========= ========= ============ ========== ============ Outstanding at March 31, 2006 33,000 33,000 $.10 - $.365 ========= ========= ============ ========== ============
Net loss and net loss per common share determined as if the Company accounted for stock options granted under the fair value method of SFAS 123 would result in the same amounts reported. 16 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) Note 8 - Contingency There were two holders of convertible notes dated December 31, 2001 who could potentially seek similar damages from the Company. Should they seek these damages, the Company could incur additional expense of $71,668. Management feels however, that the likelihood that the other holders will seek the damages is remote, and therefore, no provision for this expense has been made in the accompanying financial statements. On October 16, 2003, a judgment was entered against the Company by its landlord, BT Lincoln L.P. for breach of lease in the amount of $184,706.76. The Company intends to negotiate a settlement. Note 9 - Related Parties A Director of the Company provided consulting services during 2006 and 2005 that amounted to $0 and $4,000 respectively. As of March 31, 2006, the Company owes this Director $0. Note 10 - Purchase of CGM Applied Security Technology, Inc. On March 1, 2005, the Company acquired substantially all of the assets of CGM Security Solutions, Inc., a Florida corporation ("CGM"), for (i) $1,500,000 in cash and (ii) a 2.86% promissory note (the "Note") in the principal amount of $3,500,000, subject to adjustment (the "Acquisition"). The assets of CGM were acquired pursuant to an Asset Purchase Agreement among the Company and CGM dated as of February 25, 2005. In connection with the acquisition, the Company and CGM, each entered into an employment agreement with Erik Hoffer (the "Employment Agreement"). CGM is a manufacturer and distributor of barrier security seals, security tapes and related packaging security systems, protective security products for palletized cargo, physical security systems for tractors, trailers and containers. The principal amount of the Note is subject to adjustment based upon the average of (i) the gross revenues of CGM for the fiscal year ending December 31, 2007 and (ii) an independent valuation of CGM Sub based upon the consolidated audited financial statements of the Company and CGM Sub for the fiscal years ending December 31, 2006 and 2007. In addition, the Company has granted CGM a secondary security interest in substantially all of its assets and intellectual property. In connection with the Acquisition, the Company entered into a letter agreement with certain of its investors (the "Investors") which extended the maturity date of debt instruments issued on November 30, 2004 until March 1, 2008, and amended the conversion price of the debt that is held by the Investors to the lower of (i) $0.0005 or (ii) 40% of the average of the three lowest intraday trading prices for the Company's common stock during the 20 trading days before, but not including, the conversion date. In addition, the exercise price of the warrants held by the Investors was amended to $.001 per share. 17 Digital Descriptor Systems, Inc. and Subsidiary Notes to the Condensed Consolidated Financial Statements (Unaudited) For the Three Months Ended March 31, 2006 and 2005 (Restated) Note 11 - Restatement We have restated the Financial Statements for the three months ended March 31, 2005. and. Based upon the guidance in SFAS133 and EITF00-19, the Company concluded that the conversion features of it convertible debentures were required to be accounted for as derivatives. The imbedded derivative feature was bi-furcated and the fair market value was determined using a convertible bond valuation model. The derivative instruments are recorded at fair market value with changes in value recognized during the period of change. The impact on the financial statements is summarized below. March 31, 2005 ---------------------------- As Reported As Restated ------------ ----------- Debt discount and deferred financing costs, net $ 889,544 376,113 Total Assets 6,899,025 6,385,594 Accumulated deficit (21,964,299) (28,395,813) Total Liabilities and Shareholders Deficit 6,899,025 6,385,594 Interest and amortization of deferred debt costs 457,531 898,286 Total Expenses 747,191 1,855,874 Net Loss (643,019) (1,751,701) Net loss per share (.01) (.01) 18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following is management's discussion and analysis of certain significant factors that will have affected our financial condition and results of operations. Certain statements under this section may constitute "forward-looking statements". The following discussion should be read in conjunction with our financial statements and notes thereto included in this report. RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THREE MONTHS ENDED MARCH 31, 2005 Revenues for the three months ended March 31, 2006 of $870,964 increased $722,089 or 485% from the three months ended March 31, 2005 (restated). DDSI generates its revenues through software licenses, hardware, post customer support arrangements and other services. The increase in DDSI's revenue is attributed to the purchase of CGM Applied Security Technology, Inc in March, 2005. Cost of revenue for the three months ended March 31, 2006 was $293,342 an increase of $248,640 or 556% from the three months ended March 31, 2005 (restated). The increase was attributable to the purchase of CGM Applied Security Technology, Inc in March 2005. Cost of revenue sold as a percentage of revenue for the three months ended March 31, 2006 was 34% of total revenues. Operating expenses increased $401,341 or 139% during the three months ended March 31, 2006 versus the three months ended March 31, 2005 (restated). This increase was mainly attributable to the purchase of CGM Applied Security Technology, Inc in March 2005. General and Administrative expenses for the three months ended March 31, 2006 were $618,892 compared $259,701 for the months ended March 31, 2005 (restated) for an increase of $359,191 or 138%. This increase was mainly attributable to the purchase of CGM Applied Security Technology, Inc in March 2005. Sales and Marketing expenses increased $19,474 for the three months ended March 31, 2006 from $25,332 in 2005 to 44,806 in 2006 or a 77% increase. This increase was mainly attributable to the purchase of CGM Applied Security Technology, Inc in March 2005. Research and development for the three months ended March 31, 2006 was $26,524 compared to $3,848 for the same period prior year for an increase of $22,676 or a 589% increase, which was due in part to the purchase of CGM Applied Security Technology, Inc in March 2005. The net (loss) for DDSI increased 8% for the three months ended March 31, 2006 to $(1,897,872) from $(1,751,701) for the three months ended March 31, 2005 (restated). This was primarily due to the increase in operating expenses. Net cash (used in) operating activities for the three months ended March 31, 2006 and the three months ended March 31, 2005 (restated) was ($195,102) and ($700,566), respectively. The increase in cash (used in) operating activities for the three months ended March 31, 2006 of $505,464. This increase was due in part to the purchase of CGM Applied Security Technology, Inc. in March 2005. Net cash provided by investing activities was $0 and ($1,500,000) for the three months ended March 31, 2006 and March 31, 2005 (restated), respectively. This increase was due in part to the purchase of CGM Applied Security Technology, Inc. in March 2005. Net cash provided by (used in) financing activities was $(0) and $(6,285) for the three months ended March 31, 2006 and the three months ended March 31, 2005, respectively. The increase in net cash provided by financing activities for the three months ended March 31, 2006 was $6,285. 19 LIQUIDITY AND CAPITAL RESOURCES DDSI's revenues have been insufficient to cover the cost of revenues and operating expenses. Therefore, DDSI has been dependent on private placements of its common stock and issuance of convertible notes in order to sustain operations. In addition, there can be no assurances that the proceeds from private or other capital will continue to be available, or that revenues will increase to meet DDSI's cash needs, or that a sufficient amount of DDSI's common stock or other securities can or will be sold or that any common stock purchase options/warrants will be exercised to fund the operating needs of DDSI. Over the next twelve months, management is of the opinion that sufficient working capital will be obtained from operations and external financing to meet DDSI's liabilities and commitments as they become payable. DDSI has in the past relied on private placements of common stock securities, and loans from private investors to sustain operations. However, if DDSI is unable to obtain additional funding in the future, it may be forced to curtail or terminate operations. At March 31, 2006, DDSI had assets of $5,906,944 compared to $6,385,594 on March 31, 2005 a decrease of ($478,650) and shareholder (deficit) of $(9,964,677) on March 31, 2006 compared to shareholder (deficiet) of $(8,702,413) on March 31, 2005, an increase of ($1,262,264). This increase in shareholder (deficit) for the three months ended March 31, 2006 resulted from the net loss for the three months ended March 31, 2006. Plan of Operations Acquisition of CGM On March 1, 2005, DDSI and CGM Sub acquired substantially all of the assets of CGM, for (i) $1,500,000 in cash and (ii) a 2.86% promissory note (the "Note") in the principal amount of $3,500,000, subject to adjustment (the "Acquisition"). The assets of CGM were acquired pursuant to an Asset Purchase Agreement among DDSI, CGM Sub and CGM dated as of February 25, 2005. The principal amount of the Note is subject to adjustment based upon the average of (i) the gross revenues of CGM Sub for the fiscal year ending December 31, 2007 and (ii) an independent valuation of CGM Sub based upon the consolidated audited financial statements of the Company and CGM Sub for the fiscal years ending December 31, 2006 and 2007. In addition, the Company has granted CGM a secondary security interest in substantially all of its assets and intellectual property. In connection with the Acquisition, the Company entered into a letter agreement with certain of its investors (the "Investors") which extended the maturity date of debt instruments issued on November 30, 2004 until March 1, 2008, and amended the conversion price of the debt that is held by the Investors to the lower of (i) $0.0005 or (ii) 60% of the average of the three lowest intraday trading prices for the Company's common stock during the 20 trading days before, but not including, the conversion date. In addition, the exercise price of the warrants held by the Investors was amended to $.001 per share. The short-term objective of DDSI is the following: The Company plans to spend the majority of it's time and efforts on increasing the revenue and marketplace of its wholly owned subsidiary, CGM Applied Security Technologies, as it feels that there is a much greater potential for growth of the product line of CGM. In order to accomplish this, the Company has hired additional sales people and is increasing its marketing budget in order to expand the awareness of CGM's product line. In addition, the Company has begun a complete revamping of the company's infrastructure in order to make it better able to respond to the need of its customers and to give management the reporting it needs on a timely basis. To continue to expand the sale and acceptance of its core solutions by offering new and synergistic biometric (a measurable, physical characteristic or personal behavioral trait used to recognize the identity, or verify the claimed identity, of an individual) (i.e. FMS) security products to its installed base in the criminal justice market. DDSI's objective is to expand with these, and additional products, into much larger commercial and federal markets. Additionally, DDSI plans to execute an acquisition strategy based upon the availability of financing. We also plan to add additional product lines as a Value Added Reseller. Technologies related to DDSI's core business can bring additional cash flow with relatively small internal development capital outlay. 20 DDSI's long-term objective is as follows: To enhance its sales of the product line acquired with the acquisition of CGM both domestically and internationally, though the addition of sales representative and distributors To seek additional products to sell into its basic business market - Criminal Justice - so that DDSI can generate sales adequate enough to allow for profits. New products include biometric devices such as FMS (Fingerprint Matching System) and our integrated digital image and fingerprint package, Identify on Demand. DDSI believes that it will not reach profitability until the year 2006. Over the next twelve months, management is of the opinion that sufficient working capital will be obtained from operations and external financing to meet DDSI's liabilities and commitments as they become payable. DDSI has in the past successfully relied on private placements of common stock securities, bank debt, loans from private investors and the exercise of common stock warrants in order to sustain operations. If DDSI is unable to obtain additional funding in the future, it may be forced to curtail or terminate operations. DDSI is doing the following in its effort to reach profitability: o The Company is putting a great deal of effort to increase the sales of the CGM subsidiary. The Company believes at this time that the most significant growth in revenue will come from CGM and its product lines. o Cutting costs in areas that add the least value to DDSI. o Deriving funds through investigating business alliances with other companies who may wish to license the FMS SDK (software developer's kit). o Increasing revenues through the introduction of Compu-Capture(R), specifically towards kindergarten through twelfth grades, for the creation of ID cards. o Increasing revenues through the introduction of a scaled down version of our Compu-Capture(R) product. o Increasing revenues through the addition of innovative technologies as a Value Added Seller. o Acquiring and effectively adding management support to profitable companies complementary to its broadened target markets. Liquidity and Capital Resources We had net losses of ($1,897,872) and ($1,751,701) during the three months ended March 31, 2006 and 2005, respectively. As of March 31, 2006, we had a cash balance in the amount of $100,709 and current liabilities of $10,859,676. The total amount of notes payable and debentures is $7,053,869. We may not have sufficient cash or other assets to meet our current liabilities. In order to meet these obligations, we may need to raise cash from the sale of securities or from borrowings. The Company's revenues have been insufficient to cover the cost of revenues and operating expenses. Therefore, the Company has been dependent on private placements of its Common Stock and issuance of convertible notes in order to sustain operations. In addition, there can be no assurances that the proceeds from private placements or other capital will continue to be available, or that revenues will increase to meet the Company's cash needs, or that a sufficient amount of the Company's Common Stock or other securities can or will be sold or that any Common Stock purchase options/warrants will be exercised to fund the operating needs of the Company. The Company has contractual obligations of $8,436,605 as of March 31, 2006. These contractual obligations, along with the dates on which such payments are due are described below: One Year More Than Contractual Obligations Total or Less One Year - ----------------------- ------------ ------------ ------------ Due to Related Parties $ 0 $ 0 $ 0 Accounts Payable and Accrued Expenses 576,051 576,051 0 Accrued interest on loans 806,685 806,685 0 Note payable 3,500,000 0 3,500,000 Convertible Debentures 3,553,869 2,042,124 1,511,745 Total Contractual Obligations $ 8,436,605 $ 3,424,860 $ 5,011,745 21 The Company is currently in default on several of the convertible debentures that are included in current liabilities. Below is a discussion of our sources and (uses) of funds for the three months ended March 31, 2006 and 2005 (restated), respectively. Off Balance Sheet Arrangements We do not have any off balance sheet arrangements as of March 31, 2006 or as of the date of this report. Item 3. Control and Procedures (a) Evaluation of Disclosure Controls and Procedures As of March 31, 2006, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in our periodic reports is recorded, processed, summarized and reported, within the time periods specified for each report and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. (b) Changes in Internal Controls. There was no change in our internal controls over financial reporting that has materially affected, or is reasonable likely to materially affect, our internal control over financial reporting during the quarter covered by this Report. PART II. OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities: The Company is in default of $1,733,478 of outstanding debentures. Although the debenture holders have not pursued their rights under such debentures, there can be no assurances that such rights will not be exercised. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits 4.1 Security Agreement dated February 25, 2005 by and between CGM Applied Security Technologies, Inc. and CGM Security Solutions, Inc. (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 4.2 Intellectual Property Security Agreement dated February 25, 2005 by and between CGM Applied Security Technologies, Inc and CGM Security Solutions, Inc. (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 4.3 Letter Agreement, by and among the Company, AJW Partners, LLC, New Millennium Capital Partners II, LLC, AJW Offshore, Ltd. and AJW Qualified Partners, LLC, dated January 31, 2005 (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 4.4 2.86% Secured Convertible promissory Note in the name of CGM Security Solutions, Inc. dated February 25, 2005 (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 10.1 Asset Purchase Agreement dated February 25, 2005 by and among the Company, CGM Applied Security Technologies, Inc. and CGM Applied Security Solutions. (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 10.2 Employment Agreement, dated February 25, 2005, by and among the Company, CGM Applied Security Technologies, Inc. and CGM Security Solutions, Inc. and Eric Hoffer (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 10.3 Employment Agreement dated February 25, 2005 by and among the Company and Anthony Shupin (incorporated herein by reference to the Current Report on Form 8-K, dated April 15, 2005) 10.4 Employment Agreement dated February 25, 2005 by and among the Company and Michael J. Pellegrino (incorporated herein by reference to the Current Report on Form 8-K, dated April 15, 2005) 31.1 Certification by Chief Executive Officer pursuant to Sarbanes-Oxley Section 302 31.2 Certification by Chief Financial Officer pursuant to Sarbanes-Oxley Section 302 32.1 Certification by Chief Executive Officer pursuant to 18 U.S.C., Section 1350 32.2 Certification by Chief Financial Officer pursuant to Sarbanes-Oxley Section 1350 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DIGITAL DESCRIPTOR SYSTEMS, INC. (Registrant) Date: May 17, 2006 By: /s/ ANTHONY SHUPIN --------------------------------------- Anthony Shupin (President, Chief Executive Officer) (Chairman) Date: May 17, 2006 By: /s/ MICHAEL J. PELLEGRINO --------------------------------------- Michael J. Pellegrino Senior Vice President & CFO (Director) 23 EX-31.1 2 v043308_ex31-1.txt EXHIBIT 31.1 DIGITAL DESCRIPTOR SYSTEMS, INC. OFFICER'S CERTIFICATE PURSUANT TO SECTION 302 I, Anthony Shupin, the Chairman, President, and Chief Executive Officer, of Digital Descriptor Systems, Inc., certify that: 1) I have reviewed this Form 10-QSB of Digital Descriptor Systems, Inc. for the three months ended March 31, 2006; 2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4) The small business issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e for the small business issuer and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer is made known to us by other within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and 5) The small business issuer's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design of operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. Date: May 17, 2006 /s/ Anthony Shupin ------------------------------------- Anthony Shupin President and Chief Executive Officer EX-31.2 3 v043308_ex31-2.txt EXHIBIT 31.2 DIGITAL DESCRIPTOR SYSTEMS, INC. OFFICER'S CERTIFICATE PURSUANT TO SECTION 302 I, Michael Pellegrino, the Chief Financial Officer, of Digital Descriptor Systems, Inc., certify that: (1) I have reviewed this Form 10-QSB of Digital Descriptor Systems, Inc. for the three months ended March 31,2006; (2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; (3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; (4) The small business issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e for the small business issuer and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer is made known to us by other within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and (5) The small business issuer's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design of operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. Date: May 17, 2006 /s/ Michael Pellegrino ------------------------------------- Michael Pellegrino Chief Financial Officer EX-32.1 4 v043308_ex32-1.txt EXHIBIT 32.1 DIGITAL DESCRIPTOR SYSTEMS, INC. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Digital Descriptor Systems, Inc. (the "Company") on Form 10-QSB for the period ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Anthony Shupin, Chairman, President, and Chief Executive Officer, of the Company, certify, pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Quarterly Report on Form 10-QSB of the Company fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. A signed original of this written statement required by Section 906 has been provided to Digital Descriptor Systems, Inc. and will be retained by Digital Descriptor Systems, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. Date: May 17, 2006 /s/ Anthony Shupin ------------------------------------- Anthony Shupin President and Chief Executive Officer EX-32.2 5 v043308_ex32-2.txt EXHIBIT 32.2 DIGITAL DESCRIPTOR SYSTEMS, INC. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Digital Descriptor Systems, Inc. (the "Company") on Form 10-QSB for the period ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Michael Pellegrino, Chief Financial Officer, of the Company, certify, pursuant to 18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Quarterly Report on Form 10-QSB of the Company fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. A signed original of this written statement required by Section 906 has been provided to Digital Descriptor Systems, Inc. and will be retained by Digital Descriptor Systems, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. Date: May 17, 2006 /s/ Michael Pellegrino ------------------------------------- Michael Pellegrino Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----