SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-16730
MSGI SECURITY SOLUTIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Nevada 88-0085608
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
575 Madison Avenue
New York, New York 10022
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (917) 339-7134
_____________________________________________________
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes __ No X_
APPLICABLE ONLY TO CORPORATE ISSUERS State number of shares outstanding of each
of the issuer's classes of common equity as of the latest practical date: As of
May 6, 2005 there were 3,731,878 shares of the Issuer's Common Stock, par value
$.01 per share outstanding.
1
MSGI SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
FORM 10-Q REPORT
MARCH 31, 2005
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
March 31, 2005 (unaudited) and June 30, 2004 3
Condensed Consolidated Statements of Operations for the
three and nine months ended March 31, 2005 and 2004 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended March 31, 2005 and 2004 (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 12-18
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 19
Item 4. Controls and Procedures. 20
PART II- OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 21
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits 22
SIGNATURES 23
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
MSGI SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2005 June 30, 2004
--------------- -------------
(Unaudited) (1)
ASSETS
Current assets:
Cash and cash equivalents $ 1,770,580 $ 2,548,598
Stock subscription receivable -- 600,000
Inventory 264,352 --
Other current assets 261,671 208,293
--------- ---------
Total current assets 2,296,603 3,356,891
========= =========
Investment in Excelsa S.p.A 3,996,695 --
Goodwill 490,000 490,000
Intangible assets, net 228,080 --
Property and equipment, net 218,141 5,130
Note receivable 300,000 300,000
Related party note receivable 1,172,260 1,120,013
Other assets 22,700 15,700
--------- ---------
Total assets $ 8,724,479 $ 5,287,734
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable-trade 746,431 381,722
Accrued expenses and other current liabilities 484,394 748,603
Note payable - shareholder -- 500,000
Net liabilities of discontinued operations -- 130,742
--------- ---------
Total current liabilities 1,230,825 1,761,067
Other liabilities 934,144 1,070,570
--------- ---------
Total liabilities 2,164,969 2,831,637
Minority interest in subsidiary -- 255,517
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock - $.01 par value; 18,750 shares authorized;
9,375 shares of Series F issued and outstanding (liquidation
preference $3,070,027) 94 --
Common stock - $.01 par value; 9,375,000 shares authorized; 3,749,540 and
3,060,186 shares issued; 3,731,878 and 3,042,524 shares outstanding as of
March 31, 2005 and June 30, 2004, respectively 37,495 30,602
Additional paid-in capital 232,631,133 222,642,710
Deferred compensation (1,598,565) --
Accumulated deficit (223,116,937) (219,079,022)
Less: 17,662 shares of common stock in treasury, at cost (1,393,710) (1,393,710)
--------- ---------
Total stockholders' equity 6,559,510 2,200,580
--------- ---------
Total liabilities and stockholders' equity $ 8,724,479 $ 5,287,734
========= =========
(1) Derived from the Audited Consolidated Financial Statements for the year ended June 30, 2004.
See Notes to Condensed Consolidated Financial Statements.
3
MSGI SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED
MARCH 31, 2005 AND 2004
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
2005 2004 2005 2004
Revenues $ 346,500 $ -- $ 496,500 $ --
Cost of goods sold 130,354 -- 162,808 --
----------- ----------- ----------- -----
Gross Profit 216,146 -- 333,692 --
----------- ----------- ----------- -----
Operating costs and expenses:
Research and development 65,155 -- 140,339 --
Salaries and benefits 482,694 91,808 1,238,951 262,707
Non cash compensation 1,241,585 -- 1,477,471 --
Selling, general and administrative 569,943 261,366 1,685,353 873,566
Depreciation and amortization 60,236 -- 81,158 --
Gain on termination of lease -- -- (70,300) --
--------- ------- --------- ----------
Total operating costs and expenses 2,419,613 353,174 4,552,972 1,136,273
--------- ------- --------- ----------
Loss from operations (2,203,467) (353,174) (4,219,280) (1,136,273)
Other income (expense):
Interest income 30,790 17,405 77,540 52,614
Interest expense (17,305) -- (51,947) (20,040)
--------- ------- --------- ----------
Total other income 13,485 17,405 25,593 32,574
Minority interests in subsidiaries -- -- 255,517 --
Loss from continuing operations
before provision for income taxes (2,189,982) (335,769) (3,938,170) (1,103,699)
Provision for income taxes (3,000) (23,299) (9,000) (29,229)
--------- ------- --------- ----------
Loss from continuing operations (2,192,982) (358,998) (3,947,170) (1,132,928)
Discontinued operations:
Loss from discontinued operations (20,641) (1,209,577) (90,745) (234,409)
Loss from disposal of discontinued operations -- (981,016) -- (981,016)
--------- ------- --------- ----------
Loss from discontinued operations (20,641) (2,190,593) (90,745) (1,215,425)
Net loss (2,213,623) (2,549,591) (4,037,915) (2,348,353)
Undeclared dividends on preferred stock (70,027) -- (70,027) --
Gain on redemption of preferred stock of
discontinued subsidiary -- -- -- 280,946
--------- ------- --------- ----------
Net loss attributable to
common stockholders $(2,283,650) $(2,549,591) $(4,107,942) $(2,067,407)
========== ========== ========== ===========
Basic earnings (loss) per share:
Continuing operations $ (0.61) $ (0.17) $ (1.19) $ (0.39)
Discontinued operations (0.00) (1.00) (0.03) (0.56)
--------- ------- --------- ----------
Basic earnings (loss) per share $ (0.61) $ (1.17) $ (1.22) $ (0.95)
Weighted average common shares outstanding- basic 3,731,878 2,184,734 3,364,766 2,184,734
Diluted earnings (loss) per share:
Continuing operations $ (0.61) $ (0.17) $ (1.19) $ (0.39)
Discontinued operations (0.00) (1.00) (0.03) (0.56)
--------- ------- --------- ----------
Diluted earnings (loss) per share $ (0.61) $ (1.17) $ (1.22) $ (0.95)
Weighted average common shares outstanding- diluted 3,731,878 2,184,734 3,364,766 2,184,734
========== ========== ========== ===========
See Notes to Condensed Consolidated Financial Statements.
4
MSGI SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED MARCH 31, 2005 AND 2004
(unaudited)
2005 2004
-------------- ------------
Operating activities:
Net loss $ ( 4,037,915) $(2,348,353)
Loss from discontinued operations 90,745 1,215,425
-------------- ------------
Loss from continuing operations (3,947,170) (1,132,928)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 81,158 --
Non cash compensation 1,477,471 --
Gain from termination of lease (70,300) --
Minority interest in subsidiary (255,517) --
Changes in assets and liabilities:
Inventory (264,352) --
Other current assets (104,780) (171,960)
Other assets (7,000) --
Accounts payable - trade 364,709 160,376
Accrued expenses and other liabilities (330,334) (288,100)
-------------- ------------
Net cash used in operating activities of continuing operations (3,056,115) (1,432,612)
Net cash used in operating activities of discontinued operations (221,487) (116,239)
-------------- ------------
Net cash used in operating activities (3,277,602) (1,548,851)
Investing activities:
Proceeds from the sale of discontinued operations, net of fees -- 2,834,388
Purchase of investment in Excelsa S.p.A (3,996,695) --
Purchases of property and equipment (234,962) --
Increase in related party note receivable (52,247) (52,065)
-------------- ------------
Net cash from (used in) investing activities (4,283,904) 2,782,323
Financing activities:
Proceeds from issuance of preferred shares, net of issuance costs 2,746,819 --
Proceeds from issuance of common stock, net of issuance costs 3,816,669 --
Proceeds from exercise of stock options 720,000 --
Repayment of related party note payable (500,000) --
Repayments of long-term debt -- (200,054)
-------------- ------------
Net cash provided by (used in) financing activities
of continuing operations 6,783,488 (200,054)
Net cash used in financing activities of discontinued operations -- (249,097)
-------------- ------------
Net cash provided by (used in) financing activities 6,783,488 (449,151)
Net increase (decrease) in cash and cash equivalents (778,018) 784,321
Cash and cash equivalents at beginning of period 2,548,598 660,742
-------------- ------------
Cash and cash equivalents at end of period $ 1,770,580 $ 1,455,063
============= ============
See Notes to Condensed Consolidated Financial Statements.
5
MSGI SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited Condensed Consolidated Financial Statements include
the accounts of MSGI Security Solutions, Inc. (formerly known as Media Services
Group, Inc.) and its Subsidiaries, Future Developments America, Inc ("FDA") and
Innalogic, LLC ("Innalogic") (in combination "MSGI" or the "Company"). These
condensed consolidated financial statements are unaudited and should be read in
conjunction with the Company's Annual Report on Form 10-K, as amended, for the
fiscal year ended June 30, 2004 and the historical consolidated financial
statements and related notes included therein. In the opinion of management, the
accompanying unaudited condensed consolidated financial statements include all
adjustments, consisting of only normal recurring accruals, necessary to present
fairly the condensed consolidated financial position, results of operations and
cash flows of the Company. Certain information and footnote disclosure normally
included in financial statements prepared in conformity with generally accepted
accounting principles have been condensed or omitted pursuant to the Securities
and Exchange Commission's rules and regulations. Operating results for the
nine-month period ended March 31, 2005 are not necessarily indicative of the
results that may be expected for the fiscal year ending June 30, 2005. Certain
reclassifications have been made in the fiscal 2004 financial statements to
conform to the fiscal 2005 presentation.
On February 7, 2005, the Company held its Annual Meeting for the fiscal year
ended June 30, 2004. At this meeting, shareholders approved, by proxy vote, the
change of name for the Company to MSGI Security Solutions, Inc. The name change
became effective on February 9, 2005.
Liquidity:
The Company has limited capital resources and has incurred significant
historical losses and negative cash flows from operations. The Company believes
that funds on hand and funds available from its remaining operations should be
adequate to finance its operations and capital expenditure requirements for the
next twelve months. As explained in Note 6, the Company recently sold off
substantially all the assets relating to its telemarketing and teleservices
operations held by certain of its wholly owned subsidiary, MKTG Teleservices,
Inc. As explained in Notes 4 and 13, the Company has recently engaged in the
private placement sale of shares of both Common Stock and Series F Convertible
Preferred Stock which have raised significant working capital. The Company has
also acquired holdings in two operating entities, FDA (51%) and Innalogic (51%),
both of which are expected to produce revenues in future periods. In addition,
the Company has instituted cost reduction measures, including the reduction of
workforce and corporate overhead. The Company believes, based on expected
performance as well as the reduced corporate overhead, that its recently
acquired operations should generate sufficient future cash flow to fund
operations. Failure of the new operations to generate such sufficient future
cash flow could have a material adverse effect on the Company's ability to
continue as a going concern and to achieve its business objectives. The
accompanying financial statements do not include any adjustments relating to the
recoverability of the carrying amount of recorded assets or the amount of
liabilities that might result should the Company be unable to continue as a
going concern.
2. SUMMARY OF SIGNIFICANT POLICIES
Revenue Recognition:
The Company accounts for revenue recognition in accordance with Staff Accounting
Bulletin No. 104, ("SAB 104"), which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements. Revenues will be
reported for the operations of Future Developments America, Inc. and for
Innalogic, LLC upon the completion of a transaction that meets the following
criteria of SAB 104 when (1) persuasive evidence of an arrangement exists; (2)
delivery of our services has occurred; (3) our price to our customer is fixed or
determinable; and (4) collectibility of the sales price is reasonably assured.
6
Intangible Assets:
Intangible assets consist of unpatented technology, which is being amortized on
a straight-line basis over three years. The Company reviews the value of its
intangible assets for impairment whenever events or changes in business
circumstances indicate that the carrying amount of the assets may not be fully
recoverable or that the useful lives are no longer appropriate.
Research and Development Costs:
The Company recognizes research and development costs associated with product
development in its Future Developments America, Inc. subsidiary. All research
and development costs are expensed in the period incurred. Such expense was
$140,339 for the period ended March 31, 2005. There was no such expense in the
same period in the previous year.
Income Taxes:
The Company recognizes deferred taxes for differences between the financial
statement and tax bases of assets and liabilities at currently enacted statutory
tax rates and laws for the years in which the differences are expected to
reverse. The effect on deferred taxes of a change in tax rates is recognized in
income in the period that includes the enactment date. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized.
Use of Estimates:
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. The most significant estimates and assumptions made
in the preparation of the consolidated financial statements relate to the
carrying amount of goodwill, deferred tax valuation allowance, abandoned lease
reserves and deferred non-cash compensation. Actual results could differ from
those estimates.
Stock Based Compensation:
The accompanying financial position and results of operations for the Company
have been prepared in accordance with APB Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB No. 25"). Under APB No. 25, compensation cost is
measured as the amount by which the market price of the underlying stock exceeds
the exercise price of the stock option at the date at which both the number of
options granted and exercise price are known.
The Company has elected the disclosure only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). Stock based awards to
non-employees are accounted for under the provisions of SFAS 123.
In accordance with FASB Statement No. 148, "Accounting for Stock Based
Compensation - Transition and Disclosure", the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
FASB Statement No. 123, "Accounting for Stock Based Compensation", to
stock-based employee compensation is as follows:
7
Three months ended March 31, Nine months ended March 31,
2005 2004 2005 2004
Net loss available to common ----------- ----------- ----------- -----------
stockholders as reported $(2,283,650) $(2,549,591) $(4,107,942) $(2,067,407)
Add:
Stock based employee compensation expense
included in reported net loss 1,241,585 -- 1,241,585 --
----------- ---------- ---------- -----------
Subtotal (1,042,065) (2,549,591) (2,866,357) (2,067,407)
Less:
Stock-based employee compensation
expense determined under the fair value
method for all awards (1,416,089) (4,823) (1,508,620) (4,823)
----------- ---------- ---------- -----------
Pro forma net loss available
to common stockholders $(2,458,154) $(2,554,414) $(4,374,977) $(2,072,230)
=========== =========== =========== ============
Loss per share:
Basic loss per share - as reported $(0.61) $(1.17) $(1.22) $(0.95)
=========== =========== =========== ============
Basic loss per share - pro forma $(0.66) $(1.17) $(1.30) $(0.95)
=========== =========== =========== ============
Diluted loss per share - as reported $(0.61) $(1.17) $(1.22) $(0.95)
=========== =========== =========== ============
Diluted loss per share - pro forma $(0.66) $(1.17) $(1.30) $(0.95)
=========== =========== =========== ============
The Company has granted 445,000 options to employees and directors during the
nine months ended March 31, 2005. Of these options, 82,500 options were granted
at an exercise price equal to the market price on date of grant and do not begin
to vest until July 2005 and vest ratably over a three year period. The Company
approved 342,500 options to purchase shares of common stock at an exercise price
of $1.50, pending shareholder approval of an increase to the number of options
available under the 1999 Stock Option Plan and 20,000 options to purchase
shares of common stock at an exercise price of $4.125, pending shareholder
approval of an increase to the number of options available under the 1999 Stock
Option Plan. The shareholders approved an increase to the 1999 Plan of 1 million
shares on February 7, 2005. Upon shareholder approval, the 362,500 stock options
were granted on February 7, 2005, at which the market price of the stock was
$9.48. Due to the difference in market and exercise price, the Company recorded
a deferred compensation expense at the date of grant of approximately $2.8
million, which is being amortized over the related service period. For the
period ended March 31, 2005, the Company realized non-cash employee compensation
expense related to the stock options granted of approximately $1.2 million. The
fair value of each stock option is estimated on the date of grant using the
Black-Scholes option-pricing model. Pro forma compensation cost for stock
options under SFAS No. 123 is recognized over the service period. Previously
recognized pro forma compensation cost is not to be reversed if a vested
employee option expires unexercised. The Company stops recognizing pro forma
compensation cost when an option is fully vested. The weighted average
assumptions used to value employee stock-based compensation for stock option
grants were as follows:
Nine months ended
March 31, 2005 March 31,2004
Risk -free interest rate 4.00% 4.00%
Expected option life vesting period+ four years vesting period + four years
Dividend yield None None
Volatility 152% - 163% 160%
Weighted average fair value $17.39 $2.90
8
Recent Accounting Pronouncements:
SFAS 123(R): Share-Based Payment In December 2004, the FASB issued Statement of
Financial Accounting Standards ("SFAS") No. 123 Revised 2004, "Share-Based
Payment". This Statement requires that the cost resulting from all share-based
payment transactions are recognized in the financial statements of the Company.
That cost will be measured based on the fair market value of the equity or
liability instruments issued. SFAS 123(R) is effective at the beginning of the
first annual reporting that ends after June 15, 2005. This Statement will be
effective for the Company's first quarter of the fiscal year ended June 30,
2006. Management believes it will have an impact due to the Company's use of
options as employee incentives, but has not yet determined the impact.
FASB 151: Inventory Costs In November 2004, the Financial Accounting Standards
Board ("FASB") issued Statement No. 151, which revised ARB No. 43, relating to
inventory costs. This revision is to clarify the accounting for abnormal amounts
of idle facility expense, freight, handling costs and wasted material or
"spoilage". This statement requires that these items be recognized as a current
period charge regardless of whether they meet the criterion specified in ARB No.
43. In addition, this Statement requires the allocation of fixed production
overheads to the costs of conversion be based on normal capacity of the
production facilities. This Statement is effective for the fiscal years
beginning after June 15, 2005. Earlier application is permitted for inventory
costs incurred during fiscal years beginning after the date of issuance of this
Statement. Management believes that this Statement will have no impact on the
financial statements of the Company once adopted.
3. EARNINGS PER SHARE
On February 8, 2005, the Company announced that its Board of Directors approved
a two-for-one common stock split. The stock split was effective March 9, 2005.
Par value of the common stock remained at $0.01 per share and the number of
authorized shares of common stock remained at 9,375,000 shares. The effect of
the stock split has been reflected in the balance sheets and in all the share
and per share data in the accompanying consolidated financial statements and
Notes to Financial Statements. Stockholders' equity accounts have been
retroactively adjusted to reflect the reclassification of an amount equal to the
par value of the increase in issued common shares from paid-in-capital to the
common stock account.
Common share equivalents included in weighted average shares outstanding -
diluted for the periods ending March 31, 2005 and 2004:
2005 2004
Three Months Nine Months Three Months Nine Months
Weighted average common shares outstanding - basic 3,731,878 3,364,766 2,184,734 2,184,734
Common stock equivalents for options and warrants -- -- -- --
--------- --------- --------- ---------
Weighted average common shares outstanding - diluted 3,731,878 3,364,766 2,184,734 2,184,734
========= ========= ========= =========
Stock options and warrants in the amount of 1,345,804 and 917,714 shares and
preferred stock convertible into 461,538 and 0 shares of common stock were not
included in the computation of diluted earnings per share, as they are
anti-dilutive as a result of net losses for the three and nine months ended
March 31, 2005 and 2004, respectively.
4. EQUITY TRANSACTIONS
9
On November 10, 2004, the Company entered into a private placement agreement
with certain strategic investors in which the Company sold an aggregate of 9,375
shares of Series F Convertible Preferred Stock, par value $.01 ("Series F
Preferred Stock") and warrants to acquire 230,764 shares of common stock for
gross proceeds of $3 million. The preferred stock is convertible into shares of
common stock, at any time at the option of the holder, at a conversion rate of
$6.50. The holders of Series F Preferred Stock are entitled to receive
cumulative dividends at the rate of six percent (6%) payable in additional
shares of common stock of the Company, based on the average closing price per
share of the Company's common stock for the ten (10) consecutive trading days
prior to the payment of any dividend. As of March 31, 2005, the Company had
$70,027 of undeclared but accumulated dividends. Further, registration rights of
the holders of Series F Preferred Stock call for a registration statement to be
filed by the Company with the Securities and Exchange Commission, covering the
resale of the shares of the Company's common stock underlying the Series F
Preferred Shares (the "Reserved Shares"), within 180 days of the initial closing
date, November 10, 2004. In the event that the Company does not file such
registration statement within 180 days, the Company shall issue to the holders
additional shares of Series F Preferred Shares equal to 5% of the number of
Reserved Shares issued in the private placement, for each 30 day period,
following the 180 day period, during which such registration statement has not
been filed. Subsequently, as of May 10, 2005, no registration statement has been
filed by the Company for the Reserved Shares, therefore the Company is committed
to issue an additional 468.75 Series F Preferred Stock, which is convertible in
approximately 23,077 shares of common stock. There are no reset provisions or
anti-dilution provisions associated with the Series F Convertible Preferred
Stock. In the event of liquidation, holders of this stock are entitled to
receive the stated value plus the amount of any accrued and unpaid dividends at
that date. Preferred stockholders are entitled to common stockholder voting
rights in an amount equal to the common stock equivalent of the preferred shares
as if converted. The warrants are exercisable for a period of five years at an
exercise price of $8.125 per share. Placement fees and expenses associated with
the issuance of the Series F Preferred Stock were approximately $253,200. In
addition, the Company issued warrants to placement agents to acquire 27,692
shares of common stock at an exercise price of $6.50, exercisable for a period
of five years.
On December 30, 2004 the Company entered into a private placement offering to
certain strategic investors for the sale of 419,354 shares of the Company's
common stock at a price of $7.75 per share for gross proceeds of $3.25 million.
In connection with the offering, the Company issued warrants to purchase 209,686
shares of common stock at an exercise price per share of $8.25 exercisable for a
five-year period. The investors have "piggyback" registration rights with
respect to the shares of common stock and the common stock issuable upon the
exercise of the warrants. Placement fees and expenses associated with this
offering were approximately $215,700. In addition, the Company issued warrants
to placement agents to acquire 25,162 shares of common stock at an exercise
price of $7.75 exercisable for a period of five years.
During the year ended June 2004, the Company entered into definitive agreements
with certain strategic European investors for a private placement of an
aggregate of 500,000 shares of common stock to be sold at a price of $4.00 per
share for gross proceeds of approximately $2.0 million. The Company also agreed
to issue to the investors, and third party affiliates, warrants to purchase an
additional 300,000 shares of common stock at a price of $6.00 per share under a
three-year term. As of June 30, 2004, $1.8 million of the total $2.0 million was
closed with $1.2 million funded and $0.6 million recorded as a stock
subscription receivable. The payment for the stock subscription receivable was
received in July 2004. The final subscription of $0.2 million was closed and
funded in July 2004.
5. INVESTMENTS
10
On December 1, 2004, the Company entered into a Subscription Agreement with
Excelsa S.p.A. ("Excelsa"), a corporation organized under the laws of the
Republic of Italy, to acquire 66,632 shares of common stock of Excelsa, par
value of 1.0 Euro per share, representing 4.5% of the issued and outstanding
shares of common stock of Excelsa on a fully diluted basis. MSGI acquired the
Common Stock for an aggregate purchase price of $1,751,319, including
approximately $84,000 of acquisition costs.
On January 3, 2005, the Company entered into an additional Subscription
Agreement with Excelsa S.p.A. ("Excelsa"), a corporation organized under the
laws of the Republic of Italy, to acquire an additional 135,381 shares of common
stock of Excelsa, par value of 1.0 Euro per share, for a purchase price of
approximately $2.0 million dollars, representing 8.4% of the issued and
outstanding shares of common stock of Excelsa on a fully diluted basis. The
shares acquired, in the aggregate with the original shares acquired in December
2004 (Note 5), represent 12.5% of the issued and outstanding shares of Common
Stock of Excelsa on a fully diluted basis. Excelsa has represented to the
Company that it will not solicit, initiate, consider, encourage or accept any
other proposals or offers from any person relating to any acquisition or
purchase of all or any portion of the capital stock or assets of Excelsa or any
of its subsidiaries nor will it enter into any merger, consolidation, business
combination, recapitalization, reorganization or other extraordinary business
transaction involving or related to Excelsa or any of its subsidiaries for the
period from the date of execution of the subscription agreement through December
31, 2005. As the Company has less than 20% ownership interest in Excelsa and
does not have the ability to exercise significant influence over Excelsa, this
investment is accounted for under the cost method.
6. DISCONTINUED OPERATIONS
In March 2004, the Company completed the sale of substantially all of the assets
relating to its telemarketing and teleservices business held by its wholly owned
subsidiary, MKTG Teleservices, Inc., ("MKTG Teleservices") to SD&A Teleservices,
Inc., a wholly owned subsidiary of the Robert W. Woodruff Arts Center, Inc. for
approximately $2.5 million in cash and a note receivable for $0.3 million plus
the assumption of certain directly related liabilities. As such, the operations
and cash flows of MKTG Teleservices have been eliminated from ongoing operations
and the Company no longer has continuing involvement in the operations. Loss
from discontinued operations of approximately $91,000 during the period ended
March 31, 2005 are the result of trailing fees associated with the divestiture
of the discontinued operations and with certain legal settlements pertaining to
the discontinued operations.
7. ACQUISITIONS
On August 18, 2004, the Company completed an acquisition of a 51% membership
interest in Innalogic, LLC, for an aggregate capital contribution of $1,000,000,
pursuant to definitive agreements entered into as of August 18, 2004. Further,
subject to the terms and conditions of an Investment Agreement, the Company
issued an aggregate of 50,000 unregistered shares of its common stock to
Innalogic. These shares were subsequently distributed to the founding members of
Innalogic and were recorded as non-cash compensation in the amount of $235,886
in the period ended September 30, 2004. The Company also issued 50,000
unregistered shares of common stock to certain advisors as compensation for
services rendered in connection with the completion of this transaction. As set
forth in Innalogic's Amended and Restated Limited Liability Company Agreement,
the Company may obtain up to an additional 25% membership interest in Innalogic,
if certain pre-tax income targets are not met by certain target dates.
8. GOODWILL AND OTHER INTANGIBLE ASSETS
In connection with the acquisition of Innalogic (Note 7), intangible assets
related to unpatented technologies totaling $287,288 were acquired. The gross
carrying amount and accumulated amortization of the Company's intangible assets
as of March 31, 2004 are as follows:
11
March 31, 2005 March 31, 2004
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
Amortized intangible assets
Unpatented technology $ 287,288 $ 59,208 $ - $ -
Amortization expense recorded for the three and nine months ended March 31, 2005
was $59,208. The estimated remaining amortization expense is as follows:
Fiscal Year
2005 (remaining three months) $23,900
2006 95,800
2007 95,800
2008 12,600
9. GAIN ON TERMINATION OF LEASE
In July 2004, the Company successfully negotiated an early termination of a
lease for a certain abandoned property. The agreement resulted in a gain on
early termination of $70,300 in the nine month period ended March 31, 2005.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Special Note Regarding Forward-Looking Statements Some of the statements
contained in this Report on Form 10-Q discuss our plans and strategies for our
business or state other forward-looking statements, as this term is defined in
the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the Company,
or industry results to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. Such factors include, among others, the following: general economic
and business conditions; industry capacity; direct marketing and other industry
trends; demographic changes; competition; the loss of any significant customers;
changes in business strategy or development plans; availability and successful
integration of acquisition candidates; availability, terms and deployment of
capital; advances in technology; retention of clients not under long-term
contract; quality of management; business abilities and judgment of personnel;
availability of qualified personnel; changes in, or the failure to comply with,
government regulations; and technology costs.
Introduction
This discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity/cash flows of the Company
for the three-month and nine-month periods ended March 31, 2005 and 2004. This
should be read in conjunction with the financial statements, and notes thereto,
included in this Report on Form 10-Q and the Company's financial statements and
notes thereto, included in the Company's Annual Report on Form 10-K, as amended,
for the year ended June 30, 2004.
Financial Reporting Release No. 60 requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. The following is a brief description of the more
significant accounting policies and methods used by the Company.
12
Revenue Recognition: The Company accounts for revenue recognition in accordance
with the Securities and Exchange Commission's Staff Accounting Bulletin No. 104,
("SAB 104"), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements.
Revenues will be reported for the operations of Future Developments America,
Inc. and for Innalogic, LLC upon the completion of a transaction that meets the
following criteria of SAB 104 when (1) persuasive evidence of an arrangement
exists; (2) delivery of our services has occurred; (3) our price to our customer
is fixed or determinable; and (4) collectibility of the sales price is
reasonably assured.
FDA recognized no revenues during the period ended March 31, 2005.
Revenues derived from the operations of Innalogic, from the sale of equipment
and the provision of supporting services if requested by the customer, are
realized upon shipment or delivery of the product and/or upon the services being
provided and completed.
Goodwill and Intangible Assets:
Under Statement of Financial Accounting Standards ("SFAS"), No. 142, "Goodwill
and Other Intangible Assets", goodwill is no longer amortized. The Company
performs an annual impairment test to determine if there is any impairment of
goodwill. The current goodwill of $490,000 resulted from the Company's
acquisition of FDA during in April 2004. The Company has not yet performed an
annual impairment test related to this amount since the acquisition was recent,
but an impairment test will be performed during the fourth quarter of fiscal
2005.
Intangible assets of approximately $287,000 were acquired during the period
ended March 31, 2005 in connection with the acquisition of Innalogic. These
assets are amortized over a period of three years. The carrying value of
intangible assets subject to amortization will be evaluated for impairment
whenever changes in circumstances indicate that the carrying value may not be
recoverable. In determining recoverability, the Company assesses whether the
carrying value exceeds the undiscounted cash flows associated with the
intangible assets. If exceeded, the Company would then evaluate whether an
impairment charge is required by determining if the asset's carrying value also
exceeds its fair value. An impairment loss would be recognized for the excess of
the carrying amount over the fair value. The Company would estimate the fair
value based on the projected discounted future cash flows associated with the
intangible assets. Significant management judgments and estimates are required
and used in the forecasts of future operating results that are used in the
discounted cash flow method of valuation, including: the sales volume forecast
and selling price evolution, our market penetration, the market acceptance of
our technologies and costs evaluation. Our evaluations are based on financial
plans updated with the latest available projections from Innalogic and the sales
expectations and are consistent with the plans and estimates that we use to
manage our business. It is possible, however, that the plans and estimates used
may be incorrect and that future adverse changes in market conditions or
operating results of Innalogic may not be in line with the estimates and may
therefore require impairment of these intangible assets. At March 31, 2005, the
Company recognized amortization expenses of approximately $59,000, representing
amortization of the intangible assets from date of acquisition through March 31,
2005 and the remaining value of intangible assets subject to amortization
amounted to approximately $228,000
Long-Lived Assets: In accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", the Company reviews for impairment
of long-lived assets and certain identifiable intangibles whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. In general, the Company will recognize impairment when the sum
of undiscounted future cash flows (without interest charges) is less than the
carrying amount of such assets. The measurement for such impairment loss is
based on the fair value of the asset.
13
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
most significant estimates and assumptions made in the preparation of the
consolidated financial statements relate to the carrying amount and amortization
of intangible assets, deferred tax valuation allowance and abandoned lease
reserves. Actual results could differ from those estimates.
Recent Accounting Pronouncements: In November 2004, the Financial Accounting
Standards Board ("FASB") issued Statement No. 151, which revised ARB No. 43,
relating to inventory costs. This revision is to clarify the accounting for
abnormal amounts of idle facility expense, freight, handling costs and wasted
material or "spoilage". This statement requires that these items be recognized
as a current period charge regardless of whether they meet the criterion
specified in ARB 43. In addition, this Statement requires the allocation of
fixed production overheads to the costs of conversion be based on normal
capacity of the production facilities. This Statement is effective for the
fiscal years beginning after June 15, 2005. Earlier application is permitted for
inventory costs incurred during fiscal years beginning after the date of
issuance of this Statement. Management believes that this Statement will have no
impact on the financial statements of the Company once adopted.
In December 2004, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 123 Revised 2004, "Share-Based Payment", ("SFAS 123(R)"). This
Statement requires that the cost resulting from all share-based payment
transactions are recognized in the financial statements of the Company. That
cost will be measured based on the fair market value of the equity or liability
instruments issued. SFAS 123(R) is effective at the beginning of the first
annual reporting that ends after June 15, 2005. This Statement will be effective
in the first quarter of the Company's fiscal yearended June 30, 2006. The
Company is currently evaluating this pronouncement regarding the potential
impact on the Company's results of operations.
Significant Events:
To facilitate an analysis of MSGI operating results, certain significant events
should be considered.
In March 2004, the Company completed the sale of substantially all of the assets
relating to its telemarketing and teleservices business held by its wholly owned
subsidiary, MKTG Teleservices, to SD&A Teleservices, Inc., a wholly owned
subsidiary of the Robert W. Woodruff Arts Center, Inc. for approximately $2.5
million in cash and a note receivable for $0.3 million plus the assumption of
certain directly related liabilities. As such, the operations and cash flows of
MKTG Teleservices have been eliminated from ongoing operations and the Company
no longer has continuing involvement in the operations.
In April 2004, the Company completed its purchase of 51% of the outstanding
shares of the common stock of FDA for an aggregate purchase price of $1.0
million, pursuant to a definitive agreement entered into as of April 10, 2004.
Further, subject to the terms and conditions of the Stock Purchase Agreement,
the Company may obtain up to an additional 25% beneficial ownership of FDA, if
certain pre-tax income targets are not met by certain target dates as set forth
in the Stock Purchase Agreement.
14
In August 2004, the Company completed an acquisition of a 51% membership
interest in Innalogic, LLC, for an aggregate capital contribution of $1,000,000.
Further subject to the terms and conditions of an Investment Agreement, the
Company issued an aggregate of 50,000 unregistered shares of its common stock to
Innalogic. These shares were subsequently distributed to the founding members of
Innalogic. In addition, the Company may issue, at its discretion, an aggregate
of 50,000 options to purchase shares of common stock to the founding members of
Innalogic, if certain pre-tax income targets are exceeded. The options will have
an exercise price equal to the fair market value of the Company's common stock
at the time of the grant of the options. The Company also issued 50,000
unregistered shares of common stock to certain advisors as compensation for
services rendered in connection with the completion of this transaction. As set
forth in Innalogic's Amended and Restated Limited Liability Company Agreement,
the Company may obtain up to an additional 25% membership interest in Innalogic,
if certain pre-tax income targets are not met by certain target dates.
On February 8, 2005, the Company announced that its Board of Directors approved
a motion to split the shares of common stock of the Company on a "two-for-one"
basis. Par value of the common stock remains at $0.01 per shares and the number
of authorized shares of common stock remains at 9,375,000. The effective date of
the split was March 9, 2005. All stock prices, per share and share amounts have
been retroactively restated to reflect the forward split and are reflected in
this document.
Results of Operations for the Three Months Ended March 31, 2005, Compared to the
Three Months Ended March 31, 2004.
The Company reported revenues of approximately $0.3 million for the three months
ended March 31, 2005 (the "Current Period") compared to no revenue during the
three months ended March 31, 2004 (the "Prior Period"). Revenue is currently
limited due to the fact that the Company has undertaken new operations and
revenue from all previously owned and operated businesses have been divested and
are no longer reported as current operations.
The Company reported cost of goods sold of approximately $0.1 million in the
Current Period in with no comparable expense in the Prior Period.
The Company had research and development costs of approximately $65,000 in the
Current Period with no comparable expense in the Prior Period. The research and
development costs related to the new operating subsidiaries which did not exist
in the Prior Period.
Salaries and benefits of approximately $0.5 million in the Current Period
increased by approximately $0.4 million or 400% over salaries and benefits of
approximately $0.1 million in the Prior Period. Salaries and benefits increased
due to the addition of the two new operating subsidiaries and certain corporate
staff.
The Company recognized non-cash employee compensation expenses of approximately
$1.2 million in the Current Period with no comparable expense in the Prior
Period for the fair market value of stock options granted to certain employees
and directors at an exercise price below market value at the measurement date
and accounted for under APB No. 25 with guidance from FIN 44.
Selling, general and administrative expenses of approximately $0.6 million in
the Current Period increased by approximately $0.3 million or 100% over
comparable expenses of $0.3 million in the Prior Period. The increase is due
primarily to the addition of selling general and administrative costs associated
with the two new operating subsidiaries as well as by increases in various
corporate professional fees, offset by reductions in corporate insurance costs
and corporate office related expenses.
Depreciation and amortization expenses were approximately $60,000 in the Current
Period with no comparable expenses in the Prior Period. The increase in expenses
is due primarily to the fact that the Company has undertaken new operations and
new fixed assets have been obtained. The Current Period expense includes
amortization expenses for intangible technology assets from the date of
acquisition through March 31, 2005. The intangible assets were acquired in
August 2004.
15
Interest income of approximately $31,000 in the Current Period increased by
approximately $14,000 or 82% from interest income of approximately $17,000 in
the Prior Period. The increase is due primarily to improvements in interest
earned on cash balances and equivalents.
Interest expenses were approximately $17,000 in the Current Period with no
comparable expenses in the Prior Period. The Current Period expenses are the
result of increased imputed interest expense related to accrued leases on
abandoned properties.
The net provision for income taxes of $3,000 in the Current Period decreased by
approximately $20,000 or 87% from similar net provisions of approximately
$23,000 in the Prior Period. The Company records provisions for state and local
taxes incurred on taxable income or equity at the operating subsidiary level,
which cannot be offset by losses incurred at the parent company level or other
operating subsidiaries. The Company has recognized a full valuation allowance
against the deferred tax assets because it is more likely than not that
sufficient taxable income will not be generated during the carry forward period
to utilize the deferred tax assets.
As a result of the above, loss from continuing operations of approximately $2.2
million in the Current Period increased by approximately $1.8 million over
comparable loss from continuing operations of $0.4 million in the Prior Period.
The loss from discontinued operations of approximately $21,000 in the Current
Period is the result of trailing expenses related to the settlement of certain
legal matters pertaining to a discontinued operation (see Note 6). The loss from
discontinued operations of approximately $2.2 million in the Prior Period
resulted primarily from the disposal of the telemarketing operations, which were
sold in March 2004.
As a result of the above, net loss of approximately $2.2 million in the Current
Period decreased by approximately $0.3 million over comparable net loss of
approximately $2.5 million in the Prior Period.
The Company has recognized an expense of approximately $70,000 associated with
the cost of undeclared cumulative dividends on preferred stock. There was no
similar expense in the Prior Period.
As a result of the above, net loss available to common stockholders of
approximately $2.3 million in the Current Period decreased by approximately $0.2
million over comparable net loss of approximately $2.5 million in the Prior
Period
Results of Operations for the Nine Months Ended March 31, 2005, Compared to the
- -------------------------------------------------------------------------------
Nine Months Ended March 31, 2004.
- ---------------------------------
The Company had revenue of approximately $0.5 million for the nine months ended
March 31, 2005 (the "Current Period") compared to no revenue during the nine
months ended March 31, 2004 (the "Prior Period"). Revenue increased due to the
fact that the Company has undertaken new operations and revenue from all
previously owned and operated businesses have been divested and are no longer
reported as current operations.
The company reported cost of goods sold of approximately $0.2 million in the
Current Period in with no comparable expense in the Prior Period.
The Company had research and development costs of approximately $0.1 million in
the Current Period with no comparable expense in the Prior Period. The research
and development costs related to the new operating subsidiaries which did not
exist in the Prior Period.
16
Salaries and benefits of approximately $1.2 million in the Current Period
increased by approximately $0.9 million or 300% over salaries and benefits of
approximately $0.3 million in the Prior Period. Salaries and benefits increased
due to the addition of the two new operating subsidiaries and certain corporate
staff.
Non cash compensation expenses of approximately $1.5 million in the Current
Period are the result of the fair market value of common shares issued to the
founding members of Innalogic by MSGI as part of the acquisition of a 51%
membership in Innalogic and the fair market value of stock options granted to
employees and directors at an exercise price favorable to the market price at
the measurement date.
Selling, general and administrative expenses of approximately $1.7 million in
the Current Period increased by approximately $0.8 million or 89% over
comparable expenses of $0.9 million in the Prior Period. The increase is due
primarily to the addition of selling general and administrative costs associated
with the two new operating subsidiaries as well as by increases in various
corporate professional fees, offset by reductions in corporate insurance costs
and corporate office related expenses.
Depreciation and amortization expenses was approximately $81,000 in the Current
Period with no comparable expense in the Prior Period. The increase in expenses
is due primarily to the fact that the Company has undertaken new operations and
new fixed assets have been obtained. The Current Period expense includes
amortization expenses for intangible technology assets from the date of
acquisition through March 31, 2005. Comparable expenses from all previously
owned and operated businesses have been divested and are no longer reported as
current operations.
The gain from termination of a lease of approximately $70,000 in the Current
Period is the result of the early termination of the lease for an abandoned
property. A final settlement payment of approximately $175,000 was paid in order
to terminate the lease early against accrued costs of approximately $245,000.
Interest income of approximately $78,000 in the Current Period increased by
approximately $25,000 or 47% from interest income of approximately $53,000 in
the Prior Period. The increase is due primarily to improvements in interest
earned on cash balances and equivalents.
Interest expenses of approximately $52,000 in the Current Period increased by
approximately $32,000 or 160% over comparable expenses of $20,000 in the Prior
Period as a result of increased imputed interest expense related to accrued
leases on abandoned properties.
The minority interests in subsidiaries of approximately $0.3 million in the
Current Period represent the minority holdings in FDA, which losses are limited
to their equity investment. There were no such minority interests to report in
the Prior Period.
The net provision for income taxes of $9,000 in the Current Period decreased by
approximately $20,000 or 69% over net provisions of approximately $29,000 in the
Prior Period. The Company records provisions for state and local taxes incurred
on taxable income or equity at the operating subsidiary level, which cannot be
offset by losses incurred at the parent company level or other operating
subsidiaries. The Company has recognized a full valuation allowance against the
deferred tax assets because it is more likely than not that sufficient taxable
income will not be generated during the carry forward period to utilize the
deferred tax assets.
As a result of the above, loss from continuing operations of approximately $3.9
million in the Current Period increased by approximately $2.8 million over
comparable loss from continuing operations of $1.1 million in the Prior Period.
17
The loss from discontinued operations of approximately $91,000 in the Current
Period is the result of trailing expenses related to the settlement of certain
legal matters pertaining to a discontinued operation (see Note 6). The loss from
discontinued operations of approximately $1.2 million in the Prior Period
resulted primarily from the disposal of the telemarketing operations, which were
sold in March 2004, as well as from reductions in certain loss reserves expensed
in previous periods.
As a result of the above, net loss of approximately $4.0 million in the Current
Period increased by approximately $1.9 million over comparable net loss of
approximately $2.1 million in the Prior Period.
The Company has recognized an expense of approximately $70,000 associated with
the cost of undeclared cumulative dividends on preferred stock. There was no
similar expense in the Prior Period.
As a result of the above, net loss available to common stockholders of
approximately $4.1 million in the Current Period increased by approximately $2.0
million over comparable net loss of approximately $2.1 million in the Prior
Period
Capital Resources and Liquidity
Financial Reporting Release No. 61, which was released by the SEC, requires all
companies to include a discussion to address, among other things, liquidity,
off-balance sheet arrangements, contractual obligations and commercial
commitments. The Company currently does not maintain any off-balance sheet
arrangements.
Leases: The Company leases various office space and equipment under
non-cancelable long-term leases. The Company incurs all costs of insurance,
maintenance and utilities.
Future minimum rental commitments under all non-cancelable leases as of March
31, 2005 are as follows:
Minimum Rent Expense
Fiscal Year --------------------
2005 (remaining three months) 98,700
2006 256,200
2007 240,000
2008 240,000
2009 240,000
Thereafter 260,000
-----------
$ 1,334,900
===========
The Company has accrued for approximately $1.28 million of the approximately
$1.33 million in liabilities for minimum rental expenses as a result of an
abandoned lease property.
Debt: As a result of the sale of the operations of MKTG Teleservices in March
2004, the company no longer retains any short term borrowing facilities. The
balance due at the closing of the sale transaction was paid in full at closing
and the relationship with the credit provider was terminated.
Liquidity: Historically, the Company has funded its operations, capital
expenditures and acquisitions primarily through cash flows from operations,
private placements of equity transactions, and its credit facilities. At March
31, 2005, the Company had cash and cash equivalents of approximately $1.8
million and a working capital of approximately $1.1 million.
18
The Company recognized a net loss of approximately $4.0 million in the Current
Period. Cash used in operating activities was approximately $3.3 million. Cash
used in operating activities principally resulted from the operating losses from
both continuing operations and discontinued operations in addition to increases
in inventory and other current assets as well as decreases in accrued
liabilities and minority interests in Future Developments America, Inc. offset
by increases in accounts payable. The decrease in accrued liabilities is due
primarily to payments made against reserves for rent on abandoned properties.
The net cash used in operating activites of discontinued operations relates
primarly to trailing expense resulting from settlements made with regard to the
sale of the MKTG Teleservices operations. Cash used in operating activities in
the Prior Period was $1.5 million.
In the Current Period, net cash of $4.3 million was used in investing activities
consisting of an investment in a subsidiary which was booked on a cost basis and
purchases of property and equipment. In the Prior Period, approximately $2.8
million was provided by investing activities resulting from the proceeds of the
sale of the MKTG Teleservices operations in March 2004.
In the Current Period, net cash of $6.8 million was provided by financing
activities. Net cash provided by financing activities consisted primarily of net
proceeds from the issuance of Common Stock of $3.8 million, net proceeds from
the issuance of Preferred Shares of approximately $2.7 million and proceeds from
the exercise of stock options of approximately $0.7 million offset by the
repayment of a related party note payable of $0.5 million. In the Prior Period,
net cash of $0.4 million was used in financing activities consisting of
repayments of long-term debt and an increase in a related party receivable.
While the Company has realized significant losses in past periods, it has most
recently raised significant working capital through the unregistered sale of
Common Stock, the sale of Series F Convertible Preferred Stock (Note 4) and the
exercise of certain stock options. In addition, the Company's subsidiary,
Innalogic, has begun to realize revenue during the period ended March 31, 2005.
The Company expects that both FDA and Innalogic will realize positive earnings
during the next fiscal year. The Company believes, based on the expected
performance, that its recently acquired operations should generate sufficient
future cash flow to fund operations. Failure of the new operations to generate
such sufficient future cash flow could have a material adverse effect on the
Company's ability to continue as a going concern and to achieve its business
objectives. The accompanying financial statements do not include any adjustments
relating to the recoverability of the carrying amount of recorded assets or the
amount of liabilities that might result should the Company be unable to continue
as a going concern.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company believes that it does not have any material exposure to market risk
associated with interest rate risk, foreign currency exchange rate risk,
commodity price risk, equity price risk, or other market risks.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Accounting Officer, of the
effectiveness of the Registrant's disclosure controls and procedures, as defined
in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934.
Based on that evaluation, it has been concluded that the Company's disclosure
controls and procedures as of March 31, 2005 were effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission's rules and forms.
19
Changes in Internal Control Over Financial Reporting
On October 13, 2004, our independent registered accounting firm Amper,
Politziner & Mattia, P.C. ("AP&M"), informed us and our Audit Committee of the
Board of Directors that in connection with their review of our financial results
for the fiscal year ended June 30, 2004, AP&M had discovered a condition which
they deemed to be a material weakness in our internal controls (as defined by
standards established by the Public Company Accounting Oversight Board). AP&M
noted a lack of sufficient resources and an insufficient level of monitoring and
oversight, which may restrict the Company's ability to gather, analyze and
report information relative to the financial statement assertions in a timely
manner, including insufficient documentation and review of selection and
application of generally accepted accounting principles to significant
non-routine transactions. In addition, the limited size of the accounting
department makes it impracticable to achieve an optimum separation of duties,
especially with the Company's continued growth and the increased demands of
public reporting information. The impact of the above condition was relevant to
the period ended June 30, 2004 only and did not affect the results of this
period or any prior periods.
The condition of insufficient resources and insufficient monitoring and
oversight, as noted by AP&M, remains as of the period ended March 31, 2005. It
is the Company's intention to increase the staffing levels of the accounting
department as the rebuilding efforts currently undertaken continue and the
demands on the accounting staff increase.
Conclusions. Based upon the controls evaluation, our CEO and CAO have each
concluded that, our disclosure controls are effective to ensure that material
information relating to the Company and its consolidated subsidiaries is made
known to management, including the CEO and CAO, as of the fiscal reporting
period ended March 31, 2005. Our CEO and CAO also concluded that our disclosure
controls are effective to ensure that information required to be disclosed in
the reports that we file or submit under the Exchange Act is accumulated and
communicated to our management, including our CEO and CAO, to allow timely
decisions regarding required disclosures.
There has been no change in our internal control over financial reporting (as
defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) identified
in connection with the evaluation required by Rule 13a-15(b) under the
Securities Exchange Act of 1934 of the effectiveness of our disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934) as of March 31, 2005, that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
However, in connection with being a public company, we have begun the process of
reviewing our policies and procedures on internal control over financial
reporting in anticipation of the requirement to comply with Section 404 of the
Sarbanes-Oxley Act of 2002, for the year ending June 30, 2007.
20
PART II- OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
On February 8, 2005, the Company announced that its Board of Directors approved
a motion to forward split the common shares of the Company on a "two-for-one"
basis. Par value of the remains at $0.01 per shares and the number of authorized
shares of Common Stock remains at 9,375,000. All stock prices, per share and
share amounts have been retroactively restated to reflect the forward split and
are reflected in this document.
Item 4. Submission of Matters to a Vote of Security Holders
(a) An Annual Meeting of Shareholders was held on February 7, 2005.
(c) Four matters were voted upon at the Annual Meeting of Shareholders. Votes
were solicited via proxies pursuant to Regulation 14 under the Securities Act of
1934.
1. A vote was held for the approval of an amendment to the Amended and
Restated Articles of Incorporation of the Company to change the name of the
Company to MSGI Security Solutions, Inc. The total number of votes cast was
1,571,846 with 1,568,905 voted in favor, 2,480 voted against and 461
abstaining.
2. A vote was held for the uncontested reelection of Mr. John Gerlach as
Director. The total number of votes cast was 1,571,846 with 1,549,971 voted
in favor and 21,875 withheld.
3. A vote was held for an amendment to the 1999 Stock Option Plan increasing
the number of authorized shares from 62,560 to 562,560. The total number of
votes cast was 1,000,786 with 803,324 voted in favor, 187,698 voted against
and 9,764 abstaining. A total of 571,060 votes were not cast. The total
number of shares available in the 1999 Stock Option Plan was subsequently
adjusted to 1,125,120 as a result of the forward 2 for 1 stock split.
4. A vote was held for the approval of the issuance of 20,000 options to
purchase common stock outside of the 1999 Stock Option Plan. The total
number of votes cast was 1,000,786 with 972,415 voted in favor, 21,798
voted against and 6,555 abstaining. A total of 571,060 votes were not cast.
The number of approved options was subsequently adjusted to 40,000 as a
result of the forward 2 for 1 stock split.
Item 6. Exhibits
(a) Exhibits
31.1 Rule 13a-14(a)/15d-14(a) Certification.
31.2 Rule 13a-14(a)/15d-14(a) Certification.
32.1 Section 1350 Certification.
32.2 Section 1350 Certification.
21
SIGNATURES
Pursuant to the requirements of the Exchange Act of 1934, the registrant has
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
MSGI SECURITY SOLUTIONS, INC.
(Registrant)
Date: May 16, 2005 By: /s/ J. Jeremy Barbera
----------------------
J. Jeremy Barbera
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Richard J. Mitchell III
----------------------------
Richard J. Mitchell III
Chief Accounting Officer
(Principal Financial Officer)
22
Exhibit 31.1
CERTIFICATION
I, J. Jeremy Barbera, certify, pursuant to 18 U.S.C. ss. 1350, as adopted
pursuant to ss. 302 of the Sarbanes-Oxley Act of 2002, that:
(1) I have reviewed this quarterly report on Form 10-Q of MSGI Security
Solutions, Inc.;
(2) Based on my knowledge, this quarterly 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 quarterly report; and
(3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of registrant as of, and for, the periods presented in this quarterly
report; and
(4) The registrant'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 registrant 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 registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
(b) Intentionally omitted.
(c) Evaluated the effectiveness of the registrant'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
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
(5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial data; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Dated: May 16, 2005 By: /s/ J. Jeremy Barbera
----------------------
J. Jeremy Barbera
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
23
Exhibit 31.2
CERTIFICATION
I, Richard J. Mitchell III, certify, pursuant to 18 U.S.C. ss. 1350, as adopted
pursuant to ss. 302 of the Sarbanes-Oxley Act of 2002, that:
(1) I have reviewed this quarterly report on Form 10-Q of MSGI Security
Solutions, Inc.;
(2) Based on my knowledge, this quarterly 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 quarterly report; and
(3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of registrant as of, and for, the periods presented in this quarterly
report; and
(4) The registrant'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 registrant 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 registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
(b) Intentionally omitted.
(c) Evaluated the effectiveness of the registrant'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
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
(5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial data; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Dated: May 16, 2005 By: /s/ Richard J. Mitchell III
----------------------------
Richard J. Mitchell III
Chief Accounting Officer
(Principal Financial Officer)
24
Exhibit 32.1
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 MSGI Security Solutions, Inc. (the
"Company") on Form 10-Q for the period ended March 31, 2005 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, J.
Jeremy Barbera, as Chairman of the Board and Chief Executive Officer of the
Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906
of the Sarbanes-Oxley Act of 2002, that:
1) The Report 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.
Dated: May 16, 2005 By: /s/ J. Jeremy Barbera
----------------------
J. Jeremy Barbera
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
This certification accompanies this Quarterly Report on Form 10-Q pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the
extent required by such Act, be deemed filed by the registrant for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended.
25
Exhibit 32.2
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 MSGI Security Solutions, Inc. (the
"Company") on Form 10-Q for the period ended March 31, 2005 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Richard
J. Mitchell III, as Chief Accounting Officer of the Company, certify, pursuant
to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act
of 2002, that:
1) The Report 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.
Dated: May 16, 2005 By: /s/ Richard J. Mitchell III
----------------------------
Richard J. Mitchell III
Chief Accounting Officer
(Principal Financial Officer)
This certification accompanies this Quarterly Report on Form 10-Q pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the
extent required by such Act, be deemed filed by the registrant for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended.
26