Attached files
file | filename |
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EX-32 - CYBERDEFENDER CORP | v206019_ex32.htm |
EX-31.1 - CYBERDEFENDER CORP | v206019_ex31-1.htm |
EX-31.2 - CYBERDEFENDER CORP | v206019_ex31-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-Q/A
(Amendment
No. 1)
Mark
One
x
|
Quarterly
report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934 for the quarterly period ended June 30, 2010; 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 No. 333-138430
CYBERDEFENDER CORPORATION
|
(Exact
name of registrant as specified in its
charter)
|
Delaware
|
65-1205833
|
|
(State
or other jurisdiction of
|
(I.R.S.
Employer Identification No.)
|
|
incorporation
or organization)
|
617 West 7th Street, 10th Floor, Los Angeles, California
90017
|
(Address
of principal executive offices)
|
(213) 689-8631
|
(Registrant’s
telephone number, including area
code)
|
(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. x Yes oNo
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation
S-T (§232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files). o Yes o No (The registrant is
not yet subject to this requirement.)
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer
|
¨
|
Accelerated
filer
|
¨
|
|
Non-accelerated
filer
|
¨
|
(Do
not check if a smaller reporting company)
|
Smaller
reporting company
|
x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
¨ Yes x No
As of
August 5, 2010, 27,026,109 shares of the registrant’s common stock, $0.001 par
value, were outstanding.
CYBERDEFENDER
CORPORATION
FORM
10-Q/A
June 30,
2010
TABLE OF
CONTENTS
Page
Number
|
||
PART
I - FINANCIAL INFORMATION
|
||
Item
1. Financial Statements (Unaudited)
|
||
Condensed
Balance Sheets - June 30, 2010 and December 31, 2009
|
2
|
|
Condensed
Statements of Operations - For the Three and Six Months Ended June 30,
2010 and 2009
|
3
|
|
Condensed
Statements of Cash Flows - For the Six Months Ended June 30, 2010 and
2009
|
4
|
|
Notes
to Condensed Financial Statements
|
6
|
|
Forward-Looking
Statements
|
27
|
|
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
|
28
|
|
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
|
36
|
|
Item
4. Controls and Procedures
|
36
|
|
PART
II - OTHER INFORMATION
|
||
Item
1. Legal Proceedings
|
37
|
|
Item
1A. Risk Factors
|
37
|
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
37
|
|
Item
3. Defaults Upon Senior Securities
|
37
|
|
Item
4. Removed and Reserved
|
37
|
|
Item
5. Other Information
|
37
|
|
Item
6. Exhibits
|
38
|
|
Signatures
|
39
|
EXPLANATORY NOTE
This
Amendment No. 1 to the Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 2010 contains restated financial statements correcting an error
in the financial statements contained in the Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 2010 as originally filed with the Securities
and Exchange Commission (“SEC”) on August 9, 2010. Please see Note 9 to
the Condensed Financial Statements for a description of the accounting error
which led to the restatement. As a result of this restatement, we are also
amending disclosures which appear in Part I, Item 1, Notes to the Condensed
Financial Statements and Item 4T. Controls and Procedures. This amended
Form 10-Q also contains currently dated certifications pursuant to Section 302
and 906 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1, 31.2, 32.1 and
32.2.
Except as
described above, no other information in the original filing has been updated
and this Amendment continues to speak as of the date of the original
filing. Other events occurring after the information in the original
filing or other disclosures necessary to reflect subsequent events have been or
will be addressed in other reports filed with or furnished to the SEC subsequent
to the date of the original filing. Accordingly, this Form 10-Q/A should
be read in conjunction with such reports.
1
Part
I - FINANCIAL INFORMATION
Item
1. Financial Statements (Unaudited)
CYBERDEFENDER
CORPORATION
CONDENSED
BALANCE SHEETS
(UNAUDITED)
June
30,
|
December
31,
|
|||||||
2010
|
2009
|
|||||||
(Restated)
|
(Restated)
|
|||||||
ASSETS
|
||||||||
CURRENT
ASSETS:
|
||||||||
Cash
|
$ | 4,896,518 | $ | 3,357,510 | ||||
Restricted
cash
|
2,059,028 | 1,565,841 | ||||||
Accounts
receivable, net
|
1,146,705 | 489,464 | ||||||
Deferred
financing costs, current
|
25,509 | 191,566 | ||||||
Prepaid
expenses
|
215,885 | 302,291 | ||||||
Deferred
charges, current
|
2,700,504 | 3,316,535 | ||||||
Total
Current Assets
|
11,044,149 | 9,223,207 | ||||||
PROPERTY
AND EQUIPMENT, net
|
852,705 | 242,927 | ||||||
DEFERRED
FINANCING COSTS, net of current portion
|
19,132 | 47,892 | ||||||
DEFERRED
CHARGES, net of current portion
|
510,252 | 609,904 | ||||||
OTHER
ASSETS
|
110,028 | 67,605 | ||||||
Total
Assets
|
$ | 12,536,266 | $ | 10,191,535 | ||||
CURRENT
LIABILITIES:
|
||||||||
Accounts
payable
|
$ | 6,281,488 | $ | 4,893,186 | ||||
Accrued
expenses
|
1,446,760 | 862,023 | ||||||
Deferred
revenue, current
|
10,112,645 | 9,662,030 | ||||||
Capital
lease obligations, current
|
90,992 | 9,410 | ||||||
Total
Current Liabilities
|
17,931,885 | 15,426,649 | ||||||
DEFERRED
RENT
|
254,197 | 65,938 | ||||||
DEFERRED
REVENUE, less current portion
|
1,968,789 | 1,117,116 | ||||||
CONVERTIBLE
NOTES PAYABLE, net of discount
|
4,242,500 | 1,593,000 | ||||||
CAPITAL
LEASE OBLIGATIONS, less current portion
|
137,536 | 9,708 | ||||||
Total
Liabilities
|
24,534,907 | 18,212,411 | ||||||
STOCKHOLDERS’
DEFICIT:
|
||||||||
Preferred stock, par value
$0.001; 10,000,000 shares authorized; no shares issued and outstanding at
June 30, 2010 and December 31, 2009, respectively
|
- | - | ||||||
Common stock, par value $0.001;
100,000,000 shares authorized; 27,023,709 and 25,673,967 shares issued and outstanding at
June 30, 2010 and December 31, 2009, respectively
|
27,024 | 25,674 | ||||||
Additional
paid-in capital
|
53,240,973 | 36,884,000 | ||||||
Accumulated
deficit
|
(65,266,638 | ) | (44,930,550 | ) | ||||
Total
Stockholders’ Deficit
|
(11,998,641 | ) | (8,020,876 | ) | ||||
Total Liabilities
and Stockholders’ Deficit
|
$ | 12,536,266 | $ | 10,191,535 |
See
accompanying notes to condensed financial statements
2
CYBERDEFENDER
CORPORATION
CONDENSED
STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
|
Six Months Ended
|
|||||||||||||||
June
30,
|
June
30,
|
June
30,
|
June
30,
|
|||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
(Restated)
|
(Restated)
|
(Restated)
|
(Restated)
|
|||||||||||||
REVENUES:
|
||||||||||||||||
Net
sales
|
$ | 9,712,586 | $ | 3,686,644 | $ | 19,189,916 | $ | 6,878,274 | ||||||||
COST
OF SALES
|
4,013,801 | 753,324 | 7,168,851 | 1,433,028 | ||||||||||||
GROSS
PROFIT
|
5,698,785 | 2,933,320 | 12,021,065 | 5,445,246 | ||||||||||||
OPERATING
EXPENSES:
|
||||||||||||||||
Media
and marketing services
|
11,977,108 | 4,146,124 | 22,207,039 | 8,645,858 | ||||||||||||
Product
development
|
963,392 | 365,497 | 1,715,519 | 665,234 | ||||||||||||
Selling,
general and administrative
|
3,722,377 | 1,565,995 | 6,599,590 | 2,817,552 | ||||||||||||
Investor
relations and other related consulting
|
- | 1,135,418 | 549,543 | 1,530,703 | ||||||||||||
Depreciation
and amortization
|
54,903 | 9,760 | 75,145 | 20,096 | ||||||||||||
Total
Operating Expenses
|
16,717,780 | 7,222,794 | 31,146,836 | 13,679,443 | ||||||||||||
LOSS
FROM OPERATIONS
|
(11,018,995 | ) | (4,289,474 | ) | (19,125,771 | ) | (8,234,197 | ) | ||||||||
OTHER
INCOME/(EXPENSES):
|
||||||||||||||||
Change
in the value of derivative liabilities
|
- | - | - | 109,058 | ||||||||||||
Interest
expense, net
|
(990,748 | ) | (841,838 | ) | (1,209,917 | ) | (1,718,732 | ) | ||||||||
Total
Other Expenses, net
|
(990,748 | ) | (841,838 | ) | (1,209,917 | ) | (1,609,674 | ) | ||||||||
LOSS
BEFORE INCOME TAX EXPENSE
|
(12,009,743 | ) | (5,131,312 | ) | (20,335,688 | ) | (9,843,871 | ) | ||||||||
INCOME
TAX EXPENSE
|
200 | 200 | 400 | 400 | ||||||||||||
NET
LOSS
|
$ | (12,009,943 | ) | $ | (5,131,512 | ) | $ | (20,336,088 | ) | $ | (9,844,271 | ) | ||||
Basic
and fully diluted net loss per share
|
$ | (0.45 | ) | $ | (0.25 | ) | $ | (0.78 | ) | $ | (0.51 | ) | ||||
Weighted
Average Shares Outstanding:
|
||||||||||||||||
Basic
and fully diluted
|
26,427,048 | 20,392,487 | 26,094,502 | 19,198,137 |
See
accompanying notes to condensed financial statements
3
CYBERDEFENDER
CORPORATION
CONDENSED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended
|
||||||||
June 30,
2010
|
June 30,
2009
|
|||||||
(Restated)
|
(Restated)
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
loss
|
$ | (20,336,088 | ) | $ | (9,844,271 | ) | ||
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
Amortization
of debt discount
|
772,071 | 783,294 | ||||||
Provision
for doubtful accounts receivable
|
165,330 | - | ||||||
Change
in fair value of derivative liabilities
|
- | (109,058 | ) | |||||
Depreciation
and amortization
|
75,145 | 20,096 | ||||||
Compensation
expense from vested stock options
|
390,314 | 141,637 | ||||||
Amortization
of deferred financing costs
|
245,835 | 302,752 | ||||||
Warrants
issued for media and marketing services
|
11,958,816 | 1,065,420 | ||||||
Shares
and warrants issued for services, interest and penalties
|
549,543 | 1,648,203 | ||||||
Warrants
issued in connection with warrant tender offer
|
- | 500,631 | ||||||
Changes
in operating assets and liabilities:
|
||||||||
Restricted
cash
|
(493,187 | ) | (632,487 | ) | ||||
Accounts
receivable
|
(822,571 | ) | 53,238 | |||||
Prepaid
expenses
|
86,406 | 137,722 | ||||||
Deferred
charges
|
715,684 | (1,549,181 | ) | |||||
Other
assets
|
(42,423 | ) | (6,363 | ) | ||||
Accounts
payable and accrued expenses
|
2,260,436 | (409,129 | ) | |||||
Deferred
revenue
|
1,302,288 | 3,586,431 | ||||||
Cash
Flows Used In Operating Activities:
|
(3,172,401 | ) | (4,311,066 | ) | ||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Purchase
of property and equipment
|
(424,631 | ) | (6,567 | ) | ||||
Cash
Flows Used In Investing Activities
|
(424,631 | ) | (6,567 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Proceeds
from convertible notes payable and notes payable, net of
costs
|
4,948,982 | 621,700 | ||||||
Principal
payments on capital lease obligations
|
(50,882 | ) | (13,046 | ) | ||||
Proceeds
from exercise of stock options
|
53,765 | 83,086 | ||||||
Proceeds
from exercise of stock warrants, net of placement fees
|
184,175 | 1,899,420 | ||||||
Proceeds
from sale of stock, net of placement fees
|
- | 3,106,880 | ||||||
Cash
Flows Provided by Financing Activities
|
5,136,040 | 5,698,040 | ||||||
NET
INCREASE IN CASH
|
1,539,008 | 1,380,407 | ||||||
CASH,
beginning of period
|
3,357,510 | 779,071 | ||||||
CASH,
end of period
|
$ | 4,896,518 | $ | 2,159,478 |
See
accompanying notes to condensed financial statements
4
CYBERDEFENDER
CORPORATION
CONDENSED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended
|
||||||||
June 30,
2010
|
June 30,
2009
|
|||||||
(Restated)
|
(Restated)
|
|||||||
Supplemental
disclosures of cash flow information:
|
||||||||
Income
taxes paid
|
$ | 800 | $ | 800 | ||||
Cash
paid for interest
|
$ | 121,501 | $ | 67,317 | ||||
Supplemental
schedule of non-cash investing and financing activities:
|
||||||||
Discount
on note payable
|
$ | 908,571 | $ | 178,602 | ||||
Property
and equipment acquired through capital lease obligations
|
$ | 260,292 | $ | - | ||||
Warrants
issued in connection with sale of stock
|
$ | - | $ | 18,197 | ||||
Conversion
of notes payable and accrued interest to common stock
|
$ | 2,313,139 | $ | 1,908,495 | ||||
Cumulative
effect of accounting change to additional paid-in capital for
derivative liabilities
|
$ | - | $ | 7,065,940 | ||||
Cumulative
effect of accounting change to retained earnings for derivative
liabilities
|
$ | - | $ | 723,930 | ||||
Value
of warrants and embedded conversion features recorded to derivative
liabilities
|
$ | - | $ | 906,805 | ||||
Reclassification
of derivatives to equity
|
$ | - | $ | 7,139,757 |
See
accompanying notes to condensed financial statements
5
CYBERDEFENDER CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
1 - INTERIM FINANCIAL STATEMENTS
These
unaudited interim financial statements have been prepared by CyberDefender
Corporation (the “Company”) pursuant to the rules and regulations of the
Securities and Exchange Commission (“SEC”) for interim financial
statements. The information furnished herein reflects all adjustments
(consisting of normal recurring accruals and adjustments) that are, in the
opinion of management, necessary to fairly present the operating results for the
respective periods. Certain information and footnote disclosures normally
present in annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America (“GAAP”) have been
omitted pursuant to such rules and regulations. These unaudited
interim financial statements should be read in conjunction with the
audited financial statements and footnotes for the Company for its year
ended December 31, 2009 included in the Company’s Annual Report on Form
10-K. The results for the six-month interim period ended June 30, 2010 are
not necessarily indicative of the results to be expected for the full year
ending December 31, 2010.
NOTE
2 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Organization and
Business
The
Company, based in Los Angeles, California, is a provider of Internet security
software, utilities and live PC support services to the consumer and small
business market. The Company markets its products directly to consumers through
multiple channels including the Internet, radio and television. The Company’s
goal is to be a leading provider of advanced solutions to protect consumers and
small businesses against threats such as Internet viruses, spyware and identity
theft, and to provide remote technical resolution services.
Our
software products include CyberDefender Early Detection Center, a comprehensive
antispyware and antivirus suite, and CyberDefender Registry Cleaner, a PC
optimization suite. Both products are compatible with Windows XP, Vista
and 7.
CyberDefender
also provides remote tech on call services 7 days a week and 365 days a year.
Our technicians are available to address PC problems that cannot be resolved
with simple do-it-yourself software. Our technicians connect to customers’
computers using a popular remote access software and provide our customers with
quick and reliable computer repair. Repair and optimization services
include (but are not limited to) malware removal, speed optimization, software
updates, file backup, privacy optimization and hardware
troubleshooting.
The
Company developed a collaborative Internet security network, which it refers to
as CyberDefender Argus Network (formerly known as the earlyNETWORK), based on
certain technology principles commonly found in a peer-to-peer network
infrastructure. A peer-to-peer network does not have the notion of clients
or servers, but only equal peer nodes that simultaneously function as both
“clients” and “servers” to the other nodes on the network. This means that
when a threat is detected from a computer that is part of the CyberDefender
Argus Network, the threat is relayed to our Early Alert Center. The Early
Alert Center tests, grades and ranks the threat, automatically generates
definition and signature files based on the threat, and relays this information
to the Alert Server, in some cases after a human verification step. The
Alert Server will relay the information it receives from the Early Alert Center
to other machines in the CyberDefender Argus Network, and each machine that
receives the information will, in turn, relay it to other machines that are part
of the CyberDefender Argus Network. This protocol allows us to rapidly
distribute alerts and updates regarding potentially damaging viruses and other
threats to members of the CyberDefender Argus Network, without regard for the
cost of the bandwidth involved. Because cost is not a factor, updates can
be continuous, making our approach significantly faster than the client/server
protocols used by traditional Internet security companies that provide manual
broadcast-updated threat management systems. Computer users join the
CyberDefender Argus Network simply by downloading and installing our security
software.
During
May 2010, the Company entered into an Agreement and Plan of Merger with a
wholly owned Delaware subsidiary, pursuant to which the Company merged with and
into the Delaware subsidiary, with the Delaware subsidiary being the surviving
corporation, on the basis of one share of common stock of the Delaware
subsidiary to be exchanged for each outstanding share of common stock of the
Company, all as more particularly set forth in the Agreement and Plan of Merger.
The main purpose of the merger was to change the Company’s state of
incorporation from California to Delaware. Additionally, at the time of the
merger the Company increased the number of authorized shares of common stock to
100 million, changed the common stock from no par value to $0.001 par value and
authorized 10 million shares of preferred stock. As a result the Company
retroactively restated its December 31, 2009 common stock balance as if the
change in par value was effective for all periods presented.
Use of
Estimates
The
preparation of financial statements in conformity with GAAP 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. Significant estimates made by management are, among
others, collectability of accounts receivable, recoverability of prepaid
expenses, deferred charges and property and equipment, value of shares and
options/warrants granted, valuation of deferred tax assets and recognition of
revenue. Actual results could differ from those estimates and
assumptions.
6
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Liquidity
The
Company has experienced operating losses since inception. Management has
implemented plans to continue to build its revenue base, expand sales and
marketing and improve operations, however, through September 2010, the Company
continued to operate at negative cash flow. For the six months ended June
30, 2010 and the year ended December 31, 2009, the Company has incurred a net
loss of $20.3 million and $19.8 million with negative cash flows from operations
of $3.2 million and $6.0 million, respectively. As of June 30, 2010 and
December 31, 2009, the Company had stockholders’ deficit of $12.0 million and
$8.0 million, respectively. To date, the Company’s operations have been
primarily financed through debt and equity proceeds from private placement
offerings. Management believes that it has sufficient working capital from
recent financings to fund operations through at least December 31, 2010.
As discussed in Note 9, the Company entered into a Revolving Credit Loan
Agreement with GRM effective as of December 3, 2010.
The credit facility permits the Company to borrow up to $5 million,
and the initial principal amount includes $4,287,660 of outstanding trade
payables owed by the Company to GRM on December 3, 2010 pursuant to a certain
Media and Marketing Services Agreement described in Note 5 below. All
outstanding principal and accrued but unpaid interest is due and payable in full
at the earlier of either March 31, 2011 or the closing of the Company’s sale and
issuance of any debt or equity securities of the Company in an aggregate amount
exceeding $10 million. The Company intends to obtain additional financing prior
to March 31, 2011 to satisfy the obligation. However, there can be no
assurance that the Company will secure the additional financing on terms
acceptable to the Company, or at all. In the event the Company is unable to
obtain additional financing, the Company expects it would be able to renegotiate
the terms of the GRM revolving credit facility, however, there is no assurance
that this would occur. Failure to obtain additional financing or an
amendment to the GRM revolving credit facility may require the Company to
significantly curtail its operations which could have a
material adverse impact on the Company’s results of operations and financial
position.
Accounts
Receivable
During
2010, the Company began offering a payment plan to its customers for the
purchase of multi-year technical support service plans. The payment plan allows
customers to pay in two installments over sixty days.
Property and
Equipment
Property
and equipment are recorded at cost. Expenditures for major additions and
improvements are capitalized and minor replacements, maintenance and repairs are
charged to expense as incurred. When equipment is retired or otherwise disposed
of, the cost and accumulated depreciation are removed from the accounts and any
resulting gain or loss is included in the results of operations for the
respective period. Depreciation is provided over the estimated useful lives of
the related assets ranging from three to seven years, using the straight-line
method. Amortization of leasehold improvements is provided over the shorter of
the estimated useful lives of the improvements or the term of the
lease.
Equipment under Capital
Lease
The
Company leases certain of its equipment under agreements accounted for as
capital leases. The assets and liabilities under capital lease are recorded at
the lesser of the present value of aggregate future minimum lease payments,
including estimated bargain purchase options, or the fair value of the assets
under lease. Assets under capital lease are depreciated using the straight-line
method over their estimated useful lives.
Revenue
Recognition
The
Company sells off-the-shelf software products and technical support services and
packages that include both.
The
Company recognizes revenue from the sale of software licenses under the guidance
of the Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) Topic 985, “Software.”
Specifically,
the Company recognizes revenues from its software products when all of the
following conditions for revenue recognition are met:
i.
|
persuasive
evidence of an arrangement exists,
|
|
ii.
|
the
product or service has been delivered,
|
|
iii.
|
the
fee is fixed or determinable, and
|
|
iv.
|
collection
of the resulting receivable is reasonably
assured.
|
As part
of the sales price of some of its software licenses, the Company provides
renewable product support and content updates, which are separate components of
product licenses and sales. Term licenses allow customers to use the Company’s
products and receive product support coverage and content updates for a
specified period, generally twelve months. The Company invoices for product
support, content updates and term licenses at the beginning of the term. These
revenues contain multiple element arrangements where “vendor specific objective
evidence” (“VSOE”) may not exist for one or more of the elements. Certain of the
Company’s software licenses are in substance a subscription and therefore the
sale is deferred and recognized ratably over the term of the arrangement.
Revenue is recognized immediately for the sale of software products that are
utility products and that do not require product updates.
7
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue
is recognized immediately for the sale of our one-time technical support service
as it is performed when purchased. The Company recognizes a portion of the sale
of one of its annual services at the time of purchase when all of the elements
necessary for revenue recognition have occurred (i.e. the initial technical
support call has occurred) and the remaining revenue is deferred over the annual
term. Revenue is deferred and recognized over the term of the service
agreements for the technical support services that are provided by third
parties.
The
Company recognizes revenue on the sale of bundled products based on the
individual components included in the bundle using the residual method. The
Company has established VSOE of fair value of the individual components based on
historical sales. The customer type (retail customer) and product are exactly
the same for all of these bundles. Revenue is recognized on the individual
components as detailed above.
The
Company also uses third parties to sell its software and therefore evaluates the
criteria of FASB ASC Topic 605, “Revenue Recognition,” in
determining whether it is appropriate to record the gross amount of revenue and
related costs or the net amount earned as commissions. The Company is the
primary obligor, is subject to inventory risk, has latitude in establishing
prices and selecting suppliers, establishes product specifications, and has the
risk of loss. Accordingly, the Company's revenue is recorded on a gross
basis.
The
Company still supports MyIdentityDefender Toolbar and CyberDefender FREE 2.0,
which were free to subscribers. Revenues are earned from advertising networks
which pay the Company to display advertisements inside the software or through
the toolbar search. The Company recognizes revenue from the advertising networks
monthly based on a rate determined either by the quantity of the ads displayed
or the performance of the ads based on the amount of times the ads are clicked
by the user. Furthermore, advertising revenue is recognized provided that no
significant Company obligations remain at the end of a period and collection of
the resulting receivable is probable. The Company’s obligations do not include
guarantees of a minimum number of impressions.
Deferred
Charges
The
Company uses a third party to provide technical support services associated with
the CyberDefenderULTIMATE product. The costs associated with this service
are deferred and amortized against the recognition of the related sales
revenue.
Advertising
Costs
The
Company expenses all advertising costs as incurred. As described in detail in
Note 4 below, the Company issued warrants for media and marketing
services. The non-cash value of those warrants is included in media and
marketing services on the accompanying statements of operations. For the
three months ended June 30, 2010 and 2009, the Company recorded non-cash expense
of $6.5 million and $0.7 million, respectively. For the six months ended June
30, 2010 and 2009, the Company recorded non-cash expense of $12.0 million and
$1.5 million, respectively.
Reserve for
Refunds
The
Company’s policy with respect to refunds is to offer refunds within the first 30
days after the date of purchase. The Company may voluntarily issue refunds to
customers after 30 days of purchase, however the majority are issued within 30
days of the original sale and are charged against the associated sale or
deferred revenues (as applicable). Refunds were $1.4 million and $2.5 million
for the three and six months ended June 30, 2010, respectively. Refunds were
$0.7 million and $1.3 million for the three and six months ended June 30, 2009,
respectively. As of June 30, 2010 and December 31, 2009, the Company had $0
accrued for customer refunds, based on historical timing of
refunds.
Certain Risks and
Concentrations
As of
June 30, 2010, all of our cash was maintained at a major financial institution
in the United States. At times, deposits held with the financial institution may
exceed the amount of insurance provided on such deposits by the Federal Deposit
Insurance Corporation (“FDIC”) which provides deposit coverage with limits up to
$250,000 per owner through December 31, 2013. As of June 30, 2010, the Company
had a balance of approximately $4.6 million in excess of the FDIC
limit.
Income
Taxes
The
Company has adopted the liability method of accounting for income taxes pursuant
to FASB ASC Topic 740, “Income
Taxes.” Deferred income taxes are recorded to reflect tax consequences on
future years for the differences between the tax basis of assets and liabilities
and their financial reporting amounts at each year-end. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statements carrying amounts of existing assets
and liabilities and their respective tax basis. Deferred tax assets, including
tax loss and credit carryforwards, and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
8
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Deferred
income tax expense represents the change during the period in the deferred tax
assets and deferred tax liabilities. The components of the deferred tax assets
and liabilities are individually classified as current and non-current based on
their characteristics. Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized.
FASB ASC
Topic 740 prescribes recognition thresholds that must be met before a tax
position is recognized in the financial statements and provides guidance on
de-recognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. An entity may only recognize or continue to
recognize tax positions that meet a “more likely than not”
threshold.
The
Company does not have any unrecognized tax benefits as of June 30, 2010 that, if
recognized, would affect the Company’s effective income tax rate.
The
Company’s policy is to recognize interest and penalties related to income tax
issues as components of income tax expense. The Company did not recognize or
have any accrual for interest and penalties relating to income taxes as of June
30, 2010.
Software Development
Costs
The
Company accounts for software development costs in accordance with FASB ASC
Topic 985, “Software.”
Such costs are expensed prior to achievement of technological feasibility and
thereafter are capitalized. There have been very limited software development
costs incurred between the time the software and its related enhancements have
reached technological feasibility and its general release to customers. As a
result, all software development costs have been charged to product development
expense.
Derivative
Instruments
Effective
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815,
“Derivatives and
Hedging,” that
applies to any freestanding financial instruments or embedded features that have
the characteristics of a derivative and to any freestanding financial
instruments that are potentially settled in an entity’s own common stock. As a
result, as of January 1, 2009, 7,134,036 of the Company’s issued and outstanding
common stock purchase warrants previously treated as equity pursuant to the
derivative treatment exemption were no longer afforded equity treatment. In
addition, amounts related to the embedded conversion feature of convertible
notes issued prior to January 1, 2009 and treated as equity pursuant to the
derivative treatment exemption were also no longer afforded equity treatment. As
such, effective January 1, 2009, the Company reclassified the fair value of
these common stock purchase warrants and the fair value of the embedded
conversion features, which both have exercise price reset features, from equity
to liability status as if these warrants and embedded conversion features were
treated as a derivative liability since the earliest date of issue in
September 2006. On January 1, 2009, the Company reclassified from
additional paid-in capital, as a cumulative effect adjustment,
$7,065,940 to beginning additional paid-in capital, $723,930 to opening
retained earnings and $6,342,010 to a long-term derivative liability to
recognize the fair value of such warrants and embedded conversion features on
such date.
During
the three and six months ended June 30, 2009, the Company issued 0 and 1,192,000
common stock purchase warrants that contained features that required the Company
to record their fair value as a derivative liability. In addition, the
value related to the embedded conversion feature of convertible notes issued
during the six months ended June 30, 2009 was also recorded as a derivative
liability. We recognized income of $0 and $109,058 from the change in fair value
of the outstanding warrants and embedded conversion feature for the three and
six months ended June 30, 2009.
The
Company obtained waivers from the warrant and note holders, pursuant to which
the warrant and note holders forever waived, as of and after April 1, 2009, any
and all conversion or exercise price adjustments that would otherwise occur, or
would have otherwise occurred on or after April 1, 2009, as a result of the
price reset provisions included in the warrants and notes. As a result of
obtaining the waivers, the warrants and notes are now afforded equity treatment
resulting in the elimination of the derivative liabilities of $7,139,757 and a
corresponding increase in additional paid-in capital.
9
CYBERDEFENDER CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair Value
Measurements
FASB ASC
Topic 820, “Fair Value
Measurements and Disclosures,” defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value
measurements. The fair value hierarchy distinguishes between assumptions based
on market data (observable inputs) and an entity’s own assumptions (unobservable
inputs). The hierarchy consists of three levels:
|
•
|
Level
one — Quoted market prices in active markets for identical assets or
liabilities;
|
|
•
|
Level
two — Inputs other than level one inputs that are either directly or
indirectly observable; and
|
|
•
|
Level
three — Unobservable inputs developed using estimates and assumptions,
which are developed by the reporting entity and reflect those assumptions
that a market participant would
use.
|
Determining
which category an asset or liability falls within the hierarchy requires
significant judgment. The Company evaluates its hierarchy disclosures each
quarter. The Company has no assets or liabilities that are measured at fair
value on either a recurring or non-recurring basis.
All of
our financial instruments are recorded at fair value. For certain of the
Company’s financial instruments, including cash, restricted cash, accounts
receivable, accounts payable, other accrued liabilities and notes payable, the
carrying amounts approximate fair value due to their short
maturities.
Loss Per
Share
In
accordance with FASB ASC Topic 260, “Earnings Per Share,” the
basic loss per common share is computed by dividing net loss available to common
stockholders by the weighted average number of common shares outstanding.
Diluted loss per common share is computed similar to basic loss per common
share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potential
common shares had been issued and if the additional common shares were dilutive.
As of June 30, 2010 and 2009, there were 19,250,652 and 15,352,948 shares of
potentially dilutive securities outstanding, respectively. As the Company
reported a net loss, none of the potentially dilutive securities were
included in the calculation of diluted loss per share since their effect would
be anti-dilutive for that reporting period.
Stock Based
Compensation
The
Company applies FASB ASC Topic 718, “Compensation – Stock Compensation,”
which requires companies to measure and recognize the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value. For non-employee stock based compensation, the Company
recognizes an expense in accordance with FASB ASC Topic 505, “Equity,” and values the
equity securities based on the fair value of the security on the date of grant.
For stock-based awards the value is based on the market value of the stock on
the date of grant or the value of services, whichever is more readily available.
Stock option awards are valued using the Black-Scholes option-pricing
model.
The
Company accounts for equity instruments issued to consultants and vendors in
exchange for goods and services in accordance with the provisions of FASB ASC
Topic 505, “Equity.”
The measurement date for the fair value of the equity instruments issued is
determined at the earlier of (i) the date at which a commitment for performance
by the consultant or vendor is reached or (ii) the date at which the consultant
or vendor’s performance is complete. In the case of equity instruments issued to
consultants, the fair value of the equity instrument is recognized over the term
of the consulting agreement. An asset acquired in exchange for the issuance of
fully vested, non-forfeitable equity instruments should not be presented or
classified for accounting purposes as an offset to equity on the grantor’s
balance sheet once the equity instrument is granted. Accordingly, the Company
records the fair value of the fully vested, non-forfeitable common stock issued
for future consulting services as prepaid expense in its balance
sheet.
10
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - NATURE OF BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (Continued)
Segment
Disclosures
The
Company operates in one segment and its chief operating decision maker is its
chief executive officer.
Subsequent
Events
The
Company has evaluated subsequent events through the filing date of this Form
10-Q, and determined that no subsequent events have occurred that would require
recognition in the condensed financial statements or disclosure in the notes
thereto other than as discussed in the accompanying notes (see Note
8).
Recently Issued Accounting
Pronouncements
The
Company has adopted all accounting pronouncements effective before June 30, 2010
which are applicable to the Company.
In
September 2009, the FASB issued an update to its accounting guidance
regarding multiple-deliverable revenue arrangements. The guidance addresses how
to measure and allocate consideration to one or more units of accounting.
Specifically, the guidance requires that consideration be allocated among
multiple deliverables based on relative selling prices. The guidance establishes
a selling price hierarchy of (1) vendor-specific objective evidence, (2)
third-party evidence and (3) estimated selling price. This guidance is effective
for annual periods beginning on or after June 15, 2010 but may be early adopted
as of the beginning of an annual period. The Company expects to adopt this
guidance on January 1, 2011 and does not expect this guidance to have a material
impact on its financial statements.
In
October 2009, the FASB issued an update to its accounting guidance
regarding software revenue recognition. The guidance changes the accounting
model for revenue arrangements that include both tangible products and software
elements. Under this guidance, tangible products containing software components
and non-software components that function together to deliver the tangible
product’s essential functionality are excluded from the software revenue
guidance in FASB ASC Topic 985, “Software.” In addition,
hardware components of a tangible product containing software components are
always excluded from the software revenue guidance. This guidance is effective
prospectively for revenue arrangements entered into or materially modified in
fiscal years beginning on or after June 15, 2010 but may be early adopted. The
Company expects to adopt this guidance on January 1, 2011 and does not expect
this guidance to have a material impact on its financial
statements.
In
January 2010, the FASB issued an update to its accounting guidance regarding
fair value measurement and disclosure. The guidance affects the disclosures made
about recurring and non-recurring fair value measurements. This guidance is
effective for annual reporting periods beginning after December 15, 2009, except
for the disclosures about purchases, sales, issuances and settlements in the
roll forward of activity in Level 3 fair value measurements. Those disclosures
are effective for fiscal years beginning after December 15, 2010. Early
adoption is permitted. The Company is currently evaluating the impact that this
guidance will have on its financial statements.
In
February 2010, the FASB issued amended guidance on subsequent events. Under
this amended guidance, SEC filers are no longer required to disclose the date
through which subsequent events have been evaluated in originally issued and
revised financial statements. This guidance was effective immediately and we
adopted this new guidance in the quarter ended June 30, 2010. See Note 8 —
Subsequent Events to our condensed financial statements.
NOTE
3 – RESTRICTED CASH
Under a
credit card processing agreement with a financial institution, the Company is
required to maintain a security reserve deposit as collateral. The amount
of the deposit is at the discretion of the financial institution and as of June
30, 2010 and December 31, 2009 was $10,000. Under a separate credit card
processing agreement with a different financial institution, the Company is also
required to maintain a security reserve deposit as collateral. The amount of the
deposit is currently based on 10% of the six-month rolling sales volume and was
approximately $1.8 million and $1.3 million as of June 30, 2010 and December 31,
2009, respectively. The security reserve deposit is funded by the institution
withholding a portion of daily cash receipts from Visa and MasterCard
transactions.
On
September 30, 2009, the Company entered into a second amendment to its premises
lease as more fully described in Note 6 below. As part of the amendment the
Company was required to issue a $250,000 letter of credit as a security deposit.
The letter of credit is collateralized by cash held in an account at the
Company’s bank. The account is interest bearing and the Company receives the
interest that is earned.
11
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
4 - STOCKHOLDERS’ DEFICIT
Common
Stock
During
February 2009, the Company issued 94,628 shares of restricted common stock
valued at $1.10 per share to a vendor as settlement for past services
rendered.
In April
2009, one investor exercised warrants to purchase 36,294 shares of common stock
exercisable at $1.01 per share. The warrant was exercised pursuant to the
cashless provision contained in the warrant and as such, the Company issued
16,732 shares to the investor.
In May
2009, one investor exercised warrants to purchase 172,928 shares of common stock
exercisable at $1.00 per share. The warrant was exercised pursuant to the
cashless provision contained in the warrant and as such, the Company issued
88,150 shares to the investor.
In June
2009, five investors exercised warrants to purchase 116,232 shares of common
stock exercisable at $1.00 to $1.01 per share. The warrants were exercised
pursuant to the cashless provision contained in the warrants and as such, the
Company issued 82,378 shares to the investor.
On June
4, 2009, the Company closed the sale and issuance of 1,142,860 shares of common
stock to GR Match, LLC (“GRM”) for an aggregate purchase price of $2,000,005, of
which $400,000 must be used for the creation and production by GRM of television
commercials advertising the Company’s products and services, and the balance of
which the Company will use for general working capital. Pursuant to the terms of
the Securities Purchase Agreement documenting the transaction, GRM has demand
and piggyback registration rights with respect to the shares.
On June
10, 2009, the Company closed the sale and issuance of 632,500 shares of common
stock to Shimski L.P. for an aggregate purchase price of $1,106,875. Pursuant to
the terms of the Securities Purchase Agreement, Shimski L.P. has demand and
piggyback registration rights with respect to the shares.
During
the six months ended June 30, 2010, six investors exercised warrants to purchase
156,750 shares of common stock exercisable at prices ranging from $1.00 to $2.25
per share.
See
“stock warrants” below for additional shares issued related to the exercise of
stock warrants.
See
“stock options” below for additional shares issued related to the exercise of
stock options.
See Note
5 for additional shares issued related to the convertible notes
payable.
12
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
4 - STOCKHOLDERS’ DEFICIT (Continued)
Stock
warrants
On
November 11, 2008, the Company entered into a consulting agreement with Newview
Consulting L.L.C. (“Newview”) Pursuant to this agreement, Newview provided
investor relations services for a period of 6 months in exchange for warrants to
purchase 2,250,000 shares of common stock at a price of $1.25 per share. 900,000
warrants vested immediately and 270,000 warrants were to vest on the 1st of each
month beginning December 1, 2008 and ending April 1, 2009. At January 1,
2009, the Company amended the vesting schedule in the Newview warrant to vest
the remaining 1,080,000 warrants on the first of each month from January 1, 2009
to June 1, 2009 at the rate of 180,000 warrants per month. As such,
540,000 and 1,080,000 warrants vested during the three and six month periods
ended June 30, 2009 and the value of $619,141 and $1,010,673, using the Black
Scholes pricing model, was expensed to investor relations and other related
consulting expense. At June 30, 2009, all of the warrants had
vested.
On
January 17, 2009, the Company entered into a two-month consulting agreement with
a consultant for services relating to financial management and reporting.
As part of the agreement, the consultant was granted a warrant to purchase 2,500
shares of common stock with a term of five years at an exercise price of $1.25
per share, for each month of the term of the agreement. The fair value of
these warrants was $3,753, using a Black Scholes pricing model, and was expensed
to investor relations and other related consulting expense. On April 24, 2009,
the Company entered into a second agreement with the consultant. As part
of the agreement, the consultant was granted a warrant to purchase 2,500 shares
of common stock at an exercise price of $1.80 per share. The fair value of
the warrant, which was computed as $3,453, was expensed to investor relations
and other related consulting expense for the three and six months ended June 30,
2009.
On
October 30, 2008, the Company executed a letter of intent with GRM to create,
market and distribute direct response advertisements to sell the Company’s
products. Pursuant to the letter of intent, GRM was responsible for
creating, financing, producing, testing and evaluating a radio commercial to
market the Company’s products in exchange for $50,000 and a fully vested,
non-forfeitable warrant to purchase 1,000,000 shares of common stock at a price
of $1.25 per share with an estimated fair value of $951,495 using the
Black-Scholes pricing model. The fair value of the warrant was capitalized
to prepaid expenses at the time of issuance and was expensed over the five-month
term of service. The Company expensed $0 and $570,897 to media and marketing
services expense for the three and six months ended June 30, 2009. The warrant
included an anti-dilutive provision that reduced the exercise price of the
warrant if the Company at any time while this warrant is outstanding sells and
issues any common stock at a price per share less than the then exercise price.
During August 2009, the Company received a waiver whereby GRM permanently
waived, as of and after April 1, 2009, any and all exercise price adjustments
that would otherwise occur, or would have occurred on or after April 1, 2009, as
a result of this provision.
On March
24, 2009, the Company entered into a Media and Marketing Services Agreement (the
“Media Agreement”) with GRM. Pursuant to the Media Agreement, GRM will
provide direct response media campaigns, including radio and television direct
response commercials, to promote the Company’s products and services and will
purchase media time on the Company’s behalf. During the term of the Media
Agreement, which is to continue until June 1, 2011, as amended, subject to
certain rights of termination, GRM will be the exclusive provider of all media
purchasing and direct response production services. On June 23, 2009, per
the Media Agreement, the Company appointed a representative of GRM to the
Company’s board of directors. A GRM representative will continue to serve
throughout the term of the Media Agreement and for so long as GRM owns shares of
the Company’s common stock or the right to purchase shares of the Company’s
common stock which constitute at least 5% of the Company’s issued and
outstanding common stock.
13
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
4 - STOCKHOLDERS’ DEFICIT (Continued)
As
compensation for GRM’s services, the Company agreed to amend the warrant
described above so that the terms were consistent with the warrants described
below. None of the amended terms resulted in an accounting change to the
warrant. In conjunction with the execution of the Media Agreement and for
creating, financing, producing, testing and evaluating a television commercial
to market the Company’s products, the Company issued to GRM a second five-year
warrant for the purchase of 1,000,000 shares of the Company’s common stock at a
price of $1.25 per share valued at $712,303 using the Black-Scholes pricing
model. The fair value of the warrant was capitalized at the time of issuance and
was expensed over the five-month expected term of service. During the three and
six months ended June 30, 2009, $427,382 and $569,842 was expensed to media and
marketing services expense. This warrant may be exercised only for
cash. Finally, the Company agreed to issue to GRM a five-year warrant
(“Media Services Warrant”) for the purchase of 8,000,000 shares of the Company’s
common stock at an exercise price of $1.25 per share. The Media Services
Warrant may be exercised only with cash and is subject to vesting as follows:
for each $2 of media placement costs advanced by GRM on the Company’s behalf,
the right to purchase one share of the Company’s common stock will vest.
As of June 30, 2010, the right to purchase 5,427,316 of the 8,000,000 Media
Services Warrant shares has vested and was valued at $16,590,022 using the
Black-Scholes pricing model. During the three and six months ended June
30, 2010, 2,043,846 and 3,589,984 warrants vested, and $6,469,026 and
$11,958,816 was expensed to interest media and marketing services expense.
During the three and six months ended June 30, 2009, 227,050 and 277,050
warrants vested, and $310,435 and $353,117 was expensed to media and marketing
services expense. The remaining 2,572,684 shares from the Media Services Warrant
are not guaranteed to vest as they are contingent upon GRM advancing media
placement costs; therefore, these unvested warrants have not been included or
accounted for as outstanding dilutive securities at June 30, 2010. These
warrants included an anti-dilutive provision that reduced the exercise price of
the warrants if the Company at any time while the warrants are outstanding sells
and issues any common stock at a price per share less than the then exercise
price. During August 2009, the Company received a waiver whereby GRM permanently
waived, as of and after April 1, 2009, any and all exercise price adjustments
that would otherwise occur, or would have occurred on or after April 1, 2009, as
a result of this provision.
If GRM
terminates the Media Agreement due to a breach by the Company in the Company’s
performance or as a result of the Company’s discontinuance, dissolution,
liquidation, winding up or insolvency, or if the Company terminates the Media
Agreement for any reason, any unexpired and unvested rights of GRM to purchase
shares of the Company’s common stock pursuant to the Media Agreement will
immediately vest. If the Company breaches its payment obligations under the
agreement and fails to cure the breach within 15 days after receiving notice
from GRM, then the number of warrant shares which would otherwise vest during
the month of the delinquent payment will automatically double.
In
November 2009, the Company amended the Media Agreement with GRM. Pursuant to
this amendment, if any of the warrants that have been issued to GRM are
outstanding and the Company sells and issues common stock at a price per share
less than the exercise price set forth in the applicable warrant, as adjusted
thereunder (such issuances collectively, a “Lower Priced Issuance”), without the
prior written consent of GRM, then 37.5% of any unexpired and
unvested rights of GRM to purchase shares of the Company’s common stock pursuant
to the Media Services Warrant shall immediately and automatically vest in full
without any notice or action of GRM. As of June 30, 2010, no common stock has
been issued at a price less than the exercise price of the GRM
warrants.
On April
1, 2009, the Company entered into an agreement with a consultant for management
consulting and business advisory services on an as needed basis. The
consultant was granted a warrant to purchase 850,000 shares of the Company’s
common stock for a period of five years at an exercise price of $1.25.
These warrants vest as follows: 300,000 immediately and 50,000 per month on the
1st
day of each month commencing May 1, 2009 and ending March 1, 2010. As of March
31, 2010, all of the warrant shares have vested. During the three and six
months ended June 30, 2010, $0 and $523,610 was expensed to investor relations
and other related consulting expense. During the three and six months ended June
30, 2009, $436,546 was expensed to investor relations and other related
consulting expense.
14
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
4 - STOCKHOLDERS’ DEFICIT (Continued)
On April
5, 2009, the Company entered into an agreement with a consultant for marketing
related services. The agreement had a term of three months. The
agreement provided compensation of $13,000 for month one, $14,000 for month two
and $15,000 for month three. In addition, the consultant was granted a
warrant to purchase 15,000 shares of the Company’s common stock for a period of
five years at an exercise price of $1.25. This warrant was to vest 5,000 shares
per month over the term of the agreement. On May 15, 2009, the original
agreement was terminated, along with the right to purchase 5,000 shares of
common stock that would have vested in June 2009, and the Company entered into a
second agreement with the consultant. The second agreement had a term of
three months and provided compensation of $17,500 for month one, of which 50%
will be deferred for 30 days, and $8,750 per month thereafter. In addition, the
consultant was granted a warrant to purchase 15,000 shares of the Company’s
common stock for a period of five years at an exercise price of $1.25. The
warrant was to vest 5,000 shares per month over the term of the second
agreement. The second agreement also provided for a bonus of up to 50,000
additional warrant shares at an exercise price of $1.83 for achieving certain
goals. On June 15, 2009, the second agreement was terminated, along with the
right to purchase 10,000 shares of common stock that would have vested in July
and August 2009, and the Company entered into a third agreement with the
consultant. The third agreement has a term of two months. The third
agreement provided compensation of $12,500 per month. In addition, the
consultant was granted a warrant to purchase 10,000 shares of the Company’s
common stock for a period of five years at an exercise price of $1.25. This
warrant vests 5,000 shares per month over the term of the agreement.
Additionally, the consultant was granted a warrant to purchase 5,000 shares of
the Company’s common stock for a period of five years at an exercise price of
$1.83 for deferring 50% of the compensation due for May 2009 until July 30, 2009
and a warrant to purchase 5,000 shares of the Company’s common stock for a
period of five years at an exercise price of $1.83 as part of the bonus per the
second agreement. The third agreement also provided for a bonus of up to 45,000
additional warrant shares at an exercise price of $1.83 for achieving certain
goals. The fair value of the 25,000 warrants that were granted and vested of
$46,414 was expensed to investor relations and other related consulting expense
for the three and six months ended June 30, 2009.
In May
2009, the Company began an offering to the holders of its warrants issued with
“cashless exercise” provisions and/or “down-round” provisions (collectively the
“Released Provisions”). Pursuant to the offering, the warrant holders were
given the opportunity to increase by 10% the number of shares of common stock
covered by their warrants in exchange for extinguishing the Released Provisions
from their warrants. In order for the warrant holders to take advantage of
the offer, they were required to exercise a portion of their warrant(s) and
purchase for cash no less than 30% of the shares of common stock covered by
their warrant(s), after giving effect to the increase. On June 29, 2009,
the Company filed a Schedule TO with the SEC covering this offering. Per
the originally filed Schedule TO, the offering was to expire on July 28,
2009. Subsequent to June 30, 2009, the Schedule TO was amended and the
offering was extended until August 17, 2009. As of June 30, 2009, the Company
received $1,899,420 in proceeds, net of offering costs of $68,891, and issued
1,732,248 shares of common stock to warrant holders that have participated in
this offer. Additionally, the Company issued warrants to purchase 243,005
shares of the Company’s common stock for the 10% increase in warrants offered to
warrant holders. The additional warrants were valued at $500,630, using the
Black Scholes pricing model, and were expensed to interest expense during the
three and six months ended June 30, 2009.
On May
15, 2009, the Company entered into an agreement with a second consultant for
marketing related services. The agreement had a term of three months and
provided compensation of $17,500 for month one, of which 50% will be deferred
for 30 days, and $8,750 per month thereafter. In addition, the consultant was
granted a warrant to purchase 15,000 shares of the Company’s common stock for a
period of five years at an exercise price of $1.83. The warrant was to
vest 5,000 shares per month over the term of the second agreement. The agreement
also provided for a bonus of up to 50,000 additional warrants at an exercise
price of $1.83 for achieving certain goals. On June 15, 2009, the agreement was
terminated, along with the right to purchase 10,000 shares of common stock that
would have vested in June and July 2009, and the Company entered into a second
agreement with the consultant. The second agreement has a term of two
months and provided compensation of $12,500 per month. In addition, the
consultant was granted a warrant to purchase 10,000 shares of the Company’s
common stock for a period of five years at an exercise price of $1.83.
This warrant vests 5,000 shares per month over the term of the agreement.
Additionally, the consultant was granted a warrant to purchase 5,000 shares of
the Company’s common stock for a period of five years at an exercise price of
$1.83 for deferring 50% of the compensation due for May 2009 until July 30, 2009
and a warrant to purchase 5,000 shares of the Company’s common stock for a
period of five years at an exercise price of $1.83 as part of the bonus per the
second agreement. The second agreement also provided for a bonus of up to 45,000
additional warrants at an exercise price of $1.83 for achieving certain goals.
The fair value of the 15,000 warrants that were granted and vested of $29,864
was expensed to investor relations and other related consulting expense for the
three and six months ended June 30, 2009.
On August
1, 2009, the Company entered into an agreement with a consultant for business
development services related to the signing of the Wiley licensing
contract. The consultant was granted a warrant to purchase 55,000 shares
of the Company’s common stock for a period of three years at an exercise price
of $2.18. The warrant was to vest 15,000 shares at the signing of the
Wiley contract, 15,000 shares at the Wiley launch and 25,000 shares at the
earlier of the first anniversary date of the agreement or when sales of the
Wiley branded products exceed 100,000 units. The second 15,000 warrant shares
vested during the six months ended June 30, 2010 and $25,933 was expensed to
investor relations and other related consulting expense.
15
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
4 - STOCKHOLDERS’ DEFICIT (Continued)
See Note
5 for additional warrants issued during the three and six months ended June 30,
2009 related to the convertible notes payable.
The
following represents a summary of the warrants outstanding at June 30, 2010
and 2009 and changes during the six months then ended:
Six Months Ended
|
||||||||||||||||||||||||
June 30, 2010
|
June 30, 2009
|
|||||||||||||||||||||||
Weighted
|
Weighted
|
|||||||||||||||||||||||
Number
|
Average
|
Aggregate
|
Number
|
Average
|
Aggregate
|
|||||||||||||||||||
of
|
Exercise
|
Intrinsic
|
Of
|
Exercise
|
Intrinsic
|
|||||||||||||||||||
Warrants
|
Price
|
Value
|
Warrants
|
Prices
|
Value
|
|||||||||||||||||||
Outstanding,
beginning of period
|
13,026,657 | $ | 1.20 | 11,029,890 | $ | 1.14 | ||||||||||||||||||
Issued
|
3,589,984 | $ | 1.25 | 2,580,855 | $ | 1.24 | ||||||||||||||||||
Exercised
|
(156,750 | ) | $ | 1.23 | (2,057,702 | ) | $ | 1.12 | ||||||||||||||||
Outstanding,
end of period
|
16,459,891 | $ | 1.21 | $ | 42,977,156 | 11,553,043 | $ | 1.17 | $ | 24,002,870 | ||||||||||||||
Exercisable,
end of period
|
16,434,891 | $ | 1.21 | $ | 42,933,406 | 11,103,043 | $ | 1.17 | $ | 23,102,870 |
The
following table summarizes information about warrants outstanding at
June 30, 2010:
Weighted
|
||||||||
Average
|
||||||||
Number
of
|
Remaining
|
|||||||
Warrant
|
Contractual
|
|||||||
Exercise
Price
|
Shares
|
Life
(Years)
|
||||||
$ 1.00
|
2,704,840
|
1.36
|
||||||
$ 1.01
|
700,306
|
5.41
|
||||||
$ 1.20
|
324,875
|
2.51
|
||||||
$ 1.25
|
12,469,880
|
3.19
|
||||||
$ 1.80
|
2,500
|
3.82
|
||||||
$ 1.83
|
125,000
|
3.89
|
||||||
$ 2.05
|
77,490
|
4.23
|
||||||
$ 2.18
|
55,000
|
2.23
|
||||||
16,459,891
|
The
weighted average grant date fair value of warrants granted and vested during the
six months ended June 30, 2010 and 2009 was $3.33 and $0.90 per share,
respectively. As of June 30, 2010, 25,000 shares of common stock covered by a
warrant, with an estimated remaining value of $43,222, remain unvested and will
vest once a milestone has occurred per the underlying contract. The weighted
average remaining life of the vested warrants is 2.97
years.
16
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
4 - STOCKHOLDERS’ DEFICIT (Continued)
Stock
options
In
January 2005, the Company adopted the CyberDefender Corporation 2005 Stock
Option Plan (sometimes called the CyberDefender Corporation 2005 Equity
Incentive Plan and referred to herein as the “2005 Plan”), which consists of
equity programs that provide for the granting of Incentive Stock Options or
Nonstatutory Stock Options, the issuance of stock purchase rights and awards of
stock. Under the terms of the 2005 Plan, the exercise price of options granted
may be equal to, greater than or less than the fair market value on the date of
grant, the options may have a maximum term of ten years and generally vest over
a period of service
or attainment of specified performance objectives. The maximum aggregate amount
of options that may be granted from the 2005 Plan is 931,734 shares, of
which awards for the purchase of 733,233 shares have been granted and are
outstanding, awards for the purchase of 198,125 shares have been exercised and
awards for the purchase of 376 shares are available for grant at June 30,
2010.
On
October 30, 2006, the Company adopted the Amended and Restated 2006 Equity
Incentive Plan (“2006 Plan”) that provides for the granting of Incentive Stock
Options or Nonstatutory Stock Options, the issuance of stock purchase rights and
awards of stock. Under the terms of the 2006 Plan, the exercise price of
options granted may be equal to, greater than or less than the fair market value
on the date of grant, the options may have a maximum term of ten years and
generally vest over a period of service or attainment of specified performance
objectives. The Company amended the 2006 Plan in June 2009 to increase the
maximum number of shares available to be granted by 1,500,000 shares. The
maximum aggregate amount of stock based awards that may be granted from the
2006 Plan is 2,875,000 shares, of which awards for the purchase of 1,865,528
shares have been granted and are outstanding, awards for the purchase of 518,149
shares have been exercised and awards for the purchase of 491,323 shares are
available for grant at June 30, 2010.
On
January 1, 2009, the Company entered into a three-month consulting agreement
with Unionway International, LLC, an entity controlled by Mr. Bing Liu, for
consulting services. As part of the agreement, Mr. Liu was granted 10-year
options to purchase a total of 18,000 shares of common stock at an exercise
price of $1.00 per share vesting over the term of the agreement as compensation
for 2008 achievements. In addition, Mr. Liu was granted 10-year options to
purchase 5,000 shares of common stock at an exercise price of $1.00 per share
vesting 2,500 shares on January 1, 2009, 1,250 shares on February 1, 2009 and
1,250 shares on March 1, 2009.
On
January 17, 2009, the Company entered into a two-month consulting agreement with
a consultant for services relating to financial management and reporting.
As part of the agreement, the consultant was granted options to purchase 2,500
shares of common stock at an exercise price of $1.25 per share, per month for
the term of the agreement.
On April
1, 2009, the Company entered into a three-month consulting agreement with
Unionway International, LLC, an entity controlled by Mr. Bing Liu, for
consulting services. As part of the agreement, Mr. Liu was granted a
10-year option to purchase 15,000 shares of common stock at an exercise price of
$1.25 per share vesting over the term of the agreement.
During
the six months ended June 30, 2009, the Company granted to employees options to
purchase a total of 585,000 shares of common stock under the 2006 Plan and the
2005 Plan at prices ranging from $1.00 to $3.30 per share.
During
the six months ended June 30, 2010, the Company granted to employees options to
purchase a total of 869,126 shares of common stock under the 2006 Plan and the
2005 Plan at prices ranging from $1.00 to $4.70 per share.
See Note
6 for discussion of options granted to Company executives.
17
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
4 - STOCKHOLDERS’ DEFICIT (Continued)
A summary
of stock option activity for the 2005 Plan and 2006 Plan is as
follows:
Six
Months
|
||||||||||||||||||||||||||||||||
June
30, 2010
|
June
30, 2009
|
|||||||||||||||||||||||||||||||
Weighted
|
Weighted
|
|||||||||||||||||||||||||||||||
Weighted
|
Average
|
Weighted
|
Average
|
|||||||||||||||||||||||||||||
Number
|
Average
|
Remaining
|
Aggregate
|
Number
|
Average
|
Remaining
|
Aggregate
|
|||||||||||||||||||||||||
Of
|
Exercise
|
Contractual
|
Intrinsic
|
of
|
Exercise
|
Contractual
|
Intrinsic
|
|||||||||||||||||||||||||
Options
|
Price
|
Term
|
Value
|
Options
|
Prices
|
Term
|
Value
|
|||||||||||||||||||||||||
Outstanding,
beginning of year
|
1,856,293 | $ | 1.09 | 7.57 | 1,444,084 | $ | 0.83 | 7.66 | ||||||||||||||||||||||||
Granted
|
869,126 | $ | 3.63 | 9.79 | 628,000 | $ | 1.45 | 9.75 | ||||||||||||||||||||||||
Exercised
|
(64,658 | ) | $ | 0.83 | 5.70 | (75,106 | ) | $ | 1.11 | 8.83 | ||||||||||||||||||||||
Forfeited
|
(62,000 | ) | $ | 2.15 | (104,041 | ) | $ | 1.08 | ||||||||||||||||||||||||
Outstanding,
end of period
|
2,598,761 | $ | 1.92 | 7.98 | $ | 5,310,447 | 1,892,937 | $ | 1.01 | 7.85 | $ | 4,243,794 | ||||||||||||||||||||
Exercisable,
end of period
|
1,478,440 | $ | 1.01 | 6.93 | $ | 4,328,409 | 1,210,411 | $ | 0.76 | 7.02 | $ | 3,009,875 | ||||||||||||||||||||
Vested,
exercisable and expected to vest in the future
|
2,444,778 | $ | 1.73 | 7.87 | $ | 5,447,259 | 1,664,391 | $ | 0.94 | 7.65 | $ | 3,837,986 |
The
weighted-average grant date fair value of options granted during the six months
ended June 30, 2010 and 2009 was $2.52 and $1.33 per option,
respectively.
As of
June 30, 2010 and 2009, 1,120,321 and 682,526 of the option shares granted are
not vested with an estimated remaining value of $2,052,787 and $697,073,
respectively. At June 30, 2010 and 2009, the remaining value of non vested
options granted is expected to be recognized over the weighted average vesting
period of 2.73 and 2.92 years, respectively.
The
Company recorded compensation expense associated with the issuance and
vesting of stock options of $298,954 and $390,314 in selling, general and
administrative expense for the three and six months ended June 30, 2010,
respectively. The Company recorded compensation expense associated with the
issuance and vesting of stock options of $56,429 and $141,637 in selling,
general and administrative expense for the three and six months ended June 30,
2009, respectively.
During
the six months ended June 30, 2010 and 2009, options for the purchases of 64,658
and 75,106 shares were exercised for total proceeds to the Company of $53,765
and $83,086, respectively. The aggregate intrinsic value of the exercised
options was $215,278 and $143,575 for the six months ended June 30, 2010 and
2009, respectively.
The
Company recognizes the fair value of options issued to employees and consultants
as stock-based compensation expense over the vesting period of the awards. The
estimated fair value of options is based on the Black-Scholes pricing
model.
18
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - CONVERTIBLE NOTES PAYABLE
In
November and December 2008, the Company entered into a Securities Purchase
Agreement, that also included registration rights, with certain accredited
investors to which it sold 10% Convertible Promissory Notes (“2008 Convertible
Notes”), due eleven months from the date of issuance and convertible into shares
of Common Stock in the aggregate principal amount of $845,000, which may be
converted at the price of $1.25 per share (subject to adjustment) into an
aggregate of 676,000 shares of common stock. In conjunction with the sale
of the 2008 Convertible Notes, the Company issued common stock purchase warrants
to purchase an aggregate of 338,000 shares of common stock at $1.25 per share
and paid its placement agent a total of $50,700 in commissions and issued to its
placement agent a five-year warrant to purchase an additional 50,700 shares of
the Company’s common stock, at an exercise price of $1.25 per share, valued at
$47,498 using the Black-Scholes option pricing model. In January
2009, the Company completed the sale and issuance of the Company’s 2008
Convertible Notes. Accordingly, the Company received additional gross
proceeds of $355,000, which may be converted at the price of $1.25 per share
into an aggregate of 284,000 shares of common stock. In conjunction with
the sale of the 2008 Convertible Notes, the Company issued common stock purchase
warrants to purchase an aggregate of 142,000 shares of common stock at $1.25 per
share and paid its placement agent a total of $21,300 in commissions and issued
to its placement agent a five-year warrant to purchase an additional 21,300
shares of the Company’s common stock, at an exercise price of $1.25 per share,
valued at $18,197 using the Black-Scholes option pricing model.
Under the
terms of the Registration Rights Agreement executed in conjunction with the
offering, the Company was obligated to file a registration statement with the
SEC covering the resale of the shares issuable upon conversion of the 2008
Convertible Notes and the exercise of the common stock purchase
warrants The Company was required to file the registration statement
no later than 60 days following the final closing date of the sale and issuance
of the 2008 Convertible Notes and warrants, and to use its best efforts to cause
the registration statement to become effective no later than 120 days
thereafter. If the Company was delinquent in the filing deadline or the
effectiveness deadline of the registration statement, it would have been
obligated to pay the holders of the 2008 Convertible Notes liquidated damages
equal to 1% of the outstanding principal amount of the 2008 Convertible Notes
for every 30-day period of delinquency, up to a maximum of 10%. The Company
would have been required to pay any such liquidated damages in cash or its
common stock valued at the average volume weighted average price (“VWAP”) for
the five trading days preceding the applicable due date, provided such average
VWAP exceeds $1.00 per share. On May 1, 2009, the Company received a Consent and
Waiver from the holders of the 2008 Convertible Notes waiving all liquidated
damages under the Registration Rights Agreement.
The
warrants are redeemable at a price of $0.01 per share in the event (i) the
average VWAP of the Company’s common stock for 10 consecutive trading days
equals or exceeds 2.5 times the then current exercise price, (ii) the average
daily trading volume of the common stock during such 10-trading day period is at
least 50,000 shares and (iii) there is an effective registration statement
covering the resale of the shares issuable upon exercise of the
warrants.
The total
value of the 2008 Convertible Notes was allocated between the 2008 Convertible
Notes and the warrants, including the discount, which amounted to $595,646 and
$604,354, respectively. The discount of $604,354 ($158,886 was recorded in the
first quarter of 2009) related to the warrants is being amortized over the term
of the 2008 Convertible Notes. The Company amortized $164,824 and $329,648 to
interest expense related to the 2008 Convertible Notes for the three and six
months ended June 30, 2009, respectively. At June 30, 2010 and December 31,
2009, $0 and $109,001 of accrued interest on these notes is included in accrued
expenses on the accompanying condensed balance sheets.
In
addition, as part of the transaction, the Company paid to the placement agent
$72,000 and issued common stock purchase warrants to purchase an aggregate of
72,000 shares of common stock at $1.25 per share. The warrants were valued at
$65,695 using the Black-Scholes pricing model. These costs, totaling $137,695
($39,497 was recorded in 2009), are being amortized over the term of the 2008
Convertible Notes. The Company recorded amortization of $37,553 and
$75,106 to interest expense during the three and six months ended June 30, 2009,
respectively.
19
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - CONVERTIBLE NOTES PAYABLE (Continued)
On
September 30, 2009, all of the holders of the 2008 Convertible Notes converted
$1,200,000 of principal into 960,000 shares of common stock at $1.25 per share
and all of the related note discount and debt issuance costs were amortized to
interest expense.
During
May 2009, the Company entered into a Securities Purchase Agreement with certain
accredited investors to which it sold $300,000 in aggregate principal amount of
the Company’s 10% Convertible Promissory Notes (“2009 10% Convertible Notes”),
due five months from the date of issuance and convertible into shares of Common
Stock at a conversion price of $1.75 per share. In conjunction with the
sale of the 2009 10% Convertible Notes, the Company paid its placement agent a
total of $12,000 in commissions, which was amortized in full during
2009.
The total
value of the 2009 10% Convertible Notes was allocated between the 2009 10%
Convertible Notes and the discount, which amounted to $19,715. The discount was
amortized over the term of the 2009 10% Convertible Notes. At June 30, 2010 and
December 31, 2009, $0 and $12,500 of accrued interest on these notes is included
in accrued expense on the accompanying condensed balance sheets.
On
September 30, 2009, all of the holders of the 2009 10% Convertible Notes
converted $300,000 of principal into 171,429 shares of common stock at $1.75 per
share and all of the related note discount and debt issuance costs have been
amortized to interest expense.
On
November 4, 2009, the Company closed the sale and issuance of $2.2 million in
aggregate principal amount of its 8% Secured Convertible Promissory Notes (the
“2009 8% Convertible Notes”), convertible into common stock of the Company at a
conversion price of $2.05 per share. All outstanding principal and
interest of the 2009 8% Convertible Notes was due April 1, 2011. Out of
the total gross proceeds of the offering, the Company paid its placement agent
$154,980 in commissions, equal to 7% of the gross proceeds of the offering, and
issued to its placement agent a three year warrant to purchase 77,490 shares of
common stock, equal to 3.5% of the number of shares of common stock into which
the 2009 8% Convertible Notes initially may be converted, at an exercise price
of $2.05 per share. The warrants were valued at $132,369 using the Black-Scholes
pricing model. These deferred financing costs, totaling $287,349, are being
amortized over the term of the 2009 8% Convertible Notes. The Company recorded
amortization of $191,566 and $239,458 to interest expense during the three and
six months ended June 30, 2010.
The total
value of the 2009 8% Convertible Notes was allocated between the 2009 8%
Convertible Notes and the discount, which amounted to $745,200. The discount is
being amortized over the term of the 2009 8% Convertible Notes. The Company
amortized $496,800 and $621,000 to interest expense related to the 2009 8%
Convertible Notes for the three and six months ended June 30, 2010. At June 30,
2010 and December 31, 2009, $0 and $32,719 of accrued interest on these notes is
included in accrued expenses on the accompanying condensed balance
sheets.
On May
15, 2010, all of the holders of the 2009 8% Convertible Notes converted $2.3
million of principal and accrued interest into 1.1 million shares of common
stock at $2.05 per share and all of the related note discount and debt issuance
costs have been amortized to interest expense.
On March
31, 2010, the Company sold and issued in a private placement to GRM a 9% Secured
Convertible Promissory Note in the aggregate principal amount of $5,300,000 (the
“GR Note”), due March 31, 2012. The Company received net proceeds of
$5,000,000 after payment of an issuance fee of $300,000 to GRM. The
Company has recorded the $300,000 as a discount to the GR Note as if the amount
were an original issue discount. The GR Note will accrue simple interest at the
rate of 9% per annum, payable on the first day of each calendar quarter in cash;
provided, however, that GRM may elect to cause the accrued unpaid interest for
any applicable quarter to be added to the then outstanding principal amount of
the GR Note in lieu of a cash payment of interest by delivering written notice
of such election to the Company no later than 15 days prior to the applicable
interest payment date. The Company may elect to make the first interest
payment due July 1, 2010 either in cash or by adding it to the aggregate
principal amount of the GR Note. For the three and six months ended June 30,
2010 the Company recorded interest expense of $119,250 under the GR
Note.
20
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
5 - CONVERTIBLE NOTES PAYABLE (Continued)
Commencing
180 days after March 31, 2010, the outstanding principal amount of the GR Note
and accrued unpaid interest due thereon may be converted, at GRM’s election,
into the Company’s common stock at a conversion price of $3.50 per share (the
“Conversion Price”), subject to adjustment only in the event of stock splits,
dividends, combinations, reclassifications and the like. If at any time
after 180 days from the later of March 31, 2010 or such date when a registration
statement filed with the SEC covering the resale of the shares issuable upon
conversion of the GR Note becomes effective, the volume weighted average price
of the Company’s common stock for each of any 30 consecutive trading days, which
period shall have commenced after the effective date of such registration
statement, exceeds 250% of the then applicable Conversion Price, and the daily
trading volume for the common stock is at least 100,000 shares (subject to
adjustment for stock splits, combinations, recapitalizations, dividends and the
like) during such 30 trading day period, then the Company may force GRM to
convert all or part of the then outstanding principal amount of the GR
Note. GRM has piggyback and demand registration rights with respect to the
shares issuable upon conversion of the GR Note.
The
Company has the right to prepay the GR Note at any time without penalty upon 30
days written notice to GRM. GRM’s right to convert the GR Note (commencing
180 days after its issuance date), remains active during the prepayment notice
period. Therefore, if the Company notifies GRM of its election to prepay
the GR Note sooner than 150 days from the issuance date of the GR Note, then GRM
would be obligated to accept repayment in cash.
The
Company granted GRM a first lien priority security interest in all of the
Company’s assets securing the Company’s obligations under the GR Note, subject
to certain permitted indebtedness and liens permitted in connection with the
same.
The
Company agreed that on or before 90 days following March 31, 2010, the Company
shall: (i) cause each holder (each, a “Senior Debt Holder”) of the Company’s
outstanding 2009 8% Convertible Notes, dated on or about November 5, 2009, in
the aggregate principal amount of $2,214,000, to (A) be entirely converted,
along with accrued unpaid interest thereon, into shares of the Company’s common
stock in accordance with the terms thereof; or (B) expressly subordinate any
lien which the Senior Debt Holder holds in the Company's assets to
the GR Note and the security interest granted to GRM pursuant to a written
subordination agreement with GRM acceptable to GRM in its sole discretion; or
(C) prepay the entire outstanding principal balance of each 2009 8% Convertible
Note, and any accrued unpaid interest thereon and cause each of the 2009 8%
Convertible Notes to be cancelled. As described above all outstanding
principal of the 2009 8% Convertible Notes along with all accrued interest was
converted to shares of the Company’s common stock.
The total
value of the GR Note was allocated between the GR Note and the discount, which
amounted to $1,208,571 including the $300,000 issuance fee. The discount will be
amortized over the term of GR Note. The Company amortized $151,071 to interest
expense related to the GR Note for the three and six months ended June 30,
2010.
As part
of the transaction, the Company incurred deferred financing costs of
approximately $51,000. These costs are being amortized over the term of the GR
Note. The Company recorded amortization of $6,377 to interest expense
during the three and six months ended June 30, 2010.
Convertible
notes payable consist of the following:
June 30, 2010
|
December 31, 2009
|
|||||||
GR
Note
|
5,300,000 | - | ||||||
2009
8% Convertible Notes
|
- | 2,214,000 | ||||||
Unamortized
discount
|
(1,057,500 | ) | (621,000 | ) | ||||
Convertible
notes payable, net
|
$ | 4,242,500 | $ | 1,593,000 |
NOTE
6 - COMMITMENTS AND CONTINGENCIES
Royalty
Agreement
On July
24, 2009, the Company entered into a licensing agreement with Wiley Publishing,
Inc., owner of the For
Dummies® trademark, for use of the For
Dummies® trademark in connection with the manufacture, development,
operation, sale, distribution and promotion of the Company’s products. The
term of the agreement is five years with an option for the Company to renew for
an additional five years provided that the Company has paid to Wiley a minimum
royalty of $2,000,000 during the initial term of the agreement. The Company paid
a $100,000 non-refundable royalty advance that is recorded in prepaid expenses
on the accompanying balance sheet. There was no royalty expense for the
three and six months ended June 30, 2010.
21
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
6 - COMMITMENTS AND CONTINGENCIES (Continued)
Operating
Leases
The
Company's primary offices are in Los Angeles, California. The Company
entered into a lease on October 19, 2007 which commenced on March 24, 2008 for
approximately 4,742 rentable square feet of office space with a term of
sixty-two months. On October 9, 2009, the Company entered into a second
amendment of its lease with its current landlord to relocate and to occupy
approximately 16,000 square feet in the building to accommodate growth. The
lease calls for a base monthly rent of $35,060 with annual increases of 3% plus
common area expenses with a term of ten years. The Company’s rent on its
original space was abated beginning July 1, 2009 and the abatement continues on
the new space for a period of fourteen (14) months from the date the Company
began to occupy the new space, which was February 1, 2010, as long as the
Company abides by all the terms and conditions of the lease and if no event of
default occurs. Rent expense (including any rent abatements or escalation
charges) is recognized on a straight-line basis from the date the Company takes
possession of the property to the end of the lease term. In the event the
Company fails to abide by all the terms and conditions of the lease or an event
of default occurs the Company shall reimburse the landlord for the abated rent
along with interest. Aside from the monthly rent, the Company is required to pay
its share of common operating expenses.
Litigation
In the
ordinary course of business, the Company may face various claims brought by
third parties and the Company may, from time to time, make claims or take legal
actions to assert its rights. Any of these claims could subject the Company to
costly litigation and, while the Company generally believes that it has adequate
insurance to cover many different types of liabilities, the Company’s insurance
carriers may deny coverage or the Company’s policy limits may be inadequate to
fully satisfy any damage awards or settlements. If this were to happen, the
payment of any such awards could have a material adverse effect on the Company’s
operations, cash flows and financial position. Additionally, any such claims,
whether or not successful, could damage the Company’s reputation and business.
Management believes the outcome of currently pending claims and lawsuits will
not likely have a material effect on the Company’s operations or financial
position.
Guarantees and
Indemnities
During
the normal course of business, the Company has made certain indemnities and
guarantees under which it may be required to make payments in relation to
certain transactions. The duration of these indemnities and guarantees varies
and, in certain cases, is indefinite. The majority of these indemnities and
guarantees do not provide for any limitation of the maximum potential future
payments the Company could be obligated to make. The Company hedges some of the
risk associated with these potential obligations by carrying insurance.
Historically, the Company has not been obligated to make significant payments
for these obligations and no liabilities have been recorded for these
indemnities and guarantees in the accompanying condensed balance
sheets.
The
Company has entered into, and will likely enter into in the future,
indemnification agreements with the individuals who serve as its officers and
directors. Pursuant to these agreements, the Company agrees to provide
indemnity if the officer or director is made a party to, or threatened to be
made a party to, any proceeding by reason of the fact that he is or was a
director or officer of the Company, or is or was serving at the request of the
Company as a director, officer, employee, or agent of another entity. The
agreements require the Company to indemnify its officers and directors against
all expenses, judgments, fines and penalties actually and reasonably incurred by
them in connection with the defense or settlement of any such proceeding, so
long as the conditions expressed in the agreement are met.
22
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
6 - COMMITMENTS AND CONTINGENCIES (Continued)
On April
26, 2010 the Company entered into an Amended and Restated Key Executive
Employment Agreement with each of Gary Guseinov, the Company’s Chief Executive
Officer, Kevin Harris, the Company’s Chief Financial Officer, and Igor Barash,
the Company’s Chief Information Officer.
Amended and Restated Key
Executive Employment Agreement with Gary Guseinov (the “Guseinov
Agreement”)
The
Guseinov Agreement has a term of three years commencing as of January 1, 2010
and will renew for successive one-year periods if not terminated sooner in
accordance with its terms. The Company will pay Mr. Guseinov an annual
base salary of $281,250 plus certain reimbursable expenses. The
Company will review Mr. Guseinov’s base salary every six months and the Board
may in its discretion increase Mr. Guseinov’s base salary at such intervals
without amendment or modification of the Guseinov Agreement. Mr. Guseinov
will be entitled to participate in any incentive bonus compensation plan as the
Board may adopt from time to time; provided that Mr. Guseinov may not receive
more than 50% of his base salary for any twelve-month period. The Company
will provide, at its cost, at least $3,000,000 in key man life insurance on Mr.
Guseinov’s life during the term of the Guseinov Agreement and Mr. Guseinov will
have the right to designate the beneficiary of $1,000,000 of the policy or
policies, and the Company will be the beneficiary of $2,000,000 of the policy or
policies. If the Company terminates Mr. Guseinov’s employment without
cause during the term of the Guseinov Agreement, or takes actions that
constitute constructive termination, then Mr. Guseinov will be entitled to
accrued but unpaid salary, earned and pro rata bonus compensation, full vesting
of all unvested stock and stock options, vested benefits under the Company’s
employee benefit plans, continuing payment of Mr. Guseinov’s base salary in
effect at the time of termination for the greater of nine months following the
date of termination or the balance of the then applicable term and continuing
coverage of Mr. Guseinov, his spouse and children, if any, at the Company’s
expense, under any health and dental insurance plans that covered Mr. Guseinov
immediately prior to his termination, for a period of six months following the
date of termination.
Amended and Restated Key
Executive Employment Agreement with Kevin Harris (the “Harris
Agreement”)
The
Harris Agreement has a term of three years commencing as of January 1, 2010 and
will renew for successive one-year periods if not terminated sooner in
accordance with its terms. The Company will pay Mr. Harris an annual base
salary of $237,500 plus certain reimbursable expenses. The Company
will review Mr. Harris’s base salary every six months and the Board may in its
discretion increase Mr. Harris’s base salary at such intervals without amendment
or modification of the Harris Agreement. Mr. Harris shall retain his
existing stock options for 400,000 shares exercisable for $1.00 per share
granted pursuant to the terms of his original Key Executive Employment Agreement
with the Company (which includes bonus options for 2009 and 2010), of which
325,000 option shares are deemed fully vested and the remaining 75,000 option
shares will vest in three equal installments on June 30, 2010, September 30,
2010 and December 31, 2010. Mr. Harris will receive an additional option
to purchase 300,000 shares of common stock at an exercise price of $4.04 per
share. Mr. Harris will be entitled to participate in any incentive
bonus compensation plan as the Board may adopt from time to time; provided that
Mr. Harris may not receive more than 40% of his base salary for any twelve-month
period. The Company will provide, at its cost, at least $1,000,000 in term
life insurance on Mr. Harris’s life during the term of the Harris Agreement and
Mr. Harris will be the beneficiary of 100% of such policy or policies. If
the Company terminates Mr. Harris’s employment without cause during the term of
the Harris Agreement, or takes actions that constitute constructive termination,
then Mr. Harris will be entitled to accrued but unpaid salary, earned and pro
rata bonus compensation, full vesting of all unvested stock and stock options,
vested benefits under the Company’s employee benefit plans, continuing payment
of Mr. Harris’s base salary in effect at the time of termination for the greater
of nine months following the date of termination or the balance of the then
applicable term and continuing coverage of Mr. Harris, his spouse and children,
if any, at the Company’s expense, under any health and dental insurance plans
that covered Mr. Harris immediately prior to his termination, for a period of
six months following the date of termination.
Amended and Restated Key
Executive Employment Agreement with Igor Barash (the “Barash
Agreement”)
The
Barash Agreement has a term of three years commencing as of January 1, 2010 and
will renew for successive one-year periods if not terminated sooner in
accordance with its terms. The Company will pay Mr. Barash an annual base
salary of $218,750 plus certain reimbursable expenses. The Company
will review Mr. Barash’s base salary every six months and the Board may in its
discretion increase Mr. Barash’s base salary at such intervals without amendment
or modification of the Barash Agreement. The unvested portion of Mr.
Barash’s existing stock option for 150,000 shares exercisable for $1.00 per
share, granted on or about July 1, 2008, will immediately vest and Mr. Barash
will receive an additional option to purchase 50,000 shares of common stock at
an exercise price of $4.04 per share. Mr. Barash will be entitled to
participate in any incentive bonus compensation plan as the Board may adopt from
time to time; provided that Mr. Barash may not receive more than 30% of his base
salary for any twelve-month period. The Company will provide, at its cost,
at least $500,000 in term life insurance on Mr. Barash’s life during the term of
the Barash Agreement and Mr. Barash will be the beneficiary of 100% of such
policy or policies. If the Company terminates Mr. Barash’s employment
without cause during the term of the Barash Agreement, or takes actions that
constitute constructive termination, then Mr. Barash will be entitled to accrued
but unpaid salary, earned and pro rata bonus compensation, full vesting of all
unvested stock and stock options, vested benefits under the Company’s employee
benefit plans, continuing payment of Mr. Barash’s base salary in effect at the
time of termination for the greater of six months following the date of
termination or the balance of the then applicable term and continuing coverage
of Mr. Barash, his spouse and children, if any, at the Company’s expense, under
any health and dental insurance plans that covered Mr. Barash immediately prior
to his termination, for a period of six months following the date of
termination.
23
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
7 - RELATED PARTY TRANSACTIONS
Unionway
International, LLC, an entity controlled by Bing Liu, a former officer, provided
software development services to the Company. During the three and six months
ended June 30, 2009, the Company paid Unionway International, LLC $36,000 and
$49,500, respectively.
The
Company purchased promotional items with the Company’s name and logo on them
from VK Productions, an entity controlled by Mr. Guseinov’s spouse. During the
three and six months ended June 30, 2010, VK Productions invoiced the Company $0
and $6,173.
On April
1, 2010, the Company and GRM entered into a License Agreement (the “License
Agreement”) whereby the Company granted to GRM an exclusive royalty-bearing
license to market, sell and distribute, in the United States through retail
channels of distribution (such as retail stores, online retail storefronts,
kiosks, counters and other similar retail channels) and television shopping
channels (such as QVC and Home Shopping Network), and in certain foreign
countries through retail channels, television shopping channels, direct response
television and radio, and Internet websites associated with such marketing
channels (other than www.cyberdefender.com),
the Company’s line of antivirus and Internet security products or services (the
“License”).
In
consideration of the license granted to GRM in the License Agreement, GRM will
pay royalties to the Company on a product-by-product basis for each annual
subscription and each annual renewal by end users of the products covered by the
License Agreement. Upon the achievement of certain milestones or
conditions in the License Agreement, GRM will make annual advances of royalties
to the Company in the amount of $250,000 per year. If GRM fails to pay an
annual advance when due, and if certain other conditions are met, the License
shall become non-exclusive.
The
License Agreement provides that GRM and the Company will share costs associated
with localizing products and related material to comport to the language, laws
and/or customs of foreign countries, subject to certain caps on GRM’s expenses
with respect to such localization efforts.
Under the
License Agreement, the Company will provide customer service and all product and
technical support services to end users of the products in the United States and
will retain all revenue from such services. Additionally, with respect to
each foreign country in which GRM markets the products, the Company will have
the right to provide customer service and all product and technical support
services to end users of the products in such foreign
country.
The
License Agreement also provides that, after certain conditions are met, the
Company has the right to buy back and terminate the License (and the related
rights of GRM) as it relates to the territory of United States (the “Domestic
Buy-Out Right”) and/or to the collective territories outside of the United
States (the “International Buy-Out Right”). The price to be paid by the
Company in connection with the Domestic Buy-Out Right or International Buy-Out
Right, as applicable, will be based on a combination of factors, including (i)
the annualized gross revenue earned by GRM in connection with the sale and
distribution of products in the applicable territory being “bought out” by the
Company (the “Annualized Gross Revenue”), (ii) the enterprise value of the
Company, (iii) the gross revenue of the Company for the 12 months preceding its
exercise of such buy-out right and/or (iv) the fair market value of GRM’s rights
under the License Agreement (with respect to the territory being “bought out” by
the Company). In no case, however, will the buy-out price be less
than (a) 1.5 times the Annualized Gross Revenue, if the applicable buy-out right
is exercised within one year of such right becoming exercisable, or (b) 3.0
times the Annualized Gross Revenue, if the applicable buy-out right is exercised
at any time after the one-year anniversary of such right becoming
exercisable. The buy-out price will be payable in cash or in shares of the
Company’s common stock, or any combination thereof, at GRM’s
discretion.
The
License Agreement may be terminated by mutual consent of the parties. The
License Agreement may also be terminated by either party upon a default of the
other party under the License Agreement that remains uncured for 30 days
following notice of such default. Additionally, GRM may terminate the
License Agreement at any time for convenience, provided that GRM may not market
any antivirus or Internet security products or services that compete with the
Company’s products or services in the distribution channels covered by the
License Agreement for one year following such a termination for
convenience.
See Note
4 for a detailed description of all warrants issued to GRM and the vesting of
those warrants in connection with the Media Agreement.
GRM
invoiced the Company $86,937 and $164,244 for the three and six months ended
June 30, 2010 and $6,090 and $13,852 for the three and six months ended June 30,
2009, respectively, for their overhead expense reimbursement on media costs
incurred by GRM pursuant to the Media Agreement.
See Note
5 for detailed description of the GR Note.
24
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
8 - SUBSEQUENT EVENTS
During
July 2010, the Company and its landlord negotiated a third amendment to the
lease for the Company’s premises. Pursuant to the third amendment, the Company
will occupy an additional 16,000 square feet in the building to accommodate
growth. Once executed, the third amendment will require a base monthly rent upon
occupancy of $35,060 for the additional space, making the total base monthly
rent $70,120, with annual increases of 3%. The Company expects to occupy
the additional space on November 1, 2010. The third amendment will provide for
six months of rent abatement on the additional space as long as the Company
occupies the space for the full lease term. In the event the Company fails to
abide by all the terms and conditions of the lease or an event of default occurs
the Company shall reimburse the landlord for the abated rent along with
interest. Aside from the monthly rent, the Company is required to pay its share
of common operating expenses.
During
July 2010, the Company received notice from GRM that pursuant to Section 2(a) of
the GR Note, GRM elected to have the first interest payment due July 1, 2010
added to the aggregate principal amount of the GR note.
NOTE
9 - RESTATEMENT
On
November 19, 2010, the Company’s Audit Committee concluded that the Company’s
financial statements for the year ended December 31, 2009 and the quarters ended
March 31, 2009 and 2010, June 30, 2009 and 2010 and September 30, 2009 should be
restated in order to make the following adjustments: (i) the Black
Scholes value of the warrants issued by the Registrant in March 2009 pursuant to
a Media and Marketing Services Agreement should have been classified as an
operating expense rather than interest expense and that the Black Scholes value
of such warrants should be measured as of each monthly vesting date rather than
the grant date starting from March 2009 through September 2010; (ii) certain
warrants issued to consultants must be revalued as of their respective vesting
dates rather than the grant date, using the Black Scholes method; and (iii) all
of the Registrant’s advertising expenses starting in the fourth quarter of 2009
should have been expensed as incurred rather than capitalized and amortized
against revenues for a period of 12 months under ASC
340-20 (collectively, the “Adjustments”).
The
following tables set forth the effects of the restatement on certain line items
within our consolidated balance sheet at December 31, 2009 and our statement of
operations for the three and six months ended June 30, 2010 and
2009:
June
30, 2010
|
December
31, 2009
|
|||||||||||||||||||||||
Restated
|
Adjustments
|
As
Filed
|
Restated
|
Adjustments
|
As
Filed
|
|||||||||||||||||||
Deferred
changes, current
|
$ | 2,700,504 | $ | (3,985,002 | ) | $ | 8,786,348 | $ | 3,316,535 | $ | (2,312,753 | ) | $ | 5,629,288 | (1) | |||||||||
Total
Current Assets
|
$ | 11,044,149 | $ | (3,985,002 | ) | $ | 17,129,993 | $ | 9,223,207 | $ | (2,312,753 | ) | $ | 11,535,960 | ||||||||||
Additional
paid-in capital
|
$ | 53,240,973 | $ | 8,598,841 | $ | 39,628,942 | $ | 36,884,000 | $ | 3,825,872 | $ | 33,058,128 |
(2)(3)
|
|||||||||||
Accumulated
deficit
|
$ | (65,266,638 | ) | $ | (12,583,843 | ) | $ | (45,568,763 | ) | $ | (44,930,550 | ) | $ | (6,138,625 | ) | $ | (38,791,925 |
)
(2)
|
||||||
Total
Stockholders’ Deficit
|
$ | (11,998,641 | ) | $ | (3,985,002 | ) | $ | (5,912,797 | ) | $ | (8,020,876 | ) | $ | (2,312,753 | ) | $ | (5,708,123 | ) |
Reference
(1)
Expensing of direct-response advertising costs as incurred rather than
capitalizing and amortizing per ASC 340-20.
(2) The
Adjustments as described above.
(3) Per
Note 2 above, there was a reclassification from common stock to additional
paid-in capital as a result of the merger.
For
the Three Months Ended
|
For
the Six Months Ended
|
|||||||||||||||||||||||
June
30, 2009
|
June
30, 2009
|
|||||||||||||||||||||||
Restated
|
Adjustments
|
As
Filed
|
Restated
|
Adjustments
|
As
Filed
|
|||||||||||||||||||
Media
and marketing services
|
$ | 4,146,124 | $ | 737,817 | $ | 3,408,307 | (1) | $ | 8,645,858 | $ | 1,493,857 | $ | 7,152,001 | (1) | ||||||||||
Investor
relations and other related consulting
|
$ | 1,135,418 | $ | (210,789 | ) | $ | 1,346,207 | (1) | $ | 1,530,703 | $ | (1,035,506 | ) | $ | 2,566,209 | (1) | ||||||||
Total
Operating Expenses
|
$ | 7,222,794 | $ | 527,028 | $ | 6,695,766 | $ | 13,679,443 | $ | 458,351 | $ | 13,221,092 | ||||||||||||
LOSS
FROM OPERATIONS
|
$ | (4,289,474 | ) | $ | (527,028 | ) | $ | (3,762,446 | ) | $ | (8,234,197 | ) | $ | (458,351 | ) | $ | (7,775,846 | ) | ||||||
Interest
expense
|
$ | 841,838 | $ | (211,083 | ) | $ | 1,052,921 | (1) | $ | 1,718,732 | $ | (246,698 | ) | $ | 1,965,430 | (1) | ||||||||
NET
LOSS
|
$ | (5,131,512 | ) | $ | (315,945 | ) | $ | (4,815,567 | ) | $ | (9,844,271 | ) | $ | (211,653 | ) | $ | (9,632,618 | ) | ||||||
EPS
|
$ | (0.25 | ) | $ | (0.01 | ) | $ | (0.24 | ) | $ | (0.51 | ) | $ | (0.01 | ) | $ | (0.50 | ) |
Reference
(1)
Reclassification of warrants from interest expense and revaluation of
warrants.
25
CYBERDEFENDER
CORPORATION
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
9 – RESTATEMENT (continued)
For
the Three Months Ended
|
For
the Six Months Ended
|
|||||||||||||||||||||||
June
30, 2010
|
June
30, 2010
|
|||||||||||||||||||||||
Restated
|
Adjustments
|
As
Filed
|
Restated
|
Adjustments
|
As
Filed
|
|||||||||||||||||||
Media
and marketing services
|
$ | 11,977,108 | $ | 8,569,869 | $ | 3,407,239 | (1) | $ | 22,207,039 | $ | 15,731,907 | $ | 6,475,132 | (2) | ||||||||||
Investor
relations and other related consulting
|
- | - | - | (2) | $ | 549,543 | $ | 384,498 | $ | 165,045 | (2) | |||||||||||||
Total
Operating Expenses
|
$ | 16,717,780 | $ | 8,569,869 | $ | 8,147,911 | $ | 31,146,836 | $ | 16,116,405 | $ | 15,030,431 | ||||||||||||
LOSS
FROM OPERATIONS
|
$ | (11,018,995 | ) | $ | (8,569,869 | ) | $ | (2,449,126 | ) | $ | (19,125,771 | ) | $ | (16,116,405 | ) | $ | (3,009,366 | ) | ||||||
Interest
expense
|
$ | 990,748 | $ | (1,455,837 | ) | $ | 2,446,585 | (2) | $ | 1,209,917 | $ | (2,557,155 | ) | $ | 3,767,072 | (2) | ||||||||
NET
LOSS
|
$ | (12,009,943 | ) | $ | (7,114,032 | ) | $ | (4,895,911 | ) | $ | (20,336,088 | ) | $ | (13,559,250 | ) | $ | (6,776,838 | ) | ||||||
EPS
|
$ | (0.45 | ) | $ | (0.26 | ) | $ | (0.19 | ) | $ | (0.78 | ) | $ | (0.28 | ) | $ | (0.50 | ) |
Reference
(1) $1.7
million relates to expensing of direct-response advertising costs as incurred
rather than capitalizing and amortizing per ASC 340-20 and balance relates to
reclassification and revaluation of warrants.
(2)
Reclassification of warrants from interest expense and revaluation of
warrants.
26
FORWARD-LOOKING
STATEMENTS
This
Quarterly Report on Form 10-Q filed by CyberDefender Corporation (referred to as
“the Company”, “we”, “us” or “our”) contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. These are statements regarding financial and
operating performance and results and other statements that are not historical
facts. The words “expect,” “project,” “estimate,” “believe,” “anticipate,”
“intend,” “plan,” “forecast,” and similar expressions are intended to identify
forward-looking statements. Certain important risks could cause results to
differ materially from those anticipated by some of the forward-looking
statements. Some, but not all, of these risks include, among other
things:
·
|
changes
in local, state or federal regulations that will adversely affect our
business;
|
·
|
our
ability to market and distribute or sell our
products;
|
·
|
our
ability to protect our intellectual property and operate our business
without infringing upon the intellectual property rights of
others;
|
·
|
whether
we will continue to receive the services of certain officers and
directors; and
|
·
|
other
uncertainties, all of which are difficult to predict and many of which are
beyond our control.
|
We do not
intend to update forward-looking statements. You should refer to and carefully
review the risks identified in the Company’s Form 10-K for the year ended
December 31, 2009 and the information in future documents we file with the
Securities and Exchange Commission.
27
ITEM
2.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
|
OVERVIEW
We are a
provider of security software and services to the consumer and small business
market. We are located in Los Angeles, California. Our mission is to bring
to market advanced solutions to protect computer users against Internet viruses,
spyware, identity theft and related security threats. In addition, we provide
remote support services to assist customers with their technology
needs.
The
market in which we operate is highly competitive and rapidly changing. We
believe we can be successful in this market due to several factors.
|
·
|
Our
proprietary CyberDefender Argus Network (formerly known as the
“earlyNETWORK”) security platform uses a secure peer-to-peer protocol and
the power of user community, which we believe differentiates our core
anti-malware product and allows us to combat threats faster and more cost
effectively than our competitors.
|
|
·
|
Our
security platform complements other security suites allowing our customers
to adopt multiple security products for increased
protection.
|
|
·
|
We
are expanding our technical support services to provide our customers with
the technical expertise necessary to insure that their technology is
working properly, thereby providing them with a higher degree of
security.
|
|
·
|
We
are expanding our marketing efforts (i) to include direct-response
marketing and retail distribution through partnerships with GRM and
Allianex, leaders in those areas, and (ii) by expanding internationally
through our partnership with GRM.
|
|
·
|
We
are focusing on expanding our product offerings by creating new products
internally and by expanding the number of products marketed under the
For
Dummies® brand.
|
We
believe that providing a “software only” solution to computer security problems
is not as effective as our comprehensive solution, which includes security and
optimization software in conjunction with access to remote technicians.
Our customers benefit from having a technician analyze their PC and repair
problems that they do not have the expertise to resolve. While we still do not
yet represent a significant presence in the security software industry, we
believe that the combination of our software security and optimization
solutions, our CyberDefender Argus Network platform, our live remote
tech-on-call capability and our direct response marketing focus, have improved
our ability to expand our presence in the security software market.
We
evaluate our financial performance utilizing a variety of indicators. Four of
the primary indicators that we utilize to evaluate the ongoing performance of
our business include gross sales (a non-GAAP measure), income/loss from
operations, net cash used in operating activities and renewal revenue and
renewal rates. See the “Reconciliation of GAAP to Non-GAAP Financial
Measures” below.
Gross
sales are a non-GAAP measure which we define as total sales before refunds and
chargebacks and before deferring revenue for GAAP purposes. We believe gross
sales serves as an appropriate measure to be used in evaluating the performance
of our business as it gives a better indication of our operating performance and
the profitability of our marketing initiatives. Gross sales for the three
months ended June 30, 2010 increased $6.2 million, or 100%, to $12.4 million
from $6.2 million for the three months ended June 30, 2009. Gross sales
for the six months ended June 30, 2010 increased $11.8 million, or 95%, to $24.2
million from $12.4 million for the six months ended June 30, 2009. This
increase was mainly attributable to our increased direct-response advertising
efforts through our partnership with GRM. Also, as detailed in the table
in the section below titled “Trends, Events and Uncertainties”, both service
revenues and renewal revenues more than doubled from the same period in the
prior year. The increase in our service revenues was a direct result of
our efforts to increase service revenues through increased advertising and the
expansion of our call center infrastructure. Product sales also increased
for the three and six months ended June 30, 2010 as compared to 2009 due to our
increased marketing efforts. Ancillary sales increased for the six months ended
June 30, 2010 as compared to 2009 and showed a slight decrease for the three
months ended June 30, 2010 as compared to 2009.
28
Loss from
operations for the three months ended June 30, 2010 increased $6.7 million, or
157%, to $11.0 million from $4.3 million for the three months ended June 30,
2009. Loss from operations for the six months ended June 30, 2010 increased
$10.9 million, or 132%, to $19.1 million from $8.2 million for the six months
ended June 30, 2009. This increase in loss from operations is primarily
attributable to the value of the Media Services Warrant and other warrants
issued to GRM. The increased value of the warrants was due to two factors.
The first, is the increased number of warrants that vested due to an increase in
the amount of media spend per the Media Services Agreement and the second is the
calculated value of the warrants. During the three months ended June 30, 2010
and 2009, 2,043,846 and 227,050 warrants vested. The average value of the
warrants increased from $1.37 per warrant during the three months ended June 30,
2009 to $3.17 per warrant during the three months ended June 30, 2010. During
the six months ended June 30, 2010 and 2009, 3,589,984 and 277,050 warrants
vested. The average value of the warrants increased from $1.27 per warrant
during the three months ended June 30, 2009 to $3.33 per warrant during the
three months ended June 30, 2010. The warrants were valued using the
Black-Scholes option-pricing model and are measured at each vesting date. The
Black-Scholes option-pricing model does not factor in the illiquidity of the
underlying shares when calculating the value of the warrants. The Company
recorded non-cash expense of $6.5 million and $0.7 million to media and
marketing services for the three months ended June 30, 2010 and 2009,
respectively. The Company recorded non-cash expense of $12.0 million and $1.5
million to media and marketing services for the six months ended June 30, 2010
and 2009, respectively.
Net cash
used in operating activities for the six months ended June 30, 2010 decreased
$1.1 million, or 26%, to $3.2 million from $4.3 million for the six months ended
June 30, 2009. Net cash used in operating activities during the six months ended
June 30, 2010 was primarily the result of our net loss of $20.3 million.
Net loss was adjusted for non-cash items such as warrants issued for media and
marketing services of $12.0 million, shares and warrants issued for services of
$0.5 million, amortization of debt discount of $0.8 million and compensation
expense for vested options of $0.4 million. Other changes in working capital
accounts include an increase in restricted cash of $0.5 million, an increase in
accounts receivable of $0.8 million, a decrease in deferred charges of $3.1
million, an increase in accounts payable and accrued expenses of $2.3 million
and an increase of $1.3 million in deferred revenue resulting from increased
sales
Renewal
revenue, on a non-GAAP gross basis, for the three months ended June 30, 2010
increased $0.9 million, or 180%, to $1.4 million from $0.5 million for the three
months ended June 30, 2009. Renewal revenue, on a non-GAAP gross basis, for the
six months ended June 30, 2010 increased $1.6 million, or 178%, to $2.5 million
from $0.9 million for the six months ended June 30, 2009. This increase was
primarily attributable to the increase in our subscriber base due for renewal.
Renewal rates have remained relatively consistent from the same period from the
prior year. We believe that we can improve our renewal rates, leading to
increased renewal revenue. To that end, we have signed a contract with Vindicia,
a consumer subscription billing platform, which we believe will help us improve
customer retention. Renewal revenue is important to us for two reasons. The
first is that when customers renew, it underscores our commitment to delivering
top quality products and services. Second, the cost of renewal customers is
minimal. As we continue to build our renewal base, our advertising costs as a
percentage of revenue should decrease, which we expect to help us reach
profitability.
There are
challenges and risks associated with our recent growth and the many initiatives
that we are focused on implementing. Our growth may not continue as
expected or at all. Any one or all of our new initiatives may not produce
the expected results including; (i) our contract with Vindicia to increase
renewal rates, (ii) our new international and retail distribution licensing
agreement with GRM, and (iii) our new products that we expect to launch under
our brand and the For
Dummies® brand.
If our growth does not continue or does not meet our expectations the costs
incurred to expand our call center infrastructure may not produce a return on
our investment and our costs may continue to exceed our revenues.
On March
31, 2010, we received net proceeds of $5 million from a promissory note issued
to GRM as part of a strategic investment in the Company. This investment
will be used to continue the expansion of our business. In addition to this
investment, we signed a license agreement granting GRM certain international and
domestic distribution rights which we believe will allow us to leverage GRM’s
powerful international sales and distribution channels as well as augment our
domestic retail marketing initiatives.
Effective
June 6, 2010 the Company’s common stock is listed on the NASDAQ Global
Market.
Critical Accounting Policies and
Estimates
We had no
significant changes in our critical accounting policies and estimates during the
six months ended June 30, 2010 as compared to the critical accounting
policies and estimates disclosed in “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” included in our annual
report on Form 10-K for the year ended December 31,
2009.
29
Contractual
Obligations
We are
committed under the following contractual obligations:
Contractual
Obligations
|
Payments
Due By Period
|
|||||||||||||||||||
Total
|
Less
than 1 year
|
1
to 3 Years
|
3
to 5 Years
|
Over
5 Years
|
||||||||||||||||
Debt
obligations
|
$ | 5,300,000 | $ | - | $ | 5,300,000 | $ | - | $ | - | ||||||||||
Capital
lease obligations
|
$ | 292,306 | $ | 107,729 | $ | 184,577 | $ | - | $ | - | ||||||||||
Operating
lease obligations
|
$ | 4,423,996 | $ | 116,470 | $ | 899,828 | $ | 940,242 | $ | 2,467,456 |
Off-Balance
Sheet Arrangements
We do not
have off-balance sheet arrangements. As part of our ongoing business, we
do not participate in transactions that generate relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, often established
for the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes.
Indemnities
During
the normal course of business, we have agreed to certain indemnifications.
In the future, we may be required to make payments in relation to these
commitments. These indemnities include agreements with our current and
former officers and directors which may require us to indemnify these
individuals for liabilities arising by reason of the fact that they were or are
officers or directors. The duration of these indemnities varies and, in
certain cases, is indefinite. There is no limit on the maximum potential
future payments we could be obligated to make pursuant to these
indemnities. We hedge some of the risk associated with these potential
obligations by carrying general liability insurance. Historically, we have
not been obligated to make any payments for these obligations and no liabilities
have been recorded for these indemnities in our condensed financial
statements.
Trends,
Events and Uncertainties
As
described above in the discussion of revenue recognition, we generally receive
payment upon the sale of our products and services and defer the revenue over
the life of the license agreement or service plan, which ranges from one to
three years.
The
following table summarizes our GAAP revenue and deferred revenue for each
quarter of the two most recently completed fiscal years as well as for the most
recent quarters.
Quarter Ended
|
Net Revenue
|
Cumulative
Deferred
Revenue
|
||||||
31-Mar-08
|
$ | 475,046 | $ | 1,019,071 | ||||
30-Jun-08
|
742,862 | $ | 1,673,889 | |||||
30-Sep-08
|
1,202,715 | $ | 3,220,738 | |||||
31-Dec-08
|
2,467,136 | $ | 4,552,953 | |||||
Fiscal
Year 2008 Total
|
$ | 4,887,759 | ||||||
31-Mar-09
|
$ | 3,191,630 | $ | 6,687,198 | ||||
30-Jun-09
|
3,686,644 | $ | 8,139,384 | |||||
30-Sep-09
|
4,427,404 | $ | 9,656,352 | |||||
31-Dec-09
|
7,536,215 | $ | 10,779,146 | |||||
Fiscal
Year 2009 Total
|
$ | 18,841,893 | ||||||
31-Mar-10
|
$ | 9,477,330 | $ | 11,619,760 | ||||
30-Jun-10
|
9,712,586 | $ | 12,081,434 | |||||
Fiscal
Year 2010 Total
|
$ | 19,189,916 |
30
The
following table summarizes our gross sales by category for each quarter of the
two most recently completed fiscal years as well as for the most recent
quarters. Gross sales are a non-GAAP measure that we use in assessing our
operating performance. We define gross sales as total sales before refunds and
chargebacks and before deferring revenue for GAAP purposes. We reference this
non-GAAP financial measure frequently in our decision-making as management
believes it provides a better indication of our operating performance and the
profitability of our marketing initiatives. We include this non-GAAP financial
measure in our earnings announcements in order to provide transparency to our
investors and to enable investors to better understand our operating
performance. However, we do not recommend that gross sales are solely used to
assess our financial performance or to formulate investment
decisions.
Quarter
Ended
|
Software
|
Services
|
Ancillary
|
Renewals
|
Total
|
|||||||||||||||||||||||||||||||
31-Mar-08
|
$ | 147,423 | 25 | % | $ | 68,597 | 11 | % | $ | 72,858 | 12 | % | $ | 311,470 | 52 | % | $ | 600,348 | ||||||||||||||||||
30-Jun-08
|
680,606 | 41 | % | 300,939 | 18 | % | 225,910 | 14 | % | 445,790 | 27 | % | 1,653,245 | |||||||||||||||||||||||
30-Sep-08
|
1,652,904 | 49 | % | 853,629 | 26 | % | 475,971 | 14 | % | 358,434 | 11 | % | 3,340,938 | |||||||||||||||||||||||
31-Dec-08
|
2,107,307 | 49 | % | 1,493,234 | 35 | % | 669,477 | 16 | % | - | 0 | % | 4,270,018 | |||||||||||||||||||||||
Fiscal
Year 2008 Totals
|
$ | 4,588,240 | 47 | % | $ | 2,716,399 | 28 | % | $ | 1,444,216 | 15 | % | $ | 1,115,694 | 11 | % | $ | 9,864,549 | ||||||||||||||||||
31-Mar-09
|
$ | 2,475,095 | 40 | % | $ | 2,645,857 | 43 | % | $ | 606,051 | 10 | % | $ | 463,948 | 7 | % | $ | 6,190,951 | ||||||||||||||||||
30-Jun-09
|
2,501,266 | 40 | % | 2,678,978 | 43 | % | 584,144 | 9 | % | 466,747 | 8 | % | 6,231,135 | |||||||||||||||||||||||
30-Sep-09
|
2,666,274 | 40 | % | 2,915,731 | 43 | % | 461,120 | 7 | % | 699,068 | 10 | % | 6,742,193 | |||||||||||||||||||||||
31-Dec-09
|
4,401,569 | 45 | % | 3,705,830 | 38 | % | 982,460 | 10 | % | 717,949 | 7 | % | 9,807,808 | |||||||||||||||||||||||
Fiscal
Year 2009 Totals
|
$ | 12,044,204 | 42 | % | $ | 11,946,396 | 41 | % | $ | 2,633,775 | 9 | % | $ | 2,347,712 | 8 | % | $ | 28,972,087 | ||||||||||||||||||
31-Mar-10
|
$ | 4,092,152 | 35 | % | $ | 5,802,486 | 49 | % | $ | 856,297 | 7 | % | $ | 1,062,473 | 9 | % | $ | 11,813,408 | ||||||||||||||||||
30-Jun-10
|
3,504,147 | 28 | % | 6,967,067 | 56 | % | 568,525 | 5 | % | 1,389,064 | 11 | % | 12,428,803 | |||||||||||||||||||||||
Fiscal
Year 2010 Totals
|
$ | 7,596,299 | 31 | % | $ | 12,769,553 | 53 | % | $ | 1,424,822 | 6 | % | $ | 2,451,537 | 10 | % | $ | 24,242,211 |
The
tables above indicate an upward trend in gross sales, GAAP revenue and deferred
revenue resulting from our focus on promoting our new products and services and
the addition of our new marketing channels, as discussed above. We cannot
guarantee that this upward trend will continue, even with increased spending on
advertising.
Reconciliation
of GAAP to Non-GAAP Financial Measures
The
following is a reconciliation of gross sales to net revenue for the three and
six months ended June 30, 2010 and 2009:
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Gross
Sales
|
$ | 12,428,803 | $ | 6,231,135 | $ | 24,242,211 | $ | 12,422,086 | ||||||||
Less:
Returns and chargebacks
|
(2,254,543 | ) | (1,092,305 | ) | (3,750,007 | ) | (1,957,381 | ) | ||||||||
Less:
Change in deferred revenue
|
(461,674 | ) | (1,452,186 | ) | (1,302,288 | ) | (3,586,431 | ) | ||||||||
Net
revenue
|
$ | 9,712,586 | $ | 3,686,644 | $ | 19,189,916 | $ | 6,878,274 |
Other
trends, events and uncertainties that may impact our liquidity are included in
the discussion below.
31
RESULTS
OF OPERATIONS
Three
and Six Months Ended June 30, 2010 Compared to Three and Six Months Ended June
30, 2009
Net
Sales
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Net
sales
|
$ | 9,712,586 | $ | 3,686,644 | $ | 6,025,942 | 163 | % | $ | 19,189,916 | $ | 6,878,274 | $ | 12,311,642 | 179 | % |
The
increase in net revenue was primarily attributable to our increased
direct-response advertising efforts through our partnership with GRM and the
increase in our service revenue as a result of increased advertising and the
expansion of our call center operations. See the discussion of advertising
expenses below.
Revenue
from product sales increased $1.6 million, or 80%, to $3.6 million for the three
months ended June 30, 2010 from $2.0 million for the three months ended June 30,
2009. Revenue from services increased $3.8 million, or 345%, to $4.9 million for
the three months ended June 30, 2010 from $1.1 million for the three months
ended June 30, 2009. Revenue from renewals increased $0.7 million, or 233%, to
$1.0 million for the three months ended June 30, 2010 from $0.3 million for the
three months ended June 30, 2009.
Revenue
from product sales increased $4.3 million, or 116%, to $8.0 million for the six
months ended June 30, 2010 from $3.7 million for the six months ended June 30,
2009. Revenue from services increased $6.8 million, or 340%, to $8.8 million for
the six months ended June 30, 2010 from $2.0 million for the six months ended
June 30, 2009. Revenue from renewals increased $1.1 million, or 183%, to $1.7
million for the six months ended June 30, 2010 from $0.6 million for the six
months ended June 30, 2009.
Cost
of Sales
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Cost
of Sales
|
$ | 4,013,801 | $ | 753,324 | $ | 3,260,477 | 433 | % | $ | 7,168,851 | $ | 1,433,028 | $ | 5,735,823 | 400 | % |
The
increase in cost of sales was primarily attributable to the expansion of our
internal and external call center operations to support the increase in sales of
our technical support services. Additionally, we have reduced our use of an
offshore call center that was on a revenue share basis and increased our use of
a U.S. based third-party call center that is invoiced on a usage basis.
The revenue share arrangement allowed us to defer the cost of the offshore call
center for GAAP accounting. Cost of sales includes compensation related
expenses of our internal technical support staff, as well as the cost of
outsourced call centers. Compensation-related expenses for our internal
technical support staff totaled $1.8 million for the three months ended June 30,
2010 as compared to $0 for the three months ended June 30, 2009. Expenses
related to outsourced call centers totaled $2.0 million for the three months
ended June 30, 2010 as compared $0.6 for the three months ended June 30, 2009.
Compensation-related expenses for our internal technical support staff totaled
$2.7 million for the six months ended June 30, 2010 as compared to $0 for the
six months ended June 30, 2009. Expenses related to outsourced call centers
totaled $4.1 million for the six months ended June 30, 2010 as compared $1.2 for
the six months ended June 30, 2009.
Operating
Expenses
Media
and marketing services
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Media
and marketing services
|
$ | 11,977,108 | $ | 4,146,124 | $ | 7,830,984 | 189 | % | $ | 22,207,039 | $ | 8,645,858 | $ | 13,561,181 | 157 | % |
Media and
marketing services expense is comprised primarily of non-cash expense related to
the Media Services Warrant and other warrants issued to GRM. Media and
marketing services costs also include media and channel fees, including online
and offline advertising and related functional resources. This increase was
primarily attributable to the non-cash expense related to the Media Services
Warrant and other warrants issued to GRM. Direct advertising costs were
$5.2 million and $3.2 million for the three months ended June 30, 2010 and 2009,
respectively. Direct advertising costs were $9.7 million and $6.8 million
for the six months ended June 30, 2010 and 2009,
respectively.
32
Product
Development
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Product
Development
|
$ | 963,392 | $ | 365,497 | $ | 597,895 | 164 | % | $ | 1,715,519 | $ | 665,234 | $ | 1,050,285 | 158 | % |
Product
development expenses are primarily comprised of research and development costs
associated with the continued development of both current and new products. This
increase is primarily attributable to increased staffing to ensure the ongoing
support and improvement of all of our products and as a result of the increase
in the number of products currently offered and expected to be offered under the
For
Dummies® brand.
Selling,
General and Administrative
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
S,G
& A
|
$ | 3,722,377 | $ | 1,565,995 | $ | 2,156,382 | 138 | % | $ | 6,599,590 | $ | 2,817,552 | $ | 3,782,038 | 134 | % |
Selling,
general and administrative expenses are primarily comprised of salaries and
wages, third party credit card processing fees, legal and professional fees,
rent and other normal operating expenses.
The
increase in S,G & A was primarily attributable to an increase in salaries
and wages and related compensation expenses, i.e. benefits and payroll taxes,
due to the increase in staffing across all departments required as a result of
the increase in sales. The largest increase was seen in our call center
operations. There was also an overall increase in expenses in all S,G & A
categories due to the increased staffing and sales activities in the current
period. Additionally, there was an increase in professional fees related to
listing the Company’s common stock on the NASDAQ Global Market.
Investor
Relations and Other Related Consulting
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Investor
relations and other related consulting
|
$ | -0- | $ | 1,135,418 | $ | (1,135,418 | ) | (100 | )% | $ | 549,543 | $ | 1,530,703 | $ | (981,160 | ) | (64 | )% |
The
decrease in investor relations and other related consulting expense was
primarily attributable to the fact that no new stock or warrants for services
were issued during the three or six months ended June 30, 2010. The
current period expense relates to the vesting of warrants granted in the prior
year and issued for services as more fully described in the notes to the
financial statements.
Loss
From Operations
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change in
|
Change in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Loss
from operations
|
$ | 11,018,995 | $ | 4,289,474 | $ | 6,729,521 | 157 | % | $ | 19,125,771 | $ | 8,234,197 | $ | 10,891,574 | 132 | % |
This
increase in loss from operations is primarily attributable to the value of the
Media Services Warrant and other warrants issued to GRM. The warrants were
valued using the Black-Scholes option-pricing model and are measured at each
vesting date. The calculated value of the warrants increased significantly at
each new vesting date as the stock price increased. The Black-Scholes
option-pricing model does not factor in the illiquidity of the underlying shares
when calculating the value of the warrants. The Company recorded non-cash
expense of $6.5 million and $0.7 to media and marketing services for the three
months ended June 30, 2010 and 2009, respectively. The Company recorded non-cash
expense of $12.0 million and $1.5 million to media and marketing services for
the three months ended June 30, 2010 and 2009, respectively. There were also
increases in selling, general and administrative costs and product development
costs offset by an increase in net revenues.
33
Other
Income/(Expense)
Change
in fair value of derivative liabilities
Three
Months Ended June 30,
|
Six
Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change
in
|
Change
in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Change
in fair value of derivative liabilities
|
$ | -0- | $ | -0- | $ | -0- | 0 | % | $ | -0- | $ | 109,058 | $ | (109,058 | ) | (100 | )% |
As more
fully described in the notes to the financial statements, on January 1,
2009 we adopted the provisions of FASB ASC Topic 815, “Derivatives and Hedging,”
that apply to any freestanding financial instruments or embedded features that
have the characteristics of a derivative. As a result, we were required to
reclassify certain amounts from the equity section of the balance sheet to the
liabilities section. In addition, the value of these instruments must be
reassessed by us as of each balance sheet date. During August 2009, the
Company obtained waivers from the warrant and note holders that forever waive,
as of and after April 1, 2009, any and all conversion or exercise price
adjustments that would otherwise occur, or would have otherwise occurred on or
after April 1, 2009, as a result of certain anti-dilution provisions included in
the warrants and notes. As a result of obtaining the waivers, the warrants and
notes are now afforded equity treatment. The change in fair value of these
instruments for the six months ended June 30, 2009 resulted in a gain of
$109,058.
Interest
expense, net
Three
Months Ended June 30,
|
Six
Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change
in
|
Change
in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Interest
expense
|
$ | 990,748 | $ | 841,838 | $ | 148,910 | 18 | % | $ | 1,209,917 | $ | 1,718,732 | $ | (508,815 | ) | (30 | )% |
The
increased interest expense was attributable the accelerated amortization of the
note discount and deferred financing costs from the 2009 8% Convertible Notes
that converted on May 15, 2010 offset by the decrease in interest and
amortization expense from the 10% Convertible Promissory Notes and the 10%
Secured Debentures that were converted during 2009.
Net
Loss
Three
Months Ended June 30,
|
Six
Months Ended June 30,
|
|||||||||||||||||||||||||||||||
Change
in
|
Change
in
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
$
|
%
|
2010
|
2009
|
$
|
%
|
|||||||||||||||||||||||||
Net
loss
|
$ | 12,009,943 | $ | 5,131,512 | $ | 6,878,431 | 134 | % | $ | 20,336,088 | $ | 9,844,271 | $ | 10,491,817 | 107 | % |
This
increase in net loss is primarily attributable to the value of the Media
Services Warrant and other warrants issued to GRM. The warrants were valued
using the Black-Scholes option-pricing model and must be measured at each
vesting date. The calculated value of the warrants increased significantly at
each vesting date as the stock price increased. The Black-Scholes
option-pricing model does not factor in the illiquidity of the underlying shares
when calculating the value of the warrants. The Company recorded non-cash
expense of $6.5 million and $0.7 to media and marketing services for the three
months ended June 30, 2010 and 2009, respectively. The Company recorded non-cash
expense of $12.0 million and $1.5 to media and marketing services for the three
months ended June 30, 2010 and 2009, respectively. There were also increases in
selling, general and administrative costs and product development costs offset
by an increase in net revenues.
34
Liquidity
and Capital Resources
As
detailed in the section above titled “Trends, Events and Uncertainties”, our
revenues have been increasing on a quarterly basis since January
2008.
To help
with our cash flow, we occasionally sell our debt or equity securities. At
June 30, 2010 we had outstanding $5.3 million in principal amount of a 9%
convertible promissory note issued to GRM.
At June
30, 2010, we had cash totaling $4.9 million. In the six months ended June
30, 2010, we generated positive cash flows of $1.5 million.
Cash
provided/(used) during the six months ended June 30, 2010 included:
Operating
Activities
Net cash
used in operating activities during the six months ended June 30, 2010 was
primarily the result of our net loss of $20.3 million. Net loss was
adjusted for non-cash items such as amortization of debt discount of $0.8
million, provision of doubtful accounts receivables of $0.2 million,
compensation expense for vested stock options of $0.4 million, amortization of
deferred financing costs of $0.2 million, warrants issued for media and
marketing services of $12.0 million and shares and warrants issued for services
of $0.5 million. Other changes in working capital accounts include an increase
in restricted cash of $0.5 million, an increase in accounts receivable of $0.8
million, a decrease in deferred charges of $0.7 million, an increase in accounts
payable and accrued expenses of $2.3 million and an increase of $1.3 million in
deferred revenue resulting from higher new customer and renewal
sales.
Our
primary source of operating cash flow is the collection of sales receipts from
our customers and the timing of payments to our vendors and service
providers. During the six months ended June 30, 2010, we began offering
payment plans to our customers for the purchase of multi-year technical support
service plans. We expect this change to increase gross sales but to also impact
operating cash flow as sales receipts will be spread over three months instead
of being received upon the sale.
The
increase in cash related to accounts payable and accrued expenses was $2.3
million. Our operating cash flows, including changes in accounts payable
and accrued liabilities, are impacted by the timing of payments to our vendors
for accounts payable. We typically pay our vendors and service providers
in accordance with invoice terms and conditions. The timing of cash
payments in future periods will be impacted by the nature of accounts payable
arrangements. We did not make any significant changes to the timing of
payments to our vendors during the six months ended June 30, 2010.
Our
working capital deficit at June 30, 2010, defined as current assets minus
current liabilities, was $6.9 million as compared to a working capital deficit
of $6.2 million at December 31, 2009. The decrease in working capital
of approximately $0.7 million from December 31, 2009 to June 30, 2010 was
primarily attributable to an increase in cash of $1.5 million, an increase in
restricted cash of $0.5 million, an increase in accounts receivable of $0.7
million offset by an increase in accounts payable and accrued expenses of $2.0
million, a decrease of deferred charges of $0.6 million and an increase in
deferred revenue of $0.5 million, resulting from increased sales.
Investing
Activities
Net cash
used in investing activities during the six months ended June 30, 2010 was $0.4
million, which was used for property and equipment purchases. We expect to
continue to purchase property and equipment in the normal course of our
business. The amount and timing of these purchases and the related cash
outflows in future periods is difficult to predict and is dependent on a number
of factors, including but not limited to any increase in the number of our
employees and changes in computer hardware and software used in our
business. Net cash used in investing activities during the six months
ended June 30, 2009 was $0.
Financing
Activities
Cash
provided by financing activities during the six months ended June 30, 2010 was
$5.1 million, which was primarily the result of the net proceeds of $4.9 million
from the issuance of a convertible note and the exercise of common stock
warrants and stock options totaling $0.2 million. Cash provided by
financing activities during the six months ended June 30, 2009 was primarily
from the proceeds that we received from the sale of our common stock of
approximately $3.1 million, proceeds from the exercise of warrants to purchase
our common stock, net of offering costs, of approximately $1.9 million and
proceeds of approximately $0.6 million from the issuance of convertible notes
payable, net of offering costs.
Other
than as discussed above, we know of no trends, events or uncertainties that are
reasonably likely to impact our future liquidity.
35
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
The
registrant is a smaller reporting company and is not required to provide this
information.
ITEM
4. CONTROLS AND PROCEDURES
We
conducted an evaluation, 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, as defined in Rules 13a-15(e) and
15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange
Act”) as of June 30, 2010, to ensure that information required to be disclosed
by us in the reports filed or submitted by us under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission’s rules and forms. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that as of June 30, 2010, our disclosure controls and procedures were
not effective at the reasonable assurance level due to the material weakness
described below.
A
material weakness is a control deficiency (within the meaning of the Public
Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. Management has identified
the following material weakness which has caused management to conclude that, as
of September 30, 2010, our disclosure controls and procedures were not effective
at the reasonable assurance level:
We have
become aware that in applying accounting standards, our control environment is
dependent upon a review function and the ability to recognize and obtain
assistance for transactions. Because of the failure of this control, we
were required to adjust (i) the Black Scholes value of the warrants issued by us
in March 2009 pursuant to a Media and Marketing Services Agreement which should
have been classified as an operating expense rather than interest expense and
that the Black Scholes value of such warrants should have been measured as of
each monthly vesting date rather than the grant date starting from March 2009
through September 2010; (ii) certain warrants issued to consultants which must
be revalued as of their respective vesting dates rather than the grant date,
using the Black Scholes method; and (iii) all of our advertising expenses
starting in the fourth quarter of 2009 which should have been expensed as
incurred rather than capitalized and amortized against revenues for a period of
12 months under ASC 340-20.
Changes
in Internal Control over Financial Reporting
During
the second quarter of 2010, there were the following changes to our
internal control over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15 (f) under the Exchange Act) that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting. The Company established an independent board of directors
by appointing four independent directors and established an independent audit
committee. The Company hired a corporate controller who documented all of
the Company’s policies and procedures in a formalized manner.
Limitations
on Effectiveness of Controls
Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure controls and procedures or our internal
controls will prevent all errors and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within our Company have been detected.
36
PART
II - OTHER INFORMATION
ITEM 1.
LEGAL
PROCEEDINGS
On
February 4, 2010, Scott Wade, a former employee, filed an action against the
Company in the Superior Court of the State of California, County of Los Angeles,
alleging wrongful termination, disability discrimination, failure to pay wages
and breach of contract. A description of this action is included in our
Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, which was
filed with the Securities and Exchange Commission on May 17, 2010.
ITEM 1A. RISK FACTORS
Not
applicable.
ITEM 2.
UNREGISTERED SALES
OF EQUITY SECURITIES AND USE OF PROCEEDS
During
the three months ended June 30, 2010, two investors exercised warrants to
purchase 30,000 shares of common stock exercisable at prices ranging from $1.25
to $2.25 per share. We relied on section 4(2) of the Securities Act of 1933 to
issue the common stock inasmuch as the securities were issued to accredited
investors without any form of general solicitation or general
advertising.
For
information relating to additional unregistered securities that were sold during
the three months ended June 30, 2010, please see our Current Report on Form 8-K,
which was filed with the Securities and Exchange Commission on June 10,
2010.
ITEM
3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4.
REMOVED
AND RESERVED
ITEM 5.
OTHER
INFORMATION
None.
37
ITEM 6.
EXHIBITS
2.1
|
Agreement
and Plan of Merger dated May 25, 2010 between CyberDefender
Corporation, a Delaware corporation, and CyberDefender Corporation, a
California Corporation (1)
|
|
2.2
|
State
of California Certificate of Ownership (1)
|
|
3.1
|
Certificate
of Incorporation (1)
|
|
3.2
|
Bylaws
(1)
|
|
10.1
|
License
Agreement dated April 1, 2010 between the registrant and GR Match, LLC
(2)+
|
|
10.2
|
Amended
and Restated Key Executive Employment Agreement dated April 26, 2010
between the registrant and Gary Guseinov (3)
|
|
10.3
|
Amended
and Restated Key Executive Employment Agreement dated April 26, 2010
between the registrant and Kevin Harris (3)
|
|
10.4
|
Amended
and Restated Key Executive Employment Agreement dated April 26, 2010
between the registrant and Igor Barash (3)
|
|
10.5
|
Form
of Indemnification Agreement entered into by the registrant and its
officers and directors (4)
|
|
31.1
|
Certification
Pursuant to Rule 13a-14(a) and 15d-14(a) *
|
|
31.2
|
Certification
Pursuant to Rule 13a-14(a) and 15d-14(a) *
|
|
32
|
|
Certification
Pursuant to Section 1350 of Title 18 of the United States
Code*
|
(1)
Incorporated by reference from the Registration Statement on Form S-3, File No.
333-167910, filed with the Securities and Exchange Commission on June 30,
2010.
(2)
Incorporated by reference from Amendment No. 1 to Registration Statement on Form
S-3, File No. 333-167910, filed with the Securities and Exchange Commission on
July 30, 2010.
(3)
Incorporated by reference from the registrant’s Current Report on Form 8-K/A
filed with the Securities and Exchange Commission on May 27, 2010
(4)
Incorporated by reference from the registrant’s Current Report on Form 8-K filed
with the Securities and Exchange Commission on June 2, 2010
*Filed
herewith.
+
Certain information in this exhibit has been omitted pursuant to a request for
confidential treatment. The redacted information has been filed separately with
the Securities and Exchange Commission.
38
SIGNATURES
Pursuant
to the requirements 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.
CYBERDEFENDER
CORPORATION
|
||
By:
|
/s/ Gary
Guseinov
|
|
Date:
December 20, 2010
|
Gary
Guseinov, President and
|
|
Chief
Executive Officer
|
||
By:
|
/s/ Kevin
Harris
|
|
Date:
December 20, 2010
|
Kevin
Harris, Chief Financial
Officer
|
39