CYBERDEFENDER CORPORATION

CONDENSED BALANCE SHEETS

(UNAUDITED)

 

		September 30,				December 31,
		2010				2009
						(Restated)
ASSETS
CURRENT ASSETS:
Cash		$	2,805,701			$	3,357,510
Restricted cash			2,520,215				1,565,841
Accounts receivable			2,032,724				489,464
Deferred financing costs			103,484				191,566
Prepaid expenses			307,117				302,291
Deferred charges, current			1,811,889				3,316,535
Total Current Assets			9,581,130				9,223,207
PROPERTY AND EQUIPMENT, net			1,716,746				242,927
DEFERRED CHARGES, net of current portion			451,627				609,904
OTHER ASSETS			281,572				115,497
Total Assets		$	12,031,075			$	10,191,535
LIABILITIES AND STOCKHOLDERS’ DEFICIT
CURRENT LIABILITIES:
Accounts payable		$	7,850,476			$	4,893,186
Accrued expenses			1,010,763				862,023
Deferred revenue, current			10,790,277				9,662,030
Capital lease obligations, current			115,511				9,410
Total Current Liabilities			19,767,027				15,426,649
DEFERRED RENT			360,558				65,938
DEFERRED REVENUE, less current portion			3,372,994				1,117,116
CONVERTIBLE NOTES PAYABLE, net of discount			4,512,822				1,593,000
CAPITAL LEASE OBLIGATIONS, less current portion			170,185				9,708
Total Liabilities			28,183,586				18,212,411
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ DEFICIT:
Preferred stock, par value $0.001; 10,000,000 shares authorized; no shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively			-				-
Common stock, par value $0.001; 100,000,000 shares authorized; 27,034,651 and 25,673,967 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively			27,035				25,674
Additional paid-in capital			59,968,412				36,884,000
Accumulated deficit			(76,147,958	)			(44,930,550	)
Total Stockholders’ Deficit			(16,152,511	)			(8,020,876	)
Total Liabilities and Stockholders’ Deficit		$	12,031,075			$	10,191,535

 

See accompanying notes to condensed financial statements

 

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CYBERDEFENDER CORPORATION

CONDENSED STATEMENTS OF OPERATIONS

(UNAUDITED)

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
						(Restated)								(Restated)
REVENUES:
Net sales		$	12,746,103			$	4,427,404			$	31,936,019			$	11,305,678
COST OF SALES			5,833,897				1,018,370				13,002,748				2,451,398
GROSS PROFIT			6,912,206				3,409,034				18,933,271				8,854,280
OPERATING EXPENSES:
Media and marketing services			12,455,307				4,717,729				34,662,346				13,363,588
Product development			742,207				464,761				2,457,726				1,129,995
General and administrative			4,252,866				2,128,523				11,402,399				6,477,178
Depreciation and amortization			51,867				8,980				127,012				29,076
Total Operating Expenses			17,502,247				7,319,993				48,649,483				20,999,837
LOSS FROM OPERATIONS			(10,590,041	)			(3,910,959	)			(29,716,212	)			(12,145,557	)
OTHER INCOME/(EXPENSES):
Change in the value of derivative liabilities			-				-				-				109,058
Interest expense, net			(291,279	)			(445,458	)			(1,501,196	)			(2,164,189	)
Total Other Expenses, net			(291,279	)			(445,458	)			(1,501,196	)			(2,055,131	)
NET LOSS		$	(10,881,320	)		$	(4,356,417	)		$	(31,217,408	)		$	(14,200,688	)
Basic and diluted net loss per share		$	(0.40	)		$	(0.18	)		$	(1.18	)		$	(0.69	)
Weighted Average Shares Outstanding:
Basic and diluted			27,027,189				23,619,718				26,408,814				20,688,198

See accompanying notes to condensed financial statements

 

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CYBERDEFENDER CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

		For the Nine Months Ended
		September 30, 2010				September 30, 2009
						(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(31,217,408	)		$	(14,200,688	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of debt discount			923,143				1,044,826
Change in fair value of derivative liabilities			-				(109,058	)
Depreciation and amortization			127,012				29,076
Compensation expense from vested stock options			700,569				200,479
Amortization of deferred financing costs			186,992				375,697
Warrants issued for media and marketing services			18,321,762				2,095,548
Shares and warrants issued for services, interest and penalties			592,765				2,631,003
Warrants issued in connection with warrant tender offer			-				548,728
Changes in operating assets and liabilities:
Restricted cash			(954,374	)			(1,297,093	)
Accounts receivable			(1,543,260	)			73,012
Prepaid expenses			(4,826	)			(27,151	)
Deferred charges			1,662,923				(2,244,144	)
Other assets			(213,967	)			(6,663	)
Accounts payable and accrued expenses			3,619,039				265,938
Deferred revenue			3,384,125				5,103,399
Cash Flows Used In Operating Activities:			(4,415,505	)			(5,517,091	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment			(1,264,231	)			(6,567	)
Cash Flows Used In Investing Activities			(1,264,231	)			(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			(70,022	)			(19,900	)
Proceeds from exercise of stock options			62,392				83,086
Proceeds from exercise of stock warrants, net of placement fees			186,575				2,024,901
Proceeds from sale of stock, net of Commercial Funds			-				3,206,880
Cash Flows Provided by Financing Activities			5,127,927				5,916,667
NET INCREASE/(DECREASE) IN CASH			(551,809	)			393,009
CASH, beginning of period			3,357,510				779,071
CASH, end of period		$	2,805,701			$	1,172,080

See accompanying notes to condensed financial statements

 

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CYBERDEFENDER CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

		For the Nine Months Ended
		September 30, 2010				September 30, 2009
						(Restated)
Supplemental disclosures of cash flow information:
Income taxes paid		$	800			$	800
Cash paid for interest		$	121,501			$	102,338
Supplemental schedule of non-cash investing and financing activities:
Discount on note payable		$	908,571			$	178,601
Property and equipment acquired through capital lease obligations		$	336,600			$	-
Warrants issued for placement fees		$	-			$	18,197
Conversion of notes payable and accrued interest to common stock		$	2,313,139			$	3,942,754
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

 

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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/A.  The results for the nine-month interim period ended September 30, 2010 are not necessarily indicative of the results to be expected for the full year ending December 31, 2010.

NOTE 2 – 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, June 30 and September 30, 2009, and the quarters ended March 31 and June 30, 2010, should be restated in order to make the following adjustments:  (i) the Black Scholes value of the warrants issued by the Company in March 2009 pursuant to a certain Media and Marketing Services Agreement should have been classified as an operating expense rather than interest expense, and the Black Scholes value of the 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 Company’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 nine months ended September 30, 2009:

		December 31, 2009
		Restated				Adjustments				As Filed
Deferred charges, current		$	3,316,535			$	(2,312,753	)		$	5,629,288	(1)
Total Current Assets		$	9,223,207			$	(2,312,753	)		$	11,535,960
Additional paid-in capital		$	36,884,000			$	3,825,872			$	33,058,128	(2)(3)
Accumulated deficit		$	(44,930,550	)		$	(6,138,625	)		$	(38,791,925	)(2)
Total Stockholders’ Deficit		$	(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 Nine Months Ended
		September 30, 2009												September 30, 2009
		Restated				Adjustments				As Filed				Restated				Adjustments				As Filed
Media and marketing services		$	4,717,729			$	1,172,588			$	3,545,141			$	13,363,588			$	2,666,446			$	10,697,142	(1)
General and administrative		$	2,128,523			$	25,916			$	2,102,607	(2)		$	6,477,178			$	(1,009,190	)		$	7,486,368	(1)(2)
Total Operating Expenses		$	7,319,993			$	1,198,504			$	6,121,489			$	20,999,837			$	1,657,256			$	19,342,581
LOSS FROM OPERATIONS		$	(3,910,959	)		$	(1,198,504	)		$	(2,712,455	)		$	(12,145,557	)		$	(1,657,256	)		$	(10,488,301	)
Interest expense		$	445,458			$	(397,638	)		$	843,096			$	2,164,189			$	(644,337	)		$	2,808,526	(1)
NET LOSS		$	(4,356,417	)		$	(800,666	)		$	(3,555,751	)		$	(14,200,688	)		$	(1,012,319	)		$	(13,188,369	)
EPS		$	(0.18	)		$	(0.03	)		$	(0.15	)		$	(0.69	)		$	(0.05	)		$	(0.64	)

Reference

(1) Reclassification and revaluation of warrants.

(2) The Company consolidated its 2009 investor relations and other related consulting expense and income tax expense with general and administrative expense.

 

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 3 - 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 LiveTech support services to the consumer and small business market. The Company markets its products directly to consumers through multiple channels including television, radio, the Internet and print. 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 LiveTech 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 is not based upon traditional clients and servers, but rather upon 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 distribute rapidly 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.

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 nine months ended September 30, 2010 and the year ended December 31, 2009, the Company has incurred a net loss of $31.2 million and $19.8 million with negative cash flows from operations of $4.4 million and $6.0 million, respectively.  As of September 30, 2010 and December 31, 2009, the Company had stockholders’ deficit of $16.2 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 March 31, 2011.  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.

 

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 3 -   NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Reclassification

To conform to the current year's presentation, as a result of management's continuing analysis of its financial reporting, the Company consolidated its 2009 investor relations and other related consulting expense and income tax expense with general and administrative expense on the statement of operations. These reclassifications had no effect on the previously reported net loss for 2009.

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.

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 three 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.

Internal Use Software

Certain costs related to computer software developed or obtained for internal use are capitalized. The Company capitalizes only those direct costs incurred during the application development and implementation stages for developing, purchasing or otherwise acquiring software solely to meet the Company’s internal needs. Capitalized costs will be amortized on a straight-line basis over the estimated useful lives of the underlying software, which generally are three years. During the third quarter of 2010 and for the nine month period ended, the Company capitalized $0.7 million of costs which are included in property and equipment on the accompanying condensed balance sheet.

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.

 

 

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 3 -   NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES   (Continued)

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.

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, which is no longer being sold but is still supported.  The costs associated with this service are deferred and amortized against the recognition of the related sales revenue.

Advertising Costs

The Company expenses advertising costs as incurred. As described in detail in Note 5 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 September 30, 2010 and 2009, the Company recorded non-cash expense of $6.4 million and $1.2 million, respectively. For the nine months ended September 30, 2010 and 2009, the Company recorded non-cash expense of $18.3 million and $2.7 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 $2.2 million and $4.7 million for the three and nine months ended September 30, 2010, respectively. Refunds were $0.7 million and $2.0 million for the three and nine months ended September 30, 2009, respectively. As of September 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 September 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 September 30, 2010, the Company had a balance of approximately $2.9 million in excess of the FDIC limit.

 

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 3 -   NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES   (Continued)

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.

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 classified individually 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 September 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 September 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, $7.1 million to beginning additional paid-in capital, $0.7 million to opening retained earnings and $6.3 million 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 nine months ended September 30, 2009, the Company issued 0 and 1,192,000 common stock purchase warrants, respectively, 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 nine months ended September 30, 2009 was also recorded as a derivative liability. We recognized income of $0 and $109,000 from the change in fair value of the outstanding warrants and embedded conversion feature for the three and nine months ended September 30, 2009, respectively.

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 $7.1 million and a corresponding increase in additional paid-in capital.

 

9

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 3 -   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 September 30, 2010 and 2009, there were 21,775,362 and 14,114,207 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

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 3 -   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 9).

Recently Issued Accounting Pronouncements

The Company has adopted all accounting pronouncements effective before September 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.

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 September 30, 2010. See Note 9 — Subsequent Events to our condensed financial statements.

NOTE 4 – 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 September 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 $2.3 million and $1.3 million as of September 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 7 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

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 5 - 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.

During the nine months ended September 30, 2009, eight investors exercised warrants to purchase 387,954 shares of common stock exercisable at $1.00 to $1.01 per share.  The warrants were exercised pursuant to the cashless provisions contained in the warrants and, as a result, the Company issued 230,706 shares to the investors.

On June 4, 2009, the Company issued 1,142,860 shares of common stock to GR Match, LLC (“GRM”) for an aggregate purchase price of $2.0 million, of which $400,000 must be used for the creation and production by GRM of television commercials advertising the Company’s products and services (the “Commercial Funds”), 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 issued 632,500 shares of common stock to Shimski L.P. for an aggregate purchase price of $1.1 million. Pursuant to the terms of the Securities Purchase Agreement, Shimski L.P. has demand and piggyback registration rights with respect to the shares.  

On July 21, 2009, the Company issued 200,000 shares of common stock to twenty-eight accredited investors for an aggregate purchase price of $0.5 million, the proceeds of which the Company will use for general working capital. There were no issuance costs related to this sale.

On July 30, 2009, one investor exercised warrants to purchase 15,000 shares of common stock exercisable at $1.25 per share.

On August 17, 2009, the Company issued 1,838,952 shares of common stock for warrants that were exercised in connection with a tender offer as more fully described in “stock warrants” below.

During the nine months ended September 30, 2010, seven investors exercised warrants to purchase 159,150 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 6 for additional shares issued related to the convertible notes payable.

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, 0 and 1,080,000 warrants vested during the three and nine month periods ended September 30, 2009 and the value of $0 and $1.0 million, using the Black Scholes pricing model, was expensed.  As of September 30, 2009, all of the warrants had vested.

 

12

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 5 - STOCKHOLDERS’ DEFICIT (Continued)

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 $4,000, using a Black Scholes pricing model, and was expensed to investor relations and other related consulting expense during the nine months ended September 30, 2009. 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 $3,000, was expensed during the nine months ended September 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 $951,000 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 $571,000 to media and marketing services during the three and nine months ended September 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.  The Media Agreement was amended subsequent to September 30, 2010; see Note 9 Subsequent Events below.

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 $712,000 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 nine months ended September 30, 2009, $142,000 and $712,000 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 September 30, 2010, 7,875,968 Media Services Warrant shares have vested and were valued at $23.0 million using the Black-Scholes pricing model.  During the three and nine months ended September 30, 2010, 2.4 million and 6.0 million warrants vested, and $6.4 million and $18.3 million was expensed to media and marketing services expense. During the three and nine months ended September 30, 2009, 0.6 million and 0.8 million warrants vested, and $1.0 million and $1.4 million was expensed to media and marketing services expense. These warrants included an anti-dilutive provision that would have resulted in a reduction of the exercise price of the warrants if the Company at any time while the warrants were outstanding sold and issued 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 October 22, 2010, the Media Agreement was extended, as more fully described below in Note 9 Subsequent Events, to include payment of $75,000 per month to GRM as compensation for the same services provided pursuant to the Media Agreement.

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 vested 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 were vested.  During the three and nine months ended September 30, 2010, $0 and $0.5 million was expensed. During the three and nine months ended September 30, 2009, $0.3 million and $0.7 million, was expensed.

 

13

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 5 - 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 8,387 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% was to 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 had 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 vested 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. These goals were achieved and the Company issued the bonus warrant to the consultant on August 15, 2009. The fair value of the 76,613 warrants that were granted and vested of $128,000 was expensed to general and administrative expense, $81,000 and $128,000 for the three and nine months ended September 30, 2009, respectively.

In May 2009, the Company began an offering to the holders of its warrants issued with “cashless exercise” provisions and/or “down-round” provisions (together, 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.  Pursuant to the originally filed Schedule TO, the offering was to expire on July 28, 2009.  The Schedule TO was amended and the offering was extended until August 17, 2009. The Company received $2.0 million in proceeds, net of offering costs of $73,000, and issued 1.8 million shares of common stock to warrant holders that participated in this offer.  Additionally, in accordance with the terms of the offering, the Company issued warrants to purchase 270,000 shares of the Company’s common stock in exchange for extinguishing the Released Provisions. The additional warrants were valued at $549,000 using the Black Scholes pricing model, and $48,000 and $549,000 was expensed to interest expense during the three and nine months ended September 30, 2009, respectively.

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% was to 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 had 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 vested 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. These goals were achieved and the Company issued the bonus warrant to the consultant on August 15, 2009. The fair value of the 70,000 warrant shares that were granted and vested of $116,000 was expensed to general and administrative expense, $86,000 and $116,000 for the three and nine months ended September 30, 2009, respectively.

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 fair value of the initial 15,000 warrant shares that were granted and vested of $26,000 was expensed during the three and nine months ended September 30, 2009. The remaining 40,000 warrant shares vested during the nine months ended September 30, 2010 and $69,000 was expensed.

 

 

14

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		Nine Months Ended
		September 30, 2010												September 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			6,038,636			$	1.25								3,337,389			$	1.28
Exercised			(159,150	)		$	1.23								(2,241,906	)		$	1.11
Outstanding, end of period			18,906,143			$	1.23			$	49,828,886				12,125,373			$	1.19			$	15,903,284
Exercisable, end of period			18,906,143			$	1.21			$	49,828,886				11,785,373			$	1.18			$	15,515,484

 

The following table summarizes information about warrants outstanding at September 30, 2010:

 

The weighted average grant date fair value of warrants granted and vested during the nine months ended September 30, 2010 and 2009 was $3.03 and $1.66 per share, respectively. The weighted average remaining life of the vested warrants is 2.84 years.

 

15

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 5 - 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 September 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 1,918,986 shares have been granted and are outstanding, awards for the purchase of 326,691 shares have been exercised and awards for the purchase of 429,323 shares are available for grant at September 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 nine months ended September 30, 2009, the Company granted to employees options to purchase a total of 650,000 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 nine months ended September 30, 2010, the Company granted to employees options to purchase a total of 880,626 shares of common stock under the 2006 Plan and the 2005 Plan at prices ranging from $1.00 to $4.70 per share.

 

 

16

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 5 - STOCKHOLDERS’ DEFICIT (Continued)

A summary of stock option activity for the 2005 Plan and 2006 Plan is as follows:

		Nine Months
		September 30, 2010																September 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			938,626			$	3.65				9.55								693,000			$	1.50				9.54
Exercised			(73,200	)		$	0.85				5.71								(75,106	)		$	1.11				8.58
Forfeited			(69,500	)		$	2.28												(235,144	)		$	1.09
Outstanding, end of period			2,652,219			$	1.97				7.77			$	5,137,768				1,826,834			$	1.04				7.60			$	2,704,068
Exercisable, end of period			1,586,269			$	1.11				6.84			$	4,359,134				1,242,178			$	0.78				6.81			$	2,134,108
Vested, exercisable and expected to vest in the future			2,456,463			$	1.78				7.65			$	5,203,768				1,676,932			$	0.97				7.44			$	2,589,585

The weighted-average grant date fair value of options granted during the nine months ended September 30, 2010 and 2009 was $2.50 and $1.37 per option, respectively. 

As of September 30, 2010 and 2009, 1,065,950 and 584,656 of the option shares granted are not vested with an estimated remaining value of $1.8 million and $0.6 million, respectively. At September 30, 2010 and 2009, the remaining value of non vested options granted is expected to be recognized over the weighted average vesting period of 2.61 and 2.68 years, respectively.

 

The Company recorded compensation expense associated with the issuance and vesting of stock options of $310,000 and $701,000 in general and administrative expense for the three and nine months ended September 30, 2010, respectively. The Company recorded compensation expense associated with the issuance and vesting of stock options of $59,000 and $200,000 in general and administrative expense for the three and nine months ended September 30, 2009.

During the nine months ended September 30, 2010 and 2009, options for the purchases of 73,200 and 75,106 shares were exercised for total proceeds to the Company of $62,000 and $83,000, respectively.  The aggregate intrinsic value of the exercised options was $242,000 and $144,000 for the nine months ended September 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.

 

 

17

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 6 - CONVERTIBLE NOTES PAYABLE

In November and December 2008, the Company entered into a Securities Purchase Agreement, which 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 $47,000 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 $21,000 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 $18,000 using the Black-Scholes option pricing model.

Under the terms of the Registration Rights Agreement executed in connection with the issuance of the 2008 Convertible Notes,  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 $596,000 and $604,000, respectively. The discount of $604,000 ($159,000 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 $218,000 and $548,000 to interest expense related to the 2008 Convertible Notes for the three and nine months ended September 30, 2009, respectively. At September 30, 2010 and December 31, 2009, $0 and $109,000 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 $66,000 using the Black-Scholes pricing model. These costs, totaling $138,000 ($39,000 was recorded in 2009), are being amortized over the term of the 2008 Convertible Notes.  The Company recorded amortization of $50,000 and $125,000 to interest expense during the three and nine months ended September 30, 2009, respectively.

 

 

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CYBERDEFENDER CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 6 - CONVERTIBLE NOTES PAYABLE (Continued)

On September 30, 2009, all of the holders of the 2008 Convertible Notes converted $1.2 million 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 pursuant to which it sold to certain accredited investors $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 $20,000. The discount was amortized over the term of the 2009 10% Convertible Notes. At September 30, 2010 and December 31, 2009, $0 and $13,000 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 issued $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 $155,000 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 $132,000 using the Black-Scholes pricing model. These deferred financing costs, totaling $287,000, are being amortized over the term of the 2009 8% Convertible Notes. The Company recorded amortization of $0 and $239,000 to interest expense during the three and nine months ended September 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 $0 and $621,000 to interest expense related to the 2009 8% Convertible Notes for the three and nine months ended September 30, 2010. At September 30, 2010 and December 31, 2009, $0 and $33,000 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 issued in a private placement to GRM a 9% Secured Convertible Promissory Note in the aggregate principal amount of $5.3 million (the “GR Note”), due March 31, 2012.  The Company received net proceeds of $5.0 million 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 GR Note was amended subsequent to September 30, 2010; see Note 9 Subsequent Events below. GRM chose to have the first interest payment due July 1, 2010 added to the aggregate principal amount of the GR Note. For the three and nine months ended September 30, 2010 the Company recorded interest expense of $122,000 and $241,000, respectively, under the GR Note.

 

 

19

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