The accompanying notes are an integral part of these consolidated financial statements.
XFormity Technologies, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2012
Note 1 Organization and Nature of Business.
The reporting entity in this form 10-Q is XFormity Technologies, Inc. (a Colorado Corporation) ("XFormity" or the "Company") and includes the operations of XFormity, Inc. (a Texas Corporation) (XFM), the wholly owned subsidiary of the Company. XFormity provides technology and services to multi-unit business operators. The Companys core products are hosted Business Intelligence (BI), Balanced Scorecard and Benchmarking solutions. These solutions help customers with operational data analysis, trend reporting, issue identification and tracking. The Company provides data integration and management services that feed the BI and Scorecard solution with data from many key data sources. The Companys solutions are provided to customers as a hosted (software-as-a-service) model, which allows the Company to rapidly configure and implement solutions for new customers in an affordable, cost-effective manner.
The Company provides services for franchisors and franchisees in a growing list of customers across the United States and Canada. XFormity is the provider of Burger King Corporation's (BKC) operational reporting for all company owned and operated restaurants in the US and Canada. In addition to this deployment, the Company has had success in delivering solutions on a big scale by the use of its balanced scorecard and financial benchmarking tools for all Burger King Corporate restaurants in the United States and Canada, totalling nearly 6,500 restaurants. The Company has expanded its services to customers in both fine and casual dining.
As noted below in Note 2, the Company has executed an Asset Sale and Purchase Agreement effective August 1, 2012 (APA) which will result in the disposition of all material operations including all current revenue streams for the Company.
Note 2 Discontinued Operations.
In August, 2012, the Company executed and delivered the following agreements with Altametrics XFormity, LLC (Altametrics):
Asset Sale and Purchase Agreement effective August 1, 2012 (APA)
Under the terms of the APA, Altametrics agreed to purchase substantially all of the Companys assets in consideration of $1,300,000. Of the total purchase price, $650,000 has been deposited into escrow with the Companys stock transfer agent, Corporate Stock Transfer, Inc., as Escrow Agent under the terms of an Escrow Agreement. Consummation of the APA is subject to several material conditions precedent, including the approval of the Companys shareholders. Pending consummation of the APA, the Company entered into two additional agreements with Altametrics: a Management Agreement pursuant to which Altametrics agreed to serve as Business Manager of the Companys operations effective August 1, 2012; and a License Agreement pursuant to which, in consideration of a one time license fee in the
amount of $300,000, the Company granted to Altametrics a non-exclusive license to use the Companys intellectual property rights. The entire proceeds of $300,000 was recorded as a gain with the transaction as the Company had no related asset on the balance sheet at the time of the sale, and had no further obligations related to the disposition. Since August 1, 2012, Altametrics has been managing the Companys operations under the Management Agreement and License, in consideration for which Altametrics is entitled to retain any net profits realized from those operations during the management period. As a part of this agreement, Altametrics will contribute sufficient funds for working capital purposes as necessary to keep the Company operating. These funds are not owed back to Altametrics from the Company and are considered capital contributions regardless of the outcome of the APA. During the period ended December 31, 2012, the Company received $208,687 in contributions from Altametrics.
Effective July 31, 2012, all of the Companys senior secured convertible debentures (Debentures) in the aggregate principal amount of approximately $1.2 million matured and became due and payable in full. As a result, the Company is in default under the Debentures; and a majority in interest of the Debenture holders have served upon the Company a notice of default and a further notice that the Debenture holders would not agree to a further extension of the Debentures. The Debenture holders have a senior security interest in all of the tangible and intangible assets of the Company and could foreclose on those assets at any time. A majority in interest of the Debenture holders have agreed in principle to accept payment in the amount of the total net proceeds received by the Company from the consummation of the APA with Altametrics in satisfaction of all liability under the Debentures, which amount is expected to be several hundred thousand dollars less than the total principal and accrued and unpaid interest due under the Debentures. In the event the Company is unable to secure the approval of its shareholders to the APA, the Debenture holders have executed a back-up Asset Purchase Agreement with Altametrics pursuant to which they have agreed to foreclose on the Companys assets under their senior security interest and convey those assets to Altametrics for the same consideration, to wit: $1.3 million. Under either scenario, there will be no funds available for distribution to the Companys shareholders resulting from the sale of its assets to Altametrics.
As a result of the foregoing transactions, effective August 1, 2012, the Companys assets, other than its cash and cash equivalents, accounts receivable resulting from sales made prior to August 1, 2012, and specific insurance polices, are reflected as assets held for sale and include its property and equipment, security deposits and its intellectual property with a carrying value of $21,550 as of December 31, 2012. Concurrently, the liabilities associated with the discontinued operation, including all accounts payable and accrued expenses incurred in the normal course of the discontinued operation are reflected as liabilities associated with the assets held for sale with a carrying value of $257,217 as of December 31, 2012. Revenue from discontinued operations for the six months ended December 31, 2012 and 2011 was $422,963 and $738,099, respectively. For further information on the results from discontinued operations see managements discussion and analysis of the revenues and expenses relating to the discontinued operation.
Note 3 Basis of Financial Statement Presentation.
The accompanying unaudited consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been consolidated or omitted in accordance with such rules and regulations. The information furnished in the interim consolidated financial statements includes normal recurring adjustments and reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of such consolidated financial statements.
The Company does not expect the adoption of recently issued accounting pronouncements to have a significant impact on its results of operation, financial position or cash flow.
Although management believes the disclosures and information presented are adequate to not make the information misleading, it is suggested that these interim consolidated financial statements be read in conjunction with the Company's most recent audited financial statements and notes thereto included in its June 30, 2012 Annual Report on Form 10-K and the 8-K and 8-K/A as reflected above. Operating results for the three months and six months ended December 31, 2012 are not necessarily indicative of the results that may be expected for the entire year or any other period.
The Company's financial statements are prepared using accounting principles generally accepted in the United States of America applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The ability of the Company to continue as a going concern is dependent on the Company; (1) to obtain adequate capital from outside sources, or (2) to fund itself through profitable operations. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
Note 4 Going Concern
As shown in the accompanying consolidated financial statements, the Company has incurred an accumulated deficit of $8,579,968 and a working capital deficit of $1,432,788 as of December 31, 2012. The consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern or if the sale of its assets to Altametrics is not completed.
Note 5 Property and Equipment - (are part of the assets held for sale)
Property and equipment are stated at cost less accumulated depreciation. Depreciation of property and equipment is computed for financial statement purposes using accelerated methods over a five year estimated useful life of the assets. Accumulated depreciation at December 31, 2012 was $189,834 and $185,742 at June 30, 2012. Management has evaluated the difference between the straight line and accelerated method used and has deemed the difference immaterial.
Note 6 Deferred Credits (are part of the liabilities associated with assets held for sale)
In January 2006, the Board of Directors, agreed to offer then seven major customers, (consortium members) the following options in exchange for any further billing credits: (1) a right to receive $150,000 in billing credits applied against their monthly business intelligence software billings at a rate of 25% of the billings commencing July 1, 2006, or (2) a right to receive an additional 833,333 shares of the Companys common stock per consortium member. These shares would be in addition to the shares issued to consortium members in exchange for their original $100,000 investment in fiscal 2004.
Only two consortium members elected option (1), one commencing January 1, 2006, and the other commencing July 1, 2006. The deferred credits at December 31, 2012 in the respective amounts of $64,100 and $66,484, net of amortization, are expected to be utilized over an 11 to 12 year period based on their current billing rates using a 5% discount rate that approximated the risk-free rate in effect during the offered option period.
Note 7 Accounts Payable
Accounts payable represents balances due to trade creditors and fees for professional services incurred for
legal and audit services.
Note 8 Accrued Expenses
Accrued expenses other than as reflected herein are part of the liabilities associated with assets held for sale.
Accrued interest on convertible debentures
Note 9 Convertible Debentures
If all of the remaining debenture holders at December 31, 2012 elected to convert their debentures and warrants into shares of the Companys common stock, the Company would be required to issue an additional 18,824,392 shares. Effective July 31, 2012, all of the Companys senior secured convertible debentures (Debentures) in the aggregate principal amount of approximately $1.2 million matured and became due and payable in full. As a result, the Company is in default under the Debentures; and a majority in interest of the Debenture holders have served upon the Company a notice of default and a further notice that the Debenture holders would not agree to a further extension of the Debentures. The Debenture holders have a senior security interest in all of the tangible and intangible assets of the Company and could foreclose on those assets at any time. A majority in interest of the Debenture holders have agreed in principle to accept payment in the amount of the total net proceeds received by the Company from the consummation of the APA with Altametrics in satisfaction of all liability under the Debentures, which amount is expected to be several hundred thousand dollars less than the total principal and accrued and unpaid interest due under the Debentures. In the event the Company is unable to secure the approval of its shareholders to the APA, the Debenture holders have executed a back-up Asset Purchase Agreement with Altametrics pursuant to which they have agreed to foreclose on the Companys assets under their senior security interest and convey those assets to Altametrics for the same consideration, to wit: $1.3 million. As a result, it is unlikely that the Debenures will be converted into shares of common stock.
Note 10 Derivative Liabilities
The Companys warrants and its Convertible Notes have reset provisions to the exercise price and conversion price if the Company issues equity or other derivatives at a price less than the exercise price set forth in such warrants and notes. This ratchet provision resulted in a derivative liability in our financial statements that was evaluated at zero at June 30, 2012 and December 31, 2012 by an independent consultant.
In the six months quarters ended December 31, 2011, the derivative liabilities decreased to $449,894 at December 31, 2011, from $514,086 at June 30, 2011. During the three months and six months ended December 31, 2011, the Company recorded a gain of $8,237 and $64,192, respectively, for the change in fair value.
Note 11 Earnings per Share
Basic earnings per share are calculated based on the weighted-average number of outstanding common shares. As of December 31, 2012, the Company had 53,756,553 shares outstanding, As of December 31, 2012, the Company had issued convertible debentures in the amount of $1,206,763 convertible at a conversion price of the lesser of (i) 70% of the price per share of common stock or common stock equivalent paid by investors in the Companys next round of equity or debt financing consisting of at least
$1,000,000 in cumulative gross proceeds, or (ii) $0.12, warrants outstanding of 4,802,642 consisting of 2,401,321 with an exercise price of $0.14 and 2,401,321 with an exercise price of $0.18.
For the six months ended December 31, 2012, the conversion of all of the above would result in a possible dilution of 23,627,028 shares. However, as the convertible debentures, options, and warrants have a strike price equal to or in excess of the market price, $0.0024 at December 31, 2012, and are considered not in the money, they are excluded from the calculation of diluted earnings per share due to their anti-dilutive effect.
Note 12 Income Taxes
As of July 1, 2007, the Company adopted the current accounting guidance for the Accounting for Uncertainty in Income Taxes, which seeks to reduce the diversity in practice associated with the accounting and reporting for uncertainty in income tax positions. The Company believes it does not have any uncertain tax positions taken or expected to be taken in its income tax returns.
At December 31, 2012, the Company had net operating loss carry-forwards approximating $15,100,000 that expire in 2017 through 2028. The carry-forward losses and the related deferred tax benefit are significantly limited by the provisions of Internal Revenue Code Section 382. The Companys taxable losses, have created a deferred tax benefit of approximately $1,963,000 that is fully reserved.
Note 13 Related Party Transactions
Six of our customers who are also stockholders in the Company, generated revenues approximating $42,200 and $84,200, respectively, in the three months and six months ended December 31, 2012. In the same periods in the prior year, revenues approximated $38,200 and $76,700, respectively. A principal in one current customer serves as a member of the Board of Directors and the Audit Committee.
Of the total 9% convertible debentures issued through December 31, 2012, related parties hold $906,682. Interest expense accrued to related parties for the three months and six months ended December 31, 2012 was $41,136.
Note 14 Commitments and Contingencies
The lease obligations are part of the liabilities associated with assets held for sale. The Company entered into a 65 month net lease at its Dallas, Texas office, commencing June 1, 2008, with rent approximating $4,300 per month. The Company also had a month-to-month lease for $700 per month at its Northbrook, Illinois office that was terminated as of August 31, 2012. Total rent expense for the three months and six months ended December 31, 2012 was $17,314 and $27,371, respectively, compared to $15,086 and $30,171 in the comparable periods in the prior year. The Company accounts for these leases as operating leases.
Note 15 Subsequent Events
Management reported that there are no reportable events through the date of this filing.
Safe Harbour - Forward Looking Statements
When used in this Quarterly Report on Form 10-Q, in documents incorporated herein and elsewhere by us from time to time, the words "believes," "anticipates," "expects" and similar expressions are intended to identify forward-looking statements concerning our business operations, economic performance and financial condition, including in particular, our business strategy and means to implement the strategy, our objectives, the amount of future capital expenditures required, the likelihood of our success in developing and introducing new products and expanding the business, and the timing of the introduction of new and modified products or services. These forward looking statements are based on a number of assumptions and estimates which are inherently subject to significant risks and uncertainties, many of which are beyond our control and reflect future business decisions which are subject to change.
A variety of factors could cause actual results to differ materially from those expected in our forward-looking statements, including those set forth from time to time in our press releases and reports and other filings made with the Securities and Exchange Commission. We caution that such factors are not exclusive. Consequently, all of the forward-looking statements made in this document are qualified by these cautionary statements and readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release the results of any revisions of such forward-looking statements that may be made to reflect events or circumstances after the date hereof, or thereof, as the case may be, or to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
REVENUE The Companys primary revenue is derived by delivering software as a service, or hosted solutions for its clients billed on a monthly basis for each location serviced. For the three months and six months ended December 31, 2012, the Company generated $168,126 and $422,963, respectively, in revenues compared to $341,647 and $738,099 in the comparable prior years periods. The decreases in revenues were attributable to the loss of two major accounts representing approximately 1,000 stores over the comparable periods, one primarily because Company stores were sold to franchisees and the other to competition.
COST OF REVENUE The cost of revenue for the three months and six months ended December 31, 2012 and 2011, consist primarily of personnel, related payroll costs and support service costs in the respective amounts of $58,343 and $132,626 compared to $109,005 and $256,681 in the comparable prior years periods. Other costs include travel, data hosting services, telecommunication costs and depreciation of computer equipment used in the maintenance and processing of customers' data. The decrease was primarily attributable to a reduction in personnel and related payroll costs, further decreased by a reallocation of time to research and development from existing personnel, for reductions of $44,701 and $115,693, respectively. Other operating costs including license fees decreased by $5,961 and $8,362, respectively.
RESEARCH AND DEVELOPMENT Research and development costs are charged to operations as incurred and consist primarily of personnel, related benefit costs and outside contracted services. The costs for the three months and six months ended December 31, 2012 and 2011 were $128,582 and $266,046, respectively, and $118,630 and $214,308, respectively, in the prior years periods. In the current years periods, the Company re-allocated personnel time from operations to research and development, resulting
in increased payroll and related costs of $21,396 and $71,866, respectively. The Company further reduced the use of outside contractors by $10,000 and $22,000, respectively, and its other costs by $1,444 and $1,872, respectively, in the three and six months ended December 31, 2011. The Companys research and development is part of its strategic plan to provide enhancements and integration into new and existing franchise operations in the retail market.
MARKETING AND SELLING The costs for the three months and six months ended December 31, 2012 were $48,980 and $82,020 compared to 37,262 and $68,945 in the comparable periods of the prior year. The Companys marketing and selling expenses in the current periods increased due to re-allocated personnel time to marketing and sales from operations and administration offset by the elimination of an outside sales consultant for a net increase of $3,750 in the three months ended December 31, 2012 and a, decrease of $657 in the six months ended December 31, 2012. Other marketing and selling costs increased by $7,969 and $13,732 for the respective three months and six months ended December 31, 2012 due to additional marketing and trade shows. For the current fiscal year, the Company continues to attempt to expand its customer base through direct sales, related business partnerships, trade shows and referrals from its relationship with existing clients.
GENERAL AND ADMINISTRATIVE The Companys general and administrative costs consist primarily of executive salaries and related benefits, professional fees for attorneys, our independent auditor, rent, expenses related to being a public company and other administrative costs. The costs for the three month and six month period ended December 31, 2012 were $76,505 and $202,776 compared to $99,062 and $ 211,453 in the comparable periods of the prior year. In the current periods, due to a reallocation of time from marketing and sales, payroll and related costs decreased by $24,289 and $32,365, respectively. Professional fees increased in these same periods by $9,910 and $30,462. Other operating costs decreased for the three and six months ended December 31, 2011 by $624 and $6,776, respectively.
INTEREST EXPENSE Interest expense consists of the following:
NET (LOSS) INCOME The net loss for the three months and six months ended December 31, 2012 was $21,951 and $177,967, respectively, compared to net losses of $108,670 and $132,385, respectively, for the comparable periods in 2011. The increase in the net loss was primarily the result of the significant loss of revenues compared to the prior year and reductions in most other categories as noted above, offset by termination the change in fair value of the derivatives.
The net (loss) per share for the three months and six months ended December 31, 2012 was ($0.00) and ($0.00) per share on 53,756,553 weighted average common shares outstanding, respectively, and ($0.00) and ($0.00) per share, respectively, in both of the comparable periods in the prior year on 51,931,553 and 53,548,264 weighted average common shares outstanding.
LIQUIDITY AND CAPITAL RESOURCES
The Company had previously addressed resulting liquidity issues through the sales of its software and professional services and the issuance of convertible debentures. In July 2012, Company received an offer to acquire its assets from Altametrics, a California Company that provides unrelated services to the hospitality industry, an offer to acquire a non-exclusive license for its Business Intelligence Solution and the notice of no further forbearance on the convertible debentures. The Board of Directors reviewed all of the existing options available to the Company, and agreed that it was in the best interest of the Company and its shareholders to accept the offer from Altametrics. The sale of the assets requires shareholder approval that if not given, the debenture holders will foreclose on those assets and take possession under the terms of the Debentures. If consummated, of which there can be no assurance, the Company will use the proceeds from these transactions to retire all of its current obligations and pay the principal on the convertible debentures. Shareholders will not receive any distribution from the proceeds of the sale of the assets under the APA but will retain their interest in the remaining shell company.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management has evaluated, under the supervision and with the participation of our chief executive officer and chief financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were ineffective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act") is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error or 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. Due to 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, have been detected. Accordingly, management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.
Changes in Internal Control over Financial Reporting
In addition, our management with the participation of our Principal Executive Officer and Principal Financial Officer have determined that no change in our internal control over financial reporting occurred during or subsequent to the quarter ended December 31, 2012 that has materially affected, or is (as that term is defined in Rules 13(a)-15(f) and 15(d)-15(f) of the Securities Exchange Act of 1934) reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1 Legal Proceedings
Item 1A Risk Factors
Item 2 Unregistered Sales of Securities and Use of Proceeds
ITEM 3 Defaults upon Senior Securities
None, except as previously reported.
ITEM 4 [Removed]
ITEM 5 Other information
ITEM 6 Exhibits