Pre-Effective Amendment to Registration of Securities of a Small-Business Issuer — Form SB-2 Filing Table of Contents
Document/ExhibitDescriptionPagesSize 1: SB-2/A Pre-Effective Amendment to Registration of HTML 948K Securities of a Small-Business Issuer
17: CORRESP ¶ Comment-Response or Other Letter to the SEC HTML 854K
2: EX-5 Opinion re: Legality HTML 15K
3: EX-10.1 Material Contract HTML 90K
7: EX-10.16 Material Contract HTML 8K
8: EX-10.17 Material Contract HTML 8K
9: EX-10.18 Material Contract HTML 24K
10: EX-10.19 Material Contract HTML 10K
11: EX-10.20 Material Contract HTML 7K
12: EX-10.21 Material Contract HTML 6K
13: EX-10.22 Material Contract HTML 97K
14: EX-10.31 Material Contract HTML 8K
15: EX-10.32 Material Contract HTML 6K
4: EX-10.4 Material Contract HTML 8K
5: EX-10.5 Material Contract HTML 7K
6: EX-10.6 Material Contract HTML 8K
16: EX-23.1 Consent of Experts or Counsel HTML 11K
‘SB-2/A’ — Pre-Effective Amendment to Registration of Securities of a Small-Business Issuer
Approximate
date of proposed sale to the public: From time to time after the effective
date
of this Registration Statement.
If
any of
the securities being registered on this Form are to be offered on a delayed
or
continuous basis pursuant to Rule 415 under the Securities Act of 1933, other
than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. x
If
this
form is filed to register additional securities for an offering pursuant to
Rule
462(b) under the Securities Act, please check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. o
If
this
form is a post-effective amendment filed pursuant to Rule 462(c) under the
Securities Act, check the following box and list the Securities Act registration
statement number of the earlier effective registration statement for the same
offering. o
If
this
Form is a post-effective amendment filed pursuant to Rule 462(d) under the
Securities Act, check the following box and list the Securities Act registration
statement number of the earlier effective registration statement for the same
offering. o
If
delivery of the prospectus is expected to be made pursuant to Rule 434, please
check the following box. o
THE
REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS
MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A
FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON
SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SECTION
8(A), MAY DETERMINE.
The
information in this prospectus is not complete and may be changed. We may not
sell these securities until the registration statement filed with the Securities
and Exchange Commission is effective. This prospectus is not an offer to sell
these securities and is not soliciting an offer to buy these securities in
any
state where the offer or sale is not permitted.
This
prospectus covers the resale by selling shareholders named on page 38 of
up to
6,076,956 shares of our common stock which include:
·
50,000
shares of common stock;
·
3,013,478
shares of common stock underlying common stock purchase warrants
issued
pursuant to a Securities Purchase Agreement dated as of September12,2006; and
·
3,013,478
shares of common stock underlying the 10% secured convertible debentures
we issued in conjunction with the Securities Purchase
Agreement.
This
offering is the initial public offering of our common stock. This offering
is
not being underwritten.
There
is
no current trading market for our securities. These securities will be offered
for sale by the selling shareholders identified in this prospectus in accordance
with the methods and terms described in the section of this prospectus titled
“Plan of Distribution.” We estimate that the selling shareholders will sell at a
price between $X.XX to $X.XX per share until our shares are quoted on the
OTC
Bulletin Board and thereafter at prevailing market prices or privately
negotiated prices.
We
will
not receive any of the proceeds from the sale of these shares. However, we
may
receive up to $3,013,478 upon the exercise of warrants. If some or all of the
funds are received, such funds will be used for general corporate purposes,
including working capital requirements. We will pay all expenses incurred in
connection with the offering described in this prospectus, with the exception
of
the brokerage expenses, fees, discounts and commissions which will all be paid
by the selling shareholders. Our common stock and warrants are more fully
described in the section of this prospectus titled “Description of
Securities.”
AN
INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE “RISK
FACTORS” BEGINNING AT PAGE 4.
NEITHER
THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION
HAS
APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
You
should rely only on the information contained in this prospectus to make your
investment decision. We have not authorized anyone to provide you with different
information. This prospectus may be used only where it is legal to sell these
securities. You should not assume that the information in this prospectus is
accurate as of any date other than the date on the front page of this
prospectus.
The
following table of contents has been designed to help you find important
information contained in this prospectus. We encourage you to read the entire
prospectus carefully.
The
date
of this prospectus is __________, 2007
Table
of Contents
Prospectus
Summary
1
Risk
Factors
4
Special
Note Regarding Forward-Looking Statements
12
Use
of Proceeds
13
Determination
of Offering Price
13
Market
For Common Equity and Related Shareholder Matters
13
Management’s
Discussion and Analysis or Plan of Operation
18
Description
of Business
26
Directors,
Executive Officers, Promoters and Control Persons
35
Executive
Compensation
37
Certain
Relationships and Related Transactions
40
Selling
Shareholders
42
Plan
of Distribution
43
Security
Ownership of Certain Beneficial Owners and Management
45
Description
of Securities
47
Disclosure
of Commission Position on Indemnification for Securities Act
Liabilities
48
Where
You Can Find More Information
51
Experts
51
Legal
Matters and Interests of Named Experts
51
Financial
Information
F-1
Prospectus
Summary
This
summary highlights material information contained elsewhere in this prospectus.
You should read the entire prospectus carefully, including the section titled
“Risk Factors” and our consolidated financial statements and the related
notes.
Our
Company
Networks
such as the Internet can enable rapid communication of information between
computers. Unfortunately, the capability of computers to communicate is often
used to victimize computer systems and/or their users. A variety of known
threats, such as computer viruses, spam and phishing schemes, are spread using
the Internet.
We
are a
California corporation that provides what we believe to be a radical new
approach to Internet security. Other providers of secure content management
software, such as Symantec, McAfee and Trend Micro, use the client/server
method
to find and distribute information regarding threats. This means that the
provider must discover the threat then distribute this information on a
one-on-one basis to each of its customers. As described below, our approach
relies on a network of users. We use a secure peer-to-peer network, rather
than
a traditional server, to find and relay information regarding potential threats.
We acquired this technology in 2005. Using this technology as a platform,
we
began in mid-2005 to evolve from a marketing-focused software publisher to
a
full-line security software developer.
Prior
to
November 20, 2006 we offered a single product, CyberDefender AntiSpyware
2006.
On November 20, 2006 we stopped licensing this product to new subscribers
(although we continue to support and upgrade it for existing users). We now
offer CyberDefender Early Detection Center and CyberDefender Free 2.0. These
are
complete Internet security suites that protect home computer users against
spam,
spyware, viruses and scams. The software programs are identical but are
distributed in one of two ways. If the subscriber chooses the free version
(CyberDefender Free 2.0), he will receive the software with advertising banners
in it. If the subscriber does not wish to receive the advertising, he may
pay to
purchase a license for CyberDefender Early Detection Center. The annual
licensing fee can be as low as $11.99 or as high as $39.99, depending on
the
marketing and distribution channels that we use.
As
indicated above, we use a secure peer-to-peer network to provide protection
from
on-line threats. Our software users know our technology as the Collaborative
Internet Security Network, which is sometimes referred to in this prospectus
as
“CISN” or the “earlyNetwork™”. Each user of our software is a “node” on the
network. The node is designed to sense potential threats (every threat has
a
“signature” which is a characteristic of the threat that is unique and,
therefore, distinguishes the threat from other potentially benign files or
computer programs) and automatically alerts our Automated Threat Analysis
System, currently called Threat Central and soon to be renamed, and referred
to
in this prospectus as, the Early Alert Center (EAC). At the heart of the
EAC is
a proprietary expert system that automatically tests and grades all potential
threats (with some human help for quality assurance). The EAC relays the
threat
signature of every proven threat to the Alert Server.
Unlike
conventional update networks, the Alert Server does not wait to send out a
batch
of updates to all computers that are a part of our software network, but instead
sends out the update without delay. We can do this because we are not
broadcasting to all computers at our expense, but instead we are posting the
update to be relayed from computer to computer on a secure basis, which makes
use of local user bandwidth. We have applied for patent protection for this
technology with the U.S. Patent and Trademark Office.
Risks
Related to Our Business
Our
business is subject to a number of risks, which you should be aware of before
making an investment decision. These risks are discussed more fully in the
section of this prospectus titled “Risk Factors.”
The
Offering
The
shares issued and outstanding prior to this offering consist of 12,173,914
shares of common stock and do not include:
·
877,552
shares of common stock issuable upon the exercise of warrants having
an
exercise price of $1.01 per share;
·
830,797
shares of common stock reserved for issuance under our 2005 Stock
Option
Plan;
·
1,375,000
shares of common stock reserved for issuance under our Amended and
Restated 2006 Equity Incentive Plan;
and
·
434,000
shares of common stock reserved for issuance upon the exercise
of
outstanding unit purchase options having an exercise price of $1.00
per
unit, with each unit consisting of one share of common stock and
a warrant
to purchase one share of common stock for $1.00 per
share.
We
are
registering 6,076,956 shares of our common stock for sale by the selling
shareholders identified in the section of this prospectus titled “Selling
Shareholders.” The shares included in the table identifying the selling
shareholders consist of:
·
50,000
shares of common stock owned by ARC Investment Partners
LLC;
·
3,013,478
shares of common stock underlying common stock purchase warrants
issued
pursuant to a Securities Purchase Agreement dated as of September12,2006; and
·
3,013,478
shares of common stock underlying 10% secured convertible debentures
we
issued in conjunction with the Securities Purchase Agreement.
On
or
about September 12, 2006, we entered into a Securities Purchase Agreement
with
the selling shareholders pursuant to which we sold 10% secured convertible
debentures in the aggregate principal amount of $3,243,378 and common stock
purchase warrants to purchase an aggregate of 3,243,378 shares of our common
stock at $1.00 per share. This aggregate principal amount of $3,243,378 includes
the conversion of $580,878 of principal and accrued interest related to our
previously outstanding 8% secured notes. This amount also includes a
subscription by our attorneys for $62,500 worth of 10% secured convertible
debentures and warrants, which our attorneys paid for by cancelling $62,500
of
indebtedness incurred by us for legal services.
In
connection with the Securities Purchase Agreement, we also entered into a
Registration Rights Agreement pursuant to which we are obligated to register
for
resale at least 130% of the shares of our common stock issuable upon the
conversion of the 10% secured convertible debentures and the exercise of
the
common stock purchase warrants. However, the Registration Rights Agreement
also
prohibits us from registering shares of common stock that total more than
one-half of our issued and outstanding shares of common stock, reduced by
10,000
shares.
After
this offering, assuming the conversion of all outstanding 10% secured
convertible debentures and the exercise of all the warrants issued concurrently
with such debentures, we would have 18,660,670 shares of common stock
outstanding, which does not include 830,797 shares of common stock reserved
for
issuance under our 2005 Stock Option Plan, 1,375,000 shares of common stock
reserved for issuance under our Amended and Restated 2006 Equity Incentive
Plan,
877,552 shares of common stock reserved for issuance upon exercise of warrants
held by our prior lenders, or 434,000 shares of common stock reserved for
issuance upon the exercise of outstanding unit purchase options.
Information
regarding our common stock and the warrants is included in the section of
this
prospectus titled “Description of Securities.”
2
Corporate
Information
We
maintain our principal offices at 12121 Wilshire Boulevard, Suite 350, LosAngeles, California90025. Our telephone number at that address is (310)
826-1781. Our web address is www.cyberdefender.com. Information included
on our
website is not part of this prospectus.
Reverse
Split
On
October 30, 2006 our board of directors and those shareholders holding a
majority of our voting power approved a 0.93173414-for-1 reverse split of our
common stock. The reverse split was effective on October 31, 2006. Unless
otherwise indicated, all discussions included in this prospectus relating to
the
outstanding shares of our common stock, including common stock to be issued
upon
the conversion of our 10% secured convertible debentures and upon the exercise
of outstanding warrants and options, refer to post-split shares.
3
Risk
Factors
You
should carefully consider the risks described below before making an investment
decision. Our business could be harmed by any of these risks. The trading price
of our common stock could decline due to any of these risks, and you may lose
all or part of your investment. In assessing these risks, you should also refer
to the other information contained in this prospectus, including our financial
statements and related notes.
Risks
Related to Our Business
Our
limited operating history makes evaluation of our business difficult.
We
were
incorporated in the State of California as Network Dynamics in August 2003
and
have limited historical financial data upon which to base planned operating
expenses or to accurately forecast our future operating results. We have
a
limited operating history which makes it difficult to evaluate our performance.
You must consider our prospects in light of the risks, expenses and difficulties
we face as an early stage company with a limited operating history. These
risks
include uncertainty whether we will be able to:
· increase
revenues from sales of our product;
· successfully
protect our Collaborative Internet Security Network from all security
attacks;
· successfully
protect personal computer or corporate networks against all Internet
threats;
· respond
effectively to competitive pressures;
· protect
our intellectual property rights;
· continue
to develop and upgrade our technology; and
· continue
to renew our customers’ subscriptions to current and future
products.
If
we continue to incur losses for a significant amount of time, the value of
your
investment could be adversely affected and you could even lose your entire
investment.
We
incurred a net loss of $140,909 and $2,281,419 for the fiscal years ended
December 31, 2003 and 2004, respectively, and we had net income of $642,896
for
the fiscal year ended December 31, 2005. We incurred a net loss of $3,031,415
for the nine months ended September 30, 2006. As we move from being a marketing
focused software publisher to a full-line security software developer, we
are
likely to continue to incur losses. We cannot predict when, or if, we will
be
profitable in the future. Even if we achieve profitability, we may not be
able
to sustain it.
4
As
of September 30, 2006, we had $1,896,570 in cash. If we earn no revenues,
we
believe that we could operate through February 2007. In order to meet our
financial obligations for a period of 12 months, we will need an additional
$1,500,000. If we are not able to raise additional funds by March 2007, our
business could be adversely affected.
We
have
no committed sources of additional capital. We have been funding our operations
and capital expenditures from limited cash flow from operations, our cash
on
hand and the net proceeds from the financing we undertook in September 2006.
As
of September 30, 2006 we had $1,896,570 in cash. We believe that this cash
will
fund our operations through February 2007. However, we will need additional
funds to continue our operations, pursue business opportunities (such as
expansion or the development of new products or services), react to unforeseen
difficulties or respond to competitive pressures. We cannot assure you that
any
financing arrangements will be available in amounts or on terms acceptable
to
us, if at all. If additional financing is not available or is not available
on
acceptable terms, we may be unable to continue our operations. This would
have a
material adverse effect on our business and the value of our common stock.
If we
choose to raise additional funds through the issuance of equity securities,
our
existing equity security holders may experience significant dilution of their
ownership interests, and holders of the additional equity securities may
have
rights senior to those of the holders of our common stock. If we obtain
additional financing by issuing debt securities, the terms of these securities
could restrict or prevent us from paying dividends and could limit our
flexibility in making business decisions.
If
we fail to market our product effectively, our sales could
decline.
We
market
our product and related services over the Internet, primarily through space
purchased from Internet-based marketers and search engines. Some of the Internet
sites on which our advertising is placed include Google, Yahoo! and MSN.
If
Internet advertising fails to perform as we anticipate, this could reduce
our
sales and increase our expenses, as well as weaken our competitive
position.
We
face intense competition, and our competitors may gain market share in the
markets for our product, which could adversely affect the growth of our business
and cause our revenues to decline.
We
have
many competitors in the markets for our product. If existing or new competitors
gain market share in any of these markets, we may experience a decline in
revenues, which could adversely affect our business and operating results.
Our
competitors include software companies that offer products that directly
compete
with our product or bundle their software products with Internet security
software offered by another company. End-user customers may prefer to purchase
Internet security software that is manufactured by the same company that
provides its other software programs because of greater product breadth offered
by the company, perceived advantages in price, technical support, compatibility
or other issues.
Some
of
our competitors include WebRoot Software, Kaspersky Labs and Sunbelt Software.
Many of our competitors have greater brand name recognition and financial,
technical, sales, marketing and other resources than we do and consequently
may
have an ability to influence customers to purchase their products rather
than
ours. Our future and existing competitors could introduce products with superior
features, scalability and functionality at lower prices than our product,
and
could also bundle existing or new products with other more established products
in order to compete with us. Our competitors could also gain market share
by
acquiring or forming strategic alliances with our other competitors. Finally,
because new distribution methods offered by the Internet and electronic commerce
have removed many of the barriers to entry historically faced by start-up
companies in the software industry, we may face additional sources of
competition in the future. Any of the foregoing effects could cause our revenues
to decline, which would harm our financial position and results of
operations.
If
we are unable to develop new and enhanced products that achieve widespread
market acceptance, we may be unable to recover product development costs and
our
earnings and revenues may decline.
5
Our
future success depends on our ability to address the rapidly changing needs
of
our customers by developing, acquiring and introducing new products, product
updates and services on a timely basis. For example, in November 2006 we
introduced our security suite of products, CyberDefender Early Dedection
Center/CyberDefender FREE 2.0, in response to new products released by companies
such as Symantec. We must also keep pace with technological developments
and
emerging industry standards. We intend to commit a portion of our resources
to
developing new software products and services. Industry standards for products
relating to Internet security are evolving and changing. If demand for our
products and services does not materialize or occurs more slowly than we
expect,
we will have expended resources (such as personnel and equipment) and capital
without realizing sufficient revenue to recover these costs, and our business
and operating results could be adversely affected.
Our
products may contain significant errors and failures, which could adversely
affect our operating results.
Product
errors or failures could cause delays in new product releases or product
upgrades, or our products might not work in combination with other software,
which could adversely affect market acceptance of our products. If our customers
were dissatisfied with product functionality or performance, or if we were
to
experience significant delays in the release of new products or new versions
of
products, we could lose competitive position and revenue and our business and
operating results could be adversely affected.
Our
ability to effectively recruit and retain qualified officers and directors
could
be adversely affected if we experience difficulty in obtaining directors' and
officers' liability insurance.
We
may be
unable to obtain or maintain insurance as a public company on terms affordable
to us to cover liability for claims made against our officers and directors.
If
we are unable to adequately insure our officers and directors, we may not be
able to retain or recruit qualified officers and directors to manage our
business.
Loss
of any of our key management personnel could negatively impact our business
and
the value of our common stock.
Our
ability to execute our business strategy will depend on the skills, experience
and performance of key members of our management team. We heavily depend
on the
services of Gary Guseinov, our Chief Executive Officer, Ivan Ivankovich,
our
acting Chief Financial Officer, Igor Barash, our Chief Information Officer
and
Secretary; and Bing Liu, our Chief Software Architect. We do not have long-term
employment agreements with any of the members of our management team, except
Gary Guseinov. We have entered into employment agreements with Mr. Barash
and
Mr. Liu, but they are “at-will” and do not preclude any of them from leaving us.
We have an independent contractor agreement with Mr. Ivankovich that will
expire
on March 31, 2007.
On
December 31, 2006 our employment agreement with Riggs Eckelberry, our former
President and Chief Operating Officer, expired, although he may continue
to
serve us in a consulting capacity beginning in February 2007. Mr. Eckleberry
was
hired to assist us with transitioning from a marketing-focused software
publisher to a full-line security software developer and to assist us with
the
launch of our new product, CyberDefender Early Detection Center/CyberDefender
FREE 2.0. Those goals were accomplished in November 2006.
As
we
lose members of our key management personnel, we may be forced to expend
significant time and money in the pursuit of replacements, which could result
in
both a delay in the implementation of our business plan and the diversion of
limited working capital. We cannot assure you that we will find satisfactory
replacements for these key management personnel at all, or on terms that are
not
unduly expensive or burdensome to our company. We do not maintain key man
insurance policies on any of our key officers or employees. Although we have
in
the past and intend in the foreseeable future to issue stock options or other
equity-based compensation, such incentives may not be sufficient to attract
and
retain key personnel.
6
Changes
in government regulation and industry standards may adversely affect our
business.
Laws
and
regulations that apply to Internet communications, commerce and advertising
are
becoming more prevalent. These regulations could affect the costs of
communicating on the Internet and adversely affect the demand for our products
or otherwise harm our business, results of operations and financial condition.
The United States Congress has enacted Internet legislation regarding children’s
privacy, copyrights, sending of unsolicited commercial email (e.g., the Federal
CAN-Spam Act of 2003), spyware (e.g., H.R. 29, the “Spy Act”), and taxation.
Other laws and regulations have been adopted and may be adopted in the future,
and may address issues such as user privacy, spyware, pricing, intellectual
property ownership and infringement, taxation, and quality of products and
services. This legislation could hinder growth in the use of the Internet
generally and decrease the acceptance of the Internet as a communications,
commercial and advertising medium.
In
addition, the growth and development of the market for Internet commerce may
prompt calls for more stringent consumer protection laws, both in the United
States and abroad, that may impose additional burdens on companies conducting
business over the Internet. The laws governing the Internet remain largely
unsettled, even in areas where there has been some legislative action. It may
take years to determine how existing laws, including those governing
intellectual property, privacy, libel and taxation apply to the Internet and
Internet advertising. Our business, results of operations and financial
condition could be materially and adversely affected by the adoption or
modification of laws or regulations relating to the Internet, or the application
of existing laws to the Internet or Internet-based advertising.
If
we do not protect our proprietary information and prevent third parties from
making unauthorized use of our products and technology, our revenues could
be
harmed.
We
rely
on a combination of copyright, patent, trademark and trade secret laws,
confidentiality procedures, contractual provisions and other measures to
protect
our proprietary information. All of these measures afford only limited
protection. These measures may be invalidated, circumvented or challenged,
and
others may develop technologies or processes that are similar or superior
to our
technology. We may not have the proprietary information controls and procedures
in place that we need to protect our proprietary information adequately.
Despite
our efforts to protect our proprietary rights, unauthorized parties may attempt
to copy our products or obtain or use information that we regard as proprietary,
which could harm our revenues.
Third
parties claiming that we infringe their proprietary rights could cause us to
incur significant legal expenses and prevent us from selling our
products.
As
the
number of products in the software industry increases and the functionality
of
these products further overlap, we believe that we may become increasingly
subject to infringement claims, including patent, copyright and trademark
infringement claims. In addition, former employers of our former, current or
future employees may assert claims that such employees have improperly disclosed
to us the confidential or proprietary information of these former employers.
Any
such claim, with or without merit, could:
· be
time
consuming to defend;
· result
in
costly litigation;
· divert
management’s attention from our core business;
· require
us to stop selling, delay providing or redesign our product; and
7
· require
us to pay monetary amounts as damages, for royalty or licensing
arrangements.
Risks
Related With Ownership of Our Securities
The
holders of our 10% secured convertible debentures have a security interest
in
all of our assets. If we were to fail to pay the debentures as required,
or any
other event of default set forth in the debentures were to occur, these
investors could foreclose on their security interest and your securities
could
become worthless.
In
September 2006 we placed $3,243,378 worth of our 10% secured convertible
debentures. The payment of these debentures is secured with all of our assets.
If we were to default in our repayment obligation, or any other event of
default
set forth in the debentures were to occur, the investors who purchased the
debentures could foreclose the security interest, take our assets and sell
or
otherwise dispose of them. If that were to happen, we may not be able to
continue our business and your securities would become
worthless.
The
holders of our 10% secured convertible debentures have anti-dilution rights
that
are triggered by a disposition of our common stock at a price per share that
is
lower than the conversion price of the debentures. These rights are not
available to the holders of our common stock. If future issuances of our
common
stock trigger the anti-dilution rights, your investment in our common stock
will
be diluted.
Holders
of our 10% secured convertible debentures may convert the debenture amount
to
common stock at $1.00 per share. If, during the time that these debentures
are
outstanding, we sell or grant any option to purchase, or sell or grant any
right
to reprice our securities, or otherwise dispose of or issue any common stock
or
common stock equivalents entitling any person to acquire shares of our common
stock at a price per share that is lower than the conversion price of the
debentures (which, for purposes of this discussion will be designated as the
“Base Conversion Price”) or that is higher than the Base Conversion Price but
lower than the daily volume weighted average price of the common stock, then
the
conversion price of the debentures will be reduced.
In
the
first instance, the conversion price will be reduced to the Base Conversion
Price. In the second instance, the conversion price will be multiplied by a
fraction the denominator of which will be the number of shares of common stock
outstanding on the date of the issuance plus the number of additional shares
of
common stock offered for purchase and the numerator of which will be the number
of shares of common stock outstanding on the date of such issuance plus the
number of shares which the aggregate offering price of the total number of
shares so offered would purchase at the daily volume weighted average
price.
For
example, if we sold common stock to an investor at $0.50 per share while the
debentures remain outstanding, then the holder of a debenture for $100,000
could
convert it into 200,000 shares of common stock rather than into 100,000 shares.
Alternatively, if the daily volume weighted average price of the common stock
were $2.00, but we sold 100,000 shares of common stock at $1.50 per share,
then
the conversion price would be reduced from $1.00 to $0.998 (assuming 12,173,914
shares of common stock outstanding on the date of sale). The investors holding
our 10% secured convertible debentures also have anti-dilution rights in the
event that we undertake a rights offering or make a pro rata distribution of,
among other things, our assets to the holders of our common stock
A
reduction in the conversion price resulting from any of the foregoing would
allow holders of these debentures to receive more shares of common stock than
they would otherwise be entitled to receive. In that case, your investment
would
be diluted to a greater extent than it would be if no adjustment to the
conversion price were required.
There
is currently no public trading market for our common stock and we cannot
assure
you that an active public trading market for our common stock will develop
or be
sustained. Even if a market develops, you may be unable to sell at or near
ask
prices or at all if you need to sell your shares to raise money or otherwise
desire to liquidate your shares.
8
There
is
currently no public trading market for our common stock and no such market
may
ever develop. While we intend to seek and obtain quotation of our common
stock
for trading on the OTC Bulletin Board, there is no assurance that our
application will be approved. Even if our application for quotation is approved,
the number of persons interested in purchasing our common stock at or near
ask
prices at any given time may be relatively small or non existent. This situation
may be attributable to a number of factors, including the fact that we are
a
small company that is relatively unknown to stock analysts, stock brokers,
institutional investors and others in the investment community that generate
or
influence sales volume, and that even if we came to the attention of such
persons, they tend to be risk averse and may be reluctant to follow a relatively
unproven company such as ours or purchase or recommend the purchase of our
shares until such time as we became more seasoned and viable. As a consequence,
assuming that our common stock is accepted for quotation, there may be periods
of several days or more when trading activity in our shares is minimal or
non
existent, as compared to a seasoned issuer which has a large and steady volume
of trading activity that will generally support continuous sales without
an
adverse effect on share price. We cannot assure you that an active public
trading market for our common stock will develop or be
sustained.
If
our common stock is accepted for quotation on the OTC Bulletin Board, it
will be
considered a “penny stock”. The application of the “penny stock” rules to our
common stock could limit the trading and liquidity of the common stock,
adversely affect the market price of our common stock and increase your
transaction costs to sell those shares.
If
our
common stock is accepted for quotation on the OTC Bulletin Board, it will
be a
“low-priced” security or “penny stock” under rules promulgated under the
Securities Exchange Act of 1934. In accordance with these rules, broker-dealers
participating in transactions in low-priced securities must first deliver
a risk
disclosure document which describes the risks associated with such stocks,
the
broker-dealer’s duties in selling the stock, the customer’s rights and remedies
and certain market and other information. Furthermore, the broker-dealer
must
make a suitability determination approving the customer for low-priced stock
transactions based on the customer’s financial situation, investment experience
and objectives. Broker-dealers must also disclose these restrictions in writing
to the customer, obtain specific written consent from the customer, and provide
monthly account statements to the customer. The effect of these restrictions
will probably decrease the willingness of broker-dealers to make a market
in our
common stock, will decrease liquidity of our common stock and will increase
transaction costs for sales and purchases of our common stock as compared
to
other securities.
The
stock market in general and the market prices for Internet-related companies
in
particular, have experienced volatility that often has been unrelated to
the
operating performance of such companies. These broad fluctuations may be
the
result of unscrupulous practices that may adversely affect the price of our
stock, regardless of our operating performance.
Shareholders
should be aware that, according to SEC Release No. 34-29093 dated April 17,
1991, the market for penny stocks has suffered in recent years from patterns
of
fraud and abuse. Such patterns include (1) control of the market for the
security by one or a few broker-dealers that are often related to the promoter
or issuer; (2) manipulation of prices through prearranged matching of purchases
and sales and false and misleading press releases; (3) boiler room practices
involving high-pressure sales tactics and unrealistic price projections by
inexperienced sales persons; (4) excessive and undisclosed bid-ask differential
and markups by selling broker-dealers; and (5) the wholesale dumping of the
same
securities by promoters and broker-dealers after prices have been manipulated
to
a desired level, along with the resulting inevitable collapse of those prices
and with consequent investor losses. The occurrence of these patterns or
practices could increase the volatility of our share price.
Our
executive officers, directors and insider shareholders own or control
approximately 48% of our outstanding common stock on a fully diluted basis,
which may limit the ability of our shareholders, whether acting alone or
together, to propose or direct our management or overall direction.
Additionally, this concentration of ownership could discourage or prevent a
potential takeover that might otherwise result in our shareholders receiving
a
premium over the market price for our common stock.
Approximately
48% of the outstanding shares of our common stock on a fully diluted basis
is
owned and controlled by a group of insiders, including current directors
and
executive officers and their friends and family. Mr. Gary Guseinov, our Chief
Executive Officer and President, owns 33% of our common stock. Such concentrated
control may adversely affect the price of our common stock. These insiders
may
be able to control matters requiring approval by our shareholders, including
the
election of directors, mergers or other business combinations. Such concentrated
control may also make it difficult for our shareholders to receive a premium
for
their shares of our common stock in the event we merge with a third party
or
enter into different transactions that require shareholder approval. These
provisions could also limit the price that investors might be willing to
pay in
the future for shares of our common stock. If you acquire shares of common
stock, you may have no effective voice in our management.
9
We
do not expect to pay dividends for the foreseeable future, and we may never
pay
dividends.
We
currently intend to retain any future earnings to support the development
of our
business and do not anticipate paying cash dividends in the foreseeable future.
Our payment of any future dividends will be at the discretion of our board
of
directors after taking into account various factors, including but not limited
to our financial condition, operating results, cash needs, growth plans and
the
terms of any credit agreements that we may be a party to at the time. In
addition, our ability to pay dividends on our common stock may be limited
by
California state law. Accordingly, investors must rely on sales of their
common stock after price appreciation, which may never occur, as the only
way to
realize a return on their investment. Investors seeking cash dividends should
not purchase our common stock.
Limitations
on director and officer liability and our indemnification of officers and
directors may discourage shareholders from bringing suit against a
director.
Our
certificate of incorporation and bylaws provide, with certain exceptions as
permitted by governing California law, that a director or officer shall not
be
personally liable to us or our shareholders for breach of fiduciary duty as
a
director, except for acts or omissions which involve intentional misconduct,
fraud or knowing violation of law, or unlawful payments of dividends. These
provisions may discourage shareholders from bringing suit against a director
for
breach of fiduciary duty and may reduce the likelihood of derivative litigation
brought by shareholders on our behalf against a director. In addition, our
certificate of incorporation and bylaws provide for mandatory indemnification
of
directors and officers to the fullest extent permitted by California
law.
Future
sales of our common stock could put downward selling pressure on our shares,
and
adversely affect the stock price. There is a risk that this downward pressure
may make it impossible for an investor to sell his shares at any reasonable
price, if at all.
Future
sales of substantial amounts of our common stock in the public market, if such
a
market develops, or the perception that such sales could occur, could put
downward selling pressure on our shares, and adversely affect the market price
of our common stock.
The
OTC Bulletin Board is a quotation system, not an issuer listing service,
market
or exchange. Therefore, buying and selling stock on the OTC Bulletin Board
is
not as efficient as buying and selling stock through an
exchange.
The
OTC
Bulletin Board is a regulated quotation service that displays real-time quotes,
last sale prices and volume limitations in over-the-counter
securities.
Because
trades and quotations on the OTC Bulletin Board involve a manual process,
the
market information for such securities cannot be guaranteed. In addition,
quote
information, or even firm quotes, may not be available. The manual execution
process may delay order processing and intervening price fluctuations may
result
in the failure of a limit order to execute or the execution of a market order
at
a significantly different price. Execution of trades, execution reporting
and
the delivery of legal trade confirmation may be delayed significantly.
Consequently, one may not be able to sell shares of our common stock at the
optimum trading prices.
10
When
fewer shares of a security are being traded on the OTC Bulletin Board,
volatility of prices may increase and price movement may outpace the ability
to
deliver accurate quote information. Lower trading volumes in a security may
result in a lower likelihood of an individual’s orders being executed, and
current prices may differ significantly from the price one was quoted by
the OTC
Bulletin Board at the time of the order entry.
Orders
for OTC Bulletin Board securities may be canceled or edited like orders for
other securities. All requests to change or cancel an order must be submitted
to, received and processed by the OTC Bulletin Board. Due to the manual order
processing involved in handling OTC Bulletin Board trades, order processing
and
reporting may be delayed, and an individual may not be able to cancel or
edit
his order. Consequently, one may not able to sell shares of common stock
at the
optimum trading prices.
The
dealer’s spread (the difference between the bid and ask prices) may be large and
may result in substantial losses to the seller of securities on the OTC
Bulletin Board if the common stock or other security must be sold immediately.
Further, purchasers of securities may incur an immediate “paper” loss due to the
price spread. Moreover, dealers trading on the OTC Bulletin Board may not
have a
bid price for securities bought and sold through the OTC Bulletin Board.
Due to
the foregoing, demand for securities that are traded through the OTC Bulletin
Board may be decreased or eliminated.
Shares
eligible for future sale may adversely affect the
market.
From
time
to time, certain of our shareholders may be eligible to sell all or some of
their shares of common stock by means of ordinary brokerage transactions in
the
open market pursuant to Rule 144, promulgated under the Securities Act of 1933,
as amended, subject to certain limitations. In general, pursuant to Rule 144,
a
shareholder (or shareholders whose shares are aggregated) who has satisfied
a
one-year holding period may, under certain circumstances, sell within any
three-month period a number of securities which does not exceed 1% of the then
outstanding shares of common stock. Rule 144 also permits, under certain
circumstances, the sale of securities, without any limitation, by a company’s
shareholders that are non-affiliates that have satisfied a two-year holding
period. Any substantial sale, or cumulative sales, of our common stock pursuant
to Rule 144 or pursuant to any resale prospectus may have a material adverse
effect on the market price of our securities.
We
expect volatility in the price of our common stock, which may subject us to
securities litigation.
If
established, the market for our common stock may be characterized by significant
price volatility when compared to seasoned issuers, and we expect that our
share
price will be more volatile than a seasoned issuer for the indefinite future.
In
the past, plaintiffs have often initiated securities class action litigation
against a company following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation. Securities
litigation could result in substantial costs and liabilities and could divert
management's attention and resources.
11
Special
Note Regarding Forward-Looking Statements
This
prospectus, including the sections titled “Prospectus Summary,”“Risk Factors,”“Management’s Discussion and Analysis or Plan of Operation” and “Business,”
contains forward-looking statements.
Forward-looking
statements include, but are not limited to, statements about:
·
our
lack of capital and whether or not we will be able to raise capital
when
we need it;
·
our
ability to market and distribute or sell our product;
and
·
our
ability to protect our intellectual property and operate our business
without infringing upon the intellectual property rights of
others.
These
statements relate to future events or our future financial performance, and
involve known and unknown risks, uncertainties and other factors that may cause
our actual results, levels of activity, performance or achievements to be
materially different from any future results, levels of activity, performance
or
achievements expressed or implied by these forward-looking statements. These
risks and other factors include those listed under “Risk Factors” and elsewhere
in this prospectus. In some cases, you can identify forward-looking statements
by terminology such as “may,”“will,”“expects,”“intends,”“plans,”“anticipates,”“believes,”“potential,”“continue” or the negative of these
terms or other comparable terminology. Although we believe that the expectations
reflected in the forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements. We do not
intend to update any of the forward-looking statements after the date of this
prospectus or to conform these statements to actual results. Neither the Private
Securities Litigation Reform Act of 1995 nor Section 27A of the Securities
Act
of 1933, as amended, provides any protection for statements made in this
prospectus.
12
Use
of Proceeds
We
will
not receive any proceeds from the sale of the shares by the selling
shareholders. All proceeds from the sale of the shares offered hereby will
be
for the account of the selling shareholders, as described below in the sections
titled “Selling Shareholders” and “Plan of Distribution.” However, we may
receive up to $3,013,478 upon exercise of warrants, the underlying shares
of
which are included in the registration statement of which this prospectus
is a
part. If received, such funds will be used for general corporate purposes,
including working capital requirements. With the exception of any brokerage
fees
and commissions which are the obligation of the selling shareholders, we
are
responsible for the fees, costs and expenses of this offering which are
estimated to be $155,650, inclusive of our legal and accounting fees, printing
costs and filing and other miscellaneous fees and expenses.
Determination
of Offering Price
There
has
been no public market for our common stock prior to this offering and there
will
be no public market until our common stock is approved for quotation on the
OTC
Bulletin Board. The offering price has been arbitrarily determined and does not
bear any relationship to our assets, results of operations, or book value,
or to
any other generally accepted criteria of valuation.
We
cannot
assure you that an active or orderly trading market will develop for our common
stock or that our common stock will trade in the public markets subsequent
to
this offering at or above the offering price.
Market
for
Common Equity and Related Shareholder Matters
At
this
time, our common shares are not traded on any public markets. We currently
have
12,173,914 shares of common stock issued and outstanding. We have 29
shareholders of record of our common stock.
We
also
have outstanding common stock purchase warrants to purchase 877,552 shares
of
common stock and $3,243,378 of 10% secured convertible debentures that are
convertible into an additional 3,243,378 shares of common stock together with
warrants to purchase an additional 3,243,378 shares of common
stock.
After
this offering, upon the conversion of all outstanding 10% secured convertible
debentures and assuming exercise of all the warrants, we will have 18,660,670
shares of common stock outstanding, which does not include 830,797 shares
of
common stock reserved for issuance under our 2005 Stock Option Plan and
1,375,000 shares of common stock reserved for issuance under our Amended
and
Restated 2006 Equity Incentive Plan. Of the amount outstanding, 10,110,422
shares could be sold pursuant to Rule 144 under the Securities Act of 1933,
as
amended (assuming compliance with the requirements of Rule 144) and 6,126,950
shares could be sold pursuant to the registration statement of which this
prospectus is a part.
In
accordance with our 2005 Stock Option Plan we have also issued an option
to an
employee to purchase a total of 326,106 shares of our common stock. The option
will expire 10 years from the date of grant. The exercise price for each
share
of common stock purchased pursuant to the 2005 Stock Option Plan options
is
$0.0107.
On
November 2, 2006 and on December 11, 2006, in accordance with the terms of
Amended and Restated 2006 Equity Incentive Plan the Board of Directors approved
the issuance of options to employees and consultants to purchase a total
of
1,148,904 shares of our common stock. As of January 30, 2007, we had options
outstanding to employees and consultants to purchase a total of 934,007 shares
of our common stock. The options will expire 10 years from the date of grant.
The exercise price for each share of common stock purchased pursuant to the
Amended and Restated 2006 Equity Incentive Plan is between $0.85 and
$1.00.
Dividends
During
the year ended December 31, 2005, our Board of Directors authorized the payment
of a dividend of $0.05 per share. The total amount of the dividend was $31,400.
The dividend was paid to all of our shareholders, with the exception of
shareholders who were also officers and directors. However, we anticipate
that
any future earnings will be retained for the development of our business
and do
not anticipate paying any dividends on our common stock in the foreseeable
future.
13
Employee
Benefit Plans
2005
Stock Option Plan
Our
board
of directors and shareholders approved our 2005 Employee Stock Option Plan
(the
“2005 Plan”) on December 31, 2004. The 2005 Plan provides for the grant of
incentive stock options to our employees, and for the grant of nonstatutory
stock options, restricted stock, stock appreciation rights and performance
shares to our employees, directors and consultants.
We
have
reserved a total of 830,797 shares of our common stock for issuance pursuant
to
the 2005 Plan.
Our
board
of directors, or a committee of our board, administers the 2005 Plan. The board
or its committee, who are referred to as the administrator in this prospectus,
has the power to determine the terms of the awards, including the exercise
price, the number of shares subject to each such award, the exercisability
of
the awards and the form of consideration, if any, payable upon exercise. The
administrator also has the authority to institute an exchange program whereby
the exercise prices of outstanding awards may be reduced or outstanding awards
may be surrendered in exchange for awards with a lower exercise
price.
The
administrator determines the exercise price of options granted under the 2005
Plan. With respect to all incentive stock options, the exercise price must
at
least be equal to the fair market value of our common stock on the date of
grant. The term of an incentive stock option may not exceed 10 years, except
that with respect to any participant who owns 10% of the voting power of all
classes of our outstanding stock or the outstanding stock of any parent or
subsidiary of ours, the term must not exceed five years and the exercise price
must equal at least 110% of the fair market value on the grant date. The
administrator determines the term of all other options; however, no option
will
have a term in excess of 10 years from the date of grant.
After
termination of an employee, director or consultant, he or she may generally
exercise his or her option for 90 days following termination of such
employment.
The
2005
Plan does not allow for the transfer of options and only the recipient of an
option may exercise an option during his or her lifetime. However, the recipient
of an option may designate one or more beneficiaries of his or her outstanding
options, which will automatically transfer to such beneficiaries upon the
participant’s death. With respect to nonstatutory stock options, a participant
may assign his or her options to immediate family members or trusts for estate
planning purposes during his or her lifetime.
Stock
appreciation rights may be granted under the 2005 Plan. Stock appreciation
rights allow the recipient to receive the appreciation in the fair market value
of our common stock between the exercise date and the date of grant. The
administrator determines the terms of stock appreciation rights, including
when
such rights become exercisable and whether to pay the increased appreciation
in
cash or with shares of our common stock, or a combination thereof.
The
2005
Plan provides that in the event of our change in control, outstanding options
will automatically accelerate and become exercisable, unless the successor
corporation or its parent assumes or substitutes a cash incentive program
for
each outstanding option, or the administrator placed restrictions on
acceleration at the time of the grant. With respect to stock appreciation
rights, our repurchase rights will automatically terminate and all the shares
will fully vest upon a change of control, unless the repurchase rights are
assigned to the successor corporation or its parent or the administrator
places
restrictions on acceleration of vesting at the time of the
issuance.
The
2005
Plan will automatically terminate on January 1, 2015, unless it terminates
sooner because all shares available under the plan have been issued or all
outstanding options terminate in connection with a change of control. In
addition, our board of directors has the authority to amend the 2005 Plan
provided this action does not impair the rights of any participant.
14
Amended
and Restated 2006 Equity Incentive Plan
Our
board
of directors and those shareholders holding a majority of our outstanding voting
power adopted and approved the Amended and Restated 2006 Equity Incentive Plan
(the “2006 Plan”) on October 30, 2006. The 2006 Plan reserves 1,375,000 shares
of our common stock for issuance in accordance with its terms.
Unless
the 2006 Plan is earlier terminated in accordance with its provisions, no stock
incentives will be granted under the 2006 Plan after the earlier of ten years
from the effective date, or the date on which all of the shares reserved for
the
2006 Plan have been issued or are no longer available for use under the 2006
Plan.
The
2006
Plan will be administered by a committee of two or more members of the board
of
directors. The committee will have full power to:
·
select
eligible participants to receive awards under the 2006
Plan;
·
determine
the sizes and types of stock incentives to award under the 2006
Plan;
·
determine
the terms and conditions of such
awards;
·
interpret
the 2006 Plan and any agreement or instrument entered into under
the 2006
Plan;
·
establish,
amend, or waive rules or regulations for the administration of the
2006
Plan;
·
amend
the terms and conditions of any outstanding stock incentives as allowed
under the 2006 Plan; and
·
make
all other determinations, or take such other actions, as may be necessary
or advisable for the administration of the 2006
Plan.
The
board
of directors and the committee may grant the following stock incentives under
the 2006 Plan (each individually, a “Stock Incentive”):
·
stock
options to purchase shares of common stock, including options intended
to
qualify under Section 422 of the Internal Revenue Code (“incentive
stock options”) and options not intended to qualify under Section 422
of the Internal Revenue Code (“non-qualified stock
options”);
·
stock
awards; and
·
stock
bonus awards.
Each
of
the above Stock Incentives will be evidenced by a stock incentive agreement
executed by us and the eligible recipient, in such form and with such terms
and
conditions as the committee may, pursuant to the provisions of the 2006 Plan,
determine in their discretion from time to time.
Awards
of
Stock Incentives under the 2006 Plan may be made to our employees and those
of
our subsidiaries, non-employee directors, and consultants or advisors that
provide services (other than the offering, sale or marketing of our securities)
to us or our subsidiaries (collectively, the “Participants”). Only employees are
eligible to receive a grant of incentive stock options.
Stock
options may not be exercised after the tenth anniversary of the grant date,
except that any incentive stock option granted to a ten-percent shareholder
may
not be exercised after the fifth anniversary of the grant date.
A
stock
option issued under the 2006 Plan may not be transferable or assignable, except
by the laws of descent and distribution, and may be exercisable only by the
Participant. However, a non-qualified stock option may be transferred by the
Participant as a bona fide gift to his or her spouse, lineal descendant or
ascendant, siblings, and children by adoption.
Payment
for shares purchased pursuant to exercise of a stock option may be made in
cash
or, with the consent of the Committee, by delivery to us of a number of shares
that have been owned and completely paid for by the Participant for at least
six
months prior to the date of exercise, or a combination thereof. In addition,
if
permitted by the Committee, the stock option may be exercised through a
brokerage transaction as permitted under the provisions of Regulation T,
applicable to cashless exercises promulgated by the Board of Governors of the
Federal Reserve System, unless prohibited by Section 402 of the Sarbanes-Oxley
Act of 2002. Except as otherwise provided in the 2006 Plan, payment must be
made
at the time that the stock option, or any part thereof, is exercised, and no
shares shall be issued or delivered to the Participant upon exercise of the
option until full payment has been made by the Participant.
A
stock
bonus is an award of shares under the 2006 Plan for extraordinary service to
us
or to any subsidiary. The Committee will determine the number of shares to
be
awarded and any conditions, criteria, or performance requirements applicable
to
the stock bonus.
A
stock
award is an offer by us to sell to an eligible person shares that may or may
not
be subject to restrictions. The Committee may determine the terms, conditions,
restrictions, and other provisions of each stock award. Stock awards issued
under the 2006 Plan may have restrictions that lapse based upon the service
of a
Participant, or based upon the attainment of performance goals established
pursuant to the business criteria listed in the 2006 Plan, or based upon any
other criteria that the Committee may determine appropriate. The purchase price
of shares sold pursuant to a stock award will be determined by us on the date
the stock award is granted but may not be less than the Fair Market Value of
our
common stock on the date of grant, provided however, in the case of a sale
to a
holder of 10% or more of our common stock, the purchase price shall not be
less
than 110% of the Fair Market Value.
The
Board
of Directors or the Committee may suspend, terminate, or amend the 2006 Plan
from time to time except that certain amendments as specified in the Plan may
not be made without the approval of our shareholders, including an amendment
to
increase the number of shares reserved and issuable under the 2006 Plan, to
extend the term of the 2006 Plan, or to decrease the minimum exercise price
of
any Stock Incentive. The Board of Directors or the Committee may also modify,
amend or cancel any Stock Incentive granted under the Plan, provided, however,
that without the consent of the Participant affected, no such modification,
amendment or cancellation may diminish the rights of such Participant under
the
Stock Incentive previously granted under the 2006 Plan.
16
Equity
Compensation Plan Information
Plan
Category
Number
of securities to be issued upon exercise of outstanding options,
rights
and warrants
(a)
Weighted
average exercise price of outstanding options, rights and
warrants
(b)
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a))
(c)
Equity
compensation plans approved by security holders
1,260,114
945,683
Equity
compensation plans not approved by security holders
Management’s
Discussion and Analysis or Plan of Operation
The
following discussion of our financial condition and results of operations should
be read in conjunction with our consolidated financial statements and the notes
to those statements included elsewhere in this prospectus. In addition to the
historical consolidated financial information, the following discussion and
analysis contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ materially from those anticipated
in these forward-looking statements as a result of certain factors, including
those set forth under “Risk Factors” and elsewhere in this prospectus.
Overview
We
are a
provider of secure content management software based in Los Angeles, California.
We develop and license security software. Our mission is to bring to market
advanced solutions to combat and prevent online information theft, unwanted
advertisements, spam, Internet viruses, spyware and related computer
threats.
We
have
developed a Collaborative Internet Security Network (CISN) (also known as
the
earlyNetwork™) which is based on certain technology principles commonly found in
a peer-to-peer network infrastructure. A peer-to-peer network does not have
the
notion of clients or servers, but only equal peer nodes
that
simultaneously function as both “clients” and “servers” to the other nodes on
the network. This means that when a threat is detected from a computer that
is
part of the CISN, 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 CISN, and each machine that receives the information
will,
in turn, relay it to other machines that are part of the CISN. This protocol
allows us to rapidly distribute alerts and updates regarding potentially
damaging viruses, e-mails and other threats to members of the CISN, 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 CISN simply by downloading and installing our software.
Historically,
our revenues were derived from subscriptions to our software. We sold one
product, our CyberDefender
Anti-Spyware 2006,
at a
price of $39.99, which included the initial download and one year of updates.
The license to use the software was renewed annually, also at $39.99, with
incentives for early renewals. We acquired new users with an online direct
purchase offer. The offer, to scan a computer for spyware and then pay for
removal of the spyware found, was broadcast in emails, banners and search
ads.
During the three months ended March 31, 2006, six months ended June 30, 2006
and
nine months ended September 30, 2006, we had revenues of $100,600, $188,899
and
$274,876 respectively, attributable to new subscribers and during the three
months ended March 31, 2006, six months ended June 30, 2006 and nine months
ended September 30, 2006 we had revenues of $1,128,368, $2,128,469 and
$2,886,361, respectively, attributable to renewals.
In
November 2006 we launched our new Internet security suite called CyberDefender
Early Detection Center or CyberDefender FREE 2.0. CyberDefender FREE 2.0
is the
ad-supported version, which is free to the subscriber because advertisers
pay us
to display their ads inside the software. CyberDefender Early Detection Center
is a version of the same software, without ads, which is paid for by the
subscriber. The annual subscription rate for the version without ads ranges
from
$11.99 to $39.99, depending on the marketing or distribution channels that
we
use.
Typically,
a software developer gives away free versions of its software for a limited
trial period. Very often, though, a user of free software will not purchase
it
once the trial period is over. There is no trial period for using our
CyberDefender FREE 2.0 software with advertising, however. Once a subscriber
downloads the software, it is his to keep and we receive payment from the
advertisers. Otherwise, if the subscriber chooses, he may pay for an annual
subscription to CyberDefender Early Detection Center without advertising.
In
this way, we will generate revenues from either the advertiser or the
subscriber. This business model allows any computer user to obtain protection
against Internet threats, regardless of his ability to pay. We made this
change
because we believe that the advertising revenue we may receive, in conjunction
with the licensing fees we receive, could be substantial. We obtain the ads
from
ad networks, which are plentiful. Ad
networks provide advertising for a website and share advertiser revenue each
time the website visitors click on the ads. During
the month that the ads are displayed on a subscriber’s computer, revenues will
be earned from the ad networks each time an ad is either shown (per impression)
or when an ad is clicked (per click).
Furthermore,
we began to see that large security software companies, such as McAfee, Symantec
and Trend Micro, were offering security suites, as opposed to single,
stand-alone products. We determined that consumers would come to expect a
suite
of products that would provide comprehensive protection against Internet
threats, rather than having to license several products. As a result of this
decision, expenses related to software research and development increased
significantly during the nine months ended September 30, 2006. We expect
to
continue to invest in our technology and expect that our research and
development costs will be a significant component of our operating costs
during
the 2007 fiscal year.
18
While
we
were developing CyberDefender Early Detection Center/CyberDefender FREE 2.0,
we
slowed down our efforts in marketing our CyberDefender Anti-Spyware 2006
software so that we could devote more of our financial resources to the
development of our new product. The expense of turning a previously
marketing-focused publisher into a full-line security developer exceeded
our
revenues. During this period, our new user marketing was restricted to
experimental activities. Therefore, as and when we needed cash, we sold our
securities. To date, we have received $324,505 in cash or in the value of
services performed for us by third parties and $4,275,000 from sales of
convertible debt securities.
Critical
Accounting Policies and Estimates
Our
discussion and analysis of our financial condition and results of operations
is
based on our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the U.S. The preparation of these
financial statements requires us to make estimates and judgments that affect
the
reported amounts of assets, liabilities, revenues and expenses for each period.
The following represents a summary of our critical accounting policies, defined
as those policies that we believe are the most important to the portrayal of
our
financial condition and results of operations and that require management’s most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effects of matters that are inherently
uncertain.
Revenue
recognition.
We sell
our software over the Internet. Customers order the product and simultaneously
provide their credit card information to us. Upon receipt of authorization
from
the credit card issuer, we license the customer to download our software.
As
part of the sales price we provide product support and, from time-to-time,
content updates, modifications and upgrades to the software. Term licenses
allow
customers to use our products and receive product support coverage and content
updates for a specified period, generally twelve months. We invoice for product
support, content updates, modifications and upgrades at the beginning of
the
term, and revenues and related expenses are deferred and recognized ratably
over
the subscription term.
We
recognize revenue from the sale of software licenses when all of the following
are met:
·
persuasive
evidence of an arrangement
exists,
·
the
product has been delivered,
·
the
fee is fixed or determinable,
and
·
collection
of the resulting receivable is reasonably
assured.
We
recognize revenues from the sale of CyberDefender Anti-Spyware 2006 and
CyberDefender Early Detection Center in accordance with SOP No. 97-2, “Software
Revenue Recognition,” as amended by SOP No. 98-9, “Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions.” These
statements provide guidance for recognizing revenues related to sales by
software vendors.
19
In
November 2006, we launched a new product, CyberDefender FREE 2.0, which is
free
to the subscriber. Revenues are earned from advertising networks which pay
us to
display their customers’ advertisements inside the software. We recognize
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. Performance
is based on the number of times the ads are clicked by our
subscribers.
Customers
are permitted to return a product that has been paid for within 30 days from
the
date of purchase. During the nine months ended September 30, 2006 and September30, 2005, we did not accrue any sum for product returns or chargebacks as
such
returns and chargebacks are identified within the first 30 days of sale and
are
charged against our gross sales in the month that they occur. Our net revenue,
including returns and chargebacks for each period, are deferred and recognized
ratably over a 12 months period according to our revenue recognition
policy.
Software
Development Costs.
We
account for software development costs in accordance with Statement of Financial
Accounting Standards (“SFAS”) No. 86, “Computer Software to Be Sold, Leased, or
Otherwise Marketed”. Such costs are expensed prior to achievement of
technological feasibility and thereafter are capitalized. We have had 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.
Stock
Based Compensation.We
adopted SFAS No. 123 (Revised 2004), Share Based Payment (“SFAS
No. 123R”), under the modified-prospective transition method on
January 1, 2006. SFAS No. 123R 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. Share-based compensation
recognized under the modified-prospective transition method of SFAS
No. 123R includes share-based compensation based on the grant date fair
value determined in accordance with the original provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, for all share-based
payments granted prior to and not yet vested as of January 1, 2006 and
share-based compensation based on the grant-date fair-value determined in
accordance with SFAS No. 123R for all share-based payments granted after
January 1, 2006. SFAS No. 123R eliminates the ability to account
for the award of these instruments under the intrinsic value method prescribed
by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock
Issued to Employees, and allowed under the original provisions of SFAS
No. 123. Prior to the adoption of SFAS No. 123R, we accounted for our
stock option plans using the intrinsic value method in accordance with the
provisions of APB Opinion No. 25 and related interpretations.
Total
revenue, which includes revenue from net sales, interest income and rental
income, was $3,197,460 for the nine months ended September 30, 2006 as compared
to total revenue of $5,717,751 for the nine months ended September 30, 2005,
a
decrease of $2,520,290 or approximately 44%. This decrease in total revenue
was
due primarily to a decrease in the sales of our CyberDefender Anti-Spyware
2006
product. The decrease in revenue was directly attributable to our decreased
advertising expenditures as we invested that money in the development of
our
CyberDefender Early Detection Center/CyberDefender FREE 2.0. Because the
launch
of our CyberDefender Early Detection Center did not occur until November20,2006, there were no revenues attributable to advertising or subscription
fees
for that product during the nine months ended September 30, 2006.
Operating
Expenses
Total
operating expenses increased by $2,231,425, or approximately 56%, during
the
nine months ended September 30, 2006, to $6,228,075 as compared to $3,996,650
in
total operating expenses for the nine months ended September 30, 2005. Operating
expenses include advertising, selling, general and administrative expense,
interest and depreciation. A detailed explanation of the increase in operating
expenses is provided in the discussion below.
20
Advertising
Advertising
costs are comprised primarily of media and channel fees, including online
advertising and related functional resources. Media and channel fees fluctuate
by channel and are higher for the direct online consumer market than for
the
OEM, reseller and SMB markets. Advertising expenses decreased by $524,663,
from
$1,104,697 during the nine months ended September 30, 2005 to $580,034 during
the nine months ended September 30, 2006. This decrease was due to the
redirection of our financial resources from advertising toward developing
our
new, full-line security software. During the nine month periods ended September30, 2006 and 2005, four vendors accounted for 60% and 74% of our advertising
expense, respectively. These vendors provide Internet search and related
marketing services, programming services and design services for us. These
types
of vendors are plentiful and can be easily replaced.
Selling,
General and Administrative
Selling,
general and administrative expenses are primarily comprised of research and
development costs, executive management, rent and professional fees.
Selling,
general and administrative expenditures increased by $1,033,703, from $2,825,965
during the nine months ended September 30, 2005 to $3,859,668 during the
nine
months ended September 30, 2006. The increase is primarily attributable to
additional costs associated with the development of CyberDefender Early
Detection Center/CyberDefender FREE 2.0, of approximately $858,000. In addition,
legal fees increased by approximately $203,000 as a result of costs incurred
for
a planned reverse merger transaction that was not consummated, public relations
costs increased by approximately $60,000, employee benefits and payroll taxes
increased by approximately $88,000 as a result of an increase in employees,
and
third party commission and other expenses increased by approximately $45,000.
These costs were offset by a decrease in credit card processing fees of
approximately $220,000 due to a change in providers. Our current provider
is
also able to offer us a number of ancillary services, such as fulfillment,
which
is ultimately more cost effective than buying these services from various
providers..
Interest
expense
Interest
expense increased by $1,713,323, from $4,331 in the nine months ended September30, 2005 to $1,717,654 in the nine months ended September 30, 2006. The increase
in interest expense was primarily due to interest in the amount of approximately
$84,000 charged on the outstanding principal amount of certain bridge loan
notes, $755,173 associated with the value of the beneficial conversion feature
of these bridge notes into our common stock at a price below market value,
$506,896 associated with the amortization of the discount of these bridge
notes,
approximately $200,000 incurred from the issuance of 186,354 shares of common
stock valued at $1.07 per share to the holders of the bridge notes as additional
consideration for converting the bridge notes, interest of approximately
$96,000
accrued on the 10% secured convertible debentures and approximately $74,000
of
accretion on the note discount associated with the 10% secured convertible
debentures.
Public
company costs
We
expect
to incur increased professional fees for audit, legal and investor relations
services, and for insurance costs as a result of being a public company.
We also
anticipate that we may be required to hire additional accounting personnel
as a
public company.
Total
revenue, which includes revenues from net sales, interest income and rental
income, was $7,095,457 for the fiscal year ended December 31, 2005 as compared
to total revenue of $3,539,716 for the fiscal year ended December 31, 2004.
This
significant increase in total revenues was due primarily to an increase in
the
sales of our product and a decrease in our deferred revenues of approximately
$1.8 million.
Operating
Expenses
Total
operating expenses decreased by $1,226,570, or approximately 17%, during
the
fiscal year ended December 31, 2005, to $5,963,752 as compared to $7,190,322
in
total operating expenses for the fiscal year ended December 31, 2004. Operating
expenses include credit card processing costs, research and development,
selling, general and administrative expense and depreciation. A detailed
explanation of the increase in operating expenses is provided in the discussion
below.
Advertising
Advertising
costs are comprised primarily of media and channel fees, including online
advertising and related functional resources. Media and channel fees fluctuate
by channel and are higher for the direct online consumer market than for
the
OEM, reseller and SMB markets. We reduced advertising costs significantly,
from
$5,271,592 for the fiscal year ended December 31, 2004 to $1,413,716 for
the
fiscal year ended December 31, 2005. Media and channel fees decreased $3,857,876
during the period ended December 31, 2005 as compared to the period ended
December 31, 2004 due primarily to a decrease in online advertising as we
began
to redirect our resources towards changing our business from a marketing-focused
software publisher into a full-line security software
developer.
Selling,
General and Administrative
Selling,
general and administrative expenses are comprised of credit card processing
costs, research and development costs, personnel costs, rent, professional
fees
and interest expense. Selling, general and administrative expenses increased
by
$2,551,564, or approximately 133%, during the fiscal year ended December31,2005, to $4,465,540 as compared to $1,913,976 for the fiscal year ended December31, 2004.
Credit
Card Processing
During
the fiscal year ended December 31, 2005 direct costs consisting of credit
card
processing costs increased approximately $493,000 as compared to the fiscal
year
ended December 31, 2004 due to an increase in sales.
Research
and Development
Research
and development costs were comprised of programming, infrastructure development,
quality assurance, and information technology expenses incurred to maintain
our
software products. Research and development expenses increased $328,988 during
the year ended December 31, 2005, to $391,463 for the fiscal year ended December31, 2005 as compared to $62,475 for the fiscal year ended December 31, 2004.
The
increase in research and development costs was due primarily to the addition
of
our Chief Software Architect supported by two programmers and the use of
freelance resources, as needed.
Personnel
Costs
Costs
for
personnel increased by approximately $1,264,000 for the fiscal year ended
December 31, 2005, to $2,522,231, as compared to $1,258,695 for the fiscal
year
ended December 31, 2004. This increase included a cost of approximately $231,000
for the use of consultants for marketing and software development and a cost
of
approximately $1,038,000 that related to the additions of key executive
personnel (including the positions of Chief Operating Officer, Chief Technology
Officer, Chief Marketing Officer and Vice-President of Sales) and performance
bonuses.
22
Rent
Rent
increased by approximately $139,957 for the fiscal year ended December 31,2005,
to $225,793, as compared to $85,836 in rent paid during the fiscal year ended
December 31, 2004. Our rent costs increased significantly because we paid
rent
not only for the leases for the office space we occupied during the 2005
fiscal
year but also for the lease for the office space we occupied in the 2004
fiscal
year.
Professional
fees
The
amount of professional fees we paid during the fiscal year ended December31,2005 increased by approximately $402,780, to $785,510, as compared to $382,730
for the fiscal year ended December 31, 2004. These professional fees were
provided for services rendered by our attorneys and our auditors. Our legal fees
related primarily to general corporate matters, our efforts to raise capital
and
our efforts to execute a reverse merger transaction, which was not
consummated.
Interest
expense
Interest
expense increased by $16,849, from $245 in the fiscal year ended December 31,2004 to $17,094 in the fiscal year ended December 31, 2005. The increase in
interest expense was due to the issuance of $800,000 in convertible promissory
notes in November 2005 and assets acquired under capital leases.
Depreciation
expense increased by $79,742 or approximately 1,677%, from $4,754 for the
period
ended December 31, 2004 to $84,496 for the period ended December 31, 2005.
The
increase in depreciation expense is related primarily to the increase in
fixed
assets, consisting mostly of software, purchased during the year from Unionway
Int’l, LLC.
Net
cash
used in operating activities during the nine months ended September 30, 2006
was
primarily the result of our net loss of $3,031,415. Net loss for the nine
months
ended September 30, 2006 was adjusted for non-cash items such as accretion
of
loan discount of $74,092, beneficial conversion of debt charge of $755,173,
value of warrants issued with the conversion of debt of $506,896 associated
with
the bridge notes, the cost of additional shares issued to bridge note holders
of
$200,000 and depreciation and amortization of $70,719. Other changes in working
capital accounts include an increase in prepaid and other assets of $220,867,
an
increase in accounts payable and accrued expenses of $269,622 and a decrease
of
$513,958 in deferred revenue resulting from lower new customer and renewal
sales.
Historically,
our primary source of operating cash flow is the collection of license fee
revenues from our customers and the timing of payments to our vendors and
service providers. In 2006 and 2005, we did not make any significant changes
to
our payment terms for our customers, which are generally credit card based.
The
increase in cash related to accounts payable, accrued taxes and other
liabilities was $269,622. Our operating cash flows, including changes in
accounts payable and accrued liabilities, are impacted by the timing of payments
to our vendors for accounts payable. We typically pay our vendors and service
providers in accordance with invoice terms and conditions. The timing of
cash
payments in future periods will be impacted by the nature of accounts payable
arrangements. In the nine months ended September 30, 2006 and 2005, we did
not
make any significant changes to the timing of payments to our vendors, although
our technology development and financing activities caused an increase in
this
category.
23
Our
working capital deficit at September 30, 2006, defined as current assets
minus
current liabilities, was ($0.1) million as compared to a working capital
deficit
of ($2.2) million at December 31, 2005. The increase in working capital of
approximately $2.1 million from December 31, 2005 to September 30, 2006 was
primarily attributable to an increase in cash of approximately $1,618,000,
an
increase in deferred financing costs and other prepaid expenses of approximately
$198,000, an increase in accounts payable and accrued expenses of approximately
$189,000, a decrease in notes payable to a related party of approximately
$17,000 and a decrease in deferred revenue of approximately $514,000 as a
result
of lower new customer and renewal sales. We anticipated this decrease in
deferred revenue would result as part of redirecting our business from being
a
marketing software publisher to providing SCM software.
Net
cash
used in investing activities during the nine months ended September 30, 2006
resulted primarily from property and equipment purchases and net returns
totaling approximately $386. We
anticipate that we will continue to purchase property and equipment necessary
in
the normal course of our business. The amount and timing of these purchases
and
the related cash outflows in future periods is difficult to predict and is
dependent on a number of factors, including but not limited to our hiring
of
employees and the rate of change in computer hardware and software used in
our
business.
Cash
provided by financing activities during the nine months ended September 30,2006
was primarily the result of issuances of convertible notes totaling $3,575,000.
Cash used in financing activities was primarily used for the repayment of
debt
and the payment of dividends.
Off-Balance
Sheet Arrangements
We
do not
have off-balance sheet arrangements. As part of our ongoing business, we do
not
participate in transactions that generate relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities, often established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes.
24
Legal
Proceedings
On
June16, 2006, we were named as a defendant in a civil complaint filed with the
United States District Court, Central District of California, Western
Division, Case No. CV06-3815PA (AJWX). The action is entitled, “Wellbourne
Limited, a Seychelles corporation vs. 2Checkout.com Inc., a Delaware corporation
and CyberDefender Corporation, a California corporation.” The complaint was for
breach of contract, unjust enrichment, accounting, and constructive trust
based upon an allegation that we failed to pay for certain Internet search
traffic services allegedly provided by Wellbourne Limited to us. On July21,2006, the plaintiff filed a first amended complaint also naming our Chief
Executive Officer as a defendant. The first amended complaint seeks monetary
damages of $102,000 plus attorneys’ fees and costs. While we recorded a
liability in the amount of $102,000 when the services were rendered to us,
we
dispute the allegations made in the compliant and we intend to vigorously
defend
this action. We believe that the services provided by Wellbourne Limited
to us
consisted of artificial, or robot, traffic rather than legitimate targeted
Internet search traffic.
25
Description
of
Business
We
were
incorporated as Network Dynamics in California on August 29, 2003, and changed
our name to CyberDefender Corporation on October 21, 2005. We are a provider
of
secure content management (commonly referred to as “SCM”) software. Our mission
is to bring to market advanced solutions to combat and prevent online
information theft, unwanted advertisements, spam, Internet viruses, spyware
and
related security threats. Individuals who use personal computers make up
our
subscriber base, therefore we are not dependent on any single customer or
on a
few major customers. While our product is available for downloading from
our
website, which makes it available to anyone in the world, we do not have
a
significant customer base outside of the United States.
Our
business was originally built around the sale of a single product, our
CyberDefender anti-spyware. During the period from our founding through 2004,
our primary focus was on marketing and selling this product. In 2005, we
acquired certain assets from Unionway Int’l, LLC, an entity controlled by our
Chief Software Architect, Mr. Bing Liu. Among these assets was software that
formed the basis for our Collaborative Internet Security
Network.
On
November 20, 2006 we stopped engaging in new sales of our product, CyberDefender
Anti-Spyware 2006 (although we still continue to support the product and
will
continue upgrading it), and we began providing a suite of Internet security
products called CyberDefender Early Detection Center, which is also provided
as
CyberDefender FREE 2.0. We decided to change our focus from being a marketing
software publisher - that is, creating and marketing individual software
products - to providing SCM software, for two reasons.
First,
we
began to see that large security software companies, such as McAfee, Symantec
and Trend Micro, were offering security suites as opposed to single, stand-alone
products. A “silo” approach to threats, where separate specialized programs each
protect against a different threat, is not only cumbersome and expensive,
but it
assumes that attackers will conform to these categories. In fact, many of
the
most dangerous attacks today are hybrid attacks, which combine two or more
types
of threats. An effective SCM software system should be able to protect against
all of these threats, and we determined that consumers would come to expect
a
single product that would provide comprehensive protection against Internet
threats, rather than having to license several products.
Secondly,
we believed that the business model we had been using, where we offered free
software for a limited trial period, could be improved since oftentimes the
subscriber would not renew a subscription after the trial period expired.
Rather
than depend solely on revenues from the renewal of software licenses, we
determined that we could also earn advertising revenues by partnering with
other
businesses that would use our software for advertising. The ads are aggregated
from ad networks.
Ad
networks provide advertising for a website and share advertiser revenue each
time the website visitors click on the ads. During
the month that the ads are displayed on a subscriber’s computer, revenues will
be earned from the ad networks each time an ad is either shown (per impression)
or when an ad is clicked (per click). We offer CyberDefender FREE 2.0 as
a free
download in an ad-supported version and CyberDefender Early Detection Center,
without ads, in exchange for the payment of a licensing fee. There is no
trial
period and no monthly or annual fee to pay for using CyberDefender FREE 2.0.
Instead, we receive payment from the advertisers, typically at the end of
each
month. Subscribers who choose CyberDefender Early Detection Center pay for
the
license fees via credit card. The annual subscription rate for this version
of
the security suite ranges from $11.99 to $39.99, depending on the marketing
and
distribution channels that we use.
Once
our
CyberDefender Early Detection Center or CyberDefender FREE 2.0 suite of security
products is downloaded, the subscriber becomes a part of our Collaborative
Internet Security Network, which we sometimes refer to as CISN or
earlyNetwork™”. We believe that the CISN provides a unique approach to updating
personal computer security. We have developed the CISN based on certain
technology principles commonly found in a peer-to-peer network infrastructure.
A
peer-to-peer network does not have the notion of clients or servers, but
only
equal peer nodes
that
simultaneously function as both “clients” and “servers” to the other nodes on
the network. Therefore, as system demands increase, so does the system’s
capacity. Our CISN is designed to reduce the lag time between the identification
of a new security threat by our Early Alert Center and notification to the
personal computers that are part of the CISN. The peer-to-peer network
infrastructure allows us to provide a fluid, distributed system for alerts
and
updates, and to incorporate a universal threat definition system. This approach
is different and, we believe, significantly faster than traditional Internet
security companies that provide manual, broadcast-updated threat management
systems. (See Figure 1 below.)
26
Figure
1
Collaborative
Security Network Architecture
Traditional Client Server Architecture
Our
CISN
is an adaptive network of machines that defends automatically against a wide
spectrum of software attacks and provides users with proprietary automated
processes that rapidly identify and quarantine both known and emerging threats.
Our
customers obtain access to the CISN by downloading and installing our security
suite (CyberDefender Early Detection Center or CyberDefender FREE 2.0) or
the
CyberDefender Security Toolbar, discussed below. As
additional users are added to well-managed peer networks, the networks work
better. The same is true of our collaborative security network. With more
clients, threats are picked up faster and updates occur faster as well, because
users of our software find peers more easily than they could an update server.
Users of our software who cannot connect with other users will always be
able to
fall back on the Alert Server.
The
nature of current SCMs, which assume a single point of threat capture, a
cumbersome threat analysis system and an intermittent update system, creates
a
“coverage gap” which can delay alerts on important new infectious attacks for 12
hours or more. However, our proprietary technology quickly distributes threat
updates to all computers that are part of the CISN. Other SCMs send updates
in a
scheduled batch. For example our system for generating threat reports, the
Early
Alert Center, first reported the Sasser.E virus at 11:52 p.m. on May 7, 2004.
This was one to two days before other SCM software vendors announced their
discoveries of the same virus. We believe we are the first to provide threat
updates in this manner.
Using
the
CISN infrastructure instead of relying on expensive bandwidth for mass updates
means that our updates are relayed securely throughout the CISN using each
local
user’s bandwidth. There is no need to wait for a scheduled update - updates are
simply sent to the entire network in approximately one hour as opposed to 12
hours for a conventional network. The network responds quickly to new threats
because it enlists all the machines in the CISN to act as listening posts for
new threats. Our solution works well with existing security software and can
operate as an additional layer of security on a desktop.
Industry
Background
Secure
Content Management (SCM) Market
The
SCM
market includes content security solutions designed to secure, monitor, filter
and block threats from messaging and Internet traffic. According to information
provided on the Internet by IDC, a global provider of marketing data, the
worldwide SCM market was estimated to be $5.5 billion in 2005, representing
a
23.3% growth rate over 2004. In comparison, the SCM market was $4.5 billion
in
2004 and achieved 27.6% growth over 2003. The SCM market is forecast to increase
to $10.5 billion in 2009, representing a five-year compound annual growth
rate
of 18.7%. In 2004 the top three worldwide SCM software vendors, Symantec,
McAfee
and Trend Micro, comprised 58.3% of the market while the remaining market
share
was extremely fragmented with no vendor exceeding over 2.5% of the SCM
market.
27
SCM
protects against inbound threats such as spam, fraudulent emails, viruses,
worms, trojans, spyware and offensive material. SCM solutions are also designed
to protect against outbound threats such as confidential data, customer records,
intellectual property and offensive content leaving an
organization.
Three
specific product areas comprise SCM:
Antivirus
software
identifies and/or eliminates harmful software and macros by scanning hard
drives, email attachments, disks, Web pages and other types of electronic
traffic, e.g., instant messaging and short message service (SMS), for any known
or potential viruses, malicious code, trojans or spyware.
Web
filtering
software
is used to screen and exclude from access or availability Web pages that are
deemed objectionable or not business related. Web filtering is used by entities
to enforce corporate Internet use policies as well as by schools, universities
and home computer owners for parental controls.
Messaging
security
software
is used to monitor, filter and/or block messages from different messaging
applications, e.g., email, IM, SMS and P2P, containing spam, confidential
information and objectionable content. Messaging security is also used by
certain industries to enforce compliance with privacy regulations.
SCM
Growth Drivers
Viruses,
worms and spyware are serious threats facing businesses and consumers today
because these programs can be used to steal personal information, enable
identity theft, damage or destroy information stored on a computer and cause
damage to legitimate software, network performance and productivity. These
types
of malicious programs are introduced to computers through:
·
poor
browser security as most browsers today are full of security holes
that
are exploited by hackers and
criminals;
·
growing
use of the Internet and e-mail as a business tool and preferred
communication channel;
·
increased
use of mobile devices to access key
data;
·
opening
networks to a flood of external
traffic;
·
continued
rapid increases in spam as the majority of spam sent today originates
from
zombie machines remotely controlled by spammers;
·
explosive
growth in spyware causing theft of confidential information, loss
of
employee productivity, consumption of large amounts of bandwidth,
damage
to desktops and a spike in help desk
calls;
·
lack
of industry standards in the computer software industry to define
spyware,
adware, viruses, phishing or other malicious
code;
·
flaws
in operating systems that contribute to the wide range of current
Internet
security threats, particularly if users do not update their computers
with
patches;
·
need
to protect corporate and home systems from viruses, worms, spyware
and
malicious code; and
28
·
federal
regulations in healthcare and financial services markets around
the issue
of piracy.
As
a
result of the foregoing factors, the SCM market developed and continues to
expand in order to respond to the ever-evolving threats presented by malicious
programs.
Current
Product Limitations
Many
SCM
software vendors have attempted to solve Internet security problems with a
variety of software applications. Although many products exist today to address
such security issues, these solutions face many limitations, including the
following:
No
Real-Time Security
- Most
antivirus and antispyware software applications do not protect personal
computers against real-time threats. If new viruses or spyware exist on the
Internet but do not reside in risk definition databases, most personal computers
exposed to the threat will be infected. Typical virus protection software
requires frequent downloads and updates to work properly. If a user does not
download a patch timely, the user’s system may no longer be safe. By the time a
new virus is announced, it may already be too late to take action, and an
infection may have occurred. Also, new patches may take hours to install,
decreasing work productivity.
Inability
to Catch all Viruses and Malicious Content
-
Current threat analysis systems are not capable of detecting all malicious
codes. With current security networks, software alone cannot detect unknown
attacks - human involvement is required. Not only are threats not detected,
but
threats that are detected are resolved untimely due to intermittent update
systems delaying user alerts.
Costly
Updating
- Most
antispyware and antivirus software providers use a client-server network
infrastructure to distribute new spyware and virus definitions. Such solutions
are expensive to maintain because they rely on intensive data centers and
networks to deliver updates, thereby using a significant amount of bandwidth,
which is expensive to obtain. Also, vendors cannot afford to send threat
updates
continuously and therefore are slow to distribute them.
Every
consumer or business using any networked device needs to have some form of
Internet security. We plan to provide consumers and business users with a
platform of products and services designed to protect against all types of
security attacks.
Our
Technology
Conventional
Internet security companies use a cumbersome manual process to identify new
threats, analyze threats in labs, and distribute threat updates to their user
base. These security companies have to broadcast updates to each personal
computer user individually in the network. Serious drawbacks to conventional
broadcast updates exist, including the following:
·
The
expense related to this process; the network cannot be updated in
real-time, and instead is updated in batches spaced days
apart.
·
Because
broadcasting servers are a single point of distribution, they are
vulnerable to “flooding” attacks that prevent clients from getting the
needed updates.
·
A
threat may block a client computer’s access to the broadcast server,
disabling its ability to download an update for the
threat.
We
have
addressed these shortcomings by developing the CISN to detect, analyze and
quarantine new security threats. The
CISN
is not a conventional peer-to-peer network because the Alert Server is a
required checkpoint for all client activities, thus assuring the integrity
of
the network. The CISN is a controlled publishing network that leverages the
power of distributed bandwidth. Each client has a controlled role in relaying
the threat updates to as many as 20 clients, thus allowing continuous release
of
threat updates.
29
Unusual
behavior is detected by a personal computer equipped with our CyberDefender
Internet security software. The potential threat may be anything from spam
to a
virus. The program puts the potential threat on standby, and reports it to
our
Early Alert Center’s Alert Server™. The Alert Server compares the threat to
existing threat definitions. If the Alert Server does not recognize the threat,
the threat is sent to our AppHunter™ for analysis.
AppHunter
is an automated system that manages the threat analysis process. First,
AppHunter tests the undefined threat on an isolated computer that is
automatically wiped clean after each test. Based on the behavior of the test
computer, AppHunter ranks the threat on a scale from one to ten. Rankings of
five and above are classified as infectious (viruses). Additionally, AppHunter
carries out a confidential set of proprietary verifications to ensure that
the
threat itself is not an attempt to deceive or hack the network.
As
there
is a wide set of possible attacks that do not qualify as viruses, our AppHunter
is supplemented by a team of human technicians who classify threats that rank
below 5 in severity. Threat definitions are added as quickly as possible to
our
definition database, which is then updated to our users via our CISN. We
continually make changes to our technology to make sure that we address as many
security concerns as possible.
We
believe that our CISN may be the only network today that distributes information
securely between the individual personal computer users who have installed
our
software, which we have sometimes referred to as “peers” in this
discussion.
Using
our
peer-to-peer technology, our CyberDefender Alert Server notifies users of our
software who, in turn, notify up to 20 other users in an ever-widening circle.
This distributed notification process frees up the Alert Server to deal with
incoming alerts from clients that have encountered unexpected behavior, and
makes the network truly responsive and “tuned” to its users. Because the cost of
updating using the CISN is very small, Alert Server can send out updates as
fast
as threats are confirmed, resulting in better security coverage. In general,
from the time the first client has picked up the new threat to the updating
of
the network, about an hour passes. We believe that this process occurs roughly
ten times faster than the updating of any other competitive system.
Products
CyberDefender
Early Detection Center and CyberDefender FREE 2.0
Our
CyberDefender Early Detection Center/CyberDefender FREE 2.0 - a complete
Internet security suite - includes protection against viruses, spyware, phishing
and spam, along with helpful security utilities. This product was launched
in
November 2006. CyberDefender Early Detection Center/CyberDefender FREE 2.0
currently performs all of the following functions for users:
·
automatically
analyzes running executable files and assigns threat
levels;
·
automatically
analyzes e-mail attachment files from Outlook and assigns threat
levels;
·
automatically
blocks high-threat files and associated
files;
·
provides
an online advisory with detailed information on infected
files;
·
undertakes
a security audit that generates a daily report of security analysis
and
results;
·
the
event viewer records application running-history and other critical
activities;
·
automatically
blocks infected e-mails;
30
·
blocks
against known spyware, virus, spam-based and phishing
attacks;
·
incorporates
a Safe Search Toolbar that helps users search through a major search
provider such as Google (generating “AdWords” revenue) and helps prevent
users from accessing scam sites;
·
supports
Windows 98, 2000, NT, ME, XP;
·
updates
itself as needed when a user goes
online.
All
or
some of the features of this application will likely change from time to time
to
address new threats or business opportunities.
We
currently provide two versions of this product. One version includes advertising
and is provided to subscribers without charge. The other version, which does
not
have advertising, is available for licensing at an annual rate of $11.99
to
$39.99, depending on the marketing and distribution channels that we
use.
CyberDefender
Security Toolbar
We
believe that our security toolbar is one of the first anti-phishing and
anti-hijacking toolbars in the market. As with CyberDefender Early Detection
Center/CyberDefender FREE 2.0, persons who download our security toolbar
become
a part of the CISN. The toolbar may be downloaded free from our website.
With
the launch of the Early Detection Center, a simplified version of the Toolbar,
called the SafeSearch Toolbar, will be provided with all copies of CyberDefender
Early Detection Center/CybeDefender FREE 2.0. Our full toolbar will continue
to
be available on a private label or OEM basis.
Potential
Future Products
We
have
products in various stages of development, including a security suite to
protect
wireless devices such as cell phones and portable data assistants from security
threats, a suite of security software products and services designed for
small
to medium sized businesses and for medium to large enterprises and an Internet
alarm, which will alert users about new Internet threats. We are also
considering establishing a service to provide security updates generated
by the
CISN to those who subscribe to the service, which we believe could include
government entities, Internet service providers, software companies and security
companies. We cannot assure you that we will be successful in developing
and
marketing any of these products or that any of these products, if marketed,
will
produce significant revenues for us.
Technical
Support
We
have
support staff that is available to help with software installations or other
problems or questions via our website. Users of our software log onto our
website and register their support issue. We maintain support facilities at
our
Los Angeles office. For billing concerns we maintain a live customer support
group in Canada through a third party service provider.
Growth
Strategy
We
plan
to increase revenue by adding advertising revenues to our licensing revenues.
By
creating a large network of users of CyberDefender Early Detection
Center/CyberDefender FREE 2.0, we expect to generate advertising revenue,
referral income from sponsoring partners, and revenue from upgrades to a
product
for which payment will be required. We also plan to create private label
solutions on a fee and/or revenue sharing basis and to market private labeled
products and services into the free and paid user base. Our plan to capture
continued growth in the consumer market will be based on acquiring large
numbers
of users of CyberDefender FREE 2.0. We intend to do this by establishing
relationships with web-sites that have access to significant user bases and
to
pay them a fee for the customers we obtain through them. We are also planning
to
continue to develop and introduce additional software products to address
the
needs of the SCM market.
31
As
many
businesses do, we sometimes rely on independent contractors and vendors or
service providers to obtain services or products that we need. Aside from
Ivan
Ivankovich, our Chief Financial Officer, these include individuals or companies
who assist us with marketing and software development, billing, and advertising.
We have no long term agreements with any of these individuals, including
Mr.
Ivankovich. With the exception of Mr. Ivankovich, none of these independent
contractors, vendors or service providers bring knowledge or skills to us
that
cannot be easily replaced.
Revenue
Model
We
currently earn revenues from direct sales of our CyberDefender Early Detection
Center and advertising revenues from downloads of CyberDefender FREE 2.0.
We
license CyberDefender Early Detection Center software for $11.99 to $39.99
for
one year of service. This price includes technical support, software updates
and
definition updates. After one year of service, consumers have the option
to
renew the service. Users are notified when a subscription is due to expire
and
what the cost will be to continue the subscription.
Since
November 2006 we have begun generating revenue from advertising by showing
users
of our CyberDefender FREE 2.0 software small banners inside the CyberDefender
user interface, showing text links to third party products and/or getting
paid
by search engine companies whenever our users use our SafeSearch Toolbar.
Our
goal is to maximize our advertising revenue by increasing the number of
CyberDefender FREE 2.0 subscribers. As the number of these subscribers
increases, the amount paid to us per user will increase.
On
occasion, we also offer to our software users, both paying and non-paying,
other
subscription services such as Identity Theft Protection and Consumer Credit
Management. There are several providers of these types of additional services
and we have in the past, and will continue in the future, to affiliate with
these providers.
Retail
Sales
At
this
time our software is licensed or otherwise distributed only through the
Internet.
Customers
Our
primary customers are consumers who use home computers that use the Windows
operating system. Our customers reside primarily in the United States. The
number of our customers fluctuates due to the fact that, while we gain new
customers on a daily basis, existing customers can cancel or may not renew
their
subscriptions.
Marketing
and Sales
We
market
our products to computer users through the use of Internet marketing and
our
e-commerce site. We plan to make our products available to customers through
channels that include retailers, distributors, direct marketers, Internet-based
resellers, original equipment manufacturers (OEMs), and Internet service
providers. Current and future marketing opportunities include online
advertising, search engine optimization, advertising in trade and technical
publications, public relations, targeted customer marketing, direct e-mailings
to existing end-users, co-marketing with distributors and resellers, marketing
through the use of a CyberDefender web browser security toolbar and
participation in trade and computer shows and user group
conferences.
Competition
Internet
security markets are competitive and subject to continuous technological
innovation. Our competitiveness depends on our ability to offer products that
meet customers’ needs on a timely basis. The principal competitive factors of
our products are time to market, quality, price, reputation, terms of sales,
customer support and breadth of product line.
32
Some
of
our competitors include WebRoot Software, Sunbelt Software and Kaspersky
Labs.
In addition, we may face potential competition from operating system providers,
network equipment and computer hardware manufacturers. These competitors
may
provide various security solutions in their current and future products and
may
limit our ability to penetrate these markets. These competitors have significant
advantages due to their ability to influence and control computing platforms
and
security layers in which our products operate. At this time, we do not represent
a competitive presence in the SCM industry.
Intellectual
Property
Our
software is proprietary and we make every attempt to protect software technology
by relying on a combination of copyright, patent, trade secret and trademark
laws, restrictions on disclosure, and other methods. We filed with the US Patent
and Trademark Office for provisional patent protection on September 22, 2004
and
for final patents on September 22, 2005. While there can be no assurances,
we
and our counsel believe that ultimately we will be awarded a patent on “Threat
Protection Network” - Application No. US2006/0075504 and “System for
Distributing Information Using a Secure Peer to Peer Network” - Application No.
US2006/0075083.
We
have a
trademark in registration process for our company name and a product logo
consisting of the @ symbol with a star, for a downloadable software tool,
namely, computer software for blocking and filtering unwanted email or spam
for
use in connection with websites and email programs, filed with the US Patent
and
Trademark Office on September 15, 2003, registration number
2,966,384.
We
may
also license some intellectual property from third parties for use in our
products as well as potentially license our technology to third parties. We
face
a number of risks relating to intellectual property, including unauthorized
use
and copying of our software solutions. Litigation may be necessary to enforce
our intellectual property or to protect trade secrets or trademarks rights.
Employees
We
currently employ 19 full time employees and 6 independent contractors. Our
employees are segmented by the following functions: executive management,
research and development, information technology, marketing and sales, customer
service and call center, and finance and administration.
Description
of Property
Our
corporate office is located at 12121 Wilshire Boulevard, Suite 350, Los Angeles,
California. We currently lease this office space at a monthly rent of $10,619.
In addition to the base rent, we also pay our share of operating expenses,
tax
expenses and utilities, which is based on the square footage of the premises
we
lease. Each year these expenses are compared to the expenses of the base
year
(2005). If, at the end of any calendar year, these expenses exceed the expenses
incurred during the base year, we are required to pay our share of the expenses
which amounts to 1.5%. The lease term began on September 1, 2004 and will
extend
for a period of three years.
We
expect
that the premises in which our corporate office is located will be adequate
for
our needs for the next 12 months.
Government
Regulation and Probability of Affecting Business
33
The
development of our products is generally not subject to government regulation.
However, laws and regulations that apply to Internet communications, commerce
and advertising are becoming more prevalent. These regulations could affect
the
costs of communicating on the Internet and adversely affect the demand for
our
products or otherwise harm our business, results of operations and financial
condition. The United States Congress has enacted Internet legislation regarding
children’s privacy, copyrights, sending of unsolicited commercial email (e.g.,
the Federal CAN-Spam Act of 2003), spyware (e.g., H.R. 29, the “Spy Act”), and
taxation. Other laws and regulations may be adopted in the future. This
legislation could hinder growth in the use of the Internet generally and
decrease the acceptance of the Internet as a communications, commercial and
advertising medium.
In
addition, the growth and development of the market for Internet commerce
may
prompt calls for more stringent consumer protection laws, such as laws against
identity theft, that may impose additional burdens on companies conducting
business over the Internet. While none of the current laws governing Internet
commerce has imposed significant burdens on us to date, in the future our
business, results of operations and financial condition could be materially
and
adversely affected by the adoption or modification of laws or regulations
relating to the Internet, or the application of existing laws to the Internet
or
Internet-based advertising.
34
Directors,
Executive Officers, Promoters and Control Persons
The
following table identifies our current executive officers and directors, their
respective offices and positions, and their respective dates of election or
appointment:
Name
Age
Position
Held
Gary
Guseinov
37
Chief
Executive Officer, and Chairman
of
the Board of Directors
Ivan
Ivankovich
40
Chief
Financial Officer
Igor
Barash
36
Chief
Information Officer, Secretary, Director
Bing
Liu
45
Chief
Software Architect and
Director
There
are
no family relationships between any two or more of our directors or executive
officers. Our executive officers are appointed by our board of directors and
serve at the board’s discretion. There is no arrangement or understanding
between any of our directors or executive officers and any other person pursuant
to which any director or officer was or is to be selected as a director or
officer, and there is no arrangement, plan or understanding as to whether
non-management shareholders will exercise their voting rights to continue to
elect the current board of directors. There are also no arrangements, agreements
or understandings to our knowledge between non-management shareholders that
may
directly or indirectly participate in or influence the management of our
affairs.
None
of
our directors or executive officers has, during the past five
years,
·
had
any bankruptcy petition filed by or against any business of which
such
person was a general partner or executive officer, either at the
time of
the bankruptcy or within two years prior to that
time,
·
been
convicted in a criminal proceeding and none of our directors or executive
officers is subject to a pending criminal
proceeding,
·
been
subject to any order, judgment, or decree, not subsequently reversed,
suspended or vacated, of any court of competent jurisdiction, permanently
or temporarily enjoining, barring, suspending or otherwise limiting
his
involvement in any type of business, securities, futures, commodities
or
banking activities, or
·
been
found by a court of competent jurisdiction (in a civil action), the
Securities and Exchange Commission or the Commodity Futures Trading
Commission to have violated a federal or state securities or commodities
law, and the judgment has not been reversed, suspended, or
vacated.
Business
Experience
Gary
Guseinov
is one
of our co-founders and has served as our Chief Executive Officer and as a
director since our inception in August of 2003. Mr. Guseinov has over 12 years
of start-up business experience in the e-commerce sector in addition to direct
marketing expertise. In 1994, Mr. Guseinov rapidly grew Digital Media Concepts,
a web development firm, by establishing business relationships with AT&T and
Pacific Bell. While at Digital Media Concepts, Mr. Guseinov built a client
base
of over 475 clients in less than two years. In 1998, Digital Media Concepts
merged with Synergy Ventures Inc., a direct marketing firm focusing on online
marketing and customer acquisition. By 1999, Mr. Guseinov developed the first
Automated Media Planning System (SynergyMPS), allowing media buyers and media
sellers to communicate on a single platform and issue insertion orders. While
building SynergyMPS, Mr. Guseinov developed business relationships with over
2,500 media companies in the U.S., U.K., and Japan. In 2002, Mr. Guseinov
developed one of the largest enterprise email transmission systems capable
of
handling over 1 billion email messages per month. While at Synergy, Mr. Guseinov
was responsible for acquiring such clients as Lucent Technologies, Wells Fargo
Bank, Citibank, Chase, New Century Financial, JD Powers and Associates, Sears,
GoToMyPC and many other Fortune 1000 clients. Under Mr. Guseinov’s management,
DirectSynergy was able to generate over $2 billion in revenues for its clients.
Mr. Guseinov earned his B.A. from the California State University at Northridge,
School of Social and Behavioral Sciences.
35
Igor
Barash
is one
of our co-founders and has served as our Chief Information Officer and as a
director since our inception in August of 2003. Mr. Barash has over 10 years
of
senior level management experience with tier one Internet service providers.
In
1997, Mr. Barash became the first employee of Hostpro, a Los Angeles based
ISP.
With his extensive knowledge of the Internet based systems, servers,
administration and development, Hostpro grew to become one of the largest
hosting service providers in the world. After Hostpro’s purchase by Micron PC,
Mr. Barash took a key roll in Micron’s Internet services business, including
developing value added features on enterprise level service models,
restructuring its data center, and participating as Micron’s representative to
Microsoft. Later, Mr. Barash became the technical due diligence leader during
Micron’s procurement of other ISPs, and Mr. Barash delivered assessments of all
companies in contention to be purchased and incorporated under the Micron
umbrella. In 1999, Mr. Barash was given the task of restructuring and
incorporating WorldWide Hosting in Boca Raton, an acquisition he led. Since
January 2000, Mr. Barash has been operating his own consulting firm, supplying
high level IT solutions and management services. Mr. Barash earned his B.S.
from
the California State University at Northridge, School of Computer
Science.
Ivan
Ivankovich
joined
CyberDefender in September 2006 as its Consulting Chief Financial Officer.
Prior
to joining CyberDefender, in March 2005, Mr. Ivankovich co-founded and was
Managing Director of VisionPoint Capital, a boutique investment bank, where
he
provided services primarily related to corporate finance and mergers and
acquisitions. Prior to founding VisionPoint Capital, in August 2003, Mr.
Ivankovich joined YellowPages.com, an on-line directory of national and local
merchants, as its Chief Financial Officer. Aside from providing financial and
operational guidance, Mr. Ivankovich directed the company’s capital raising
efforts. Mr. Ivankovich led and negotiated the merger of YellowPages.com into
a
group led by SBC and Bell South. From September 2001 until August 2003, Mr.
Ivankovich served as Vice President, Portfolio Operations for Platinum Equity,
a
global acquisition firm where he managed and operated certain of its portfolio
companies. From October 1998 to August 2001, Mr. Ivankovich served as Vice
President of Finance for two venture-backed companies, Trivida Corporation
and
HealthAllies, Inc. Mr. Ivankovich started his career with Ernst & Young in
their audit practice in Los Angeles. Mr. Ivankovich is a Certified Public
Accountant and a member of the California Society of CPAs. He earned his B.A.
in
Business Economics with an emphasis in accounting from the University of
California, Santa Barbara.
36
Bing
Liu
has
served as our Chief Software Architect since January 2005 and as a director
since October 2006. Mr. Liu has worked in the software technology field for
over
22 years. Mr. Liu started his technology career in the U.S. in 1989. In 1991,
Mr. Liu founded Unionway International Corporation and developed the most
popular Asian language software called AsianSuite. AsianSuite is used by
Wal-Mart, the U.S. Army, the Library of Congress and millions of consumers
worldwide. Mr. Liu also worked as Senior Software Architect for CyberMedia
Corporation. While at CyberMedia, Mr. Liu developed ActiveHelp technology,
which
was later integrated into FirstAID and GuardDog - popular software marketed
to
Windows users. In 1997, Mr. Liu was instrumental in selling CyberMedia to
McAfee
for over $200 million. In 2001, Mr. Liu founded Cyber-Defender, an innovative
Internet security company focusing on antivirus technology. Cyber-Defender’s
technology is based on a sophisticated secure adaptive peer network that we
believe is far superior than any other competitive product on the market.
In January 2005, we acquired the software application Cyber-Defender. Mr.
Liu
holds five different software patents in the U.S. Mr. Liu also holds a Masters
and Bachelors Degree in Computer Science from Tsinghua University, Beijing
China.
All
directors serve until the next annual meeting of common shareholders and until
their successor is elected and qualified by our common shareholders, or until
the earlier of their death, retirement, resignation or removal.
Executive
Compensation
Summary
of Compensation
The
following executive compensation disclosure reflects all compensation awarded
to, earned by or paid to the executive officers below, for the fiscal years
ended December 31, 2005 and 2004. The following table summarizes all
compensation for fiscal years 2005 and 2004 received by our Chief Executive
Officer or President, and all officers who earned more than
$100,000 in fiscal year 2005.
Summary
Compensation Table
Name
and principal position
Year
Salary
($)
Bonus
($)
Stock
Awards
($)
Option
Awards
($)
Non-Equity
Incentive Plan Compen-sation
($)
Nonquali-fied
Deferred Compen-sation Earnings
($)
All
Other Compen-sation ($)
Total
($)
Gary
Guseinov, Chief Executive Officer and President(1)
2005
$422,439(1)
$416,592(1)
-0-
-0-
-0-
-0-(2)
2004
$250,000(1)
$268,481(1)
Igor
Barash, Chief Information Officer
2005
$166,187(3)
$24,799(3)
-0-
-0-
-0-
-0-
2004
$161,127(3)
$42,011(3)
Bing
Liu, Chief Software Architect
2005
$100,000
$45,000
-0-
-0-
-0-
-0-
-0-
2004
-0-
-0-
-0-
-0-
-0-
-0-
-0-
Riggs
Eckelberry, former Chief Operating Officer
2005
$43,332(4)
$45,000(5)
2004
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
(1)
According to the employment agreement executed by Mr. Guseinov and us in August
2006, he is to receive a salary of $225,000 per year. Mr. Guseinov was paid
the
additional salary and bonus because of exceptional performance during the 2004
and 2005 fiscal years.
(2)
While
Mr. Guseinov’s employment agreement requires a matching contribution to a 401(k)
plan in the amount of $2,500 per month and a life insurance policy the premium
of which is no more than $3,000 per year, we have not provided either of these
benefits to him.
(3)
According to the employment agreement executed by Mr. Barash and us, he is
to
receive a salary of $135,000 per year. Mr. Barash was paid the additional salary
and bonus because of exceptional performance during the 2004 and 2005 fiscal
years.
(4)
Mr.
Eckelberry was hired in November 2005. The amount shown in the column titled
“Salary” is pro-rated for the last two months of the 2005 fiscal year. Mr.
Eckelberry’s annual salary was $260,000 per year. His employment with us
terminated on December 31, 2006.
(5)
This
payment was made to REMG, Inc., an entity controlled by Mr.
Eckelberry.
The
following table sets forth certain information concerning stock option awards
granted to our executive officers and our directors. No options were exercised
by our executive officers or directors during the last fiscal
year.
37
OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END
OPTION
AWARDS
STOCK
AWARDS
Name
Number
of securities underlying unexercised options (#)
Exercisable
Number
of securities underlying unexercised options (#)
Unexercis-able
Equity
Incentive Plan Awards: Number of Securities underlying unexercised
unearned options (#)
Option
exercise price ($)
Option
expiration date
Number
of shares or units of stock that have not vested (#)
Market
value of shares or units of stock that have not vested ($)
Equity
incentive plan awards: number of unearned shares, units or other
rights
that have not vested (#)
Equity
incentive plan awards: Market or payout value of unearned shares,
units or
other rights that have not vested (#)
Bing
Liu
326,107
-0-
-0-
$0.0107
1/3/2015
-0-
-0-
3,368
-0-
Compensation
of Directors
Directors
do not currently receive compensation for their services as directors, but
we
plan to reimburse them for expenses incurred in attending board meetings. In
October 2006 we issued to Mr. Bing Liu a total of 832,511 shares of common
stock. The common stock was issued to him, in part, for his agreement to accept
186,347 shares of our common stock as full payment of a promissory note owed
by
us to Unionway Int’l LLC, an entity controlled by Mr. Liu. We issued the
remaining 646,164 shares of common stock to Mr. Liu in consideration for his
continued contribution to the development of our products and
technology.
Employment
Agreements, Termination of Employment and Change-in-Control Arrangements
The
following discussions provide only a brief description of the documents
described below. The discussions are qualified by the full text of the
agreements.
We
entered into an employment agreement with Mr. Gary Guseinov as of August31,2006.
The term
of the agreement is three years, however if the agreement is not terminated
during that period, then it will be renewed for a period of one year until
terminated pursuant to its terms. Mr. Guseinov receives compensation of $225,000
per year and is reimbursed for business related expenses. Under the employment
agreement, we are required to match Mr. Guseinov’s monthly contribution to our
401(k) plan up to the sum of $2,500 per month and we have agreed to provide
a
term life insurance policy with coverage in the face amount of $1,000,000,
so
long as the premium for any such policy does not exceed the sum of $3,000
per
year, however, we do not currently, and we have not in the past, provided
these
benefits. We also agreed to obtain officers and directors liability insurance
with coverage of not less than $1,000,000, but we have not yet done this.
Mr.
Guseinov receives three weeks of paid vacation per year. We are entitled
to
terminate Mr. Guseinov’s employment upon a change of control, upon Mr.
Guseinov’s disability or for cause. Constructive termination is defined as a
change in Mr. Guseinov’s position, authority, duties, responsibilities or
status, an adverse change in his title, any reduction in his salary with
which
he does not agree (unless such reduction is concurrent with and part of a
company-wide reduction for all employees), any breach by us of a material
obligation to Mr. Guseinov under this agreement, any requirement that Mr.
Guseinov relocate to an office that is outside of Los Angeles County, California
or outside of a 30 mile radius from his home, any termination of this agreement
(other than as permitted by the agreement) and the failure of Mr. Guseinov
to be
elected to the Board of Directors. Mr. Guseinov may terminate his employment
upon 30 days written notice to us or in the event that he is constructively
terminated. If Mr. Guseinov’s employment is terminated for any reason other than
voluntarily by him or for cause, he is entitled to receive upon termination
all
accrued but unpaid salary, earned and pro rata bonus compensation, vested
stock
and stock options and post termination benefits. Post termination benefits
are
defined as Mr. Guseinov’s right to receive his monthly base salary in effect at
termination for a period of one year following termination and to continue
to
receive coverage under our health and dental insurance program (if any) for
a
period of six months following his termination. By signing the agreement,
Mr.
Guseinov assigned and agreed to assign in the future, to us or to our nominees,
all intellectual property defined in the agreement as “Relevant Intellectual
Property”.
38
On
September 1, 2003 we entered into an employment agreement with Igor Barash,
our
Chief Information Officer. Mr. Barash is an “at-will” employee and we can
terminate his employment at any time. As compensation for the services he
renders to us, Mr. Barash is paid the sum of $135,000 per year. We reimburse
Mr.
Barash for reasonable business expenses. Currently, Mr. Barash is entitled
to
one week’s paid personal time and three sick days for each 12 months of
employment. After three years of continuous employment, Mr. Barash is entitled
to 14 days of paid personal time.
On
January 3, 2005 we entered into an employment agreement with Bing Liu, our
Chief
Software Architect, wherein we agreed to pay him an annual salary of $100,000.
In January 2006 we increased Mr. Liu’s salary to $165,000. Mr. Liu’s annual
salary was increased again in September 2006, and he is currently paid the
sum
of $202,000 per year. He is also entitled to receive a bonus, calculated
as two
percent of the net revenue we earn from any invention created by him during
the
course of his employment. “Net revenue” is defined as gross receipts less direct
marketing and shipping costs less returns and discounts. Inventions created
by
Mr. Liu is defined as any and all ideas, processes, trademarks, service marks,
inventions, technology, computer programs, original works of authorship,
designs, formulas, discoveries, patents, copyrights, and all improvements,
rights, and claims related to the foregoing that are conceived, developed,
or
reduced to practice by Mr. Liu alone or with others that result from any
work
performed by him for us or in which our equipment, supplies, facilities or
trade
secret information is used. This provision survives the termination of Mr.
Liu’s
employment. We reimburse Mr. Liu for reasonable business expenses. Mr. Liu
has
agreed that following termination of his employment, he will not take any
action
to induce or influence any person who provides services to us to terminate
his
or her employment nor will he attempt to employ any such person within six
months of the date that person’s employment with us terminated. Mr. Liu agrees
to keep secret our confidential information during his employment and for
a
period of one year following the termination of his employment. Mr. Liu is
an
“at-will” employee and we can terminate his employment at any time.
Also
on
January 3, 2005 we entered into an Incentive Stock Option Agreement with Mr.
Liu. Pursuant to this agreement, Mr. Liu is granted the right to purchase
326,107 shares of our common stock at an exercise price of $0.0107 per share.
The right to purchase 186,347 of the shares vests at the rate of 1/24 shares
per
month for each month of Mr. Liu’s employment. Mr. Liu will be entitled to the
right to purchase an additional 46,587 shares of common stock if we enter into
a
binding agreement to issue or sell shares of our common stock to one or more
third parties or to sell all or materially all of our assets in a transaction
which is valued at between $201 million and $249,999,999.99, and he is entitled
to the right to purchase an additional 93,173 shares of common stock if we
enter
into such an agreement having a value of $250 million. In its discretion, the
Board of Directors may agree to accelerate the vesting of any portion of the
option that is unvested if Mr. Liu’s employment is terminated without cause
within 24 months of the start of his employment or if he has good reason to
terminate his employment. Furthermore, if Mr. Liu’s employment is terminated
either without cause or for good reason within one year after a change in
control, then that part of the option that is unvested on the termination date
will immediately vest. If Mr. Liu’s employment is terminated for any reason, we
have the right, for a period of 90 days, to purchase all or any portion of
the
unvested shares at the fair market value of the shares at the time of
termination. Mr. Liu also agreed that in connection with an underwritten public
offering of our common stock, upon our request or that of the underwriter,
he
would not sell, offer for sale or otherwise dispose of any shares he acquires
upon exercise of the option for a period of at least 180 days after the
execution of the underwriting agreement, or such longer period of time as the
Board of Directors may reasonably determine, so long as all of our directors
and
executive officers agree to be similarly bound. This obligation will remain
effective for all underwritten public offerings with respect to which we have
filed a registration statement on or before two years after the closing of
our
initial public offering.
We
entered into an Independent Contractor Agreement with Ivan Ivankovich, our
Chief
Financial Officer. A complete description of this agreement is included in
the
section of this prospectus titled “Certain Relationships and Related
Transactions.”
39
Certain
Relationships and Related
Transactions
Described
below are certain transactions or series of transactions since inception
between
us and our executive officers, directors and the beneficial owners of 5%
or more
of our common stock, on an as converted basis, and certain persons affiliated
with or related to these persons, including family members, in which they
had or
will have a direct or indirect material interest in an amount that
exceeds the lesser of $120,000 or 1% of the average of our total assets at
year-end for the last three completed fiscal years, other than compensation
arrangements that are otherwise required to be described under “Executive
Compensation.”
On
March26, 2004 we entered into a sublease for suite 305 located at 12121 Wilshire
Boulevard, Los Angeles, California. The monthly rent is $4,824.60 and the
lease
term ended on November 30, 2006. Mr. Gary Guseinov, our Chief Executive Officer,
a director and a major shareholder, guaranteed the sublease. Mr. Guseinov
received no consideration for the sublease guarantee. The lease has terminated
and we have not renewed it.
On
August11, 2004, we entered into a lease for suite 350 located at 12121 Wilshire
Boulevard, Los Angeles, California. The monthly rent is $10,619.18 and the
lease
term ends on August 31, 2007. Mr. Guseinov also guaranteed this lease. Mr.
Guseinov received no consideration for the lease guarantee.
In
2005
and 2006 we made a series of advances to Mr. Guseinov and Mr. Barash for
personal expenses. As of June 30, 2006, the balances of these advances totaled
$24,755.77 and $800.36, respectively. These advances did not bear interest
and
had no scheduled repayment date. As of September 30, 2006, all advances have
been repaid or reclassified as salary during the period. Since October 1,2006,
no further advances have been made to Mr. Guseinov or Mr.
Barash.
On
May 1,2005, we entered into a lease agreement for a condominium located in Las Vegas,
Nevada with International Equity Partners, a Nevada limited liability company.
Mr. Guseinov is the manager of International Equity Partners. The monthly base
rent for this space is $3,750. The term of the lease is from May 1, 2005 until
May 31, 2008, however, the lease was terminated by the mutual agreement of
the
parties in February 2006.
In
January 2005, we entered into an asset purchase agreement with Unionway
Int’l, LLC
whereby
we purchased certain of its assets, including the software application
Cyber-Defender™ and associated rights, for $200,000. We paid $8,333 at closing
and issued a promissory note in connection with the purchase to Unionway
Int’l,
LLC for $191,667. The terms of the note require monthly payments due on the
first of each month in the amount of $8,333. Interest accrues at the rate
of 7%
per annum and is payable in a lump sum on September 1, 2007, provided that
such
interest will be waived if all payments are received by Unionway Int’l by the
third day of each month. In addition we retained the principal of Unionway
Int’l, LLC, Mr. Bing Liu, as an employee and we issued to him an incentive stock
option for the purchase of 326,107 shares of our common stock. The exercise
price is $0.0107 per share. The right to purchase 186,347 shares vests in
equal
increments over a period of 24 months; the right to purchase 46,587 shares
of
common stock will vest if we enter into a binding agreement to sell our business
for at least $201 million; and the right to purchase 93,173 shares of common
stock will vest if we enter into a binding agreement to sell our business
for at
least $250 million. At September 30, 2006 the balance outstanding on the
promissory note was $83,335. Unionway Int’l, LLC has agreed to accept payment of
the remaining balance on the note and any accrued but unpaid interest in
exchange for 186,347 shares of our common stock. We issued 186,347 shares
of
common stock to Mr. Liu for this payment.
Unionway
Int’l, LLC continues to provide software development services to us. We pay
$6,500 per month for these services. During the nine months ended September30,2006, we paid $58,000 for software development services to Unionway Int’l, LLC.
Because Mr. Liu is our Chief Software Architect, the negotiation of the monthly
fee was not done “at arm’s length”. However, we believe that we receive fair
value in the services provided to us by Unionway Int’l, LLC and that if we were
to pay an independent provider for the services, we would pay approximately
the
same amount per month.
40
On
November 1, 2005 we entered into an employment agreement with Mr. Riggs
Eckelberry for which we paid REMG, Inc., a corporation controlled by him,
a
compensatory fee of $45,000. Mr. Eckelberry’s employment agreement was
“at-will”. Mr. Eckelberry received compensation of $260,000 per year pursuant to
the terms of the employment agreement. An amendment to the employment agreement
was signed on November 22, 2006. Upon execution of the amendment, Mr. Eckelberry
received a fully vested option to purchase 200,000 shares of our common stock
at
an exercise price of $0.85 per share and a cash bonus in the amount of $50,238.
Under the agreement as amended, Mr. Eckelberry was entitled to participate
in
any benefits that we may, from time-to-time, have made available to other
executives. Mr. Eckelberry received three weeks of paid vacation per year.
We
were entitled to terminate Mr. Eckelberry’s employment upon a change of control,
upon his death or disability, for cause or for any reason other than for
cause.
Mr. Eckelberry may have terminated his employment upon 30 days written notice
to
us or in the event of a constructive termination. A constructive termination
was
defined as a change in Mr. Eckelberry’s position, authority, duties,
responsibilities or status, an adverse change in his title, any reduction
in his
salary with which he did not agree, any breach by us of a material obligation
to
Mr. Eckelberry under the employment agreement, any requirement that Mr.
Eckelberry relocate to an office that is outside of a 30 mile radius from
his
home and any termination of the employment agreement (other than as permitted
by
the agreement). If Mr. Eckelberry’s employment was terminated voluntarily by him
or for cause, he was entitled to receive accrued and unpaid salary, earned
and
pro rata bonus compensation, vested stock options and any benefits required
by
law. In the event of a constructive termination, Mr. Eckelberry was entitled
to
receive accrued but unpaid salary, earned and pro rata bonus compensation,
vested stock options and post-termination benefits. Post-termination benefits
were defined as the continuation of Mr. Eckelberry’s salary through the term of
the agreement and the continuation of coverage under any existing health
or
dental insurance program through March 31, 2007. If Mr. Eckelberry’s employment
was terminated due to his disability, then he was entitled to receive any
accrued but unpaid salary, earned and pro rata bonus compensation, vacation
time
and benefits under our benefit plans, through the date of termination. By
signing the employment agreement, Mr. Eckelberry assigned and agreed to assign
in the future, to us or to our nominees, all intellectual property defined
in
the agreement as “Relevant Intellectual Property”, with the exception of
intellectual property that qualifies under the provisions of California Labor
Code section 2870. The agreement, as amended, expired by its terms on December31, 2006.
On
September 1, 2006 Mr. Ivan Ivankovich signed an independent contractor agreement
with us for financial management and reporting services. The term of the
agreement extended for 90 days. We may terminate the agreement at any time
by
giving Mr. Ivankovich 10 days written notice of termination or, upon a breach
of
the agreement, immediately by giving written notice to Mr. Ivankovich. Mr.
Ivankovich can terminate the agreement by giving us 30 days written notice
of
termination. Pursuant to this agreement, Mr. Ivankovich received compensation
in
the amount of $8,000 per month through October 15, 2006. The agreement was
amended on October 15, 2006 and again on January 12, 2007. Pursuant to the
amendments, Mr. Ivankovich’s salary was increased to $11,000 per month and the
term of the agreement was extended through March 31, 2007.
On
October 30,
2006
we entered into Indemnification Agreements with Mr. Guseinov, Mr. Eckelberry,
Mr. Ivankovich, Mr. Liu and Mr. Barash. A complete description of these
agreements is included in the section of this prospectus titled, “Disclosure
of Commission Position of Indemnification for Securities Act
Liabilities”.
On
September 12, 2006 Mr. Guseinov agreed to transfer an aggregate of 186,347
shares of common stock back to us for cancellation. In turn, we agreed to
issue an aggregate of 186,347 shares of common stock to our bridge
investors on a pro rata basis. The shares were issued to the bridge
investors in consideration for their agreement to enter into the Note
Conversion and Warrant Lock-Up Agreement. Mr.
Guseinov transferred this stock because the terms of the 10% convertible
secured
note financing had been agreed to and, as part of that transaction, we had
agreed not to issue additional securities without the consent of the
lender.
In
October 2006 Mr. Guseinov and Mr. Igor Barash, our Chief Information Officer
and
a director, agreed to transfer an aggregate of 646,164 shares of common stock
back to us for cancellation. In turn, we agreed to issue an aggregate of
646,164 shares of common stock to Mr. Bing Liu, our Chief Software
Architect. The shares were issued in consideration of Mr.Liu’s continued
contribution to the development of our products and technology. As with the
transfer of common stock in the paragraph above, Mr. Guseinov transferred
this
stock because the terms of the 10% convertible secured note financing had
been
agreed to and, as part of that transaction, we had agreed not to issue
additional securities without the consent of the lender.
41
Selling
Shareholders
The
following table sets forth the names of the selling shareholders who may
sell
their shares under this prospectus from time to time. No selling shareholder
has, or within the past three years has had, any position, office or other
material relationship with us or any of our predecessors or affiliates other
than as a result of the ownership of our securities, except for the law firm
Richardson & Patel LLP, which serves as our legal counsel, and ARC
Investment Partners, LLC, which has served as our financial advisor. The
shares
being sold by ARC Investment Partners, LLC were issued in exchange for various
services rendered to us by it.
The
following table also provides certain information with respect to the selling
shareholders’ ownership of our securities as of January 30, 2007, the total
number of securities they may sell under this prospectus from time to time,
and
the number of securities they will own thereafter assuming no other acquisitions
or dispositions of our securities. The selling shareholders can offer all,
some
or none of their securities, thus we have no way of determining the number
they
will hold after this offering. Therefore, we have prepared the table below
on
the assumption that the selling shareholders will sell all shares covered
by
this prospectus.
Some
of
the selling shareholders may distribute their shares, from time to time, to
their limited and/or general partners or managers, who may sell shares pursuant
to this prospectus. Each selling shareholder may also transfer shares owned
by
him or her by gift, and upon any such transfer the donee would have the same
right of sale as the selling shareholder.
The
shares described in the following table consist of shares of common stock
underlying our 10% secured convertible debentures and common stock purchase
warrants that were issued in a private placement the first closing of which
was
held on September 12, 2006 and which was consummated on October 3, 2006.
A
discussion of the material terms of this offering is included in the section
of
this prospectus titled “Prospectus Summary - The Offering” at page 2. We may
amend or supplement this prospectus from time to time to update the disclosure
set forth herein, however, if a selling shareholder transfers his or her
interest in the 10% secured convertible debentures and common stock purchase
warrants prior to the effective date of the registration statement of which
this
prospectus is a part, we will be required to file a post-effective amendment
to
the registration statement to provide the information concerning the transferee.
Alternatively, if a selling shareholder transfers his or her interest in
the 10%
secured convertible debentures and common stock purchase warrants after the
effective date of the registration statement of which this prospectus is
a part,
we may use a supplement to update this prospectus. None of the selling
shareholders are or were affiliated with registered broker-dealers. See our
discussion entitled “Plan of Distribution” for further information regarding the
selling shareholders’ method of distribution of these shares.
Name
of Selling Shareholder
Number
of Shares Owned Before Offering
Number
of Shares Being Offered
Number
of Shares Owned After Offering(1)
Percentage
Owned After Offering(1)
Robert
D. Odell(2)
100,000(2)
92,912
7,088
*
Richardson
and Patel LLP(3)
125,000(3)
116,140
8,860
*
Michael
R. DeBaecke(4)
200,000(4)
185,823
14,177
*
Bushido
Capital Master Fund, LP(5)
1,280,878(5)
1,190,086
90,792
*
Pierce
Diversified Strategy Master Fund LLC, Series BUS(6)
1,280,878(6)
1,190,086
90,792
*
Garrett
S. Goggin(4)
200,000(4)
185,823
14,177
*
Robert
Goggin(7)
400,000(7)
371,647
28,353
*
Camofi
Master LDC(8)
2,000,000(8)
1,858,235
141,765
*
William
J. Santora(4)
200,000(4)
185,823
14,177
*
Ricardo
A. Salas(4)
200,000(4)
185,823
14,177
*
Brian
E. Boyle(4)
200,000(4)
185,823
14,177
*
CCM,
Inc.(9)
100,000(9)
92,912
7,088
*
Walter
W. Buckley III(4)
200,000(4)
185,823
14,177
*
ARC
Investment Partners LLC
1,065,970(10)
50,000
1,015,970
4.78%
TOTAL
7,552,726
6,076,956
1,475,770
6.994%
42
*Less
than 1% based on a total of 21,271,273 shares of common stock which includes
12,173,914 shares of common stock issued and outstanding, 3,243,378 shares
of
common stock underlying 10% secured convertible debentures outstanding;
3,243,378 shares of common stock underlying warrants to purchase common stock
issued in connection with the sale of our 10% secured convertible debentures,
877,552 shares of common stock underlying warrants issued in conjunction with
our bridge financing, 972,944 shares of common stock underlying options granted
from the 2006 Equity Incentive Plan, 326,107 shares of common stock underlying
options granted from the 2005 Stock Option Plan, and 434,000 shares of common
stock underlying warrants to purchase common stock issued to a placement agent
and a financial advisor.
(1)
Assumes that all shares will be resold by the selling shareholders after this
offering.
(2)
Includes up to 50,000 shares of common stock issuable upon conversion of a
10%
secured convertible debenture and up to 50,000 shares of common stock issuable
upon the exercise of a common stock purchase warrant.
(3)
Includes up to 62,500 shares of common stock issuable upon conversion of a
10%
secured convertible debenture and up to 62,500 shares of common stock issuable
upon the exercise of a common stock purchase warrant. Richardson & Patel LLP
received these securities in exchange for legal services having a value of
$62,500. Richardson & Patel LLP is our legal counsel and has rendered an
opinion to us regarding the validity of the shares being offered. The name
of
the person who has voting or investment control over the securities owned by
Richardson & Patel LLP is Erick Richardson.
(4)
Includes up to 100,000 shares of common stock issuable upon conversion of a
10%
secured convertible debenture and up to 100,000 shares of common stock issuable
upon the exercise of a common stock purchase warrant.
(5)
Includes up to 640,439 shares of common stock issuable upon conversion of a
10%
secured convertible debenture and up to 640,439 shares of common stock issuable
upon the exercise of a common stock purchase warrant. The name of the person
who
has voting or investment control over the securities owned by Bushido Capital
Master Fund, LP is Louis Rabman.
(6)
Includes up to 640,439 shares of common stock issuable upon conversion of a
10%
secured convertible debenture and up to 640,439 shares of common stock issuable
upon the exercise of a common stock purchase warrant. The name of the person
who
has voting or investment control over the securities owned by Pierce Diversified
Strategy MasterFund LLC, Series BUS is Christopher Rossman.
(7)
Includes up to 200,000 shares of common stock issuable upon conversion of a
10%
secured convertible debenture and up to 200,000 shares of common stock issuable
upon the exercise of a common stock purchase warrant.
(8)
Includes up to 1,000,000 shares of common stock issuable upon conversion of
a
10% secured convertible debenture and up to 1,000,000 shares of common stock
issuable upon the exercise of a common stock purchase warrant. The name of
the
person who has voting or investment control over the securities owned by Camofi
Master LDC is Richard Smithline.
(9)
Includes up to 50,000 shares of common stock issuable upon conversion of a
10%
secured convertible debenture and up to 50,000 shares of common stock issuable
upon the exercise of a common stock purchase warrant. The name of the person
who
has voting or investment control over the securities owned by CCM, Inc. is
Brian
Sutcliffe.
(10)
Includes 98,120 shares of common stock issuable upon exercise of common stock
purchase warrants. The name of the person who has voting or investment control
over the securities owned by ARC Investement Partners, LLC is Adam
Roseman.
Plan
of Distribution
Each
selling shareholder of the common stock and any of their pledgees, assignees
and
successors-in-interest may, from time to time, sell any or all of their shares
of common stock on the OTC Bulletin Board or any other stock exchange, market
or
trading facility on which the shares are traded or in private transactions.
These sales may be at fixed or negotiated prices. A selling shareholder may
use
any one or more of the following methods when selling shares:
• ordinary
brokerage transactions and transactions in which the broker dealer solicits
purchasers;
43
• block
trades in which the broker dealer will attempt to sell the shares as agent
but
may position and resell a portion of the block as principal to facilitate the
transaction;
• purchases
by a broker dealer as principal and resale by the broker dealer for its
account;
• an
exchange distribution in accordance with the rules of the applicable
exchange;
• privately
negotiated transactions;
• settlement
of short sales entered into after the effective date of the registration
statement of which this prospectus is a part;
• broker
dealers may agree with the selling shareholders to sell a specified number
of
such shares at a stipulated price per share;
• through
the writing or settlement of options or other hedging transactions, whether
through an options exchange or otherwise;
• a
combination of any such methods of sale; or
• any
other
method permitted pursuant to applicable law.
The
selling shareholders may also sell shares under Rule 144 under the Securities
Act of 1933, as amended, if available, rather than under this
prospectus.
Broker-dealers
engaged by the selling shareholders may arrange for other broker dealers to
participate in sales. Broker-dealers may receive commissions or discounts from
the selling shareholders (or, if any broker dealer acts as agent for the
purchaser of shares, from the purchaser) in amounts to be negotiated, but,
except as set forth in a supplement to this prospectus, in the case of an agency
transaction not in excess of a customary brokerage commission in compliance
with
NASDR Rule 2440; and in the case of a principal transaction a markup or markdown
in compliance with NASDR IM-2440.
In
connection with the sale of the common stock or interests therein, the selling
shareholders may enter into hedging transactions with broker-dealers or other
financial institutions, which may in turn engage in short sales of the common
stock in the course of hedging the positions they assume. The selling
shareholders may also sell shares of the common stock short and deliver these
securities to close out their short positions, or loan or pledge the common
stock to broker-dealers that in turn may sell these securities. The selling
shareholders may also enter into option or other transactions with
broker-dealers or other financial institutions or the creation of one or more
derivative securities that require the delivery to such broker-dealer or other
financial institution of shares offered by this prospectus, which shares such
broker-dealer or other financial institution may resell pursuant to this
prospectus (as supplemented or amended to reflect such
transaction).
The
selling shareholders and any broker-dealers or agents that are involved in
selling the shares are deemed to be “underwriters” within the meaning of
the Securities Act of 1933, as amended, in connection with such sales. In
such
event, any commissions received by such broker-dealers or agents and any
profit
on the resale of the shares purchased by them may be deemed to be underwriting
commissions or discounts under the Securities Act of 1933, as amended. Each
selling shareholder has informed us that it does not have any written or
oral
agreement or understanding, directly or indirectly, with any person to
distribute our common stock.
We
are
required to pay certain fees and expenses incurred by us incident to the
registration of the shares. We have agreed to indemnify the selling shareholders
against certain losses, claims, damages and liabilities, including liabilities
under the Securities Act of 1933, as amended.
44
Because
selling shareholders are deemed to be “underwriters” within the meaning of the
Securities Act of 1933, as amended, they will be subject to the prospectus
delivery requirements of the Securities Act of 1933, as amended, including
Rule
172 thereunder. In addition, any securities covered by this prospectus that
qualify for sale pursuant to Rule 144 under the Securities Act of 1933, as
amended, may be sold under Rule 144 rather than under this prospectus. There
is
no underwriter or coordinating broker acting in connection with the proposed
sale of the resale shares by the selling shareholders.
We
agreed
to keep this prospectus effective until the earlier of (i) the date on which
the
shares may be resold by the selling shareholders without registration and
without regard to any volume limitations by reason of Rule 144(k) under the
Securities Act of 1933, as amended, or any other rule of similar effect or
(ii)
all of the shares have been sold pursuant to this prospectus or Rule 144 under
the Securities Act of 1933, as amended, or any other rule of similar effect.
The
resale shares will be sold only through registered or licensed brokers or
dealers if required under applicable state securities laws. In addition, in
certain states, the resale shares may not be sold unless they have been
registered or qualified for sale in the applicable state or an exemption from
the registration or qualification requirement is available and is complied
with.
Under
applicable rules and regulations under the Securities Exchange Act of 1934,
as
amended, any person engaged in the distribution of the resale shares may not
simultaneously engage in market making activities with respect to the common
stock for the applicable restricted period, as defined in Regulation M, prior
to
the commencement of the distribution. In addition, the selling shareholders
will
be subject to applicable provisions of the Securities Exchange Act of 1934,
as
amended, and the rules and regulations thereunder, including Regulation M,
which
may limit the timing of purchases and sales of shares of the common stock by
the
selling shareholders or any other person. We will make copies of this prospectus
available to the selling shareholders and have informed them of the need to
deliver a copy of this prospectus to each purchaser at or prior to the time
of
the sale (including by compliance with Rule 172 under the Securities Act of
1933, as amended).
Security
Ownership of Certain Beneficial Owners and Management
The
following tables set forth certain information regarding beneficial ownership
of
our securities as of January 30, 2007 by (i) each person who is known
by us to own beneficially more than 5% of the outstanding shares of each
class of our voting securities, (ii) each of our directors and executive
officers, and (iii) all of our directors and executive officers as a group.
Unless otherwise stated, their address is c/o CyberDefender Corporation,
12121
Wilshire Boulevard, Suite 350, Los Angeles, California90025.
We
have
determined beneficial ownership in accordance with the rules of the Securities
and Exchange Commission. Under these rules, beneficial ownership generally
includes voting or investment power over securities. The number of shares
shown
as beneficially owned in the tables below are calculated pursuant to Rule
13d-3(d)(1) of the Securities Exchange Act of 1934. Under Rule 13d-3(d)(1),
shares not outstanding that are subject to options, warrants, rights or
conversion privileges exercisable within 60 days are deemed outstanding for
the
purpose of calculating the number and percentage owned by such person, but
not
deemed outstanding for the purpose of calculating the percentage owned by
each
other person listed. Except as otherwise indicated, we believe that the
beneficial owners listed below, based on the information furnished by these
owners, have sole investment and voting power with respect to the securities
indicated as beneficially owned by them, subject to applicable community
property laws. As of January 30, 2007, there were 12,173,914 shares of common
stock issued and outstanding.
In
computing the number of shares of common stock beneficially owned by a person
and the percent ownership of that person, we deemed outstanding shares of
common
stock subject to warrants or options held by that person that are currently
exercisable or exercisable within 60 days of January 30, 2007. We did not
deem
these shares outstanding for purposes of computing the percent ownership
of any
other person. The following table is based on a total of 21,271,273 shares
of
common stock consisting of the following:
·
12,173,914
shares of common stock issued and
outstanding;
45
·
3,243,378
shares of common stock underlying 10% secured convertible debentures
outstanding;
·
3,243,378
shares of common stock underlying warrants to purchase common stock
issued
in conjunction with the sale of our 10% secured convertible
debentures;
·
877,552
shares of common stock underlying warrants issued in conjunction
with
bridge financing transactions that occurred from November 2005 through
March 2006;
·
972,944
shares of common stock underlying options granted from the 2006 Equity
Incentive Plan;
·
326,107
shares of common stock underlying options granted from the 2005 Stock
Option Plan; and
·
434,000
shares of common stock underlying warrants to purchase common stock
issued
to a placement agent and a financial
advisor.
Name
of Director, Officer and Beneficial
Owner(1)
Number
of Shares of
Common
Stock
Beneficially
Owned
Percentage
of
Common
Stock
Named
Executive Officers and Directors:
Gary
Guseinov, Chief Executive Officer and director
7,044,024
33.12%
Igor
Barash, Chief Information Officer, Secretary and director
681,739
3.20%
Bing
Liu, Chief Software Architect and director
1,494,395(2)
7.03%
Ivan
Ivankovich, Chief Financial Officer
40,000
(3)
*
Camofi
Master LDC
2,000,000(4)
9.40%
ITU
Ventures
1,819,382(5)
8.55%
Bushido
Capital Master Fund LP
1,280,878(6)
6.02%
Pierce
Diversified Strategy Master Fund LLC, Series BUS
1,280,878(7)
6.02%
TOTAL
15,841,296
74.47%
All
Officers and Directors as a Group (5 persons)
9,460,158
44.47%
*
Less
than one percent beneficially owned.
(1)
The
address for each of our officers and directors is 12121 Wilshire Boulevard,
Suite 350, Los Angeles, California90025.
(2)
This
number consists of 832,511 shares of common stock, an option to purchase
326,107
shares of our common stock that was granted from our 2005 Stock Option Plan
(of
which the right to purchase 186,347 shares of common stock has vested) and
an
option to purchase 335,777 shares of our common stock that was approved by
our
Board of Directors on November 2, 2006. The option will be granted from our
2006
Equity Incentive Plan. The option exercise prices are $0.0107 per share and
$1.00 per share, respectively. The option to purchase 326,107 shares vests
as
follows: the right to purchase 186,347 shares vests in equal increments over
a
period of 24 months; the right to purchase 46,587 shares of common stock
will
vest if we enter into a binding agreement to sell our business for at least
$201
million; and the right to purchase 93,173 shares of common stock will vest
if we
enter into a binding agreement to sell our business for at least $250
million.
(3)
This
number consists of an option to purchase 40,000 shares of our common stock
that
was approved by our Board of Directors on November 2, 2006. The option exercise
price is $1.00 per share. The option was granted from our 2006 Equity Incentive
Plan.
(4)
This
number represents 1,000,000 shares of common stock issuable upon conversion
of a
10% secured convertible debenture and 1,000,000 shares of common stock issuable
upon the exercise of a common stock purchase warrant. The warrant exercise
price
is $1.00 per share. The address of Camofi Master LDC is c/o Centrecourt Asset
Management LLC, 350 Madison Avenue, 8th
Floor,
New York, New York10017.
(5)
This
number represents 1,252,475 shares of common stock and 566,907 shares of
common
stock issuable upon the exercise of a common stock purchase warrant. The
warrant
exercise price is $1.01 per share. The address of ITU Ventures is 1900 Avenue
of
the Stars, Suite 2701, Los Angeles, California90067.
(6)
This
number represents 640,439 shares of common stock issuable upon the conversion
of
a 10% secured convertible debenture and 640,439 shares of common stock issuable
upon the exercise of a common stock purchase warrant. The warrant exercise
price
is $1.00 per share. The address of Bushido Capital Master Fund LP is 275
7th
Avenue,
Suite 2000, New York, New York10001.
(7)
This
number represents 640,439 shares of common stock issuable upon the conversion
of
a 10% secured convertible debenture and 640,439 shares of common stock issuable
upon the exercise of a common stock purchase warrant. The warrant exercise
price
is $1.00 per share. The address of Pierce Diversified Strategy Master Fund
LLC
is 275 7th
Avenue,
Suite 2000, New York, New York10001.
(8)
Includes 98,120 shares of common stock issuable upon exercise of common stock
purchase warrants. The address of ARC Investment Services LLC is 9440 Little
Santa Monica Boulevard, Suite 400, Beverly Hills, California90210.
46
Change
of Control
Under
the
Security Agreement that we signed on September 12, 2006, we pledged all of
our
assets to secure repayment of the 10% Secured Convertible Debentures. If we
were
to default on our payment obligation, or any other event of default were to
occur under the debentures, the debenture holders could foreclose and take
possession of the pledged assets. This could be considered a change of control.
Other than the Security Agreement, to the knowledge of management, there are
no
present arrangements or pledges of securities of our company that may result
in
a change of control.
Description
of Securities
General
We
are
authorized to issue only one class of shares, which are designated as common
shares (otherwise referred to as common stock). The total number of shares
of
common stock that we may issue is 50,000,000, with a par value of $0.001 per
share.
Common
Stock
The
securities being offered by the selling shareholders are shares of our common
stock. Prior to this offering there has been no public or private trading market
for our common stock and there will be no such trading market until our common
stock is approved for quotation on the OTC Bulletin Board.
As
of
January 30, 2007, there were issued and outstanding 12,173,914 shares of
common
stock that were held of record by 29 shareholders.
The
holders of common stock are entitled to one vote per share on all matters to
be
voted upon by the shareholders. The holders of common stock are entitled to
receive ratably any dividends that may be declared from time to time by the
board of directors out of funds legally available for that purpose. In the
event
of our liquidation, dissolution or winding up, the holders of common stock
are
entitled to share ratably in all assets remaining after payment of liabilities.
The common stock has no preemptive or conversion rights or other subscription
rights. All outstanding shares of common stock are fully paid and nonassessable,
and the shares of common stock offered in this offering will be fully paid
and
not liable for further call or assessment.
Please
review our articles of incorporation, as amended, and bylaws, copies of which
have been filed with the Securities and Exchange Commission, as well as the
applicable statutes of the State of California for a more complete description
of the rights and liabilities of holders of our shares.
The
holders of common stock have cumulative voting rights, which means that every
shareholder entitled to vote at any election of directors may cumulate such
shareholder’s votes and give one candidate a number of votes equal to the number
of directors to be elected multiplied by the number of votes to which the
shareholder’s shares are normally entitled, or distribute the shareholder’s
votes on the same principle among as many candidates as the shareholder thinks
fit.
Except
for directors, who are elected by receiving the highest number of affirmative
votes of the shares entitled to be voted for them, or as otherwise required
by
California law, and subject to the rights of the holders of preferred stock
then
outstanding (if any), all shareholder action is taken by the vote of a majority
of the issued and outstanding shares of common stock present at a meeting of
shareholders at which a quorum consisting of a majority of the issued and
outstanding shares of common stock is present in person or proxy.
47
Warrants
As
of
January 30, 2007, there were outstanding warrants to purchase 3,243,378 shares
of our common stock at an exercise price of $1.00 per share, which were issued
in conjunction with the private offering we undertook in September 2006.
These
warrants are immediately exercisable. If there is no effective registration
statement registering the underlying shares by September 12, 2007, these
warrants contain cashless exercise provisions that allow the holder to exercise
the warrant for a lesser number of shares of common stock in lieu of paying
cash. The number of shares that would be issued in this case would be based
upon
the market price of the common stock at the time of the net exercise, or
if
there is no market price, the price per share as determined by our board
of
directors.
As
of
January 30, 2007, there were outstanding warrants to purchase 877,552 shares
of
our common stock at an exercise price of $1.01 per share. These warrants
are
immediately exercisable and contain cashless exercise provisions that allow
the
holder to exercise the warrant for a lesser number of shares of common stock
in
lieu of paying cash. The number of shares that would be issued in this case
would be based upon the market price of the common stock at the time of the
net
exercise, or if there is no market price, the price per share as determined
by
our board of directors.
As
of
January 30, 2007, there were outstanding unit purchase options to purchase
434,000 shares of our commons stock at an exercise price of $1.00 per share.
The
exercise price and the number of shares issuable upon exercise of all the
foregoing warrants will be adjusted upon the occurrence of certain events,
including reclassifications, reorganizations or combinations of the common
stock. At all times that the warrants are outstanding, we will authorize and
reserve at least that number of shares of common stock equal to the number
of
shares of common stock issuable upon exercise of all outstanding warrants.
Registration
Rights
Under
a
Registration Rights Agreement we have with the holders of our 10% secured
convertible debentures, we are obligated to register for resale at least 130%
of
the shares of our common stock issuable upon the conversion of the 10% secured
convertible debentures and the exercise of the common stock purchase warrants.
However, the Registration Rights Agreement also prohibits us from registering
shares of common stock on the registration statement of which this prospectus
is
a part that total more than one-half of our issued and outstanding shares of
common stock, reduced by 10,000 shares.
Holders
of certain shares and warrants for the purchase of common stock issued in
conjunction with the sale of our secured convertible promissory notes from
November 2005 through March 2006 also have registration rights. These holders
have agreed to defer their rights to require registration of their securities
on
the registration statement of which this prospectus is a part.
Disclosure
of Commission Position of Indemnification for Securities Act
Liabilities
Section
317 of the California Corporations Code states that a corporation shall have
the
power to indemnify any person who was or is a party or is threatened to be
made
a party to any proceeding (other than an action by or in the right of the
corporation to procure a judgment in its favor) by reason of the fact that
the
person is or was an agent of the corporation, against expenses, judgments,
fines, settlements, and other amounts actually and reasonably incurred in
connection with the proceeding if that person acted in good faith and in a
manner the person reasonably believed to be in the best interests of the
corporation and, in the case of a criminal proceeding, had no reasonable cause
to believe the conduct of the person was unlawful. In addition, a corporation
shall have the power to indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending, or completed action
by
or in the right of the corporation to procure a judgment in its favor by reason
of the fact that the person is or was an agent of the corporation, against
expenses actually and reasonably incurred by that person in connection with
the
defense or settlement of the action if the person acted in good faith, in a
manner the person believed to be in the best interests of the corporation and
its shareholders.
48
With
regard to a provision authorizing the indemnification of directors or agents
in
excess of that expressly permitted by Section 317, Section 204 of the California
Corporations Code stipulates that (A) such a provision may not eliminate or
limit the liability of directors or agents, among other things, (i) for acts
or
omissions that involve intentional misconduct or a knowing and culpable
violation of law, (ii) for acts or omissions that a director or agent believes
to be contrary to the best interests of the corporation or its shareholders
or
that involve the absence of good faith on the part of the director or agent,
(iii) for any transaction from which a director or agent derived an improper
personal benefit, (iv) for acts or omissions that show a reckless disregard
for
the director's or agent's duty to the corporation or its shareholders in
circumstances in which the director or agent was aware, or should have been
aware, in the ordinary course of performing a director’s or agent’s duties, of a
risk of serious injury to the corporation or its shareholders, or (v) for acts
or omissions that constitute an unexcused pattern of inattention that amounts
to
an abdication of the director's or agent’s duty to the corporation or its
shareholders, (B) no such provision shall eliminate or limit the liability
of a
director or agent for any act or omission occurring prior to the date when
the
provision becomes effective, and (C) no such provision shall eliminate or limit
the liability of an officer for any act or omission as an officer,
notwithstanding that the officer is also a director or agent or that his or
her
actions, if negligent or improper, have been ratified by the
directors.
For
purposes of Section 317, “agent” means any person who is or was a director,
officer, employee or other agent of the corporation, or is or was serving at
the
request of the corporation as a director, officer, employee or agent of another
foreign or domestic corporation, partnership, joint venture, trust or other
enterprise, or was a director, officer, employee or agent of a foreign or
domestic corporation which was a predecessor corporation of the corporation
or
of another enterprise at the request of the predecessor corporation;
“proceeding” means any threatened, pending or completed action or proceeding,
whether civil, criminal, administrative or investigative; and “expenses”
includes without limitation attorneys’ fees and any expenses of establishing a
right to indemnification.
Our
articles of incorporation provide that the liability of the directors for
monetary damages shall be eliminated to the fullest extent under California
law.
In addition, it provides that we are authorized to provide indemnification
to
agents (as defined in Section 317) for breach of duty to us and our shareholders
through bylaw provisions or through agreements with agents, or both, in excess
of the indemnification permitted by Section 317, subject to the limits on
such
excess indemnification set forth in Section 204. Our bylaws provide that
our
directors and officers shall be indemnified by us to the fullest extent not
prohibited by the California Corporations Code. Our bylaws also allow us
to
purchase and maintain insurance on behalf of any agent (as defined in Section
317) against any liability asserted against or incurred by the agent in such
capacity or arising from the agent’s status as such, whether or not we would
have the power to indemnify the agent against such liability under the
provisions of Section 317 of the California Corporations
Code.
for
any acts or omissions or transactions from which a director may not
be
relieved of liability under the California General Corporation Law;
or for
breach by an indemnified party of any duty to us or our shareholders
as to
circumstances in which indemnity is expressly prohibited by
Section 317 of the California General Corporation Law;
or
·
with
respect to proceedings or claims initiated or brought voluntarily
by an
indemnified party not by way of defense, (except with respect to
proceedings or claims brought to establish or enforce a right to
indemnification) although such indemnification may be provided if
our
Board of Directors has approved the initiation or bringing of such
proceeding or claim; or
·
with
respect to any proceeding instituted by the indemnified party to
enforce
or interpret the Indemnification Agreement, if a court of competent
jurisdiction determines that each of the material assertions made
by the
indemnified party in such proceeding was not made in good faith or
was
frivolous; or
·
for
expenses or liabilities of any type whatsoever which have been paid
directly to an indemnified party by an insurance carrier under a
policy of
directors’ and officers’ liability insurance maintained by us;
or
·
for
expenses and the payment of profits arising from the purchase and
sale by
an indemnified party of securities in violation of Section 16(b) of
the Securities Exchange Act of 1934, as amended, or any similar successor
statute.
The
Indemnification Agreements are effective as of the date they were signed and
may
apply to acts or omissions of the indemnified parties which occurred prior
to
such date if the indemnified party was an officer, director, employee or other
agent of our company, or was serving at our request as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust
or
other enterprise, at the time such act or omission occurred. All of obligations
under the Indemnification Agreements will continue as long as an indemnified
party is subject to any actual or possible matter which is the subject of the
Indemnification Agreement, notwithstanding an indemnified party’s termination of
service as an officer or director.
50
The
indemnification provisions included in the California Corporations Code, our
Articles of Incorporation and bylaws, and the Indemnification Agreements may
be
sufficiently broad to permit indemnification of our executive officers and
directors for liabilities (including reimbursement of expenses incurred) arising
under the Securities Act of 1933, as amended.
Insofar
as indemnification for liabilities arising under the Securities Act
of 1933, as amended, may be permitted to our directors, officers and
controlling persons pursuant to the foregoing provisions, or otherwise, we
have
been advised that in the opinion of the Securities and Exchange Commission
such
indemnification is against public policy as expressed in the Securities Act
of 1933, as amended, and is, therefore, unenforceable. No pending material
litigation or proceeding involving our directors, executive officers, employees
or other agents as to which indemnification is being sought exists, and we
are
not aware of any pending or threatened material litigation that may result
in
claims for indemnification by any of our directors or executive
officers.
Where
You Can Find More Information
We
have
filed with the Securities and Exchange Commission a registration statement
on
Form SB-2 under the Securities Act of 1933, as amended, with respect to the
common stock being offered in this offering. This prospectus does not contain
all of the information set forth in the registration statement and the exhibits
and schedules filed as part of the registration statement. For further
information with respect to us and our common stock, we refer you to the
registration statement and the exhibits and schedules filed as a part of the
registration statement. Statements contained in this prospectus concerning
the
contents of any contract or any other document are not necessarily complete.
If
a contract or document has been filed as an exhibit to the registration
statement, we refer you to the copy of the contract or document that has been
filed. Each statement in this prospectus relating to a contract or document
filed as an exhibit is qualified in all respects by the filed exhibit. The
reports and other information we file with the Securities and Exchange
Commission can be read and copied at the Securities and Exchange Commission’s
Public Reference Room at 100 F Street, N.E., Washington D.C. 20549. Copies
of
these materials can be obtained at prescribed rates from the Public Reference
Section of the Securities and Exchange Commission at the principal offices
of
the Securities and Exchange Commission, 100 F Street, N.E., Washington D.C.
20549. You may obtain information regarding the operation of the public
reference room by calling 1(800) SEC-0330. The Securities and Exchange
Commission also maintains a website (http://www.sec.gov) that contains reports,
proxy and information statements, and other information regarding issuers that
file electronically with the Securities and Exchange Commission.
After
this offering, we will be subject to the information and periodic reporting
requirements of the Securities Exchange Act of 1934, as amended, and we intend
to file periodic reports, proxy statements and other information with the
Securities and Exchange Commission.
Experts
AJ.
Robbins, PC, certified public accountants, audited our financial statements
at
December 31, 2005 and December 31, 2004, as set forth in their report. We have
included our financial statements in the prospectus and elsewhere in the
registration statements in reliance on the report of AJ. Robbins, PC, given
on
their authority as experts in accounting and auditing.
Legal
Matters and Interests of Named Experts
Richardson
& Patel LLP has given us an opinion relating to the due issuance of the
common stock being registered. The law firm of Richardson & Patel, LLP, or
its various principals, beneficially own 243,307 shares of our common stock,
as
further discussed in the section of this prospectus titled “Selling
Shareholders”.
Adjustments
to reconcile net income (loss) to net cash
provided
by (used in) operating activities:
Accretion
of loan discount
74,092
--
Beneficial
conversion - debt converted at below market
755,173
--
Value
of warrants issued with conversion of debt
506,896
--
Additional
shares to bridge note holders
200,000
--
Depreciation
and amortization
70,719
61,657
Changes
in:
Restricted
cash
26,747
99,733
Accounts
receivable
(1,512
)
(246,582
)
Prepaid
and other assets
(220,867
)
(30,430
)
Deferred
tax asset
--
653,531
Deferred
commissions
57,226
(82,035
)
Advances
- shareholders
--
(1,539
)
Accounts
payable and accrued expenses
269,622
(416,221
)
Deferred
revenue
(513,958
)
(1,162,577
)
Cash
Flows Provided by (Used In) Operating Activities:
(1,807,277
)
(57,693
)
CASH
FLOWS FROM (TO) INVESTING ACTIVITIES:
Purchase
of fixed assets
(14,540
)
(16,440
)
Proceeds
from return of equipment
14,926
--_
Cash
Flows Provided By (Used In) Investing Activities
386
(16,440
)
CASH
FLOWS FROM (TO) FINANCING ACTIVITIES:
Proceeds
from convertible notes payable
3,575,000
50,000
Payments
on note payable
(100,000
)
--
Payments
on note payable - related party
(16,667
)
(74,999
)
Principal
payments on capital lease obligation
(7,927
)
(5,591
)
Proceeds
from exercise of stock options
1,083
--
Dividends
paid
--
(31,400
)
Cash
Flows Provided by (Used In) Financing Activities
3,451,489
(61,990
)
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
1,644,598
(136,123
)
CASH
AND CASH EQUIVALENTS, beginning of period
251,972
393,150
CASH
AND CASH EQUIVALENTS, end of period
$
1,896,570
$
257,027
Supplemental
disclosures of cash flow information:
Income
taxes paid
$
800
$
800
Cash
paid for interest
$
8,935
$
4,431
Supplemental
schedule of non-cash financing activities:
Assets
acquired through notes payable, related party
$
--
$
200,000
Assets
acquired through capital lease obligation
$
18,410
$
61,867
Conversion
of convertible debt
$
1,262,069
$
--
Discount
on convertible debt
$
3,004,822
$
--
Discount
on conversion of debt
$
506,896
$
--
Deferred
financing costs to be paid by issuance of stock
$
1,375,046
$
--
Exchange
of accounts payable for convertible notes payable
$
62,500
$
--
F-5
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
and Business
CyberDefender
Corporation (the “Company”) based in Los Angeles, California, is a provider of
secure content management software. The Company develops and licenses security
software and related services. The Company intends to bring to market advanced
solutions to combat and prevent online information theft, unwanted
advertisements, spam, Internet viruses, spyware and related computer threats.
The Company was incorporated on August 29, 2003 under the laws of the State
of
California under the name of Network Dynamics Corp. On October 13, 2005,
the
Company changed it name to CyberDefender Corporation.
On
October 30, 2006, the Company’s board of directors and those shareholders
holding a majority of the Company voting power approved a 0.93173414-for-1
reverse split of the Company’s common stock. The effective date of the split was
October 31, 2006. All common stock amounts are shown on a post-split basis
in
these financial statements and notes.
Managements
Plans
The
Company is in the process of filing a registration statement on Form SB-2
with
the Securities and Exchange Commission (SEC) which offers for resaleshares
of
the Company’s common stock which include:
·
50,000
shares of common stock;
·
3,013,478
shares of common stock underlying common stock purchase warrants
issued
pursuant to a Securities Purchase Agreement dated as of September12,2006; and
·
3,013,478
shares of common stock underlying the 10% secured convertible debentures
issued in conjunction with the Securities Purchase
Agreement
The
Company cannot estimate the effective date of the registration statement.
Historically,
the Company’s revenues were derived from subscriptions to CyberDefender
Anti-Spyware 2006
which
included the initial download and one year of updates. The license to use
the
software was renewed annually with incentives for early renewals. The Company
acquired new users with an online direct purchase offer. The offer, to
scan a
computer for spyware and then pay for removal of the spyware found, was
broadcast in emails, banners and search ads.
F-6
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Managements
Plans (Continued)
In
November 2006, the Company launched its new Internet security suite called
CyberDefender FREE 2.0 that is free to the subscriber. Revenues are earned
from
advertising networks that pay the Company for displaying their advertiser’s
advertisements inside the software. CyberDefender Early Detection Center
is a
version of the same software, without the advertising, which is paid for
by the
subscriber. The annual subscription rate for the version without ads ranges
from
$11.99 to $39.99, depending on the marketing or distribution channels that
the
Company uses.
During
the nine months ended September 30, 2006, the Company experienced a substantial
net loss in connection with product development and the transition of the
Company’s strategy and focus on developing a new product, CyberDefender FREE
2.0.
As
of
September 30, 2006the Company had $1,896,570 in cash. Management believes
that
this cash will fund its operations through February 2007. However, the
Company
will need additional funds to continue its operations. If additional financing
is not available or is not available on acceptable terms, the Company may
be
unable to continue its operations.
The
Company entered into a Registration Rights Agreement with holders of its
10%
secured convertible debentures as disclosed in Note 8. Under the terms
of the
agreement, the Company is obligated to register for resale at least 130%
of the
shares of its common stock issuable upon the conversion of the 10% secured
convertible debentures and the exercise of the common stock purchase warrants.
However, the agreement also prohibits the Company from registering shares
of
common stock on a registration statement that total more than one-half
of the
issued and outstanding shares of common stock, reduced by 10,000
shares.
If
a
registration statement is not filed, the Company will pay to each holder
of its
10% secured convertible debentures an amount in cash, as partial liquidated
damages and not as a penalty, equal to 1.5% of the aggregate subscription
amount
paid by each holder. The Company, (1) will not be liable for liquidated
damages
with respect to any warrants or warrant shares, (2) in no event will the
Company
be liable for liquidated damages in excess of 1.5% of the aggregate subscription
amount of the holders in any 30-day period, and (3) the maximum aggregate
liquidated damages payable to a holder shall be eighteen percent (18%)
of the
aggregate subscription amount paid by such holder. If the Company fails
to pay
any partial liquidated damages in full within seven days after the date
payable,
the Company will pay interest at a rate of 18% per annum to the holder,
accruing
daily from the date such partial liquidated damages are due until such
amounts,
plus all such interest, are paid in full. The partial liquidated damages
shall
apply on a daily pro-rata basis for any portion of a month.
Pursuant
to Amendments No.1 and No.2 to the
Registration Rights Agreement, the holders of the Company’s 10% secured
convertible debentures have agreed to extend
F-7
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
the
filing date of the Registration Statement to November 3, 2006, and have
agreed
to waive their rights to enforce the liquidated damages clause above for
the
initial filing.
The
holders of certain shares and warrants for the purchase of common stock
issued
in conjunction with the sale of the Company’s previously issued secured
convertible notes from November 2005 through March 2006, which were converted
on
September 12, 2006, also have certain registration rights. These holders
have
agreed to defer their rights to require registration of their securities
on this
registration statement, however, maintain such piggyback rights on future
registrations of the Company’s common stock.
Reclassification
Certain
amounts in the prior period financial statements have been reclassified
for
comparative purposes to conform to the presentation in the current period
financial statements.
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements
and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and assumptions.
Cash
and Cash Equivalents
Cash
and
cash equivalents include cash on hand and investments with original maturities
of three months or less.
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. Total depreciation expense was $20,719 and $11,657 for the nine
month
periods ended September 30, 2006 and 2005, respectively.
F-8
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
Equipment
under Capital Lease
The
Company leases certain of its furniture and other equipment under an agreement
accounted for as a capital lease. 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 the estimated useful lives.
Fair
Value of Financial Instruments
Unless
otherwise specified, the Company believes the carrying value of financial
instruments approximates their fair value.
Revenue
Recognition
The
Company recognizes revenue from the sale of software licenses when all
of the
following is 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.
Specifically,
the Company recognizes revenues from its CyberDefender Anti-Spyware 2006
(“CyberDefenderTM”)
product in accordance with SOP No. 97-2, "Software Revenue Recognition,"
as
amended by SOP No. 98-9, "Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions." These statements provide
guidance for recognizing revenues related to sales by software vendors.
The
Company sells its CyberDefenderTM
software
over the Internet. Customers order the product and simultaneously provide
their
credit card information to the Company. Upon receipt of authorization from
the
credit card issuer, the Company licenses the customer to download
CyberDefenderTM
over the
Internet. As part of the sales price, 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 and revenues and related expenses are deferred and recognized ratably
over
the subscription term.
As
disclosed under the caption Management Plans of this Note 1, in November
2006,
the Company launched a new product,
CyberDefender FREE 2.0, which
is
free to the subscriber. Revenues
are earned from advertising networks which pay the Company to display their
advertiser’s advertisements inside the software.
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. Customers
may
choose to download a version of the same software, without advertising,
and pay
for the term license with allows the customer to use the products and receive
product support coverage and content
F-9
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue
Recognition (Continued)
updates
for a specified period, generally twelve months. The Company recognizes
revenue
on the paid software in accordance with SOP No. 97-2, "Software Revenue
Recognition," as amended by SOP No. 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions", as described
above.
Concentrations
of Risk
Revenues
are concentrated in the software industry which is highly competitive and
rapidly changing.Significant
technological changes in the industry or customer requirements, or the
emergence
of competitive products with new technologies or capabilities could adversely
affect operating results.
The
Company maintains all cash in bank accounts, which at times may exceed
federally
insured limits. The Company has not experienced a loss in such accounts.
For
the
nine month periods ended September 30, 2006 and 2005, advertising purchased
from
four (4) vendors accounted for 60% and 74% of the Company’s total advertising
expense.
Reserves
for Product Returns
The
Company’s policy with respect to product returns is defined in its End User
License Agreement ("EULA"), which states "...products purchased that are
downloadable are refundable within the first 30 days after the date of
purchase". For the nine month periods ended September 30, 2006 and 2005,
the
Company had accrued $0 for customer returns and chargeback’s. The Company may
voluntarily accept returns from a customer from time to time that are charged
against revenues upon receipt of the return.
Income
Taxes
The
Company has adopted the liability method of accounting for income taxes
pursuant
to Statement of Financial Accounting Standard (SFAS) No. 109, "Accounting
for
Income Taxes." Under SFAS No. 109, deferred income taxes are recorded to
reflect
tax consequences on future years for the differences between the tax bases
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 bases. 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
F-10
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income
Taxes (Continued)
liabilities
are individually classified as current and non-current based on their
characteristics. Deferred tax assets are reduced by a valuation allowance
when,
in the opinion of management, it is more likely than not that some portion
or
all of the deferred tax assets will be realized.
Software
Development Costs
The
Company accounts for software development costs in accordance with Statement
of
Financial Accounting Standards ("SFAS") No. 86, "Computer Software to Be
Sold,
Leased, or Otherwise Marketed". Such costs are expensed prior to achievement
of
technological feasibility and thereafter are capitalized. There has 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. For the nine month periods ended September30,2006 and 2005 product development costs were $1,114,679 and $256,865,
respectively. Further, as discussed in Note 6, the Company acquired the
CyberDefenderTM
software
application during the prior year.
Advertising
Expenses
Advertising
expenses are expensed as incurred and consist primarily of various forms
of
media purchased from Internet-based marketers and search engines. For the
nine
month periods ended September 30, 2006 and 2005, advertising expense amounted
to
$580,034 and $1,104,697, respectively.
In
February 2006, the Financial Accounting Standards Board (“FASB”) issued
SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an
amendment of FASB Statements No. 133 and 140” (“SFAS No. 155”). SFAS
No. 155 allows financial instruments that contain an embedded derivative
and that otherwise would require bifurcation to be accounted for as a whole
on a
fair value basis, at the holders’ election. SFAS No. 155 also clarifies and
amends certain other provisions of SFAS No. 133 and SFAS No. 140. This
statement is effective for all financial instruments acquired or issued
in
fiscal years beginning after September 15, 2006. The Company is evaluating
F-11
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
the
impact adoption of SFAS No. 155 will have on the Company’s financial
position and results of operations.
In
March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of
Financial Assets — an amendment of FASB Statement No. 140” (“SFAS
No. 156”). SFAS No. 156 provides guidance on the accounting for
servicing assets and liabilities when an entity undertakes an obligation
to
service a financial asset by entering into a servicing contract. This statement
is effective for the first fiscal year beginning after September 15, 2006.
The Company does not believe the adoption of SFAS No. 156 will have any
impact on the Company’s financial position or results of operations.
Earnings
Per Share
In
accordance with SFAS No. 128, “Earnings Per Share”, the basic
income/(loss) per common share is computed by dividing net income/(loss)
available to common stockholders by the weighted average number of common
shares
outstanding. Diluted income/(loss) per common share is computed similar to
basic income/(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. At September 30, 2006, there were 7,690,416 shares
of
potentially dilutive securities outstanding. As the Company reported a
net
loss none of the potentially dilutive securities were included in the
calculation of diluted earnings per share since their effect would be
anti-dilutive for that reporting period.
The
following table is a reconciliation of the numerators and denominators
of the
basic and diluted earnings per share computations for the nine months ended
September 30, 2005.
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock
Based Compensation
The
Company adopted SFAS No. 123 (Revised 2004), Share Based Payment
(“SFAS No. 123R”), under the modified-prospective transition method on
January 1, 2006. SFAS No. 123R 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. Share-based compensation
recognized under the modified-prospective transition method of SFAS
No. 123R includes share-based compensation based on the grant-date fair
value determined in accordance with the original provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, for all share-based
payments granted prior to and not yet vested as of January 1, 2006 and
share-based
compensation based on the grant-date fair-value determined in accordance
with
SFAS No. 123R for all share-based payments granted after
January 1, 2006. SFAS No. 123R eliminates the ability to account
for the award of these instruments under the intrinsic value method prescribed
by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock
Issued to Employees, and allowed under the original provisions of SFAS
No. 123. Prior to the adoption of SFAS No. 123R, the Company accounted
for its stock option plans using the intrinsic value method in accordance
with
the provisions of APB Opinion No. 25 and related interpretations. For
non-employee stock based compensation the Company recognizes an expense
in
accordance with SFAS No. 123 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 which ever is more readily available. Stock option awards
are
valued using the Black-Scholes option-pricing model.
For
periods presented prior to the adoption of SFAS No. 123R, pro forma information
regarding net income and earnings per share as required by SFAS No. 123R
has
been determined as if the Company had accounted for its employee stock
options
under the original provisions of SFAS No. 123. The fair value of these
options
was estimated using the Black-Scholes option pricing model. For purposes
of pro
forma disclosure, the estimated fair value of the options is amortized
to
expense over the options vesting period. The pro forma expense to recognize
during the nine months ended September 30, 2005 is as follows:
Net
income attributed to common stockholders:
As
reported
$
1,066,770
Compensation
recognized under APB 25
--
Compensation
recognized under SFAS 123
(2,617
)
Pro
forma
$
1,064,153
Basic
and diluted loss attributed to common stockholders per common
share:
As
reported
$
0.11
Pro-forma
$
0.11
F-13
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock
Based Compensation (Continued)
The
fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average
assumptions: risk-free interest rate of 4.62%; dividend yields of 0%;
volatility factors of the expected market price of the Company’s common shares
of 128%; and a weighted average expected life of the option of 10
years.
In
January 2005, the Company entered into an asset purchase agreement with
Unionway
Int’l, LLC whereby the Company purchased certain assets of Unionway Int’l, LLC
that principally included the software application Cyber-Defender™ and
associated rights for $200,000 through the issuance of a note payable as
disclosed in the following Note 6. The asset is being amortized over the
expected life of three years on a straight line basis. The amortization
for the
nine months ended September 30, 2006 and 2005 is $50,001 and $50,000,
respectively and the accumulated amortization is $116,667 as of September30,2006.
F-14
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
4 - INCOME TAXES
As
of
September 30, 2006, the Company had federal net operating loss carry forwards
and state net operating loss carry forwards of approximately $4,473,000
and
$4,286,000 respectively. The net federal operating loss carry forwards
begin to
expire in 2023 and net state operating loss carry forwards begin to expire
in
2013.
The
primary components of temporary differences that give rise to the Company’s net
deferred tax are as follows:
The
components of deferred income tax (benefit) are as follows:
2006
2005
Deferred
tax asset:
Net
operating losses
$
1,681,857
$
835,366
Temporary
differences
(41,190
)
(34,338
)
Total
1,640,667
801,028
Valuation
allowance
(674,117
)
--
$
966,550
$
801,028
The
components of deferred income tax expense (benefit) are as
follows:
Net
operating income (losses)
$
(704,964
)
$
626,907
Temporary
differences
30,847
26,624
Total
674,117
653,531
Increase
in valuation allowance
(674,117
)
--
--
653,531
Income
taxes, current
800
800
$
800
$
654,331
The
following is a reconciliation of the amount of income tax expense (benefit)
that
would result from applying the statutory federal income tax rates to pre-tax
loss and the reported amount of income tax expense (benefit):
2006
2005
Tax
expense (benefit) at federal statutory
$
(1,024,892
)
$
585,174
Beneficial
conversion feature
256,758
--
Accretion
of discount on convertible debt
197,536
--
Other
(40,424
)
3,352
Depreciation
and organization costs
2,120
(20,842
)
State
income tax expense (benefit)
(64,415
)
86,647
Increase
in valuation allowance related to net operating loss carryforwards
and
changes in temporary differences
674,117
--
$
800
$
654,331
F-15
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
4 - INCOME TAXES (Continued)
At
September 30, 2006, the Company has provided a partial valuation allowance
for
the deferred tax asset since management has determined that the realization
of a
portion of that asset is more likely than not. The net change in the valuation
allowance for the nine months ended September 30, 2006 is $674,117.
During
2005, the board of directors amended the Articles of Incorporation of the
Company to increase the authorized shares to 50,000,000 from 10,000,000
shares.
In January 2005, the Company implemented an Employee Stock Option Plan
(“ESOP”),
which consists
of equity programs that provide for the granting of Incentive Stock Options
or
Nonstatutory Stock Options, the issuance of Stock appreciation rights,
Stock
Purchase Rights and awards of stock. Under the terms of the 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 have a maximum term of ten
years
and generally vest over aperiod
of
service or attainment of specified performance objectives. The maximum
aggregate
amount of options that may be granted is 931,734 shares.
As
of
September 30, 2006 and 2005, 163,053 and 561,953 of the options granted
are not
vested with an estimated remaining value of $1,683 and $5,788 and a weighted
average vesting life of .26 years. At September 30, 2006 and 2005, 163,053
and
253,315 of these options were exercisable at an exercise price of $0.0107
and
will expire in 2015.
During
the nine months ended September 30, 2006, 100,939 of employee stock options
were
exercised for total proceeds to the Company of $1,083. The Company issued
100,939 shares of its common stock to two employees.
On
September 12, 2006, the holders of the Company’s convertible promissory notes
entered
into the Note Conversion and Warrant Lock-Up Agreement as described in
Note 8
and
converted the outstanding principal and accrued interest on the convertible
notes of $1,262,070 into 1,755,118 shares of the Company’s common
stock.
The rate
of conversion of these notes was lower than the market price of the Company’s
Common Stock on the date of issuance resulting in the recognition of the
beneficial conversion feature of $755,173. The warrants issued in connection
with this transaction were valued at $506,896 using the Black-Scholes option
pricing model with the following assumption: term of 5 years, a risk-free
interest rate of 4.62%, a dividend yield of 0% and volatility of 128% and
was
charged to interest expense. There were no fees paid in connection with
this
agreement.
On
September 12, 2006, Mr. Guseinov transferred an aggregate of 186,354 shares
of
common stock back to the Company for cancellation. In turn, the Company
issued an aggregate of 186,354 shares of common stock to its bridge lenders,
on
a pro rata basis; in consideration of the bridge lenders agreeing to enter
into the Note Conversion and Warrant Lock-Up Agreement described
above. The value of the shares issued to the bridge lenders was $1.073 per
share or $200,000 and was charged to interest expense.
NOTE
6 - NOTE PAYABLE - RELATED PARTY
In
January 2005, the Company entered into an asset purchase agreement with
Unionway
Int’l, LLC whereby the Company purchased certain assets of Unionway Int’l, LLC
that principally include the software application Cyber-Defender™ and associated
rights for $200,000. The Company paid $8,333 at closing and issued a promissory
note in connection with the purchase to Unionway Int’l, LLC for $191,667. The
terms of the note call for monthly payments due on the first of each month
in
the amount of $8,333. Interest shall accrue at the rate of 7% per annum
and is
payable in a lump sum on September 1, 2007, provided that such interest
shall be
waived if all payments are received by Unionway Int’l, LLC by the third day of
each month. In addition the Company has retained the principal of Unionway
Int’l, LLC as an employee and has issued an Incentive Stock Option for the
purchase of 326,107 shares of the Company’s common stock. The exercise price is
$0.01 per share. The first 186,347 share options shall vest over a period
of 24
months at the rate of 7,765 shares per month. The option to purchase 46,587
share options shall vest if the company enters into a binding agreement
to sell
all or part of the Company in a transaction in which the Company is valued
at
$201 million. The option to purchase the remaining 93,173 share options
shall
vest if the company enters into a binding agreement to sell all or part
of
theCompany
in a transaction in which the Company is valued at $250 million. At September30, 2006 the current balance outstanding was $83,335. At September 30,2006 the
Company was in default under the terms of the agreement. Unionway Int’l, LLC has
waived the default and has agreed to acceptpayment
of the remaining balance on the note and any
F-17
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
6 - NOTE PAYABLE - RELATED PARTY (Continued)
accrued
but unpaid interest in exchange for 186,347 shares of the Company’s common stock
to be issued in October 2006.
NOTE
7 - CAPITAL LEASE OBLIGATIONS
The
Company leases certain furniture and other equipment under a lease with
a
bargain purchase option. The following is a schedule by fiscal years of
the
future minimum lease payments under this capital lease together with the
present
value of the net minimum lease payments at September 30, 2006:
2007
$
24,181
2008
24,181
2009
24,181
2010
6,735
Thereafter
--
Total
minimum lease payments
79,278
Less
amount representing interest
(15,027
)
Present
value of minimum capitalized payments
64,251
Less
current portion
(16,739
)
Long-term
capital lease obligations
$
47,512
Property
and equipment and accumulated depreciation included $80,846 and $13,994
acquired
through capital leases, respectively as of September 30, 2006. Depreciation
expense of $6,629 and $5,156 is included in the total depreciation expense
for
the periods ended September 30, 2006 and 2005. Interest expense under the
lease
was $4,194 and $3,837 for the periods ended September 30, 2006 and 2005,
respectively.
NOTE
8 - CONVERTIBLE NOTE PAYABLE
On
June15, 2005the Company entered into a Note Purchase Agreement with an accredited
investor in which it issued a Convertible Promissory Note in the amount
of
$50,000. The note bears interest at a rate of 1% per annum and the maturity
date
is December 15, 2005. The note is convertible into common stock of the
Company.
On November 8, 2005, in accordance with the terms of the note, the outstanding
principal and accrued interest of the note was cancelled and the Company
issued
to the holder in
lieu
thereof a secured convertible promissory note in the principal amount of
$50,000. The note issued on November 8, 2005 in lieu of the June 15, 2005
note
is one of the notes issued between November 8, 2005 and March 31, 2006,
as
described below.
At
various times between November 8, 2005 and March 31, 2006the Company has
entered into Securities Purchase Agreements with accredited investors in
which
it issued Senior Secured Convertible Promissory Notes totaling $1,225,000.
The
notes bear interest at the rate of 9.96% per annum compounded monthly and
mature
between
F-18
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
8 - CONVERTIBLE NOTE PAYABLE (Continued)
November8, 2006 and March 31, 2007. The notes are secured by a perfected first
priority
security interest in all of the assets of the Company except for any assets
that
were covered by a security interest granted to other lenders that existed
before
November 8, 2005. The notes and any accrued interest may be voluntarily
converted by the holder into shares of the Company’s common stock at the
conversion price equal to
the
lesser of (i) 41.46% of the price per share of common stock based on the
price
per share of equity securities sold by the Company following the closing
date in
one transaction or a series of related transactions in exchange for an
aggregate
consideration of at least $2,000,000 (exclusive of any indebtedness of
the
company) (a “Qualified Offering”) subsequent to the closing, provided that if
such offering consists of any securities convertible into common stock,
then the
initial conversion price shall be 41.46% of the conversion price of such
securities (the “Securities Conversion Price”), or (ii) $ 0.68 to $.7089 per
share (depending on the issue date of the notes) in the event that a qualified
offering has not occurred at the time of the conversion, provided that
conversion may not occur within the first 60 days following the closing
date. If
the Company is a party to any consolidation or merger with a publicly traded
entity the note and any accrued interest is automatically converted into
shares
of the Company at a price per share equal to the price as necessary to
ensure
that the holder receives common stock in the public company at a 33% discount
to
the offering price of such common stock offered by the public company in
conjunction with the merger of the Company.
In
connection with the issuance of the Secured Convertible Promissory Notes
as
described above the Company issued Warrants to Purchase Common Stock of
the
Company to those same investors. The Warrants entitle the Holder to purchase
a
number of shares of common stock of the Company equal to 50% of the number
of
shares of Common Stock into which Holder’s Convertible Promissory Note is
convertible at the time of exercise of the Warrant, or if the Holder’s
Convertible Promissory Note is converted prior to the time of exercise
of the
Warrant, then 50% of the actual number of shares of Common Stock into which
Holder’s Convertible Promissory Note was converted shares of the Common Stock.
The Warrants have a term that ends between November 8, 2015 and March 31,2016.
The price at which the Warrant may be exercised shall be (i) a price per
share
equal to the price as is necessary to ensure that the Holder receives stock
of
the reverse merger company (the “Public Company”) at a price equal to the
offering price of such common stock offered by the Public Company in
conjunction
with the merger with the Company (the "Merger"), or (ii) in the event the
Merger
has not occurred, 93.9% of the price per share of Common Stock based upon
the
price per share of equity securities sold by the Company following the
Closing
Date in one transaction or a series of related transactions in exchange
for
aggregate consideration of at least $2,000,000 (exclusive of the conversion
of
any indebtedness of the Company) (a “Qualified Offering”), provided that if such
offering consists of securities
convertible
into Common Stock, then the initial conversion price shall be 93.9% of
the
conversion price of such securities, or (iii) $1.54 per share in the event
that
the Merger or a Qualified Offering has not occurred at the time of exercise,
provided that exercise under this clause (iii) may not occur within the
first 60
days following the Closing Date
F-19
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
8 - CONVERTIBLE NOTE PAYABLE (Continued)
(the
"Exercise Price"); in any case, as such Exercise Price may be adjusted
from time
to time.
On
July27, 2006, the Company entered into a Securities Purchase Agreement with
two
accredited investors pursuant to which the Company sold to each investor
an 8%
secured convertible note in the principal amount of $250,000, for aggregate
gross proceeds of $500,000.
The
Company paid a total of $35,000 of fees in connection with this agreement.
On
September 12, 2006, in accordance with the terms of the notes, each note
was
exchanged for a 10% secured convertible debenture, at a conversion rate
of 1.15
plus accrued interest, in the principal amount of $290,439 and a warrant
to
purchase 290,439 shares of common stock.
On
August18, 2006, the Company entered into a Note Conversion and Warrant Lock-Up
Agreement with the holders of previously outstanding secured convertible
promissory notes and outstanding warrants to purchase an aggregate of 877,552
shares of the Company’s common stock at an exercise price of $1.01 per share.
Pursuant to the Note Conversion and Warrant Lock-Up Agreement, these security
holders converted all $1,262,070 of outstanding principal and accrued interest
of their secured convertible promissory notes into an aggregate of 1,755,118
shares of the Company ‘s common stock, on September 12, 2006, and they agreed
not to sell or transfer any of the 877,552 common stock purchase warrants
for a
period of one year from the effective date of a Registration Statement
to be
filed with the United States Securities and Exchange Commission (SEC).
In
addition, on September 12, 2006, these security holders entered into a
Lock-Up
Agreement with the Company pursuant to which they agreed not to sell or
transfer
during the six month period following the effective date a Registration
Statement to be filed with the SEC any of the 1,755,118 shares that they
received upon conversion of their secured convertible promissory notes,
and
thereafter they may sell or transfer only limited amounts of these shares
over a
period of eighteen months, after which the transfer restrictions will have
expired. The Company has accounted for the conversion of the debentures
according to EITF 98-5 and EITF 00-27. The value of the conversion was
allocated
between the warrants and the beneficial conversion feature which amounted
to
$506,896 and $755,173, respectively. The discount related to the warrants
of
$506,896 has been fully amortized as of September 30, 2006. The Company
amortized $506,896 and $0 to interest expense for the nine months ended
September 30, 2006 and 2005, respectively. The value of the beneficial
conversion feature of $755,173 is recorded as a charge to interest expense.
There were no fees paid in connection with this agreement.
On
September 12, 2006, the Company entered into a Securities Purchase Agreement
with 13 accredited investors pursuant to which it sold 10% secured convertible
debentures in the aggregate principal amount of $3,243,378 and common stock
purchase warrants to purchase an aggregate of 3,243,378 shares of the Company’s
F-20
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
8 - CONVERTIBLE NOTE PAYABLE (Continued)
common
stock at $1.00 per share. This aggregate principal amount of $3,243,378
includes
the conversion of the Company’s previously outstanding 8% secured notes, as
discussed in the fourth paragraph of this Note 8 in the principal amount
of
$580,878 and a subscription by the Company’s attorneys for $62,500 of 10%
secured convertible debentures and warrants, which was paid for by cancelling
$62,500 of indebtedness incurred by the Company for legal services. The
debentures are due on September 12, 2009. The Company has accounted for
the
debentures according to EITF 98-5 and EITF 00-27. The value of the debentures
was allocated between the debentures, the warrants and beneficial conversion
feature which amounted to $238,556 and $3,004,882, respectively. The discount
related to the warrants and beneficial conversion feature of $3,004,882
is being
amortized over the term of the debenture. The Company amortized $74,092
and $0
to interest expense for the nine months ended September 30, 2006 and 2005,
respectively. The remaining unamortized warrant and beneficial conversion
feature value of $2,930,790 is recorded as a discount on these convertible
notes
payable on the accompanying balance sheet. In addition, as part of the
transaction, the Company paid $217,000, issued 1,000,515 shares of common
stock
in November 2006 valued at $1,000,515, issued 217,000 units with each unit
consisting of 1 share of common stock and issued a warrant to purchase
1 share
of common stock for $1.00 per share in November 2006 valued at $374,531
using
the Black-Scholes option pricing model with the following assumptions:
term of 5
years, a risk-free interest rate of 4.62%, a dividend yield of 0%, and
volatility of 128% that were also issued in November 2006. These costs
are being
amortized over the term of the debentures. The Company recorded amortization
of
$39,256 and $0 to financing expense during the nine months ended September30,2006 and 2005, respectively. The unamortized amount of $1,592,790 is recorded
as
deferred financing costs in the accompanying balance sheet.
Convertible
notes payable consist of the following:
September
30
2006
10%
debentures outstanding
$
3,243,378
Unamortized
discount on debentures
(2,930,730
)
Convertible
notes payable, net
$
312,648
NOTE
9 - RELATED PARTY TRANSACTIONS
On
May 1,2005, the Company entered into a lease agreement for a condominium located
in
Las Vegas, Nevada with International Equity Partners, a Nevada limited
liability
company. Gary Guseinov, the Chief Executive Officer, is the manager of
International Equity Partners. The monthly base rent for this space is
$3,750.
The term of the lease was from May 1, 2005 until May 31, 2008; however,
the
lease was terminated by the mutual agreement of the parties in February,
2006.
Unionway
Int’l, LLC, an entity controlled by Bing Liu, the Company’s Chief Software
Architect, provides software development services to the Company. The Company
pays
F-21
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
9 - RELATED PARTY TRANSACTIONS (Continued)
$6,500
per month for such services. During the nine months ended September 30,2006,
the Company paid $58,500 to Unionway Int’l, LLC.
NOTE
10- COMMITMENTS AND CONTINGINGIES
Operating
Leases
The
Company's primary offices are in Los Angeles, California where it entered
into a
lease for office space beginning September 1, 2004 and terminating August31,2007. The base rent is $10,020 per month for year one, $10,310 per month
for
year two, and $10,619 for year three.
Previously,
the Company had entered into a lease in Los Angeles, California beginning
April15, 2004 and terminating on November 30, 2006 at a rate of $4,825 per month.
In
July 2005, the Company sub-leased this office space at the rate of $ 3,703
per
month for a period of one year beginning November 1, 2005 and terminating
on
October 31, 2006.
As
of
September 30, 2006, the Company's future minimum lease payments required
under
the operating leases with initial or remaining terms in excess of one year
are
as follows:
Total
rent expense for the nine month periods ended September 30, 2006 and 2005
was
$168,017 and $156,030, respectively.
Employment
Agreements
On
August31, 2006, the Company entered into an employment agreement with Gary Guseinov
pursuant to which Mr. Guseinov will act as Chief Executive Officer. The
agreement is for three years and unless terminated within that period will
renew
for successive one year periods until terminated. Mr. Guseinov receives
compensation of $225,000 per year and is entitled to participate in any
bonus
compensation plan the Company adopts from time to time, so long as any
such
bonus does not exceed more than 50% of his base salary for any 12 month
period.
On
November 1, 2005, the Company entered into an employment agreement with
Riggs
Eckelberry, pursuant to which Mr. Eckelberry will act as the Company’s President
and Chief Operating Officer. The agreement is “at will” and can be terminated at
any time. Mr. Eckelberry receives compensation of $260,000 per year, plus
a
quarterly bonus of up to $60,000 and an annual bonus of up to $100,000
in 2006
and $200,000 in 2007 based on the pro-rata accomplishment of agreed upon
quarterly and annual performance measures. On November 2, 2006, Mr. Eckelberry
received 200,000 stock
F-22
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
Employment
Agreements (Continued)
options
from the Company’s equity incentive plan with an estimated remaining value of
$193,629. On December 31, 2006, the Company’s agreement with Mr. Eckelberry
expired.
On
January 3, 2005, the Company entered into an employment agreement with
Bing Liu,
pursuant to which Mr. Liu will act as Chief Software Architect. The agreement
is
“at will” and can be terminated at any time. Mr. Liu receives compensation of
$202,500 per year, two percent of the net revenues that the Company earns
from
any invention created by Mr.
Liu
during the course of his employment and 326,107 stock options from the
Company’s
equity incentive plan as disclosed in Note 6 above.
On
September 1, 2003, the Company entered into an employment agreement with
Igor
Barash pursuant to which Mr. Barash will act as Chief Information Officer.
The
agreement is “at will” and can be terminated at any time. Mr. Barash receives
compensation of $135,000 per year.
Litigation
On
June16, 2006, the Company was named as a defendant in a civil complaint filed
with
the United States District Court, Central District of California, Western
Division, Case No. CV06-3815PA (AJWX). The action is entitled, “Wellbourne
Limited, a Seychelles
corporation vs. 2Checkout.com Inc., a Delaware corporation; and CyberDefender
Corporation, a California Corporation.” The complaint was for breach of
contract, unjust enrichment, accounting, and constructive trust based upon
an allegation that the Company failed to pay for certain Internet advertising
services allegedly provided by Wellbourne Limited to the Company. On July21,2006, a First Amended Complaint was filed by the Plaintiffs naming the
Company
and its CEO as defendants. The First Amended Complaint is for breach of
contract, fraud, conversion, theft of services, unjust enrichment, constructive
trust, and piercing the corporate veil based upon the same allegations
of the
original complaint, as well as additional alter ego allegations involving
the
Company's CEO. The Company is in the process of preparing and filing an
answer denying all liability under the First Amended Complaint. The
First Amended Complaint seeks monetary damages of $102,000 plus attorneys'
fees
and costs. Litigation is always uncertain. Accordingly, there can be no
assurance that the Company will prevail in this litigation. The Company
has
recorded a liability of $102,000 when the services were rendered; however,
it
disputes the charges.
In
addition, the Company in the ordinary course of business is generally subject
to
claims, complaints, and legal actions. At September 30, 2006, management
believes that the Company is not a party to any action, except as discussed
above, that would have a material impact on its financial condition, operations
or cash flows.
F-23
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIALS STATEMENTS
(unaudited)
NOTE
11 - SUBSEQUENT EVENTS
In
October, 2006, Mr. Guseinov and Mr. Barash agreed to return an aggregate
of
832,511 shares of common stock to the Company for cancellation. In turn,
the Company agreed to issue 646,164 shares of common stock to Mr. Liu for
his contribution to the development of the Company's product and
technology. The value of the shares issued to Mr. Liu was $1.07 per
share.
On
October 1, 2006, the Company issued 186,347 shares
of common stock to Mr. Liu in consideration of his agreement to exchange
the
balance of the Unionway Int'l LLC note, as described in Note 6
above.
On
October 30, 2006, the Company adopted and approved the Amended and Restated
2006
Equity Incentive Plan that
provides for the granting of Incentive Stock Options or Nonstatutory Stock
Options, the issuance of Stock appreciation rights, Stock Purchase Rights
and
awards of stock. Under the terms of the 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 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 is 1,375,000
shares.
On
November 2, 2006 and December 11, 2006, the Company’s Board of Directors
approved option grants in the amount of 1,148,944 shares to employees and
consultants at prices between $0.85 and $1.00 with an estimated remaining
value
of $1,109,796
using
the Black-Scholes option pricing model with the following assumptions:
term of
10 years, a risk-free interest rate of 4.60%, a dividend yield of 0%, and
volatility of 128%.
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The
Board
of Directors
CyberDefender
Corporation
Los
Angeles, California
We
have
audited the accompanying balance sheet of CyberDefender Corporation
(F/K/A
Network Dynamics Corp.) as of December 31, 2005, and the related statements
of
operations, changes in stockholders' equity (deficit), and cash flows
for each
of the years in the two year period then ended. These financial statements
are
the responsibility of the Company's management. Our responsibility
is to express
an opinion on these financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public
Company
Accounting Oversight Board (United States). Those standards require
that we plan
and perform the audits to obtain reasonable assurance about whether
the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as
evaluating the overall financial statement presentation. We believe
that our
audits provide a reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly,
in all
material respects, the financial position of CyberDefender Corporation
(F/K/A
Network Dynamics Corp.) as of December 31, 2005, and the results of
its
operations and its cash flows for each of the years in the two year
period then
ended, in conformity with generally accepted accounting principles
in the United
States of America.
CyberDefender
Corporation (the “Company”) provides Internet Security and Privacy Solutions
software products to consumers and enterprises. The Company’s suite of products
is aimed at controlling unsolicited e-mail, protecting personal
computers and
networks against unwanted advertising, Spyware, AdWare, viruses,
and hackers.
The Company was incorporated on August 29, 2003 under the laws
of the State of
California under the name of Network Dynamics Corp. On October13, 2005 the
Company changed it name to CyberDefender Corporation.
On
October 31, 2006the Company’s board of directors and those shareholders holding
a majority of the Company voting power approved a 0.93173414-for-1
reverse split
of the Company’s common stock. All common stock amounts are shown on a
post-split basis in these financial statements and notes and are
presented on a
unaudited basis.
Use
of Estimates
The
preparation of financial statements in conformity with generally
accepted
accounting principles requires management to make estimates and
assumptions that
affect the reported amounts of assets and liabilities and disclosure
of
contingent assets and liabilities at the date of the financial
statements and
the reported amounts of revenues and expenses during the reporting
period.
Actual results could differ from those estimates and assumptions.
Reclassification
Certain
amounts in the prior period financial statements have been reclassified
for
comparative purposes to conform to the presentation in the current
period
financial statements.
Cash
and Cash Equivalents
Cash
and
cash equivalents include cash on hand and investments with original
maturities
of three months or less.
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. Total depreciation expense was $84,496 and $4,754 for the
years ended
December 31, 2005 and 2004, respectively.
Equipment
under Capital Lease
The
Company leases certain of its furniture and other equipment under
an agreement
accounted for as a capital lease. 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 the estimated useful lives.
F-30
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair
Value of Financial Instruments
Unless
otherwise specified, the Company believes the carrying value of
financial
instruments approximates their fair value.
Revenue
Recognition
The
Company recognizes revenues in accordance with SOP No. 97-2, "Software
Revenue
Recognition," as amended by SOP No. 98-9, "Modification of SOP
97-2, Software
Revenue Recognition, With Respect to Certain Transactions." These
statements
provide guidance for recognizing revenues related to sales by software
vendors.
The Company sells its CyberDefenderTM software ("Cyberdefender")
over the
Internet. Customers order the product and simultaneously provide
their credit
card information to the Company. Upon receipt of authorization
from the credit
card issuer, the Company licenses the customer to download CyberDefender
over
the Internet. As part of the sales price, 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 and revenues and related expenses are deferred and recognized
ratably over
the subscription term.
Concentrations
of Risk
Revenues
are concentrated in the software industry, which is highly competitive
and
rapidly changing.Significant
technological changes in the industry or customer requirements,
or the emergence
of competitive products with new technologies or capabilities could
adversely
affect operating results.
The
Company maintains all cash in bank accounts, which at times may
exceed federally
insured limits. The Company has not experienced a loss in such
accounts.
For
the
years ended December 31, 2005 and 2004, advertising purchased from
four (4)
vendors accounted for 69% and 70% of the Company’s total advertising
expense.
Reserves
for Product Returns
The
Company’s policy with respect to product returns is defined in its End
User
License Agreement ("EULA"), which states "...products purchased
that are
downloadable are NOT refundable; however, the Company reserves
the right to
award refunds to a customer on a per case basis." For the years
ended December31, 2005 and 2004, the Company had accrued $0 for customer returns
and
chargebacks. The Company may voluntarily accept returns from a
customer from
time to time that are charged against revenues upon receipt of
the
return.
F-31
NOTE
1 - 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 Statement of Financial Accounting Standard (SFAS) No. 109, "Accounting
for
Income Taxes." Under SFAS No. 109, deferred income taxes are recorded
to reflect
tax consequences on future years for the differences between the
tax bases 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 bases.
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 individually classified as current and non-current
based on
their characteristics. Deferred tax assets are reduced by a valuation
allowance
when, in the opinion of management, it is more likely than not
that some portion
or all of the deferred tax assets will be realized.
Software
Development Costs
The
Company accounts for software development costs in accordance with
Statement of
Financial Accounting Standards ("SFAS") No. 86, "Computer Software
to Be Sold,
Leased, or Otherwise Marketed". Such costs are expensed prior to
achievement of
technological feasibility and thereafter are capitalized. There
has 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. For the years ended December 31,2005 and 2004
product development costs were $391,463 and $62,475, respectively.
Further, as
discussed in Note 7 the Company acquired the CyberDefenderTM software
application during the year.
Advertising
Expenses
Advertising
expenses are expensed as incurred and consist primarily of various
forms of
media purchased from Internet-based marketers and search engines.
For the years
ended December 31, 2005 and 2004, advertising expense amounted
to $1,413,716 and
$5,271,592 respectively.
F-32
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Interest
Expense
Interest
expense was $ 17,094 and $ 245 for the years ending December 31,2005 and 2004,
respectively.
Recently
Issued Accounting Pronouncements
In
December 2004, the FASB issued SFAS No. 123 (Revised), “Share-Based
Payment”.
This revised statement eliminates the alternative to use APB Opinion
No.
25’s intrinsic value method of accounting that was provided in SFAS
No. 123 as
originally issued. Under Opinion 25, issuing stock options to employees
generally resulted in recognition of no compensation cost. This statement
requires entities to recognize the cost of employee services received
in
exchange for awards of equity instruments based on the grant-date
fair value of
those awards. For public companies that file as a small business issuer,
this statement is effective as of the beginning of the first interim
or annual
reporting period that begins after December 15, 2005. The Company
believes the pronouncement will have a material impact on the financial
statements upon adoption.
In
December 2004, the FASB issued SFAS No. 153, “Exchanges
of Nonmonetary Assets— an Amendment of APB Opinion No.29”.
SFAS No. 153 amends Opinion 29 to eliminate the exception for nonmonetary
exchanges of nonmonetary assets that do not have commercial substance.
A
nonmonetary exchange has commercial substance if the future cash
flows of the
entity are expected to change significantly as a result of the
exchange.
The adoption of SFAS 153 did not impact the financial
statements.
In
May
2005, the FASB issued SFAS No. 154, entitled “Accounting
Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB
Statement No. 3”.
This
Statement replaces APB Opinion No. 20, “Accounting
Changes”
and
FASB Statement No. 3, “Reporting
Accounting Changes in Interim Financial Statements”,
and
changes the requirements for the accounting for and reporting of
a change in
accounting principle. This statement applies to all voluntary changes
in
accounting principle. It also applies to changes required by an
accounting
pronouncement in the unusual instance that the pronouncement does
not include
specific transition provisions. Opinion 20 previously required
that most
voluntary changes in accounting principle be recognized by including
in net
income of the period of the change the cumulative effect of changing
to the new
accounting principle. This statement requires retrospective application
to prior
periods’ financial statements of changes in accounting principle, unless
it is
impracticable to determine either the period-specific effects or
the cumulative
effect of the change. This statement defines retrospective
application
as the
application of a different accounting principle to prior accounting
periods as
if that principle had always been used or as the adjustment of
previously issued
financial statements to reflect a change in the reporting entity.
This Statement
also redefines restatement
as the
revising of previously issued financial statements to reflect the
correction of
an error.The
adoption of SFAS 154 did not impact the financial statements.
F-33
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In
accordance with SFAS No. 128, “Earnings
Per Share,”
the
basic income/loss per common share is computed by dividing net
income/loss
available to common stockholders by the weighted average number
of common shares
outstanding. Diluted income/loss per common share is computed similar to
basic income/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. At December 31, 2005 and 2004 there were
1,952,081 and
zero potentially dilutive securities outstanding. The following
table is a
reconciliation of the numerators and denominators of the basic
and diluted
earnings per share computations for the year ended December 31,2005. There were
no potentially dilutive securities outstanding at December 31,2004.
SFAS
No. 123, “Accounting for Stock-Based Compensation,” establishes and
encourages the use of the fair value based method of accounting
for stock-based
compensation arrangements under which compensation cost is determined
using the
fair value of stock-based compensation determined as of the date
of grant and is
recognized over the periods in which the related services are rendered.
The
statement also permits companies to elect to continue using the
current
intrinsic value accounting method specified in Accounting Principles
Board
(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” to
account for stock-based compensation. The Company has elected to
use the
intrinsic value based method. At December 31, 2005 options for
815,268 shares
had been granted.
For
non-employee stock based compensation the Company recognizes an
expense in
accordance with SFAS No. 123 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 which ever is more readily available. Stock option
awards are
valued using the Black-Scholes option-pricing model.
F-34
NOTE
2 - RESTRICTED CASH
Under
a
credit card processing agreement with a financial institution the
Company was
required to maintain a security reserve deposit as collateral.
The amount of the
deposit that was at the discretion of the financial institution
and as of
December 31, 2005 was $26,747.
As
of
December 31, 2005, the Company had federal net operating loss carry
forwards and
state net operating loss carry forwards of approximately $2,598,000
and
$2,581,000 respectively. The net federal operating loss carry forwards
begin to
expire in 2023 and net state operating loss carry forwards begin
to expire in
2013.
The
primary components of temporary differences that give rise to the
Company’s net
deferred tax is as follows:
The
components of deferred income tax (benefit) are as follows:
2005
2004
Deferred
tax asset:
Net
operating losses
$
976,893
$
1,467,574
Temporary
differences
(10,343
)
(13,015
)
$
966,550
$
1,454,559
The
components of deferred income tax (benefit) are as
follows:
Net
operating losses
$
490,681
$
(1,384,667
)
Temporary
differences
(2,672
)
14,680
488,009
(1,369,987
)
State
income tax, current
800
800
$
488,809
$
(1,369,187
)
F-35
NOTE
4 - INCOME TAXES (Continued)
Following
is a reconciliation of the amount of income tax expense (benefit)
that would
result from applying the statutory federal income tax rates to
pre-tax loss and
the reported amount of income tax expense (benefit):
During
2005, the board of directors amended the Articles of Incorporation
of the
Company to increase the authorized shares to 50,000,000 from 10,000,000
shares.
From
time
to time the board of directors at their discretion will determine
to pay
dividends to the shareholders of the Company. During the year ended
December 31,2005, the board of directors authorized dividends totaling $31,400
that were
paid to shareholders that were not officers of the Company at the
rate of $.05
per share.
In
January 2005, the Company implemented an Employee Stock Option
Plan (“ESOP”),
which consists
of equity programs that provide for the granting of Incentive Stock
Options or
Nonstatutory Stock Options, the issuance of Stock appreciation
rights, Stock
Purchase Rights and awards of stock. Under the terms of the 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 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 shares
that may be
optioned or granted is 931,734 shares.
During
2005, 815,268 options were granted to employees all with an exercise
price of
$0.0107. The options are exercisable over a 10 year period and
vest over two
years with equal amounts vesting on a monthly basis. No options
were exercised
or canceled in 2005. The options are valued at $0, weighted average
remaining
contractual life is nine (9) years and the total number exercisable
at December31, 2005 is 337,754.
F-36
NOTE
6 - NOTE PAYABLE - RELATED PARTY
In
January 2005, the Company entered into an asset purchase agreement
with Unionway
Int’l, LLC whereby the Company purchased certain of the assets of Union
Way that
principally include the software application Cyber-Defender™ and associated
rights for $200,000. The Company paid $8,333 at closing and issued
a promissory
note in connection with the purchase to Unionway Int’l, LLC for $191,667. The
terms of the note call for monthly payments due on the first of
each month in
the amount of $8,333. Interest shall accrue at the rate of 7% per
annum and is
payable in a lump sum on September 1, 2007, provided that such
interest shall be
waived if all payments are received by Unionway Int’l by the third day of each
month. All payments have been made timely. In addition the Company
has retained
the principal of Unionway Int’l, LLC as an employee and has issued an Incentive
Stock Option for the purchase of 326,107 shares of the Company’s common stock.
The exercise price is $0.0107 per share. The first 186,347 share
options shall
vest over a period of 24 months at the rate of 7,765 shares per
month. The
option to purchase 46,587 share options shall vest if the company
enters into a
binding agreement to sell all or part of the Company in a transaction
in which
the Company is valued at $201 million. The option to purchase the
remaining
93,173 share options shall vest if the company enters into a binding
agreement
to sell all or part of the Company in a transaction in which the
Company is
valued at $250 million. At December 31, 2005 the current balance
outstanding was
$100,002.
NOTE
7 - CAPITAL LEASE OBLIGATIONS
The
Company leases certain furniture and other equipment under a lease
with a
bargain purchase option. The following is a schedule by fiscal
years of the
future minimum lease payments under this capital lease together
with the present
value of the net minimum lease payments at December 31, 2005:
2006
$
16,162
2007
16,162
2008
16,162
2009
16,162
Thereafter
2,694
Total
minimum lease payments
67,342
Less
amount representing interest
(13,574
)
Present
value of minimum capitalized payments
53,768
Less
current portion
(10,752
)
Long-term
capital lease obligations
$
43,016
F-37
NOTE
7 - CAPITAL LEASE OBLIGATIONS (Continued)
Property
and equipment and accumulated depreciation included $61,867 and
$ 7,365 acquired
through capital leases as of December 31, 2005. Depreciation expense
of $7,365
and $ 0 is included in the total depreciation expense for the years
ended
December 31, 2005 and 2004. Interest expense under the lease was
$5,369 and $0
for the years ended December 31, 2005 and 2004, respectively.
NOTE
8 - CONVERTIBLE NOTE PAYABLE
On
June15, 2005the Company entered into a Note Purchase Agreement with
an accredited
investor in which it issued a Convertible Promissory Note in the
amount of
$50,000. The note bears interest at a rate of 1% per annum and
the maturity date
is December 15, 2005. The note is convertible into common stock
of the Company.
On November 8, 2005, in accordance with the terms of the note,
the outstanding
principal and accrued interest of the note was cancelled and the
Company issued
to the holder in lieu thereof a secured convertible promissory
note in the
principal amount of $50,000. The note issued on November 8, 2005
in lieu of the
June 15, 2005 note is one of the notes issued on November 8, 2005,
as described
below.
On
November 8, 2005the Company entered into a Note Purchase Agreement
with
accredited investors in which it issued Senior Secured Convertible
Promissory Notes in the amount of $800,000, including the amount
referenced in
the preceding paragraph. The notes bears interest at the rate of
9.96% per annum
compounded monthly and mature on November 8, 2006. The note is
secured by a
perfected first priority security interest in all of the assets
of the Company
except for any assets that were covered by a security interest
granted to other
lenders that existed before November 8, 2005. The note and any
accrued interest
may be voluntarily converted by the holder into shares of the Company’s common
stock at the conversion price equal to the lesser of (i) 41.46%
of the price per
share of common stock based on the price per share of equity securities
sold by
the Company following the closing date in one transaction or a
series of related
transactions in exchange for an aggregate consideration of at least
$2,000,000
(exclusive of any indebtedness of the company) (a “Qualified Offering”)
subsequent to the closing, provided that if such offering consists
of any
securities convertible into common stock, then the initial conversion
price
shall be 41.46% of the conversion price of such securities (the
“Securities
Conversion Price”), or (ii) $ 0.68 per share in the event that a qualified
offering has not occurred at the time of the conversion, provided
that
conversion may not occur within the first 60 days following the
closing date. If
the Company is a party to any consolidation or merger with a publicly
traded
entity the note and any accrued interest is automatically converted
into shares
of the Company at a price per share equal to the price as necessary
to ensure
that the holder receives common stock in the public company at
a 33% discount to
the offering price of such common stock offered by the public company
in
conjunction with the merger of the Company.
In
connection with the issuance of the Secured Convertible Promissory
Notes as
described above the Company issued Warrants to Purchase Common
Stock of the
Company to those same certain investors. The Warrants entitle the
Holder to
purchase a number of shares of common stock of the Company equal
to 50% of the
number of shares of Common Stock into which Holder’s Convertible Promissory Note
is convertible at the time of exercise of the Warrant, or if the
Holder’s
Convertible Promissory Note is converted prior to the time of exercise
of the
Warrant, then 50% of the actual number of shares of Common Stock
into which
Holder’s Convertible Promissory Note was converted shares of the Common
Stock.
The
price
at which the Warrant may be exercised shall be (i) a price per
share equal to
the price as is necessary to ensure that the Holder receives stock
of the
reverse merger company (the “Public Company”) at a price equal to the offering
price of such common stock offered by the Public Company in conjunction
with the
merger with the Company (the "Merger"), or (ii) in the event the
Merger has not
occurred, 93.9% of the price per share of Common Stock based upon
the price per
share of equity securities sold by the Company following the Closing
Date in one
transaction or a series of related transactions in exchange for
aggregate
consideration of at least $2,000,000 (exclusive of the conversion
of any
indebtedness of the Company) (a “Qualified Offering”), provided that if such
offering consists of securities convertible into Common Stock,
then the initial
conversion price shall be 93.9% of the conversion price of such
securities, or
(iii) $1.54 per share in the event that the Merger or a Qualified
Offering has
not occurred at the time of exercise, provided that exercise under
this clause
(iii) may not occur within the first 60 days following the Closing
Date (the
"Exercise Price"); in any case, as such Exercise Price may be adjusted
from time
to time.
NOTE
9 - RELATED PARTY TRANSACTION
The
Company leases an apartment in Las Vegas, Nevada for the primary
benefit of the
Company’s Chief Executive Officer and majority stockholder from International
Equity Partners (IEP). IEP is partially owned by the majority shareholder
of the
Company. The lease term is for three years beginning May 1, 2005
and terminating
May 31, 2008. The rent is $3,750 per month for the term of the
lease.
Unionway
Int’l, LLC., an entity controlled by Bing Liu, our Chief Software Architect,
provides software development services to the Company. During the
twelve months
ended December 31, 2005, the Company paid $145.500 of software
development costs
to Unionway Int’l, LLC.
NOTE
10 - COMMITMENTS AND CONTINGINGIES
Operating
Leases:
The
Company's primary offices are in Los Angeles, CA where it entered
into a lease
for office space beginning September 1, 2004 and terminating August31, 2007.
The base rent is $10,020 per month for year one, $10,310 per month
for year two,
and $10,619 for year three.
F-39
NOTE
10 - COMMITMENTS AND CONTINGINGIES (Continued)
Previously,
the Company had entered into a lease in Los Angeles, California
beginning April15, 2004 and terminating on November 30, 2006 at a rate of $4,825
per month. In
July 2005 the Company sub-leased this office space at the rate
of $ 3,703 per
month for a period of one year beginning November 1, 2005 and terminating
on
October 31, 2006.
Total
rent expense for the years ended December 31, 2005 and 2004 was
$225,793 and
$85,836, respectively.
Merger
Agreement:
In
June
2005, the Company signed a term sheet with Calico Capital, LLC
(“Calico”),
whereby; Calico will assist the Company and a publicly traded company
(“Pubco”)
to enter into a reverse triangular merger agreement and concurrent
private
placement of equity shares of the Company. In October 2005, ARC
Investment
Partners, LLC (ARC) joined Calico as the lead partner in the
process.
In
November 2005 the Company engaged Wedbush Morgan Securities (WMS)
to act as its
lead placement agent in connection with the sale of up to $15 million
of equity
or equity-linked securities on a best efforts basis through a private
placement
or similar unregistered transaction to institutional investors.
The agreement is
for a term of six (6) months. Payments to WMS shall consist of
a cash retainer
fee of $25,000, a private placement fee to be paid in cash upon
consummation of
the transaction of 7% of the Gross Proceeds of the capital raised
by the
transaction, placement warrants consisting of five-year stock purchase
warrants
to be issued upon consummation of the transaction equivalent to
7% of the total
shares issued in the transaction with an exercise price equal to
110% of the
purchase price of the shares issued in the transaction.
NOTE
11 - SUBSEQUENT EVENTS
On
February 15, 2006 and February 22, 2006the Company entered into
Note Purchase
Agreements with certain accredited investors in which it issued
Secured
Convertible Promissory Notes in the amount of $150,000 and $50,000,
respectively. The notes are secured by a perfected security interest
in all of
the assets of the Company except for any assets that were covered
by a security
interest granted to other lenders that existed before February
15
and
February 22, 2007, respectively. The notes bear interest at the
rate of 9.96%
per annum compounded monthly and mature on February 15, 2007 and
February 22,2007.
F-40
NOTE
11 - SUBSEQUENT EVENTS (Continued)
The
notes
and any accrued interest may be voluntarily converted by the holder
into shares
of the Company’s common stock at the conversion price equal to the lesser of (i)
41.46% of the price per share of common stock based on the price
per share of
equity securities sold by the Company following the closing date
in one
transaction or a series of related transactions in exchange for
an aggregate
consideration of at least $2,000,000 (exclusive of any indebtedness
of the
company) (a “Qualified Offering”) subsequent to the closing, provided that if
such offering consists of any securities convertible into common
stock, then the
initial conversion price shall be 41.46% of the conversion price
of such
securities (the “Securities Conversion Price”), or (ii) $ 0.7089 per share in
the event that a qualified offering has not occurred at the time
of the
conversion, provided that conversion may not occur within the first
60 days
following the closing date. If the Company is a party to any consolidation
or
merger with a publicly traded entity the note and any accrued interest
is
automatically converted into shares of the Company at a price per
share equal to
the price as necessary to ensure that the holder receives common
stock in the
public company at a 33% discount to the offering price of such
common stock
offered by the public company in conjunction with the merger of
the
Company.
In
connection with the issuance of the Secured Convertible Promissory
Notes as
described above the Company issued Warrants to Purchase Common
Stock of the
Company to those same certain investors. The Warrants entitle the
Holder to
purchase a number of shares of common stock of the Company equal
to 50% of the
number of shares of Common Stock into which Holder’s Convertible Promissory Note
is convertible at the time of exercise of the Warrant, or if the
Holder’s
Convertible Promissory Note is converted prior to the time of exercise
of the
Warrant, then 50% of the actual number of shares of Common Stock
into which
Holder’s Convertible Promissory Note was converted shares of the Common
Stock.
The
price
at which the Warrant may be exercised shall be (i) a price per
share equal to
the price as is necessary to ensure that the Holder receives stock
of the
reverse merger company (the “Public Company”) at a price equal to the offering
price of such common stock offered by the Public Company in conjunction
with the
merger with the Company (the "Merger"), or (ii) in the event the
Merger has not
occurred, 93.9% of the price per share of Common Stock based upon
the price per
share of equity securities sold by the Company following the Closing
Date in one
transaction or a series of related transactions in exchange for
aggregate
consideration of at least $2,000,000 (exclusive of the conversion
of any
indebtedness of the Company) (a “Qualified Offering”), provided that if such
offering consists of securities convertible into Common Stock,
then the initial
conversion price shall be 93.9% of the conversion price of such
securities, or
(iii) $2.4085 per share in the event that the Merger or a Qualified
Offering has
not occurred at the time of exercise, provided that exercise under
this clause
(iii) may not occur within the first 60 days following the Closing
Date (the
"Exercise Price"); in any case, as such Exercise Price may be adjusted
from time
to time.
F-41
CYBERDEFENDER
CORPORATION
6,076,956
SHARES
COMMON
STOCK
PROSPECTUS
_________,
2007
Part
II
Item
24. Indemnification of Directors and Officers.
Section
317 of the California Corporations Code states that a corporation shall have
the
power to indemnify any person who was or is a party or is threatened to be
made
a party to any proceeding (other than an action by or in the right of the
corporation to procure a judgment in its favor) by reason of the fact that
the
person is or was an agent of the corporation, against expenses, judgments,
fines, settlements, and other amounts actually and reasonably incurred in
connection with the proceeding if that person acted in good faith and in a
manner the person reasonably believed to be in the best interests of the
corporation and, in the case of a criminal proceeding, had no reasonable cause
to believe the conduct of the person was unlawful. In addition, a corporation
shall have the power to indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending, or completed action
by
or in the right of the corporation to procure a judgment in its favor by reason
of the fact that the person is or was an agent of the corporation, against
expenses actually and reasonably incurred by that person in connection with
the
defense or settlement of the action if the person acted in good faith, in a
manner the person believed to be in the best interests of the corporation and
its shareholders.
With
regard to a provision authorizing the indemnification of directors or agents
in
excess of that expressly permitted by Section 317, Section 204 of the California
Corporations Code stipulates that (A) such a provision may not eliminate or
limit the liability of directors or agents, among other things, (i) for acts
or
omissions that involve intentional misconduct or a knowing and culpable
violation of law, (ii) for acts or omissions that a director or agent believes
to be contrary to the best interests of the corporation or its shareholders
or
that involve the absence of good faith on the part of the director or agent,
(iii) for any transaction from which a director or agent derived an improper
personal benefit, (iv) for acts or omissions that show a reckless disregard
for
the director's or agent's duty to the corporation or its shareholders in
circumstances in which the director or agent was aware, or should have been
aware, in the ordinary course of performing a director’s or agent’s duties, of a
risk of serious injury to the corporation or its shareholders, or (v) for acts
or omissions that constitute an unexcused pattern of inattention that amounts
to
an abdication of the director's or agent’s duty to the corporation or its
shareholders, (B) no such provision shall eliminate or limit the liability
of a
director or agent for any act or omission occurring prior to the date when
the
provision becomes effective, and (C) no such provision shall eliminate or limit
the liability of an officer for any act or omission as an officer,
notwithstanding that the officer is also a director or agent or that his or
her
actions, if negligent or improper, have been ratified by the
directors.
For
purposes of Section 317, “agent” means any person who is or was a director,
officer, employee or other agent of the corporation, or is or was serving at
the
request of the corporation as a director, officer, employee or agent of another
foreign or domestic corporation, partnership, joint venture, trust or other
enterprise, or was a director, officer, employee or agent of a foreign or
domestic corporation which was a predecessor corporation of the corporation
or
of another enterprise at the request of the predecessor corporation;
“proceeding” means any threatened, pending or completed action or proceeding,
whether civil, criminal, administrative or investigative; and “expenses”
includes without limitation attorneys’ fees and any expenses of establishing a
right to indemnification.
The
registrant’s Articles of Incorporation provide that the liability of the
directors for monetary damages shall be eliminated to the fullest extent under
California law. In addition, it provides that the registrant is authorized
to
provide indemnification to agents (as defined in Section 317) for breach of
duty
to the registrant and its shareholders through bylaw provisions or through
agreements with agents, or both, in excess of the indemnification permitted
by
Section 317, subject to the limits on such excess indemnification set forth
in
Section 204. The registrant’s bylaws provide that its directors and officers
shall be indemnified by the registrant to the fullest extent not prohibited
by
the California Corporations Code. The registrant’s bylaws also allow it to
purchase and maintain insurance on behalf of any agent (as defined in Section
317) against any liability asserted against or incurred by the agent in such
capacity or arising from the agent’s status as such, whether or not the
registrant would have the power to indemnify the agent against such liability
under the provisions of Section 317 of the California Corporations
Code.
II-1
On
October 30, 2006, the registrant entered into Indemnification Agreements with
Mr. Guseinov, Mr. Eckelberry, Mr. Ivankovich, Mr. Liu and Mr. Barash, who are
sometimes collectively referred to in this discussion as the “indemnified
parties” or individually referred to as an “indemnified party”. The agreements
require the registrant to provide indemnification for the indemnified parties
for expenses (including
attorneys’ fees, expert fees, other professional fees and court costs, and fees
and expenses incurred in connection with any appeals), judgments (including
punitive and exemplary damages), penalties, fines and amounts paid in settlement
(if such settlement is approved in advance by the registration, which approval
shall not be unreasonably withheld) actually and reasonably incurred by the
indemnified parties in connection with any threatened, pending or completed
action or proceeding (including actions brought on the registrant’s behalf, such
as shareholder derivative actions), whether civil, criminal, administrative
or
investigative, to which he is or was a party, a witness or other participant
(or
is threatened to be made a party, a witness or other participant) by reason
of
the fact that he is or was a director, officer, employee or agent of the
registrant or of any of the registrant’s subsidiaries. The indemnification
covers any action or inaction on the part of the indemnified party while he
was
an officer or director or by reason of the fact that he is or was serving at
request of the registrant as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise. The
registrant must advance the costs of the fees and expenses within 20 days
following the delivery of a written request from an indemnified party. The
indemnified parties have agreed to promptly repay the advances only if, and
to
the extent that, it is ultimately determined by the court (as to which all
rights of appeal therefrom have been exhausted or lapsed) that the indemnified
party is not entitled to the indemnity. The indemnified parties’ obligations to
repay the registrant for any such amounts are unsecured and no interest will
be
charged thereon. The registrant also agreed to indemnify the indemnified parties
to the fullest extent permitted by law, notwithstanding that such
indemnification is not specifically authorized by the other provisions of the
Indemnification Agreements, the registrant’s Articles of Incorporation, its
bylaws or by statute. In the event of any change, after the date of the
Indemnification Agreements, in any applicable law, statute or rule which expands
the right of a California corporation to indemnify a member of its board of
directors or an officer, such changes shall be within the purview of the
indemnified parties’ rights and the registrant’s obligations under the
Indemnification Agreements. In the event of any change in any applicable law,
statute or rule which narrows the right of a California corporation to indemnify
a member of its Board of Directors or an officer, such changes, to the extent
not otherwise required by such law, statute or rule to be applied to the
Indemnification Agreements will have no effect on the or the rights and
obligations of the indemnified parties and the registrant under them. The
indemnification provided by the Indemnification Agreements is not exclusive
of
any rights to which the indemnified parties may be entitled under the
registrant’s Articles of Incorporation, bylaws, any agreement, any vote of
shareholders or disinterested directors or the California Corporations Code.
The
indemnification provided under the Indemnification Agreements continues for
any
action taken or not taken while an indemnified party serves in an indemnified
capacity, even though he may have ceased to serve in such capacity at the time
of any action or other covered proceeding. If the indemnification provided
for
in the Indemnification Agreement is unavailable to an indemnified party, in
lieu
of indemnifying the indemnified party the registrant will contribute to the
amount incurred by him, whether for judgments, fines, penalties, excise taxes,
amounts paid or to be paid in settlement and/or for expenses, in connection
with
any claim relating to an indemnifiable event, in such proportion as is deemed
fair and reasonable by the court before which the action was brought. The
registrant not obligated to provide indemnification pursuant to the terms of
the
Indemnification Agreements
·
for
any acts or omissions or transactions from which a director may not
be
relieved of liability under the California General Corporation Law;
or for
breach by an indemnified party of any duty to the registrant or its
shareholders as to circumstances in which indemnity is expressly
prohibited by Section 317 of the California General Corporation Law;
or
·
with
respect to proceedings or claims initiated or brought voluntarily
by an
indemnified party not by way of defense, (except with respect to
proceedings or claims brought to establish or enforce a right to
indemnification) although such indemnification may be provided if
the
registrant’s Board of Directors has approved the initiation or bringing of
such proceeding or claim; or
II-2
·
with
respect to any proceeding instituted by the indemnified party to
enforce
or interpret the Indemnification Agreement, if a court of competent
jurisdiction determines that each of the material assertions made
by the
indemnified party in such proceeding was not made in good faith or
was
frivolous; or
·
for
expenses or liabilities of any type whatsoever which have been paid
directly to an indemnified party by an insurance carrier under a
policy of
directors’ and officers’ liability insurance maintained by the registrant;
or
·
for
expenses and the payment of profits arising from the purchase and
sale by
an indemnified party of securities in violation of Section 16(b) of
the Securities Exchange Act of 1934, as amended, or any similar successor
statute.
The
Indemnification Agreements are effective as of the date they were signed and
may
apply to acts or omissions of the indemnified parties which occurred prior
to
such date if the indemnified party was an officer, director, employee or other
agent of the registrant, or was serving at the request of the registrant as
a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, at the time such act or omission occurred.
All of obligations under the Indemnification Agreements will continue as long
as
an indemnified party is subject to any actual or possible matter which is the
subject of the Indemnification Agreement, notwithstanding an indemnified party’s
termination of service as an officer or director.
These
indemnification provisions included in the California Corporation’s Code, the
registrant’s Articles of Incorporation and bylaws and the Indemnification
Agreements may be sufficiently broad to permit indemnification of the
registrant’s executive officers and directors for liabilities (including
reimbursement of expenses incurred) arising under the Securities Act of 1933.
Item
25. Other Expenses of Issuance and Distribution.
The
following is an itemized statement of all expenses, all of which we will pay,
in
connection with the registration of the common stock offered
hereby:
Amount
SEC
registration fee
$
650.25
Printing
fees
*
$
5,000.00
Legal
fees
*
$
80,000.00
Accounting
fees and expenses
*
$
55,000.00
Miscellaneous
*
$
5,000.00
Total
*
$
155,650.25
*Estimates
Item
26. Recent Sales of Unregistered Securities.
During
the past three years, the registrant has issued and sold the following
unregistered securities. The discussions below take into account the reverse
stock split that was effected on October 30, 2006.
In
October 2006 the registrant agreed to issue 646,164 shares of common stock
to
Mr. Bing Liu, its Chief Software Architect, for
contribution
to the development of the registrant’s products and technology. The value of the
common stock was $1.07 per share. The shares were issued in reliance on the
exemption provided by Section 4(2) of the Securities Act of 1933, as
amended.
On
October 1, 2006, the registrant issued 186,347 shares of common stock to
Mr.
Bing Liu in payment of the balance due on a promissory note issued to Unionway
Int’l, LLC. The balance due was $83,335. The shares were issued in reliance
on
the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended.
II-3
On
October 30, 2006the registrant’s Board of Directors and its majority
shareholder approved the CyberDefender Corporation 2006 Equity Incentive
Plan
and set aside 1,375,000 shares of common stock for awards under this plan.
To
date, the registrant’s Board has approved stock option awards to 12 employees
and 4 consultants for a total of 934,007 shares. The terms of the options
vary.
The exercise price for the options shares is either $0.85 or $1.00 per share.
The registrant relied on Section 701 of the Securities Act of 1933, as amended,
to make these issuances.
On
or
about September 12, 2006, the registrant entered into a Securities Purchase
Agreement with 13 accredited investors pursuant to which it sold 10% secured
convertible debentures in the aggregate principal amount of $3,243,378 and
common stock purchase warrants to purchase an aggregate of 3,243,378 shares
of
our common stock at $1.00 per share. This aggregate principal amount of
$3,243,378 includes the conversion of $580,878 of principal and accrued interest
of the registrant’s previously outstanding 8% secured notes, as discussed in the
paragraph below. This amount also includes a subscription by the registrant’s
attorneys for $62,500 worth of 10% secured convertible debentures and warrants,
which was paid for by cancelling $62,500 of indebtedness incurred by the
registrant for legal services. In connection with their purchase of these
securities, the purchasers made representations that they were accredited
investors within the meaning of Regulation D under the Securities Act. These
issuances were exempt from registration requirements in reliance on Section
4(2)
of the Securities Act of 1933, as amended, or Regulation D promulgated
thereunder.
On
or
about August 18, 2006, the registrant entered into a Note Conversion and
Warrant
Lock-Up Agreement with the holders of previously outstanding secured convertible
promissory notes and outstanding warrants to purchase an aggregate of 877,552
shares of our common stock at an exercise price of $1.01 per share. Pursuant
to
the Note Conversion and Warrant Lock-Up Agreement, these security holders
agreed
to convert all $1,262,069.53 of outstanding principal and accrued interest
of
their secured convertible promissory notes into an aggregate of 1,755,105
shares
of our common stock, effective as of September 12, 2006, and they agreed
not to
sell or transfer any of the 877,552 shares underlying their common stock
purchase warrants for a period of one year from the effective date of this
Registration Statement. In addition, on or about September 12, 2006, these
security holders entered into a Lock-Up Agreement with the registrant pursuant
to which they agreed not to sell or transfer during the six month period
following the effective date of this Registration Statement any of the 1,755,105
shares that they received upon conversion of their secured convertible
promissory notes, and thereafter they may sell or transfer only limited amounts
of these shares over a period of eighteen months, after which the transfer
restrictions will have expired. In connection with their purchase of these
securities, the purchasers made representations that they were accredited
investors within the meaning of Regulation D under the Securities Act. These
issuances were exempt from registration requirements in reliance on Section
4(2)
of the Securities Act of 1933, as amended, or Regulation D promulgated
thereunder.
On
or
about July 27, 2006the registrant entered into a Securities Purchase Agreement
with two accredited investors pursuant to which the registrant sold to each
investor an 8% secured note in the principal amount of $250,000, for aggregate
gross proceeds of $500,000. In connection with their purchase of these
securities, the purchasers made representations that they were accredited
investors within the meaning of Regulation D under the Securities Act. These
issuances were exempt from registration requirements in reliance on Section
4(2)
of the Securities Act of 1933, as amended, or Regulation D promulgated
thereunder.
In
January 2005, the registrant entered into an asset purchase agreement with
Unionway Int’l, LLC, an entity controlled by the registrant’s director, Mr. Bing
Liu. At the closing, the registrant issued a promissory note to Unionway
Int’l,
LLC for $191,667. At September 30, 2006 the balance outstanding on the
promissory note was $83,335. Unionway Int’l, LLC agreed to accept payment of the
remaining balance on the note and any accrued but unpaid interest in exchange
for 186,347 shares of the registrant’s common stock. The registrant has agreed
to issue 186,347 shares of common stock to Mr. Liu for this payment. This
issuance will be exempt from registration requirements in reliance on Section
4(2) of the Securities Act of 1933, as amended.
II-4
On
March31, 2006, the registrant entered into a Securities Purchase Agreement with
accredited investors, pursuant to which the registrant sold Secured Convertible
Promissory Notes in the aggregate principal amount of $275,000 and common stock
purchase warrants to purchase an aggregate of 126,770 shares of our common
stock. On July 27, 2006the registrant repaid in full one of these notes in
the
principal amount of $100,000 plus interest. On September 12, 2006, the principal
amount and accrued interest of the remaining notes were converted into an
aggregate of 253,539 shares of common stock. In
connection with their purchase of these securities, the purchasers made
representations that they were accredited investors within the meaning of
Regulation D under the Securities Act. These issuances were exempt from
registration requirements in reliance on Section 4(2) of the Securities Act
of
1933, as amended, or Regulation D promulgated thereunder.
On
February 15, 2006, the registrant entered into a Securities Purchase Agreement
with accredited investors, pursuant to which the registrant sold Secured
Convertible Promissory Notes in the aggregate principal amount of $200,000
and
common stock purchase warrants to purchase an aggregate of 146,464 shares of
our
common stock. On September 12, 2006, the principal amount and all accrued
interest were converted into an aggregate of 293,607 shares of common stock.
In
connection with their purchase of these securities, the purchasers made
representations that they were accredited investors within the meaning of
Regulation D under the Securities Act. These issuances were exempt from
registration requirements in reliance on Section 4(2) of the Securities Act
of
1933, as amended, or Regulation D promulgated thereunder.
On
November 8, 2005, the registrant entered into a Securities Purchase Agreement
with accredited investors, pursuant to which the registrant sold Secured
Convertible Promissory Notes in the aggregate principal amount of $800,000
and
common stock purchase warrants to purchase an aggregate of 603,978 shares of
our
common stock. On September 12, 2006, the principal amount and all accrued
interest were converted into an aggregate of 1,207,954 shares of common stock.
In connection with their purchase of these securities, the purchasers made
representations that they were accredited investors within the meaning of
Regulation D under the Securities Act. These issuances were exempt from
registration requirements in reliance on Section 4(2) of the Securities Act
of
1933, as amended, or Regulation D promulgated thereunder.
On
December 31, 2004the registrant’s Board of Directors and its majority
shareholder approved the Network Dynamics, Inc. 2005 Employee Stock Option
Plan
and set aside 931,734 shares of common stock for awards under this plan.
One
option for the purchase of 326,107 shares of common stock has been granted
from
this plan to Bing Liu, the registrant’s Chief Software Architect and a director.
The term of the option is 10 years and the exercise price is $0.0107 per share.
The registrant relied on Section 701 of the Securities Act of 1933, as amended,
to make this issuance. In March and September 2006, two options for the purchase
of 100,939 of common stock were exercised at an exercise price of $0.01 per
share.
In
May
2004 the registrant closed an offering made to family and friends. The
registrant sold a total of 9,317 shares of its common stock at a price of $0.537
per share to two investors. The registrant relied on Section 504 of Regulation
D
of the Securities Act of 1933, as amended, to make the offering.
On
October 30, 2003the registrant closed an offering made to family and friends.
The registrant sold a total of 575,905 shares of its common stock at a price
of
$0.537 per share to 10 investors. The registrant relied on Section 504 of
Regulation D of the Securities Act of 1933, as amended, to make the
offering.
On
August29, 2003, the registrant issued 8,622,148 shares of common stock to Gary
Guseinov and 749,752 shares of common stock to Igor Barash in exchange for
cash
consideration of $8,622.15 and $749.75, respectively. These were founders’
shares. In connection with the purchase of these securities, the purchasers
occupied a status that afforded them effective access to the information
registration would otherwise provide. These issuances were exempt from
registration requirements in reliance on Section 4(2) of the Securities Act
of
1933, as amended.
II-5
Item
27. Exhibits.
3.1
Articles
of incorporation of the registrant, as amended**
Office
Lease between Maram Holdings LLC, a California limited liability
Company
as Landlord and Network Dynamics Corp., a California corporation
as Tenant
dated July 28, 2004*
10.17
Standard
Sublease dated March 26, 2004 between Networks Dynamics Corp. and
The
Paladin Companies, Inc. for the real property located at 12121
Wilshire
Boulevard, Suite 305, Los Angeles, California*
10.18
Residential
Lease Agreement - Nevada dated April 31, 2005 between Network Dynamics
Corporation and International Equity Partners for the real property
located at 2747 Paradise Road, Unit 1502, Las Vegas,
Nevada*
10.19
Asset
Purchase Agreement dated January 3, 2005 between Unionway International,
LLC and Network Dynamics, Inc.*
10.20
Monthly
Installment Note in the amount of $191,666.59 made by Network Dynamics,
Inc. in favor of Unionway International, LLC*
10.21
Irrevocable
Bill of Sale, Assignment and Conveyance dated January 3, 2005 between
Network Dynamics, Inc. and Unionway International, LLC*
1. To
file,
during any period in which offers or sales are being made, a post-effective
amendment to this registration statement to:
i.
Include
any prospectus required by section 10(a)(3) of the Securities Act
of
1933;
ii.
Reflect
in the prospectus any facts or events which, individually or together,
represent a fundamental change in the information in the registration
statement. Notwithstanding the foregoing,, any increase or decrease
in
volume of securities offered (if the total dollar value of securities
offered would not exceed that which was registered) any deviation
from the
low or high end of the estimated maximum offering range may be reflected
in the form of prospectus filed with the Commission pursuant to Rule
424(b) if, in the aggregate, the changes in volume and price represent
no
more than a 20% change in the maximum aggregate offering price set
forth
in the “Calculation of Registration Fee” table in the effective
registration statement; and
iii.
Include
any additional or changed material information on the plan of
distribution.
2. For
determining liability under the Securities Act of 1933, treat each
post-effective amendment as a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
3. File
a
post-effective amendment to remove from registration any of the securities
that
remain unsold at the end of offering.
4. Each
prospectus filed by the undersigned small business issuer pursuant to
Rule
424(b)(3)
shall be
deemed to be part of the registration statement as of the date the filed
prospectus was deemed part of and included in the registration statement;
and
5. Each
prospectus required to be filed pursuant to
Rule
424(b)(2),
(b)(5),
or
(b)(7)
as part
of a registration statement in reliance on Rule 430B relating to an offering
made pursuant to Rule
415(a)(1)(i),
(vii),
or
(x)
for the
purpose of providing the information required by section 10(a) of the Securities
Act shall be deemed to be part of and included in the registration statement
as
of the earlier of the date such form of prospectus is first used after
effectiveness or the date of the first contract of sale of securities in
the
offering described in the prospectus. As provided in Rule 430B, for liability
purposes of the issuer and any person that is at that date an underwriter,
such
date shall be deemed to be a new effective date of the registration statement
relating to the securities in the registration statement to which that
prospectus relates, and the offering of such securities at that time shall
be
deemed to be the initial bona fide offering thereof. Provided, however, that
no
statement made in a registration statement or prospectus that is part of
the
registration statement or made in a document incorporated or deemed incorporated
by reference into the registration statement or prospectus that is part of
the
registration statement will, as to a purchaser with a time of contract of
sale
prior to such effective date, supersede or modify any statement that was
made in
the registration statement or prospectus that was part of the registration
statement or made in any such document immediately prior to such effective
date
6. Insofar
as indemnification for liabilities arising under the Securities Act may be
permitted to our directors, officers and controlling persons under the foregoing
provisions or otherwise, we have been advised that in the opinion of the
SEC
such indemnification is against public policy as expressed in the Securities
Act
and is, therefore, unenforceable. If a claim for indemnification against
such
liabilities (other than our payment of expenses incurred or paid by any of
our
directors, officers or controlling persons in the successful defense of any
action, suit, or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, we
will,
unless in the opinion of our counsel the matter has been settled by a
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by us is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
II-7
SIGNATURES
In
accordance with the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of
the
requirements for filing on Form SB-2 and authorized this registration statement
to be signed on its behalf by the undersigned, in the City of Los Angeles,
State
of California on February 1, 2007.
CYBERDEFENDER
CORPORATION
By:/s/
Gary Guseinov
Gary
Guseinov
Chief
Executive Officer
Pursuant
to the requirements of the securities act of 1933, this registration statement
has been signed by the following persons in the capacities and on the dates
indicated:
