As
filed with the Securities and Exchange Commission on November __,
2006
Registration
Statement No. 333-
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
SB-2
REGISTRATION
STATEMENT UNDER THE SECURITIES ACT OF 1933
CyberDefender
Corporation
(Name
of
Small Business Issuer in Its Charter)
|
California
|
|
7372
|
|
65-1205833
|
|
(State
or other jurisdiction
of
incorporation or organization)
|
|
(Primary
Standard Industrial
Classification
Code Number)
|
|
(I.R.S.
Employer
Identification
No.)
|
12121
Wilshire Boulevard., Suite 350
(310)
826-1781
(Address
and telephone number of principal executive offices and principal place
of
business)
Gary
Guseinov
Chief
Executive Officer
CyberDefender
Corporation
12121
Wilshire Boulevard., Suite 350
(310)
826-1781
(Name,
address and telephone number of Agent for Service)
Copy
to:
Kevin
Friedmann, Esq.
RICHARDSON
& PATEL LLP
10900
WILSHIRE BOULEVARD, SUITE 500
(310)
208-1182
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
CALCULATION
OF REGISTRATION FEE
|
Title
of each class of securities to be
registered
|
Amount
to be
Registered
|
Proposed
maximum offering
price
per share
|
Proposed
maximum
aggregate
offering price
|
Amount
of registration
fee
|
|
Common
Stock, no par value per
share,
to be issued upon exercise of
warrants
|
3,013,478
|
$1.00
|
$3,013,478(1)
|
$322.45
|
|
Common
Stock, no par value per
share,
to be issued upon conversion
of
10% secured convertible
debentures
|
3,013,478
|
$1.00
|
$3,013,478(2)
|
$322.45
|
|
Common
Stock, no par value per
share
|
50,000
|
$1.00
|
$50,000
|
$5.35
|
|
Total
|
6,076,956
|
$1.00
|
$6,076,956
|
$650.25
|
(1)
Calculated in accordance with Rule 457(g) under the Securities Act
on the basis
of an exercise price of $1.00 per share.
(2)
Estimated solely for the purpose of calculating the registration fee
pursuant to
Rule 457(o) under the Securities Act of 1933.
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.
Subject
to Completion, dated November __, 2006
Prospectus
CyberDefender
Corporation
6,076,956
shares of Common Stock
This
prospectus covers the resale by selling shareholders named on page 38 of up
to 6,076,956 shares of our common stock, no par value per share, 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 September
12,
2006; and
|
| |
·
|
3,013,478
shares of common stock underlying the 10% secured convertible
debentures
issued in conjunction with the Securities Purchase
Agreement
|
This
offering is not being underwritten and our securities are not currently
listed
on any national securities exchange or the Nasdaq Stock Market.
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 3.
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 __________, 2006
Table
of Contents
|
Prospectus
Summary
|
1
|
|
Risk
Factors
|
3
|
|
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
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|
Management’s
Discussion and Analysis or Plan of Operation
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17
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|
Description
of Business
|
23
|
|
Directors,
Executive Officers, Promoters and Control Persons
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31
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|
Certain
Relationships and Related Transactions
|
36
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|
Selling
Shareholders
|
38
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|
Plan
of Distribution
|
39
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|
Security
Ownership of Certain Beneficial Owners and Management
|
41
|
|
Description
of Securities
|
43
|
|
Disclosure
of Commission Position on Indemnification for Securities Act
Liabilities
|
44
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Where
You Can Find More Information
|
47
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|
Experts
|
47 |
|
Legal
Matters and Interests of Named Experts
|
47
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|
Financial
Information
|
|
Prospectus
Summary
This
summary highlights information contained elsewhere in this prospectus.
It is not
complete and does not contain all of the information that you should
consider
before investing in our common stock. You should read the entire prospectus
carefully, including the section titled “Risk Factors” and our consolidated
financial statements and the related notes. In this prospectus, we refer
to
CyberDefender Corporation as “CyberDefender,” “our company,” “we,” “us” and
“our.”
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. In 2005 we acquired certain technology
that we
have used to develop software that provides threat protection for computers
by
quickly defining the threat and distributing information about it over
a secure
peer-to-peer network. 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.
Our
software users know this 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 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.
Our
corporate offices are located at 12121 Wilshire Blvd., Suite 350, Los
Angeles,
California 90025. Our telephone number is (310) 826-1781.
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
outstanding,
at 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, at an exercise 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;
|
| |
·
|
3,013,478
shares of common stock underlying common stock purchase warrants
issued
pursuant to a Securities Purchase Agreement dated as of September
12,
2006; and
|
| |
·
|
3,013,478
shares of common stock underlying 10% secured convertible debentures
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 listed below 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
of 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 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.
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 entitled “Description of Securities.”
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.
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 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
license revenues from sales of our
products;
|
| |
·
|
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.
|
Should
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 $479,954
for
the six months ended June 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.
We
may need additional funding, which may not be available to us on favorable
terms
or at all, to support our operations and capital expenditures. The lack
of
funding could materially adversely affect our business.
We
have
no committed sources of additional capital. For the foreseeable future,
we
intend to fund 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. However, we may 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 when required or is not
available
on acceptable terms, we may be unable to fund our expansion, successfully
promote our brand names, develop new products or enhance our services,
take
advantage of business opportunities, or respond to competitive pressures,
any of
which could 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 products effectively, our sales could
decline.
We
market
our products and related services over the Internet, primarily through
space
purchased from Internet-based marketers and search engines. 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 products, which could adversely affect the growth of
our
business and cause our revenues to decline.
We
have
many competitors in the markets for our products. 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 products 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, Symantec, McAfee, Computer Associates,
Alluria
Software, Microsoft 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 products, 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.
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. We must also keep pace with
technological developments and emerging industry standards. We intend
to commit
substantial resources to developing new software products and services,
including software products and services for the spyware, adware, viruses,
phishing or other malicious software code management markets. Each of
these
markets is new and unproven, and industry standards for these markets
are
evolving and changing. They also may require development of new channels.
If
these markets do not develop as anticipated, or if demand for our products
and
services in these markets does not materialize or occurs more slowly
than we
expect, we will have expended substantial resources and capital without
realizing sufficient revenue, 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.
Our
business and growth will suffer if we are unable to hire and retain highly
skilled personnel.
Our
ability to execute our business strategy depends on our ability to attract,
train, motivate and retain highly skilled employees. We may be unable
to retain
our skilled employees, or attract, assimilate and retain other highly
skilled
employees in the future. We have from time to time in the past experienced,
and
we expect to continue to experience in the future, difficulty in hiring
and
retaining highly skilled employees with appropriate qualifications. If
we are
unable to hire and retain skilled personnel, our growth may be restricted,
which
could adversely affect our future success.
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; Riggs Eckelberry,
our
President and Chief Operating 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. Eckelberry, 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 December 31, 2006 and Mr. Eckelberry will no longer be providing services
to
us as our President and Chief Operating Officer after December 31, 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.
New
rules,
including those contained in and issued under the Sarbanes-Oxley Act
of 2002,
may make it difficult for us to retain or attract qualified officers
and
directors, which could adversely affect the management of our business
and our
ability to obtain or retain quotation or listing of our common stock.
We
may be
unable to attract and retain qualified officers, directors and members
of board
committees required to provide for our effective management as a result
of the
recent and currently proposed changes in the rules and regulations which
govern
publicly held companies, including, but not limited to, certifications
from
executive officers and requirements for financial experts on the board
of
directors. The perceived increased personal risk associated with these
recent
changes may deter qualified individuals from accepting these roles. The
enactment of the Sarbanes-Oxley Act of 2002 has resulted in the issuance
of a
series of new rules and regulations and the strengthening of existing
rules and
regulations by the SEC.
Further,
certain of these recent and proposed changes heighten the requirements
for board
or committee membership, particularly with respect to an individual’s
independence from the corporation and level of experience in finance
and
accounting matters. We may have difficulty attracting and retaining directors
with the requisite qualifications. If we are unable to attract and retain
qualified officers and directors, the management of our business could
be
adversely affected.
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, copyright, trademark, trade secret,
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.
We
license some of our products under shrink-wrap license agreements that
are not
signed by licensees and therefore may be unenforceable under the laws
of some
jurisdictions. 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:
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be
time consuming to defend;
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result
in costly litigation;
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divert
management’s attention from our core
business;
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require
us to stop selling, delay shipping or redesign our product;
and
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require
us to pay monetary amounts as damages, for royalty or licensing
arrangements.
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In
addition, we license and use software from third parties in our business.
These
third party software licenses may not continue to be available to us
on
acceptable terms. Also, these third parties may from time to time receive
claims
that they have infringed the intellectual property rights of others,
including
patent and copyright infringement claims, which may affect our ability
to
continue licensing this software. Our inability to use any of this third
party
software could result in shipment delays or other disruptions in our
business,
which could materially and adversely affect our operating results.
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.
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.
Risks
Related With Ownership of Our Securities
In
certain instances the holders of our 10% secured convertible debentures
have
anti-dilution rights.
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.
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.
We
intend
to seek and obtain quotation of our common stock for trading on the OTC
Bulletin
Board, of which there can be no assurance. Even upon gaining such quotation,
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,
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.
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.
As
long
as the trading price of our common stock is below $5.00 per share, the
open-market trading of our common stock will be subject to the “penny stock”
rules. The “penny stock” rules impose additional sales practice requirements on
broker-dealers who sell securities to persons other than established
customers
and accredited investors (generally those with assets in excess of $1,000,000
or
annual income exceeding $200,000 or $300,000 together with their spouse).
These
regulations require the delivery, prior to any transaction involving
a penny
stock, of a disclosure schedule explaining the penny stock market and
the
associated risks. Under these regulations, certain brokers who recommend
such
securities to persons other than established customers or certain accredited
investors must make a special written suitability determination regarding
such a
purchaser and receive such purchaser’s written agreement to a transaction prior
to sale. These regulations have the effect of limiting the trading activity
of
the common stock, reducing the liquidity of an investment in the common
stock
and increasing the transaction costs for sales and purchases of our common
stock
as compared to other securities.
The
market price for our common stock could be particularly volatile given
our
status as a relatively unknown company with a small and thinly traded
public
float and limited operating history which could lead to wide fluctuations
in our
share price.
The
market for our common stock, if it develops, may be characterized by
significant
price volatility when compared to seasoned issuers, and we expect that
our share
price will continue to be more volatile than a seasoned issuer for the
indefinite future. The volatility in our share price will be attributable
to a
number of factors. First, as noted above, our common stock may be sporadically
and thinly traded. As a consequence of this lack of liquidity, the trading
of
relatively small quantities of shares by our shareholders may disproportionately
influence the price of those shares in either direction. The price for
our
shares could, for example, decline precipitously in the event that a
large
number of shares of our common stock are sold on the market without commensurate
demand, as compared to a seasoned issuer that could better absorb those
sales
without adverse impact on its share price. Secondly, we are a speculative
or
“risky” investment due to our limited operating history and uncertainty of
future market acceptance for our potential products and services. As
a
consequence of this enhanced risk, more risk averse investors may, under
the
fear of losing all or most of their investment in the event of negative
news or
lack of progress, be more inclined to sell their shares on the market
more
quickly and at greater discounts than would be the case with the stock
of a
seasoned issuer. Many of these factors are beyond our control and may
decrease
the market price of our common stock, regardless of our operating performance.
We cannot make any predictions or projections as to what the prevailing
market
price for our common stock will be at any time, including as to whether
our
common stock will sustain its current market price, or as to what effect
that
the sale of shares or the availability of common stock for sale at any
time will
have on the prevailing market price.
In
addition, the market price of our common stock could be subject to wide
fluctuations in response to:
· quarterly
variations in our revenues and operating expenses;
· announcements
of technological innovations or new products or services by us;
· significant
sales of our common stock by the selling stock holders;
· the
operating and stock price performance of other companies that investors
may deem
comparable to us; and
· news
reports relating to trends in our markets or general economic
conditions.
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 market and industry
fluctuations 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
our
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. Such concentrated control
may
adversely affect the price of our common stock. Our principal shareholders
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. In addition, certain provisions
of
California law could have the effect of making it more difficult or more
expensive for a third party to acquire, or of discouraging a third party
from
attempting to acquire, control of us. Accordingly, the existing principal
shareholders together with our directors and executive officers will
have the
power to control the election of our directors and the approval of actions
for
which the approval of our shareholders is required. If you acquire shares
of
common stock, you may have no effective voice in our management.
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. We cannot assure you that at such time, if ever,
as a
dividend on the common stock is declared, that we will lawfully be able
to pay
the dividends when due or at any time thereafter. Accordingly, investors
must
rely on sales of their common stock after price appreciation, which may
never
occur, as the only way to realize 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.
There
are limitations in connection with the availability of quotes and order
information on the OTC Bulletin Board.
Trades
and quotations on the OTC Bulletin Board involve a manual process, and
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.
There
are delays in order communication on the OTC Bulletin
Board.
Electronic
processing of orders is not available for securities traded on the OTC
Bulletin
Board and high order volume and communication risks may prevent or delay
the
execution of one’s OTC Bulletin Board trading orders. This lack of automated
order processing may affect the timeliness of order execution reporting
and the
availability of firm quotes for shares of our common stock. Heavy market
volume
may lead to a delay in the processing of OTC Bulletin Board security
orders for
shares of our common stock due to the manual nature of the market. Consequently,
one may not able to sell shares of our common stock at the optimum trading
prices.
There
is limited liquidity on the OTC Bulletin Board.
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. Due to lower trading volumes in shares
of
our common stock, there may be a lower likelihood of one’s orders for shares of
our common stock 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.
There
is a limitation in connection with the editing and canceling of orders
on the
OTC Bulletin Board.
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 one may not be able to cancel or edit one's
order.
Consequently, one may not able to sell shares of our common stock at
the optimum
trading prices.
Increased
dealer compensation could adversely affect the stock
price.
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 shares of our common
stock on
the OTC Bulletin Board if the stock must be sold immediately. Further,
purchasers of shares of our common stock 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 shares of our common stock on the OTC Bulletin Board.
Due
to the foregoing, demand for shares of our common stock on 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.
Special
Note Regarding Forward-Looking Statements
This
prospectus, including the sections titled “Prospectus Summary,” “Risk Factors,”
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and “Business,” contains forward-looking statements.
Forward-looking
statements include, but are not limited to, statements about:
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our
lack of capital and whether or not we will be able to raise
capital when
we need it;
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our
ability to market and sell our products;
and
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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.
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 hereunder. If received, such funds will be used for
general
corporate purposes, including working capital requirements. With the
exception
of any brokerage fees and commission 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 $130,650.25, 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 this amount, 8,298,490 shares
could be
sold pursuant to Rule 144 under the Securities Act of 1933, as amended
(assuming
compliance with the requirements of Rule 144), an additional 1,811,932
would be
available for sale pursuant to Rule 144 on November 8, 2006 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 326,107 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.
In
accordance with the Amended and Restated 2006 Equity Incentive Plan the
Board of
Directors has approved the issuance of options to employees to purchase
a total
of 972,944 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 stockholders, with the exception
of
stockholders 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.
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
place
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.
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”);
|
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.
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
|
1,299,051
|
|
906,746
|
|
Equity
compensation plans not
approved
by security holders
|
N/A
|
N/A
|
N/A
|
|
Total:
|
1,299,051
|
|
906,746
|
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 and related services. 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.
Our
revenues are currently derived from subscriptions to our software. We
currently
sell one product, our CyberDefender Anti-Spyware 2006 (CDAS), at a price
of
$39.99, which includes the initial download and one year of updates.
The license
to use the software is renewed annually, also at $39.99, with incentives
for
early renewals. We have historically 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, is broadcast in emails, banners and search
ads.
We
are
currently beta testing our Early Detection Center Internet Security Suite.
Our
plan is to offer the product free to subscribers who agree to accept
it with
advertising, and to offer subscribers who do not want advertising the
ability to
pay for their subscriptions. The price of this product has not yet been
determined. Comparable products sell for between $39 and $59 for the
first
year’s subscription.
Starting
in mid-2005, we began to invest in our proprietary technology. 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
are
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
recognize revenue 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.
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, from time to time, product support
and
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. Customers
are permitted to return a product once it is downloaded within 30 days
from the
date of purchase. During the six months ended June 30, 2006 and June
30, 2005,
we did not accrue any sum for product returns or chargebacks.
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.
Results
of Operations
Revenue
Total
revenue, which includes revenue from net sales, interest income and rental
income, was $2,340,220 for the six months ended June 30, 2006 as compared
to
total revenue of $3,981,691 for the six months ended June 30, 2005, a
decrease
of $1,641,471 or approximately 41%. This decrease in total revenue was
due
primarily to a decrease in the sales of our product as we invested our
resources
to the redirection of our business into a full-line security software
developer
to support our new technology.
Operating
Expenses
Total
operating expenses increased by $392,947, or approximately 14%, during
the six
months ended June 30, 2006, to $3,103,942 as compared to $2,710,995 in
total
operating expenses for the six months ended June 30, 2005. Operating
expenses
include credit card processing costs, research and development, selling,
general
and administrative expense and depreciation.
Advertising
Advertising
expenses are comprised primarily of costs associated with the acquisition
of
customers, primarily through on-line advertising.
Advertising
expenses decreased by $398,433, from $894,171 during the six months ended
June
30, 2005 to $495,738 during the six months ended June 30, 2006. This
decrease
was due to a redirection of our resources from advertising toward developing
our
new, full-line security software. During the six month periods ended
June 30,
2006 and 2005, four vendors accounted for 62% and 79% of our advertising
expense, respectively.
Selling,
General and Administrative
Selling,
general and administrative expenses are comprised of credit card processing
costs, research and development costs, executive management, rent, professional
fees and interest expense.
During
the six months ended June 30, 2006, the increase in selling, general
and
administrative expenditures of approximately $784,615, from $1,776,353
during
the six months ended June 30, 2005 to $2,560,968 during the six months
ended
June 30, 2006 is primarily attributable to the additional costs associated
with
credit card processing costs, software development costs, interest expense
and
the expansion of our executive management team to include a chief operating
officer, chief technology officer, chief marketing officer and a vice
president
of sales.
Credit
Card Processing
During
the six months ended June 30, 2006, direct costs consisting of credit
card
processing costs increased as compared to the six months ended June 30,
2005 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. Credit card
costs
during the six months ended June 30, 2006 represented approximately 10%
of
revenue, approximating $222,268.
Research
and Development
During
the six months ended June 30, 2006, research and development costs increased
by
$584,166, from $177,815 for the six months ended June 30, 2005 as compared
to
$761,981 for the six months ended June 30, 2006. This increase related
to
product sales research and development as new products are planned for
release.
In order to complete our planned product launches, we are increasing
research
and development personnel, augmenting the Early Alert Center Lab, and
incurring
additional third party developer tools and software costs.
Interest
expense
Interest
expense increased by $53,667, from $2,704 in the six months ended June
30, 2005
to $56,371 in the six months ended June 30, 2006. The increase in interest
expense was due to the issuance of $800,000 in convertible promissory
notes
during the last six months of the 2005 fiscal year as well as to the
issuance of
$375,000 in convertible promissory notes during the first six months
of the 2006
fiscal year.
Revenue
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.
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.
Advertising
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. 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. 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 using our resources to 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, executive management, rent, professional
fees and interest expense. Selling, general and administrative expenses
increased by $2,551,564, or approximately 133%, during the fiscal year
ended
December 31, 2005, to $4,465,540 as compared to $1,913,976 for the fiscal
year
ended December 31, 2004. This increase was due primarily to an increase
in
executive personnel. During the 2005 fiscal year, we added a chief operating
officer, chief technology officer, chief marketing officer and a vice
president
of sales.
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, primarily software, purchased during the year.
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
December
31, 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
a chief software architect supported by two programmers and the use of
freelance
resources, as needed.
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.
Liquidity
and Capital Resources
At
June 30, 2006, we had cash and cash equivalents totaling $249,792. In the
six months ended June 30, 2006, we generated negative cash flows of $2,180.
Uses of cash during the six months ended June 30, 2006 included $460,032
of net
cash used in operations, purchases
of property and equipment of $11,012 and $21,895 for payment on notes
payable
and capital lease obligations.
Operating
Activities
Net
cash provided by operating activities during the six months ended June 30,
2006 was primarily the result of our net loss of $479,954. Net loss for
the six
months ended June 30, 2006 was adjusted for non-cash items such as depreciation
and amortization of $47,236, changes in deferred income taxes of $284,166
and
changes in various assets and liabilities such as accrued taxes and other
liabilities, accounts receivable, deferred revenue and prepaid expenses,
prepaid
taxes and other assets.
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
decrease in cash related to accounts payable, accrued taxes and other
liabilities was $523,347. 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 six months ended June 30, 2006 and 2005, we did not
make any significant changes to our payment timing to our vendors.
Our
working capital deficit, defined as current assets minus current liabilities,
was ($2.6) million and ($2.2) million at June 30, 2006 and
December 31, 2005, respectively. The increase in working capital deficit of
approximately $400,000 from December 31, 2005 to June 30, 2006 was
primarily attributable to an increase of $284,166 in our deferred tax
asset
offset by an increase in our convertible notes payable of $475,000.
Net
cash provided by (used in) investing activities during the six months
ended June
30, 2006 and June 30, 2005 resulted primarily from property and equipment
purchases and net returns totaling approximately $3,914 and ($562) respectively.
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 six months ended June 30,
2006 and
2005 was primarily the result of issuances of convertible notes totaling
$475,000 and $50,000, respectively. 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.
Legal
Proceedings
On
June 16, 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 advertising services allegedly provided by Wellbourne Limited
to us. On
July 21, 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.
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.
Our
products and services address security threats to personal computers
through our
Collaborative Internet Security Network, which we refer to as CISN or
earlyNetwork™”, and which we believe provides a unique approach to updating
personal computer security. We have developed our Collaborative Internet
Security Network 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.)
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
products.
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 Early Alert Center, our system for generating
threat reports, 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. 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 (source:
IDC,
September 2005).
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
and worms continue to be the most serious threat facing corporations
and
consumers today, but spyware has rapidly climbed the priority list of
security
threats and now ranks as the second most serious threat facing companies
and
consumers today. The primary factors driving the strong growth in the
SCM market
include:
| |
·
|
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.
|
| |
·
|
Federal
regulations in healthcare and financial services markets around
the issue
of piracy.
|
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. Some large providers currently detect only 60% of all threats.
With
current security networks, software alone cannot detect unknown attacks
requiring human involvement. 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. 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.
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
We
currently have one product, a single-function anti-spyware product. We
plan to
replace this product by the end of 2006 with a full-function Internet
Security
Suite.
CyberDefender
AntiSpyware 2006
The
term
“spyware” refers to a broad category of malicious
software
designed
to intercept or take partial control of a computer’s
operation without the informed
consent
of that
machine’s owner. The term refers broadly to software that subverts the
computer’s operation for the benefit of a third party. Spyware watches what
users do with their computers and then sends that information to a third
party.
Spyware programs can attempt to track what types of websites a user visits
and
send this information to an advertisement agency or, if it’s more malicious, it
can try to record
what a user types
to try
to intercept passwords or credit card numbers.
Persons
who purchase and install our antispyware become a part of the CISN. As
suspicious files are located, they are reported to our Early Detection
Center
which provides immediate updates to the CISN computers. Our antispyware
product
works with other major antispyware products, and can be added as an additional
layer of protection. The product retails for $39.99, which includes updating
for
a period of one year. The license to use the software is renewed annually,
also
at $39.99, with incentives for early renewals.
CyberDefender
Early Detection Center (and CyberDefenderFREE)
Our
Early
Detection Center - a complete Internet security suite - includes protection
against viruses, spyware, phishing and spam, along with helpful security
utilities. This product is in public beta testing and is expected to
launch by
the end of 2006. CyberDefender Early Detection Center currently performs
all of
the following functions for users:
| |
·
|
automatically
analyzes running executable files and assigns threat
levels;
|
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·
|
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;
|
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·
|
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;
|
| |
·
|
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.
This
product is being Beta tested at this time, so we are providing it without
charge. Once the Beta testing is completed and the product is ready to
market,
our plan is to provide two versions. One version will include advertising
and
will be provided to customers without charge. The other version, which
will not
have advertising, will be available for purchase. The Beta testers will
receive
the version without advertising for 6 months without charge.
CyberDefender
Security Toolbar
We
believe that our security toolbar is one of the first anti-phishing and
anti-hijacking toolbar in the market. As with our other two products,
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 Early Detection Center/CybeDefender Free.
Our full
toolbar will continue to be available on a private label or OEM
basis.
We
have a
number of 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 also have planned a service to provide security updates generated
by
the CISN to subscribers to the service which we believe could include
government
entities, Internet service provides, software companies and security
companies.
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.
Broad
Spectrum Threat Definition
Today,
separate specialized programs handle many threats. Such a “silo” approach to
threats 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.
A
next-generation system should be able to handle all of these threats
using a
“universal severity scale”. Our technology features such a scale. This severity
scale covers all types of threats, including spam, spyware, phishing,
hijacking,
hacking and viruses. With the implementations of the full product line,
we
believe that we are able to identify, categorize and validate all threats
and
respond even to threats that are unknown today. We believe that our
broad-spectrum threat definition system is unique in the market
today.
Growth
Strategy
We
plan
to increase revenue by creating a large network of users of our free
product who
will 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 a three-part initiative to acquire large numbers of users of our free,
ad-supported product. 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
customers we obtain through them. We are also planning to roll out national
and
international public relations efforts which we expect to help us achieve
more
users.
Revenue
Model
We
currently earn revenues from direct sales. We sell our consumer software
for
$29.00 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.
It
is our
goal to attract advertising revenues also. Our plan is to undertake a
large
scale distribution of a free version of our products. We will generate
revenue
by showing users of our 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.
We are
currently testing this new platform and have generated marginal advertising
revenue from it.
Users
will be notified when a subscription is due to expire and what the cost
will be
to continue the subscription.
We
will
also offer to our software users, both paying and non-paying, other subscription
services such as Identity Theft Protection and Consumer Credit Management.
These
are currently available from a major provider of such services and we
are
enrolled as an affiliate of this provider. We plan to license these services
from the provider in the future.
We
are
also considering upgrading the current users of CyberDefender Anti-Spyware
to a
full version of CyberDefender Early Detection Center. We may do this
at the
price a subscriber is currently paying or at a higher price. However,
upgrading
may result in the loss of subscribers who do not wish to upgrade and
will not
renew their licenses. Furthermore, in order to upgrade we will need to
cancel
the subscriber’s current licensing agreement for CyberDefender Anti-Spyware and
issue a new licensing agreement for CyberDefender Early Detection Center.
This
may also deter subscribers from upgrading. There is no guarantee that
we can
upgrade subscribers without losing subscriptions.
Retail
Sales
At
this
time our software is sold only through the Internet. We plan to sell
our
software though online retailers or brick and mortar retailers around
the
world.
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
sell
products to individuals around the world mostly 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.
Some
of
our competitors include WebRoot, Symantec, McAfee, Computer Associates,
Alluria
Software, Microsoft and Sunbelt Software 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 no. 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 21 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
$10,619.18. 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.
In
March
2004 we also entered into a sublease for suite 305 at the same address.
The
sublease expires on November 30, 2006. We do not intend to renew the
sublease.
Our rent under the sublease is $4,824.60 per month. We subleased the
space to a
third party for $3,703 per month through October 31, 2006.
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
The
development of our products is generally not subject to government regulation.
However, because we intend to market our products in countries other
than the
United States, importation and exportation regulations may impact our
activities. A breach of these laws or regulations may result in the imposition
of penalties or fines or in the suspension or revocation of licenses
to do
business. We are not currently involved in any such judicial or administrative
proceedings and believe that we are in compliance with all applicable
regulations.
It
is
impossible to predict with certainty the effect that additional importation
and
exportation requirements and other regulations may have on future earnings
and
operations. We are presently unaware of any future regulations that may
have a
material effect on our business or prospects, but cannot rule out the
possibility.
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
|
|
Riggs
Eckelberry
|
54
|
President,
Chief Operating 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.
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.
Riggs
Eckelberry joined
us
in November 2005, after
providing services to us as a consultant. Mr. Eckelberry launched his
consulting
firm, TechTransform, in early 2001. TechTransform is an intervention
firm
specializing in launching and turning around high technology
companies. While with TechTransform, Mr.
Eckelberry provided employee services as a General Manager to Panda
Software USA, assisting with the development of a U.S. market which resulted
in
the company’s revenues approximately doubling in a period of eight months.
Through TechTransform, Mr. Eckelberry also provided his services as a
marketing executive to YellowPages.com. With his assistance the company’s
revenues increased substantially, resulting in its sale to SBC/Bell
South.
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
is
believed to be 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, 2004 and 2003. The following table summarizes
all
compensation for fiscal years 2005, 2004 and 2003 received by our Chief
Executive Officer or President, and all officers who earned more than
$100,000 in fiscal year 2005.
Summary
Compensation Table
| |
|
Annual
Compensation
|
|
Long
Term Compensation
Awards
|
|
Payouts
|
|
|
|
Name
and Principal
Position
|
|
Year
|
|
Salary
($)
|
|
Bonus
($)
|
|
Other
Annual
Compensation
($)
|
|
Restricted
Stock
Awards ($)
|
|
Securities
Underlying Options/ SARs(1)
|
|
LTIP
Payout ($)
|
|
All
Other Compen-sation ($)
|
|
Gary
Guseinov, Chief
Executive
Officer and
President
|
|
2005
|
|
$422,439
|
|
$416,592
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
| |
|
2004
|
|
$250,000
|
|
$269,481
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
| |
|
2003
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Igor
Barash, Chief
Information
Officer
|
|
2005
|
|
$166,187
|
|
$24,799
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
| |
|
2004
|
|
$161,127
|
|
$42,011
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
| |
|
2003
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bing
Liu, Chief
Software
Architect
|
|
2005
|
|
$100,000
|
|
|
|
|
|
|
|
326,107(1)
|
|
|
|
|
| |
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Riggs
Eckelberry
|
|
2005
|
|
$43,332(2)
|
|
$45,000(3)
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
| |
|
2004
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
| |
|
2003
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
|
---
|
(1)
Of
this amount, the right to purchase 186,347 shares of common stock has
vested.
(2)
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 is $260,000.
(3)
This
payment was made to REMG, Inc., an entity controlled by Mr.
Eckelberry.
The
following table sets forth certain information concerning the granting
of stock
options during the last completed fiscal year to our executive officers
and our
directors. No options were exercised by our executive officers or directors
during the last fiscal year.
|
Option/SAR
Grants for Last
Fiscal
Year-Individual Grants
|
| |
|
Name
|
Number
of
Securities
Underlying
Options/SARs
Granted
(#)
|
%
of Total
Options/SARs
Granted
to
Employees
in Fiscal
Year
|
Exercise
Price
($/sh)
|
Expiration
Date
|
| |
|
|
|
|
|
Bing
Liu
|
326,107(1)
|
100%
|
$0.0107share
|
|
| |
|
|
|
|
(1)
Of
this
amount, the right to purchase 186,347 shares of common stock has
vested.
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 in their entirety by the
full
text of the agreements.
We
entered into an employment agreement with Mr. Gary Guseinov as of August
31,
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. 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”.
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. Mr. Liu is an “at-will” employee and we can terminate his
employment at any time. As compensation for the services he renders to
us, Mr.
Liu is 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.
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.
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. The agreement is “at-will”. Mr. Eckelberry receives
compensation of $260,000 per year and is reimbursed for business related
expenses in accordance with our policies. He is entitled to participate
in any
benefits which we may, from time-to-time, make available to other executives.
Mr. Eckelberry receives three weeks of paid vacation per year during
the first
year of his employment, and four weeks per year thereafter. We are 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 terminate his employment upon 30 days written notice to us or in
the event
of a constructive termination. A constructive termination is 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
does 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, any termination of
the
employment agreement (other than as permitted by the agreement) and the
failure
of Mr. Eckelberry to be elected to the Board of Directors. If Mr. Eckelberry’s
employment is terminated voluntarily by him or for cause, he is 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 is entitled to receive accrued
but
unpaid salary, earned and pro rata bonus compensation, accelerated vesting
of
all unvested restricted stock or stock options (so long as he as completed
one
year of service) and post-termination benefits. Post-termination
benefits are defined as Mr. Eckelberry’s receipt of his monthly salary for a
period of three months, the continuation of coverage under any existing
health
or dental insurance program for a period of three months and earned and
pro rata
bonus compensation.
If Mr.
Eckelberry’s employment is terminated due to his retirement, death or
disability, then he will receive any accrued but unpaid salary, earned
and pro
rata bonus compensation, vested stock and stock options and post-termination
benefits. 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. Mr. Eckelberry is also entitled to
receive
bonus compensation. The bonus compensation can be earned on a quarterly
and on
an annual basis. A list of objectives to be met is mutually agreed to
by Mr.
Eckelberry and Mr. Guseinov at the beginning of each new quarter. Within
10
business days of the end of each calendar quarter, we submit to Mr. Eckelberry
a
written report of our gross revenues for the preceding calendar quarter.
Within
five business days of receiving the report, Mr. Eckelberry is to submit
to us a
written report assessing the extent to which the quarterly goals were
accomplished and proposed goals for the new quarter. If we approve Mr.
Eckelberry’s report, we pay him that percentage of the full quarterly bonus
($60,000) that was accomplished during the quarter. At the end of each
year, we
evaluate a similar list of yearly objectives and pay the appropriate
percentage
of the full annual bonus ($100,000 in 2006 and $200,000 in 2007). On
November 1,
2006, we granted to Mr. Eckelberry an option to purchase 200,000 shares
of our
common stock with an exercise price of $0.85 per share. Mr. Eckelberry
will no
longer be providing services to us as our President and Chief Operating
Officer
after December 31, 2006.
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
$60,000 other than compensation arrangements that are otherwise required
to be
described under “Executive Compensation.”
On
March
26, 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 least
term ends 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.
On
August
11, 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 least
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. The current balances of these advances totals $24,755.77
and
$800.36, respectively. These advances do not bear interest and have no
scheduled
repayment date.
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 June 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 have agreed to
issue
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 six months ended June
30, 2006,
we paid $39,000 for software development services to Unionway Int'l,
LLC.
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.
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.
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.
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
following table also provides certain information with respect to the
selling
shareholders’ ownership of our securities as of the date of this prospectus, 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.
We may
amend or supplement this prospectus from time to time to update the disclosure
set forth herein. 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%
|
*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;
• 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 may be 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.
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 October 31, 2006 by (i) each person who is known
by us to
own beneficially more than five percent (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, California 90025.
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 October 31, 2006, 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 October 31, 2006. 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;
|
| |
·
|
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%
|
|
Riggs
Eckelberry, President and Chief Operating Officer
|
200,000(2)
|
*
|
|
Igor
Barash, Chief Information Officer, Secretary and director
|
669,239
|
3.15%
|
|
Bing
Liu, Chief Software Architect and director
|
1,494,395(3)
|
7.03%
|
|
Ivan
Ivankovich, Chief Financial Officer
|
40,000
(4)
|
*
|
|
Camofi
Master LDC
|
2,000,000(5)
|
9.40%
|
|
ITU
Ventures
|
1,819,382(6)
|
8.55%
|
|
Bushido
Capital Master Fund LP
|
1,280,878(7)
|
6.02%
|
|
Pierce
Diversified Strategy Master Fund LLC, Series BUS
|
1,280,878(8)
|
6.02%
|
|
TOTAL
|
15,828,796
|
74.41%
|
| |
|
|
|
All
Officers and Directors as a Group (5 persons)
|
9,447,658
|
44.42%
|
*
Less
than one percent beneficially owned.
(2)
This
number consists of an option to purchase 200,000 shares of our common
stock that
was approved by the Board of Directors on November 2, 2006. The option
exercise
price is $0.85 per share. The option was granted from our 2006 Equity
Incentive
Plan.
(3)
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.
(4)
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.
(5)
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, d50 Madison Avenue, 8th
Floor,
New York, New York 10017.
(6)
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, California 90067.
(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 Bushido Capital Master Fund LP is
275
7th
Avenue,
Suite 2000, New York, New York 10001.
(8)
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 York 10001.
(9)
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, California 90210.
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
October 31, 2006, 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.
Warrants
As
of
October 31, 2006, 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
October 31, 2006, 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
October 31, 2006, 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.
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.
On
October 30, 2006, we 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 us 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 us, 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 our 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 ours or of any of our 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 our
request as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise. We 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 us for any
such
amounts are unsecured and no interest will be charged thereon. We 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, our Articles of
Incorporation, our 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 our 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 company under them. The indemnification provided
by
the Indemnification Agreements is not exclusive of any rights to which
the
indemnified parties may be entitled under our 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 we 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. We are 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 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.
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”.
CYBERDEFENDER
CORPORATION
6,076,956
SHARES
COMMON
STOCK
PROSPECTUS
_________,
2006
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
BALANCE
SHEET
(unaudited)
|
ASSETS
|
|
| |
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
249,792
|
|
|
|
|
|
26,747
|
|
|
|
|
|
84,722
|
|
|
|
|
|
24,205
|
|
|
Advances
- shareholders
|
|
|
30,103
|
|
|
|
|
|
138,100
|
|
|
|
|
|
1,250,716
|
|
| |
|
|
|
|
|
|
|
|
1,804,385
|
|
| |
|
|
|
|
|
PROPERTY
AND EQUIPMENT, net
|
|
|
229,218
|
|
| |
|
|
|
|
|
OTHER
ASSETS
|
|
|
20,234
|
|
| |
|
|
|
|
|
|
|
$
|
2,053,837
|
|
| |
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY (DEFICIT)
|
| |
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$
|
1,288,176
|
|
|
|
|
|
1,735,164
|
|
Current
portion of capital lease obligation
|
|
|
11,361
|
|
Convertible
notes payable
|
|
|
1,275,000
|
|
Note
payable - related party
|
|
|
83,335
|
|
| |
|
|
|
|
Total
Current Liabilities
|
|
|
4,393,036
|
|
| |
|
|
|
|
|
CAPITAL
LEASE OBLIGATION, less current portion
|
|
|
37,179
|
|
| |
|
|
|
|
|
|
|
|
4,430,215
|
|
| |
|
|
|
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
|
|
| |
|
|
|
|
|
STOCKHOLDERS’
EQUITY (DEFICIT):
|
|
|
|
|
Common
stock, $.001 par value; 50,000,000 shares authorized; 9,394,986
issued and outstanding
|
|
|
9,395
|
|
Additional
paid-in capital
|
|
|
314,860
|
|
|
|
|
|
(2,700,633
|
)
|
| |
|
|
|
|
Total
Stockholders’ Equity (Deficit)
|
|
|
(2,376,378
|
)
|
| |
|
|
|
|
Total
Liabilities and Stockholders’ Equity (Deficit)
|
|
$
|
2,053,837
|
|
| |
|
|
|
|
| |
|
|
|
|
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
STATEMENTS
OF OPERATIONS
(unaudited)
| |
|
For
the Six Month Period Ended
|
|
| |
|
June
30,
|
|
|
|
|
|
|
|
|
2005
|
|
| |
|
|
|
|
|
|
REVENUES:
|
|
|
|
|
|
|
|
|
$
|
2,317,368
|
|
$
|
3,978,327
|
|
|
|
|
|
113
|
|
|
3,364
|
|
|
|
|
|
22,739
|
|
|
—
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
2,340,220
|
|
|
3,981,691
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
495,738
|
|
|
894,171
|
|
Selling,
general and administrative
|
|
|
2,560,968
|
|
|
1,776,353
|
|
|
|
|
|
47,236
|
|
|
40,471
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
3,103,942
|
|
|
2,710,995
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
INCOME
(LOSS) BEFORE INCOME TAXES
|
|
|
(763,722
|
)
|
|
1,270,696
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
INCOME
TAX EXPENSE (BENEFIT)
|
|
|
(283,768
|
)
|
|
479,451
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
NET
INCOME (LOSS)
|
|
$
|
(479,954
|
)
|
$
|
791,245
|
|
| |
|
|
|
|
|
|
|
|
Basic
net income (loss) per share
|
|
$
|
(0.05
|
)
|
$
|
0.08
|
|
| |
|
|
|
|
|
|
|
|
Diluted
net income (loss) per share
|
|
$
|
(0.05
|
)
|
$
|
0.08
|
|
| |
|
|
|
|
|
|
|
|
Weighted
Average Shares Outstanding:
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
9,369,677
|
|
|
9,317,342
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
9,369,677
|
|
|
10,134,144
|
|
| |
|
|
|
|
|
|
|
SEE
ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
STATEMENTS
OF CHANGES IN STOCKHOLDERS EQUITY (DEFICIT)
(unaudited)
| |
|
|
|
|
|
|
|
|
|
Total
|
|
| |
|
|
|
|
|
Additional
|
|
|
|
Stockholders’
|
|
| |
|
Common
Stock
|
|
Paid-In
|
|
Accumulated
|
|
Equity
|
|
| |
|
Shares
|
|
Amount
|
|
Capital
|
|
(Deficit)
|
|
(Deficit)
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
Balances,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,317,342
|
|
|
9,312
|
|
|
314,110
|
|
|
(2,220,679
|
)
|
|
(1,897,257
|
)
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise
of Stock Option
|
|
|
77,644
|
|
|
83
|
|
|
750
|
|
|
—
|
|
|
833
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(479,954
|
)
|
|
(479,954
|
)
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,394,986
|
|
$
|
9,395
|
|
$
|
314,860
|
|
$
|
(2,700,633
|
)
|
$
|
(2,376,378
|
)
|
SEE
ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
STATEMENT
OF CASH FLOWS
(unaudited)
| |
|
For
the Six Month Period Ended
|
|
| |
|
June
30,
|
|
|
|
| |
|
|
|
2005
|
|
|
CASH
FLOWS FROM (TO) OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
$
|
(479,954
|
)
|
$
|
791,245
|
|
Adjustments
to reconcile net income (loss) to net cash
|
|
|
|
|
|
|
|
provided
by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
47,236
|
|
|
40,471
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
32,577
|
|
|
|
|
|
(48,352
|
)
|
|
(555,054
|
)
|
|
|
|
|
26,822
|
|
|
(53,549
|
)
|
|
|
|
|
(284,166
|
)
|
|
479,051
|
|
|
|
|
|
38,477
|
|
|
(165,153
|
)
|
|
|
|
|
(30,103
|
)
|
|
(78,918
|
)
|
Accounts
payable and accrued expenses
|
|
|
523,347
|
|
|
345,288
|
|
|
|
|
|
(253,339
|
)
|
|
(574,673
|
)
|
| |
|
|
|
|
|
|
|
Cash
Flows Provided by (Used In) Operating Activities:
|
|
|
(460,032
|
)
|
|
261,285
|
|
| |
|
|
|
|
|
|
|
|
CASH
FLOWS FROM (TO) INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Proceeds
from return of equipment
|
|
|
14,926
|
|
|
—
|
|
|
|
|
|
(11,012
|
)
|
|
(562
|
)
|
| |
|
|
|
|
|
|
|
Cash
Flows Provided By (Used In) Investing Activities
|
|
|
3,914
|
|
|
(562
|
)
|
| |
|
|
|
|
|
|
|
|
CASH
FLOWS FROM (TO) FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Proceeds
from convertible notes payable
|
|
|
475,000
|
|
|
50,000
|
|
Payments
on note payable - related party
|
|
|
(16,667
|
)
|
|
(50,000
|
)
|
Principal
payments on capital lease obligation
|
|
|
(5,228
|
)
|
|
(3,151
|
)
|
|
Proceeds
from exercise of stock option
|
|
|
833
|
|
|
—
|
|
|
|
|
|
—
|
|
|
(31,400
|
)
|
| |
|
|
|
|
|
|
|
|
Cash
Flows Provided by (Used In) Financing Activities
|
|
|
453,938
|
|
|
(34,551
|
)
|
| |
|
|
|
|
|
|
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
(2,180
|
)
|
|
226,172
|
|
| |
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS, beginning of period
|
|
|
251,972
|
|
|
393,150
|
|
| |
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS, end of period
|
|
$
|
249,792
|
|
$
|
619,322
|
|
| |
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
$
|
800
|
|
$
|
800
|
|
|
|
|
$
|
3,791
|
|
$
|
2,237
|
|
| |
|
|
|
|
|
|
|
|
Supplemental
schedule of non-cash financing activities:
|
|
|
|
|
|
|
|
Assets
acquired through notes payable, related party
|
|
$
|
—
|
|
$
|
200,000
|
|
Assets
acquired through capital lease obligation
|
|
$
|
—
|
|
$
|
61,867
|
|
SEE
ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL 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.
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 $47,236 and $40,471 for the
six month
periods ended June 30, 2006 and 2005, 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.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
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
six month periods ended June 30, 2006 and 2005, advertising purchased
from four
(4) vendors accounted for 62% and 79% 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 six month periods ended June 30, 2006 and 2005,
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.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
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 six month periods ended June
30, 2006
and 2005 product development costs were $761,981 and $177,815, 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 six
months periods ended June 30, 2006 and 2005, advertising expense amounted
to
$495,738 and $894,171 respectively.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recently
Issued Accounting Pronouncements
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
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 June 30, 2006 there were 2,272,512 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.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings
Per Share (Continued)
The
following table is a reconciliation of the numerators and denominators
of the
basic and diluted earnings per share computations for the six months
ended June
30, 2005.
| |
|
|
|
| |
|
Income
|
|
Shares
|
|
Per
Share
|
|
| |
|
(Numerator)
|
|
(Denominator)
|
|
Amount
|
|
| |
|
|
|
|
|
|
|
|
Basic
EPS
|
|
$
|
791,245
|
|
|
9,317,342
|
|
$
|
.08
|
|
|
Effect
of Dilutive Securities
|
|
|
|
|
|
|
|
|
|
|
|
Stock
Options
|
|
|
—
|
|
|
815,267
|
|
|
.00
|
|
|
Convertible
notes payable
|
|
|
—
|
|
|
1,535
|
|
|
.00
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
$
|
791,245
|
|
|
10,134,144
|
|
$
|
.08
|
|
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 the Company’s 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.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
1 - NATURE
OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 we had accounted for our 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 six months ended June
30, 2005 is
as follows:
|
Net
income attributed to common stockholders:
|
|
|
|
|
|
As
reported
|
|
$
|
791,245
|
|
|
Compensation
recognized under APB 25
|
|
|
—
|
|
|
Compensation
recognized under SFAS 123
|
|
|
(1,045
|
)
|
|
Pro
forma
|
|
$
|
790,200
|
|
|
Basic
and diluted loss attributed to common stockholders per common
share:
|
|
|
|
|
|
As
reported
|
|
$
|
.08
|
|
|
As
reported
|
|
$
|
.08
|
|
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 5.14%; dividend yields
of 0%; volatility factors of the expected market price of the Company’s common
shares of 106%; and a weighted average expected life of the option
of 10 years.
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 June
30, 2006 was $26,747. The Company has discontinued its relationship
with the
financial institution and is negotiating the return of the security
reserve.
NOTE
3 - PROPERTY AND EQUIPMENT
Property
and equipment consists of the following:
| |
|
|
|
| |
|
|
|
|
Furniture
and fixtures
|
|
$
|
82,470
|
|
|
Office
equipment
|
|
|
82,024
|
|
|
Software
|
|
|
201,210
|
|
| |
|
|
365,704
|
|
|
Less
accumulated depreciation
|
|
|
(136,486
|
)
|
| |
|
|
|
|
|
Net
Property and Equipment
|
|
$
|
229,218
|
|
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
4 - INCOME TAXES
As
of
June 30, 2006, the Company had federal net operating loss carry forwards
and
state net operating loss carry forwards of approximately $3,357,000
and
$3,339,000 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:
|
|
|
|
|
|
|
|
|
|
|
$
|
1,262,163
|
|
$
|
1,026,650
|
|
|
|
|
|
(11,447
|
)
|
|
(51,142
|
)
|
| |
|
|
|
|
|
|
|
| |
|
$
|
1,250,716
|
|
$
|
975,508
|
|
| |
|
|
|
|
|
|
|
|
The
components of deferred income tax (benefit) are as
follows:
|
Net
operating income (losses)
|
|
$
|
(285,270
|
)
|
$
|
435,623
|
|
|
|
|
|
1,102
|
|
|
43,428
|
|
| |
|
|
|
|
|
|
|
| |
|
|
(284,168
|
)
|
|
479,051
|
|
|
State
income tax, current
|
|
|
400
|
|
|
400
|
|
| |
|
|
|
|
|
|
|
| |
|
$
|
(283,768
|
)
|
$
|
479,451
|
|
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
|
|
$
|
(259,666
|
)
|
$
|
432,037
|
|
|
Other
|
|
|
3,371
|
|
|
1,548
|
|
|
Depreciation
and organization costs
|
|
|
(160
|
)
|
|
(39,271
|
)
|
|
State
income tax expense (benefit)
|
|
|
(27,313
|
)
|
|
85,137
|
|
| |
|
|
|
|
|
|
|
| |
|
$
|
(283,768
|
)
|
$
|
479,451
|
|
NOTE
5 - STOCKHOLDERS’ EQUITY TRANSACTIONS
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 a period
of
service or attainment of specified performance objectives. The maximum
aggregate
amount of options that may be granted is 931,734 shares.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
5 - STOCKHOLDERS’ EQUITY TRANSACTIONS (Continued)
A
summary
of stock option activity is as follows:
| |
|
|
|
| |
|
Number
of
Options
|
|
Weighted
Average
Exercise
Price
|
|
| |
|
|
|
|
|
|
Outstanding,
beginning of period
|
|
|
815,267
|
|
$
|
0.0107
|
|
| |
|
|
|
|
|
|
|
|
Exercised
|
|
|
(
77,644
|
)
|
$
|
0.0107
|
|
|
Cancelled
|
|
|
(388,223
|
)
|
$
|
0.0107
|
|
| |
|
|
|
|
|
|
|
|
Outstanding,
end of period
|
|
|
349,400
|
|
$
|
0.0107
|
|
| |
|
|
|
|
|
|
|
|
Exercisable,
end of period
|
|
|
157,230
|
|
$
|
0.0107
|
|
As
of
June 30, 2006, 192,170 of the options granted are not vested with an
estimated
remaining value of $2,469 and a weighted average vesting life of .51
years. At
June 30, 2006, 157,230 of these options were exercisable at an exercise
price of
$0.0107 and will expire in 2015.
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 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 the Company in a transaction in which the Company is
valued at
$250 million. At June 30, 2006
the
current balance outstanding was $83,335. At June 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 accept payment
of the remaining balance on the note and any accrued but unpaid interest
in
exchange for 186,347 shares of the Company’s common stock in October
2006.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
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 June 30, 2006:
|
2007
|
|
$
|
16,162
|
|
|
2008
|
|
|
16,162
|
|
|
2009
|
|
|
16,162
|
|
|
2010
|
|
|
10,775
|
|
|
Thereafter
|
|
|
—
|
|
| |
|
|
|
|
|
Total
minimum lease payments
|
|
|
59,261
|
|
|
Less
amount representing interest
|
|
|
(10,721
|
)
|
| |
|
|
|
|
|
Present
value of minimum capitalized payments
|
|
|
48,540
|
|
|
Less
current portion
|
|
|
(11,361
|
)
|
| |
|
|
|
|
|
Long-term
capital lease obligations
|
|
$
|
37,179
|
|
| |
|
|
|
|
Property
and equipment and accumulated depreciation included $61,867 and $11,784
acquired
through capital leases as of June 30, 2006. Depreciation expense of
$4,419 and
$2,946 is included in the total depreciation expense for the periods
ended June
30, 2006 and 2005. Interest expense under the lease was $2,853 and
$2,237 for
the periods ended June 30, 2006 and 2005, respectively.
NOTE
8 - CONVERTIBLE NOTE PAYABLE
On
June
15, 2005 the 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.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
8 - CONVERTIBLE NOTE PAYABLE (Continued)
At
various times between November 8, 2005 and March 31, 2006 the 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 bears interest at the rate of 9.96% per annum compounded monthly
and
mature between November 8, 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 (the "Exercise Price"); in any case, as such Exercise Price may
be adjusted
from time to time.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
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 $6,500 per month for such services. During the six months ended
June 30,
2006, the Company paid $39,000 for software development services 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 August
31, 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.
|
|
|
|
|
|
|
|
|
$
|
150,315
|
|
|
2008
|
|
|
21,856
|
|
| |
|
|
|
|
|
Total
|
|
$
|
172,171
|
|
Total
rent expense for the six month periods ended June 30, 2006 and 2005
was $113,615
and $106,102, respectively.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
10 - COMMITMENTS AND CONTINGINGIES (Continued)
Employment
Agreements:
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. Mr. Eckelberry will also
receive
200,000 stock options from the Company’s equity incentive plan.
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
$202,000 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 5
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
June
16, 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 July 21, 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.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
11 - SUBSEQUENT EVENTS
On
July
27, 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 in the principal
amount of
$290,439 and a warrant to purchase 290,439 shares of common stock.
On
August
18, 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 agreed to convert all $1,262,069.53 of outstanding principal
and accrued
interest of their secured convertible promissory notes into an aggregate
of
1,755,100 shares of the Company ‘s 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 a Registration Statement to be filed with the
United
States Securities and Exchange Commission (SEC). In addition, on or
about
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 1,755,100 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. There were
no fees paid
in connection with this agreement.
On
August
31, 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
September 12, 2006, Mr. Guseinov agreed to transfer an aggregate of
186,347
shares of common stock back to the Company for cancellation. In turn, the
Company agreed to issue an aggregate of 186,347 shares of common stock
to our
bridge lenders to be distributed to them on a pro rata basis. The
shares were issued 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 $1.00 per
share.
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
NOTE
11 - SUBSEQUENT EVENTS (Continued)
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
common stock at $1.00 per share. This aggregate principal amount of
$3,243,378
includes the conversion of $500,000 principal at a conversion rate
of 1.15 plus
accrued interest of the Company’s previously outstanding 8% secured notes, as
discussed in the first paragraph of this Note 11. This amount also
includes 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 Company
paid
$147,000 of fees in connection with this agreement. The Company also
issued as
fees in connection with this agreement a total of 250,000 shares of
common stock
and 217,000 units, with each unit consisting of 1 share of common stock
and a
warrant to purchase 1 share of common stock for $1.00 per share.
In
October, 2006 Mr. Guseinov and Mr. Barash agreed to transfer an aggregate
of
832,511 shares of common stock back to the Company for cancellation. In
turn, the Company agreed to issue an aggregate of 832,511 shares of
common stock
to Mr. Liu. The shares were issued in consideration of Mr.Liu’s agreement
to exchange the balance of the Unionway Int’l LLC note, as described in Note 6
above and for his contribution to the development of the Company’s product and
technology. The value of the shares issued to Mr. Liu was $1.00 per
share. 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, the Company’s Board of Directors approved option grants in the
amount of 972,944 shares to employees and consultants at prices between
$0.85
and $1.00.
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.
Denver,
Colorado
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
BALANCE
SHEET
DECEMBER
31, 2005
|
ASSETS
|
|
| |
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
Cash
and cash equivalents
|
|
$
|
251,972
|
|
|
|
|
|
26,747
|
|
|
|
|
|
36,370
|
|
|
|
|
|
46,037
|
|
|
|
|
|
176,577
|
|
|
|
|
|
966,550
|
|
| |
|
|
|
|
|
|
|
|
1,504,253
|
|
| |
|
|
|
|
|
PROPERTY
AND EQUIPMENT, net
|
|
|
280,368
|
|
| |
|
|
|
|
|
OTHER
ASSETS
|
|
|
25,224
|
|
| |
|
|
|
|
|
|
|
$
|
1,809,845
|
|
| |
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY (DEFICIT)
|
| |
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$
|
764,829
|
|
|
|
|
|
1,988,503
|
|
Current
portion of capital lease obligation
|
|
|
10,752
|
|
Convertible
notes payable
|
|
|
800,000
|
|
Current
portion, note payable - related party
|
|
|
100,002
|
|
| |
|
|
|
|
Total
Current Liabilities
|
|
|
3,664,086
|
|
| |
|
|
|
|
|
CAPITAL
LEASE OBLIGATION, less current portion
|
|
|
43,016
|
|
| |
|
|
|
|
|
|
|
|
3,707,102
|
|
| |
|
|
|
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
|
|
| |
|
|
|
|
|
STOCKHOLDERS’
EQUITY (DEFICIT):
|
|
|
|
|
Common
stock, $.001 par value; 50,000,000 shares authorized; 9,317,342
issued and outstanding
|
|
|
9,312
|
|
Additional
paid-in capital
|
|
|
314,110
|
|
|
|
|
|
(2,220,679
|
)
|
| |
|
|
|
|
Total
Stockholders’ Equity (Deficit)
|
|
|
(1,897,257
|
)
|
| |
|
|
|
|
Total
Liabilities and Stockholders’ Equity (Deficit)
|
|
$
|
1,809,845
|
|
SEE
ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
STATEMENTS
OF OPERATIONS
| |
|
For
the Year Ended
|
|
| |
|
December
31,
|
|
|
|
| |
|
|
|
2004
|
|
| |
|
|
|
|
|
|
REVENUES:
|
|
|
|
|
|
|
|
|
$
|
7,082,979
|
|
$
|
3,537,628
|
|
|
|
|
|
5,072
|
|
|
2,088
|
|
|
|
|
|
7,406
|
|
|
—
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
7,095,457
|
|
|
3,539,716
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
1,413,716
|
|
|
5,271,592
|
|
Selling,
general and administrative
|
|
|
4,465,540
|
|
|
1,913,976
|
|
|
|
|
|
84,496
|
|
|
4,754
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
5,963,752
|
|
|
7,190,322
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
INCOME
(LOSS) BEFORE INCOME TAXES
|
|
|
1,131,705
|
|
|
(3,650,606
|
)
|
| |
|
|
|
|
|
|
|
|
INCOME
TAX EXPENSE (BENEFIT)
|
|
|
488,809
|
|
|
(1,369,187
|
)
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
NET
INCOME (LOSS)
|
|
$
|
642,896
|
|
$
|
(2,281,419
|
)
|
| |
|
|
|
|
|
|
|
|
Basic
net income (loss) per share
|
|
$
|
0.06
|
|
$
|
(0.23
|
)
|
| |
|
|
|
|
|
|
|
|
Diluted
net income (loss) per share
|
|
$
|
0.06
|
|
$
|
(0.23
|
)
|
| |
|
|
|
|
|
|
|
|
Weighted
Average Shares Outstanding:
|
|
|
|
|
|
|
|
| |
|
|
9,317,342
|
|
|
9,317,342
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
9,649,977
|
|
|
9,317,342
|
|
SEE
ACCOMPANYING NOTES TO FINANCIAL
STATEMENTS
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
STATEMENTS
OF CHANGES IN STOCKHOLDERS EQUITY (DEFICIT)
| |
|
|
|
|
|
|
|
|
|
Total
|
|
| |
|
|
|
|
|
Additional
|
|
|
|
Stockholders’
|
|
| |
|
Common
Stock
|
|
Paid-In
|
|
Accumulated
|
|
Equity
|
|
| |
|
Shares
|
|
Amount
|
|
Capital
|
|
(Deficit)
|
|
(Deficit)
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
Balances,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,317,342
|
|
$
|
9,395
|
|
$
|
314,110
|
|
$
|
(140,909
|
)
|
$
|
182,513
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
|
|
|
|
|
|
(409,847
|
)
|
|
(409,847
|
)
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,281,419
|
)
|
|
(2,281,419
|
)
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,317,342
|
|
|
9,395
|
|
|
314,110
|
|
|
(2,832,175
|
)
|
|
(2,508,753
|
)
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(31,400
|
)
|
|
(31,400
|
)
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
642,896
|
|
|
642,896
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,317,342
|
|
$
|
9,395
|
|
$
|
314,110
|
|
$
|
(2,220,679
|
)
|
$
|
(1,897,257
|
)
|
SEE
ACCOMPANYING NOTES TO FINANCIAL
STATEMENTS
CYBERDEFENDER
CORPORATION
(F/K/A
NETWORK DYNAMICS CORP.)
STATEMENT
OF CASH FLOWS
| |
|
For
the Year Ended
|
|
| |
|
December
31,
|
|
|
|
| |
|
|
|
2004
|
|
|
CASH
FLOWS FROM (TO) OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
$
|
642,896
|
|
$
|
(2,281,419
|
)
|
Adjustments
to reconcile net income (loss) to net cash
|
|
|
|
|
|
|
|
provided
by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
84,496
|
|
|
4,754
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
129,813
|
|
|
(156,560
|
)
|
|
|
|
|
(17,109
|
)
|
|
(19,045
|
)
|
|
|
|
|
(30,574
|
)
|
|
(38,649
|
)
|
|
|
|
|
488,009
|
|
|
(1,369,987
|
)
|
|
|
|
|
(1,928
|
)
|
|
(174,649
|
)
|
|
|
|
|
65,739
|
|
|
(67,600
|
)
|
Accounts
payable and accrued expenses
|
|
|
(224,277
|
)
|
|
970,026
|
|
|
|
|
|
(1,872,338
|
)
|
|
3,860,841
|
|
| |
|
|
|
|
|
|
|
Cash
Flows Provided by (Used In) Operating Activities:
|
|
|
(735,273
|
)
|
|
727,712
|
|
| |
|
|
|
|
|
|
|
|
CASH
FLOWS FROM (TO) INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
(66,408
|
)
|
|
(41,343
|
)
|
| |
|
|
|
|
|
|
|
Cash
Flows (Used In) Investing Activities
|
|
|
(66,408
|
)
|
|
(41,343
|
)
|
| |
|
|
|
|
|
|
|
|
CASH
FLOWS FROM (TO) FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Proceeds
from convertible notes payable
|
|
|
800,000
|
|
|
|
|
Payments
on note payable - related party
|
|
|
(99,998
|
)
|
|
|
|
Principal
payments on capital lease obligation
|
|
|
(8,099
|
)
|
|
|
|
|
|
|
|
(31,400
|
)
|
|
(409,847
|
)
|
| |
|
|
|
|
|
|
|
Cash
Flows Provided by (Used In) Financing Activities
|
|
|
660,503
|
|
|
(409,847
|
)
|
| |
|
|
|
|
|
|
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
(141,178
|
)
|
|
276,522
|
|
| |
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS, beginning of year
|
|
|
393,150
|
|
|
116,628
|
|
| |
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS, end of year
|
|
$
|
251,972
|
|
$
|
393,150
|
|
| |
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
$
|
800
|
|
$
|
800
|
|
|
|
|
$
|
6,015
|
|
$
|
245
|
|
| |
|
|
|
|
|
|
|
|
Supplemental
schedule of non-cash financing activities:
|
|
|
|
|
|
|
|
Assets
acquired through notes payable, related party
|
|
$
|
200,000
|
|
$
|
|
|
Assets
acquired through capital lease obligation
|
|
$
|
61,867
|
|
$
|
|
|
SEE
ACCOMPANYING NOTES TO FINANCIAL
STATEMENTS
Organization
and Business
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 October
13, 2005 the
Company changed it name to CyberDefender Corporation.
On
October 31, 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. 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.
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 December
31, 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.
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.
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.
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.
| |
|
|
|
| |
|
Income
|
|
Shares
|
|
Per
Share
|
|
| |
|
(Numerator)
|
|
(Denominator)
|
|
Amount
|
|
| |
|
|
|
|
|
|
|
|
Basic
EPS
|
|
$
|
642,896
|
|
|
9,317,342
|
|
$
|
.07
|
|
|
Effect
of Dilutive Securities
|
|
|
|
|
|
|
|
|
|
|
|
Stock
Options
|
|
|
—
|
|
|
332,635
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
$
|
642,896
|
|
|
9,649,977
|
|
$
|
.07
|
|
Stock
Based Compensation
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.
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.
NOTE
3 - PROPERTY AND EQUIPMENT
Property
and equipment consists of the following:
| |
|
|
|
| |
|
|
|
|
Furniture
and fixtures
|
|
$
|
92,452
|
|
|
Office
equipment
|
|
|
75,956
|
|
|
Software
|
|
|
201,210
|
|
| |
|
|
369,618
|
|
|
Less
accumulated depreciation
|
|
|
(89,250
|
)
|
| |
|
|
|
|
|
Net
Property and Equipment
|
|
$
|
280,368
|
|
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:
|
|
|
|
|
|
|
|
|
$
|
976,893
|
|
$
|
1,467,574
|
|
|
|
|
|
(10,343
|
)
|
|
(13,015
|
)
|
| |
|
|
|
|
|
|
|
| |
|
$
|
966,550
|
|
$
|
1,454,559
|
|
| |
|
|
|
|
|
|
|
|
The
components of deferred income tax (benefit) are as
follows:
|
|
|
|
$
|
490,681
|
|
$
|
(1,384,667
|
)
|
|
|
|
|
(2,672
|
)
|
|
14,680
|
|
| |
|
|
|
|
|
|
|
| |
|
|
488,009
|
|
|
(1,369,987
|
)
|
|
State
income tax, current
|
|
|
800
|
|
|
800
|
|
| |
|
|
|
|
|
|
|
| |
|
$
|
488,809
|
|
$
|
(1,369,187
|
)
|
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):
| |
|
2005
|
|
2004
|
|
| |
|
|
|
|
|
|
Tax
expense (benefit) at federal statutory
|
|
$
|
391,079
|
|
$
|
(1,241,206
|
)
|
|
Other
|
|
|
5,881
|
|
|
3,257
|
|
|
Shell
acquisition cost
|
|
|
51,359
|
|
|
—
|
|
|
Depreciation
and organization costs
|
|
|
(5,887
|
)
|
|
(12,608
|
)
|
|
State
income tax expense (benefit)
|
|
|
46,377
|
|
|
(118,630
|
)
|
| |
|
|
|
|
|
|
|
| |
|
$
|
488,809
|
|
$
|
(1,369,187
|
)
|
NOTE
5 - STOCKHOLDERS’ EQUITY TRANSACTIONS
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 December
31, 2005 is 337,754.
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
|
|
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
June
15, 2005 the 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, 2005 the 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.
NOTE
8 - CONVERTIBLE NOTE PAYABLE (Continued)
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 August
31, 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.
NOTE
10 - COMMITMENTS AND CONTINGINGIES (Continued)
|
|
|
|
|
|
|
|
$
|
223,026
|
|
|
2007
|
|
|
129,953
|
|
|
2008
|
|
|
18,750
|
|
| |
|
|
|
|
|
Total
|
|
|
371,729
|
|
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, 2006 the 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.
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.
