UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
AMENDMENT NO. 2
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of Earliest Event Reported): March 30, 2005
PATRON SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 000-25675 74-3055158
(State or other jurisdiction (Commission File Number) (I.R.S. Employer
of incorporation) Identification No.)
500 NORTH MICHIGAN AVENUE, SUITE 300
CHICAGO, ILLINOIS 60611
(Address of Principal Executive Offices/Zip Code)
(312) 396-4031
(Registrant's telephone number, including area code)
Check the appropriate box below if the Form 8-K filing is intended to
simultaneously satisfy the filing obligation of the registrant under any of the
following provisions (see General Instruction A.2. below):
[ ] Written communications pursuant to Rule 425 under the Securities Act
(17 CFR 230.425)
[ ] Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17
CFR 240.14a-12)
[ ] Pre-commencement communications pursuant to Rule 14d-2(b) under the
Exchange ct (17 CFR 240.14d-2(B))
[ ] Pre-commencement communications pursuant to Rule 13e-4(c)) under the
Exchange Act (17 CFR 240.13e-4c))
This Current Report on Form 8-K/A amends Item 9.01 of the Current Report on Form
8-K filed with the Securities and Exchange Commission ("SEC") by Patron Systems,
Inc. ("Patron") on April 5, 2005 (the "Form 8-K"), reporting the merger of
Patron Systems, Inc. with Entelagent Software Corp. ("Entelagent"). The Form
8-K is hereby amended to insert those items as set forth herein.
ITEM 9.01. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements of business acquired.
INDEX OF FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PAGE
COMPLETE SECURITY SOLUTIONS, INC.
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . 3
Balance Sheet at December 31, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Statement of Operations for the Period from July 28, 2004 (Inception) to
December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Statement of Stockholders' Equity for the Period from July 28, 2004 (Inception) to
December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Statement of Cash Flows for the Period from July 28, 2004 (Inception) to
December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Notes to Consolidated Financial Statements for the Period from July 28, 2004 (Inception) to
December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
IDK ENTERPRISES, INC.
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . 21
Balance Sheet at December 31, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Statement of Operations for the Years Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Statement of Stockholders' Deficiency for the Years Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Statement of Cash Flows for the Years Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Notes to Consolidated Financial Statements for the Year Ended
December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
LUCIDLINE, INC.
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . 42
Balance Sheet at December 31, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Statement of Operations for the Years Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Statement of Stockholders' Deficiency for the Years Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
Statement of Cash Flows for the Years Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Notes to Consolidated Financial Statements for the Year Ended
December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
ENTELAGENT SOFTWARE CORP.
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . 58
Balance Sheet at December 31, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Statement of Operations for the Years Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Statement of Shareholders' Deficiency for the Years Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Statement of Cash Flows for the Year Ended
December 31, 2004 and 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Notes to Consolidated Financial Statements for the Year Ended
December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Complete Security Solutions, Inc.
We have audited the accompanying balance sheet of Complete Security Solutions,
Inc. as of December 31, 2004 and the related statements of operations,
stockholders' equity and cash flows for the period from July 28, 2004
(inception) to December 31, 2004. 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 audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by the management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred above present fairly, in all
material respects, the financial position of Complete Security Solutions, Inc.
as of December 31, 2004 and the results of its operations and its cash flows for
the period from July 28, 2004 (inception) to December 31, 2004, in conformity
with accounting principles generally accepted in the United States of America.
3
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company incurred a loss during its inception period
and has limited capital resources. These conditions raise substantial doubt
about its ability to continue as going concern. Management's plans regarding
those matters also are described in Note 2. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
/s/ Marcum & Kliegman LLP
-------------------------
Marcum & Kliegman LLP
October 7, 2005
New York, New York
4
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
BALANCE SHEET
December 31, 2004
--------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash ...................................................... $1,447,885
Prepaid expenses and other current assets ................. 96,700
----------
Total Current Assets .................................... $1,544,585
OTHER ASSETS
Deferred financing costs, net ............................. 85,167
Advances to prospective acquirer .......................... 722,000
Advances to prospective acquiree .......................... 657,847
Advances to prospective affiliates ........................ 1,375,969
----------
Total Other Assets ...................................... 2,840,983
----------
TOTAL ASSETS ............................................ $4,385,568
==========
5
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
BALANCE SHEET
December 31, 2004
--------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accrued expenses ............................................ $ 43,750
Advances from stockholder ................................... 100,000
Dividends payable ........................................... 34,539
-----------
Total Current Liabilities ................................. $ 178,289
SERIES A MANDATORILY REDEEMABLE
CONVERTIBLE PREFERRED STOCK (Liquidation
preference $9,039,469) ...................................... 3,877,219
-----------
TOTAL LIABILITIES ............................................. 4,055,508
STOCKHOLDERS' EQUITY
Common stock, par value $.01; 40,000,000 shares
authorized; 2,453,160 shares issued and outstanding ....... 24,532
Stock subscription receivable ............................... (24,532)
Additional paid in capital .................................. 673,643
Deficit accumulated during the development stage ............ (343,583)
-----------
TOTAL STOCKHOLDERS' EQUITY ................................ 330,060
-----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................ $ 4,385,568
===========
6
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
STATEMENT OF OPERATIONS
For the Period from July 28, 2004 (Inception) to December 31, 2004
--------------------------------------------------------------------------------
OPERATING EXPENSES
Employee compensation and benefits ....................... $ 84,513
Legal and professional fees .............................. 17,822
Consulting fees .......................................... 55,000
General and administrative expenses ...................... 121,927
---------
TOTAL OPERATING EXPENSES ............................... $ 279,262
---------
OPERATING LOSS ......................................... (279,262)
OTHER INCOME (EXPENSE)
Interest expense ......................................... (85,450)
Interest income - related parties ........................ 21,129
---------
TOTAL OTHER EXPENSE .................................... (64,321)
---------
LOSS BEFORE INCOME TAXES .............................. (343,583)
INCOME TAXES ............................................... --
---------
NET LOSS ............................................... $(343,583)
=========
7
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
STATEMENT OF STOCKHOLDERS' EQUITY
For the Period from July 28, 2004 (Inception) to December 31, 2004
--------------------------------------------------------------------------------
Deficit
Accumulated
Stock Additional During the
Common Stock Subscription Paid in Development
Shares Amount Receivable Capital Stage Total
--------- --------- --------- --------- --------- ---------
BALANCE - July 28, 2004 ................ -- $ -- $ -- $ -- $ -- $ --
Common stock issued in exchange for
subscriptions receivable ............. 2,453,160 24,532 (24,532) -- -- --
Warrants issued to investors of Series A
Preferred stock ........................ -- -- -- 635,843 -- 635,843
Warrants issued to Placement Agent ..... -- -- -- 37,800 -- 37,800
Net loss ............................... -- -- -- -- (343,583) (343,583)
--------- --------- --------- --------- --------- ---------
BALANCE - December 31, 2004 ............ 2,453,160 $ 24,532 $ (24,532) $ 673,643 $(343,583) $ 330,060
========= ========= ========= ========= ========= =========
8
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
STATEMENT OF CASH FLOWS
For the Period from July 28, 2004 (Inception) to December 31, 2004
--------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss .................................................... $ (343,583)
Adjustments to reconcile net loss to net cash
used in operating activities:
Interest income ........................................... $ (21,129)
Non-cash interest expense ................................. 11,980
Changes in operating assets and liabilities:
Prepaid expenses and other current assets ................. (96,700)
Accrued consulting fee .................................... 10,000
Accrued dividends ......................................... 34,539
Accrued interest .......................................... 38,931
-----------
TOTAL ADJUSTMENTS ......................................... (22,379)
-----------
NET CASH USED IN OPERATING ACTIVITIES ..................... (365,962)
-----------
CASH FLOWS FROM INVESTING ACTIVITIES
Advances to prospective acquirer ............................ (722,000)
Advances to prospective acquiree ............................ (657,847)
Advances to prospective affiliates .......................... (1,354,840)
-----------
NET CASH USED IN INVESTING ACTIVITIES ..................... (2,734,687)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES
Gross proceeds from issuance of Series A
Mandatorily Redeemable Convertible Preferred Stock ........ 4,463,534
Deferred financing costs .................................... (15,000)
Advances from stockholder ................................... 100,000
-----------
NET CASH PROVIDED BY FINANCING ACTIVITIES ................. $ 4,548,534
-----------
9
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
STATEMENT OF CASH FLOWS, Continued
For the Period from July 28, 2004 (Inception) to December 31, 2004
--------------------------------------------------------------------------------
NET INCREASE IN CASH .......................................... $1,447,885
CASH - July 28, 2004 (Inception) .................................. --
----------
CASH - December 31, 2004 .......................................... $1,447,885
----------
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES
Settlement of accrued interest by issuing Series A
Mandatorily Redeemable Convertible Preferred Stock ............ $ 38,931
Common stock issued in exchange for subscription receivable ..... $ 24,532
Accrued placement agent fee recorded as a deferred financing cost $ 33,750
10
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - THE COMPANY
ORGANIZATION
Complete Security Solutions, Inc. (the "Company"), a Delaware
corporation, was formed on July 28, 2004 with a business plan of raising
capital and consummating business combinations with certain companies
developing technologies for use in the information and homeland security
markets. As described in Note 14, the Company completed a merger with IDK
Enterprises, Inc. ("IDK") on February 24, 2005 and was acquired by Patron
Systems, Inc. ("Patron") pursuant to an agreement and plan of merger on
February 25, 2005.
NOTE 2 - LIQUIDITY AND FINANCIAL CONDITION
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. The Company incurred a net
loss of $343,583 for the period from July 28, 2004 (inception) to
December 31, 2004. The Company's working capital at December 31, 2004
amounts to $1,366,296. As described in Note 14, the Company consummated a
merger with IDK, and was subsequently merged with and into Patron on
February 25, 2005. Patron has limited capital resources and is subject to
substantial legal contingencies that raise doubt as to its ability to
continue as a going concern. The Company will require substantial
additional working capital to sustain its operations while Patron
attempts to integrate the business into its existing operations.
The Company expects to continue incurring losses for the foreseeable
future and cannot provide any assurance as to when, if ever, it will
become a profitable enterprise due to the inherent uncertainty that is
related to establishing the commercial feasibility of technological
products and developing a presence in new markets. These matters raise
substantial doubt about its ability to continue as a going concern. The
Company's continued existence is dependent upon the ability of Patron to
raise the additional capital that it needs to sustain its operations
while it continues to execute its business plan and resolve its legal
contingencies in a manner that will not have a material adverse affect on
the Company.
Patron is currently in the process of attempting to raise additional
capital and its management has taken certain steps to conserve its
liquidity while it continues to integrate the Company and other acquired
businesses into its existing operations. Neither Patron nor the Company
has obtained any commitment to provide the Company with new financing.
These matters raise substantial doubt about the Company's ability to
continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability of recorded asset amounts that
might be necessary as a result of the above uncertainty.
11
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DEVELOPMENT STAGE OPERATIONS
In accordance with Statement of Financial Accounting Standard ("SFAS")
No.7, the Company is considered to be a development stage enterprise as
its activities principally consist of raising capital and screening
potential acquisition candidates in the information and homeland security
segments.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No.
109"). SFAS No. 109 requires the recognition of deferred tax assets and
liabilities for both the expected impact of differences between the
financial statements and tax basis of assets and liabilities and for the
expected future tax benefit to be derived from tax loss and tax credit
carry forwards. SFAS No. 109 additionally requires the establishment of a
valuation allowance to reflect the likelihood of realization of deferred
tax assets.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the balance sheet for cash, advances to
prospective acquirer, acquiree and affiliates, accounts payable, accrued
expenses, and advances from stockholders approximate their fair values
based on the short-term maturity of these instruments. The carrying
amounts of the Company's Series A Mandatorily Redeemable Convertible
Preferred Stock ("Series A Preferred") approximates fair value as these
securities feature contractual dividend rates that are consistent with
current market rates of return and have an effective yield that is
consistent with instruments of similar risk, when taken together with any
equity instruments concurrently issued to the investors of these shares.
USE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS
In preparing financial statements in conformity with accounting
principles generally accepted in the United States of America, management
is required to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets
and liabilities at the date of the financial statements and revenue and
expenses during the reporting period. Actual results could differ from
those estimates.
NOTE 4 - CONCENTRATION OF CREDIT RISK
The Company maintains a cash account at a financial institution insured
by the Federal Deposit Insurance Corporation ("FDIC"). Management
monitors the soundness of this institution and considers the Company's
risk to be minimal. The amount of credit risk over the FDIC limit at
December 31, 2004 amounts to $1,347,885.
12
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 5 - DEFERRED FINANCING COSTS
Deferred financing costs include an aggregate of $48,750 of cash
transaction fees incurred in connection with the Series A Preferred
financing transaction described in Note 10. Such fees include (a) $33,750
representing a .75% transaction fee to be paid to the placement agent,
and (b) $15,000 representing a 6% origination fee paid to an investor. In
addition, the Company issued 45,000 common stock purchase warrants with a
fair value of $37,800 to the placement agent. A summary of the deferred
financing costs and accumulated amortization is as follows:
Amount
--------
Fees paid and to be paid in cash .................. $ 48,750
Placement agent warrants .......................... 37,800
--------
86,550
Less: accumulated amortization ................... (1,383)
--------
Deferred Financing Costs, Net ........... $ 85,167
========
These deferred financing costs are being amortized over the term of the
Series A Preferred to its earliest mandatory redemption date of November
22, 2009. Amortization expense with respect to deferred financing costs
amounted to $1,383 for the period of July 28, 2004 (inception) to
December 31, 2004 and is included as a component of interest expense in
the accompanying statement of operations.
NOTE 6 - ADVANCES TO PROSPECTIVE ACQUIRER
In 2004, the Company made an aggregate of $722,000 of non-interest
bearing cash advances to Patron for working capital purposes. The amounts
are due on demand. Subsequent to December 31, 2004, the Company merged
into Patron in a purchase business combination, at which time the Company
became a wholly-owned subsidiary of Patron (Note 14). The Company
classified these advances as non-current assets in the accompanying
balance sheet as a result of the business combination with Patron.
NOTE 7 - ADVANCES TO PROSPECTIVE ACQUIREE
In 2004, the Company made an aggregate of $657,847 in non-interest
bearing cash advances to IDK for working capital purposes. The amounts
are due on demand. The Company classified these advances as non-current
assets in the accompanying balance sheet as a result of the business
combination with Patron (Note 14).
13
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 8 - ADVANCES TO PROSPECTIVE AFFILIATES
Advances to prospective affiliates are as follows:
Amount
----------
LucidLine, Inc. .............................. $ 587,700
Entelagent Software Corp. .................... 788,269
----------
$1,375,969
In 2004, the Company made an aggregate of $577,000 and $777,840 in
advances to each of LucidLine, Inc. ("LucidLine") and Entelagent Software
Corp. ("Entelagent"), respectively for working capital purposes. The
advances bear interest at 10% per annum and are secured by all the
current and future assets of each of the companies. Interest income on
these loans amounted to $21,129 for the period of July 28, 2004
(inception) to December 31, 2004, including $10,700 due from LucidLine
and $10,429 due from Entelagent. Subsequent to December 31, 2004,
LucidLine and Entelagent were acquired by Patron at which time they
became affiliates of the Company through common ownership (Note 14). The
Company classified these advances as non-current assets in the
accompanying balance sheet as a result of the business combination with
Patron.
NOTE 9 - ADVANCES FROM STOCKHOLDER
Advances from stockholder represent excess advances made to the Company
by Apex Venture Partners ("Apex") in connection with its investment in
Series A Preferred. The Company repaid this amount to Apex in January
2005.
NOTE 10 - SERIES A MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
Pursuant to the Company's restated certificate of incorporation, the
Company is authorized to issue up to 10,000,000 shares of its Series A
Preferred, $0.01 par value.
In December 2004, the Company issued 4,502,465 shares of Series A
Preferred in exchange for $4,463,534 of cash and the settlement of
$38,931 of accrued interest on advances made to the Company by
stockholders. In addition, the Company issued to certain investors
holding $1,750,000 of such preferred shares, warrants to purchase up to
462,500 shares of the Company's common stock ("Warrants"). The warrants
have a seven-year term and an exercise price of $1.00 per share. The
aggregate fair value of the warrants amounts to $635,843.
14
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 10 - SERIES A MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK, continued
In accordance with APB 14, the Company allocated $3,866,622 of the
proceeds to the Series A Preferred and $635,843 of proceeds to the
warrants. The difference between the carrying amount of the Series A
Preferred and their contractual redemption is being accreted as interest
expense to November 9, 2009, the earliest redemption of the Series A
Preferred. Accretion of the aforementioned discount amounted to $10,597
for the period from July 28, 2004 (inception) to December 31, 2004 and is
included as a component of interest expense in the accompanying statement
of operations.
The Series A Preferred is convertible into common stock at any time at
the option of the holder based on a formula that currently results in a
one-for-one exchange ratio of common for preferred. This formula is
subject to adjustment for stock splits, stock dividends,
recapitalizations, and other anti-dilution provisions. The shares of
redeemable convertible preferred stock convert automatically into shares
of common stock immediately upon the effectiveness of a registration
statement under the Securities Act of 1933 with an offering price per
share of at least five times the original issue price of the Preferred
Stock and which results in aggregate cash proceeds of at least
$25,000,000.
The Company has reserved 4,964,965 shares of its common stock for
issuance upon the conversion of its redeemable convertible preferred
stock and the exercise of the related common stock purchase warrants.
The Series A Preferred also features (1) a liquidation preference
entitling the holders of Series A Preferred to be paid an amount equal to
twice the original purchase price per share, plus any accrued but unpaid
dividends, upon a liquidation event as defined, (2) cumulative,
preferential dividends of $0.10 per share per annum, and (3) a right to
participate in dividends on a pro rata basis with the common
stockholders, based upon the number of common shares into which the
Series A Preferred are convertible, if and when declared by the Board of
Directors. Dividends accrued but not paid do not bear interest and upon
conversion into common stock, any unpaid dividends are not payable. The
holders of the Series A Preferred, voting together as a class, are
entitled to elect two members of the Board of Directors.
In the event funds are sufficient to make a complete distribution to the
holders of Preferred Stock as described above, the remaining assets will
be distributed ratably to the holders of common stock and Preferred Stock
on an as-converted to common stock basis.
Holders of at least sixty six and two thirds percent (66 2/3%) in
interest of the Series A Preferred can require the Company at any time
after November 22, 2009 to redeem their Series A Preferred shares at the
original issue price per share ($1.00 per share), plus accrued but unpaid
dividends. Redemption payments, if demanded, would be payable in three
equal annual installments of 33 1/3% each beginning within 60 days
following the Company's receipt of a redemption notice by the holders of
at least 66 2/3% interest in the Series A Preferred.
15
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 10 - SERIES A MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK, continued
The Company accounted for the issuance of its Series A Preferred, with
common stock purchase warrants, in accordance with EITF 00-27,
"Convertible Securities with Beneficial Conversion Features and
Contingently Adjustable Conversion Rations". Accordingly, the Series A
Preferred is presented in the accompanying balance sheet net of the
unamortized portion of $635,843 of aggregate discounts resulting from:
(i) an allocation of the proceeds to the respective fair values of the
Series A Preferred and common stock purchase warrants and (2) beneficial
conversion features based on the "effective" conversion prices of the
Series A Preferred. The unamortized portion of the aggregate discount
amounts to $625,246 at December 31, 2004.
The Series A Preferred stock discount is being amortized over the term of
such shares to their earliest date of redemption of November 22, 2009.
The accretion of the Series A Preferred to its mandatory redemption
amount and contractual dividends are included in the accompanying
financial statements as a component of interest expense. The following
table presents a summary of the Series A Preferred stock contractual
dividends and accretion of the discount:
For the Period from
July 28, 2004
(Inception) to
December 31,
2004
-------------------
Contractual dividends at $0.10 per annum ......... $34,539
Accretion of Series A Preferred to its mandatory
redemption amount .............................. 10,597
-------
$45,136
Total non-cash interest expense, which amounts to $11,980, includes
$10,597 of accretion described above plus amortization of $1,383 of
deferred financing costs (see Note 5).
The Company classified the Series A Preferred as a liability in the
accompanying balance sheet in accordance with SFAS 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities
and Equity," since it is mandatorily redeemable at the option of the
holders.
The Company concurrently entered into an Investor Rights Agreement,
Stockholders' Agreement and Right of First Refusal and Co-sale Agreement,
each of which provides for certain rights and restrictions with respect
to the Series A Preferred investors that are more fully described in Note
11.
16
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 11 - STOCKHOLDERS' EQUITY
COMMON STOCK
On November 11, 2004, the Company issued 953,160 shares of its common
stock to its founders, who are principally employees of IDK Enterprises,
Inc. in exchange for subscriptions receivable in the amount of $9,532.
The subscriptions were paid in February 2005.
On December 31, 2004, the Company issued 1,500,000 shares of its common
stock in exchange for subscriptions receivable in the amount of $15,000
to 3 members of Patron's advisory board.
ISSUANCE OF COMMON STOCK PURCHASE WARRANTS
On December 3, 2004, the Company issued 45,000 common stock purchase
warrants with a term of 7 years and an exercise price of $1.00 per share
to the Placement Agent in the Series A Preferred financing transaction
(Note 10). The aggregate fair value of these warrants amounted to $37,800
and was accounted for as deferred financing costs.
On December 3, 2004, the Company issued 462,500 common stock purchase
warrants with a term of 7 years and an exercise price of $1.00 per share
to the Series A Preferred investors (Note 10). The aggregate fair value
of these warrants amounted to $635,843.
STOCKHOLDERS' AGREEMENT
On December 2, 2004, the Company entered into an agreement (the
"Stockholders' Agreement") with its common stockholders ("Common
Stockholders") and the investors of its Series A Preferred ("Investors"),
with the Common Stockholders and Investors, collectively referred to as
(the "Holders").
The Stockholders' Agreement provides for, among other things, (a) the
Common Stockholders, voting as a class, to designate two members to the
Company's board of directors, (b) the Investors to designate two members
to the Company's board of directors, including one to be appointed by
Apex Investment Fund V, LP (a significant investor) and the other to be
elected by a majority of the Investors voting as a class, (c) the
Holders, to collectively elect, by a majority vote, a fifth member to the
Company's board of directors, (d) certain restrictions on the transfer of
shares, and (e) a majority of the Investors (on an as converted basis to
common stock) to exercise certain "Drag Along" rights, as defined, and
for the Holders to exercise certain "Tag Along" rights, as defined in the
event of a proposed sale of a majority of shares under certain
circumstances.
17
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 11 - STOCKHOLDERS' EQUITY, continued
INVESTOR RIGHTS AGREEMENT
On December 2, 2004, the Company entered into an Investor Rights
Agreement (the "Investor Rights Agreement") with its Common Stockholders
and Investors and, on a collective basis with the Holders, providing for,
among other things, the Company to (a) reserve up to 3,500,000 shares of
its common stock for issuance under various types of employee, director
and consultant stock compensation arrangements, if and when the board of
directors may approve such plans, and (b) register under the Securities
Act certain shares of restricted stock for resale, if required by at
least 40% of the holders of such shares (the "Registration Rights").
Pursuant to the Investor Rights Agreement, such Registration Rights are
exercisable at any time after the earlier of three years from the date of
the issuance of the Series A Preferred, or six months after the
completion of an initial public offering by holders, representing at
least a 40% interest of all restricted shares. Such holders may request
the Company to register no less than 20% of their restricted shares, or
such lesser percentage if in the event the anticipated offering price
under such registration is in excess of $5,000,000.
RIGHT OF FIRST REFUSAL AND CO-SALE AGREEMENT
On December 2, 2004, the Company entered into a Right of First Refusal
and Co-sale Agreement with its Common Stockholders and Investors,
providing, among other things, for the Company or the Investors to
exercise a "Right of First Refusal" or "Co-sale Rights," as defined, to
purchase shares of common stock in the event any such shares are proposed
to be sold by any significant Common Stockholder.
NOTE 12 - CONSULTING SERVICES
The Company incurred $55,000 of consulting fees for executive management
and corporate advisory services provided by a number of its board of
directors during the period of July 2004 through December 2004.
NOTE 13 - INCOME TAXES
As of December 31, 2004, the Company has incurred book losses since
inception of $343,583 and estimates that it has net operating loss
carryforwards available to offset future taxable income of approximately
$340,000 that may be available to offset future taxable income, if any
through 2024. The Company has established a 100% valuation allowance for
the deferred tax assets arising from the net operating loss and other
temporary differences as management believes that it is more likely than
not that their benefit, if any, will not be realized in the future.
18
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 13 - INCOME TAXES, continued
The utilization of the net operating losses may be subject to substantial
limitations due to the "change of ownership" provisions under Section 382
of the Internal Revenue Code and similar state provisions, as a result of
the Company's merger with Patron on February 25, 2005 (Note 14).
The Company paid no income taxes during the year ended December 31, 2004.
NOTE 14 - SUBSEQUENT EVENTS
MERGER OF IDK ENTERPRISES, INC. INTO THE COMPANY
On February 24, 2005, the Company merged with IDK pursuant to an
Agreement and Plan of Merger, by and between the Company, IDK Acquisition
Sub, LLC, IDK, and George M. Middlemas, as Shareholder Representative of
IDK, with IDK Acquisition Sub, LLC surviving as a wholly-owned subsidiary
of the Company. In connection with the merger, all the issued,
outstanding and held-in-treasury common and preferred stock of IDK were
cancelled and retired. The Shareholders of IDK received 8,046,840 shares
of the Company's common stock.
MERGER OF THE COMPANY INTO PATRON SYSTEMS, INC.
On February 25, 2005, pursuant to the filing of an Agreement and Plan of
Merger, the merger by and between Patron with the Company became
effective. The merger was consummated pursuant to a definitive
Supplemental Agreement and the Agreement and Plan of Merger, entered into
as of February 24, 2005, each among Patron, CSSI Acquisition Co. I. Inc.,
a wholly-owned subsidiary of Patron and the Company. Pursuant to the
terms of the Supplemental Agreement and Agreement and Plan of Merger with
the Company, CSSI Acquisition Co., Inc. merged with and into the Company,
with the Company surviving the merger as a wholly-owned subsidiary of
Patron. In connection with the Company's merger, Patron issued 7,500,000
shares of common stock in exchange for the outstanding shares of the
Company's common stock, and subordinated promissory notes in the
aggregate principal amount of $4,500,000 and warrants to purchase
2,250,000 shares of common stock in exchange for the outstanding shares
of the Company's preferred stock. The warrants have a term of 5 years and
an exercise price of $0.70 per share. The subordinated promissory notes
and warrants were issued to Apex Investment Fund V, L.P., The
Northwestern Mutual Life Insurance Company, and Advanced Equities Venture
Partners I, L.P.
MERGER OF LUCIDLINE, INC. INTO PATRON SYSTEMS, INC.
On February 25, 2005, pursuant to the filing of an Agreement and Plan of
Merger, Patron's merger with LucidLine became effective.
19
COMPLETE SECURITY SOLUTIONS, INC.
(A Development Stage Enterprise)
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 14 - SUBSEQUENT EVENTS, continued
MERGER OF ENTELAGENT SOFTWARE CORP. INTO PATRON SYSTEMS, INC.
On March 30, 2005, pursuant to the filing of an Amended and Restated
Agreement and Plan of Merger, Patron's merger with Entelagent became
effective. The Amended and Restated Agreement and Plan of Merger received
a filing date of April 28, 2005 from the Secretary of State of the State
of California.
20
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
IDK Enterprises, Inc.
We have audited the accompanying balance sheet of IDK Enterprises, Inc. as of
December 31, 2004 and the related statements of operations, stockholders' equity
(deficiency) and cash flows for the years ended December 31, 2004 and 2003.
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 audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by the 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 above present fairly, in all
material respects, the financial position of IDK Enterprises, Inc. as of
December 31, 2004 and the results of its operations and its cash flows for the
years ended December 31, 2004 and 2003, in conformity with accounting principles
generally accepted in the United States of America.
21
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 3 to the
financial statements, the Company has had recurring losses since its inception
and has a working capital deficiency as of December 31, 2004. These conditions
raise substantial doubt about its ability to continue as a going concern.
Management's plans regarding those matters also are described in Note 3. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Marcum & Kliegman LLC
-------------------------
Marcum & Kliegman LLC
July 29, 2005
New York, New York
22
IDK ENTERPRISES, INC.
BALANCE SHEET
December 31, 2004
--------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash ........................................................ $ 22,497
Accounts receivable ......................................... 216,960
Prepaid expenses and other current assets ................... 3,874
--------
Total Current Assets ...................................... $243,331
PROPERTY AND EQUIPMENT, Net ................................... 26,921
DEFERRED FINANCING FEES, Net .................................. 121,900
CUSTOMER LIST, Net ............................................ 22,500
COMPUTER SOFTWARE, Net ........................................ 303,078
--------
TOTAL ASSETS .............................................. $717,730
========
23
IDK ENTERPRISES, INC.
BALANCE SHEET
December 31, 2004
--------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES
Accounts payable ........................................... $ 36,633
Accrued compensation ....................................... 143,408
Accrued expenses ........................................... 24,464
Deferred revenue ........................................... 145,275
Advances from prospective acquirer ......................... 657,847
Accrued interest ........................................... 583,291
-----------
Total Current Liabilities ................................ $ 1,590,918
SERIES A MANDATORILY REDEEMABLE
CONVERTIBLE PREFERRED STOCK (Liquidation
Preference $9,600,000) ..................................... 4,358,769
-----------
TOTAL LIABILITIES ........................................ 5,949,687
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIENCY
Common stock, par value $0.01; 10,000,000 shares
authorized; 100 shares issued and outstanding ............ 1
Additional paid in capital ................................. 2,058,841
Deferred compensation ...................................... (383,627)
Accumulated deficit ........................................ (6,907,172)
-----------
TOTAL STOCKHOLDERS' DEFICIENCY ........................... (5,231,957)
-----------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY ........... $ 717,730
===========
24
IDK ENTERPRISES, INC.
STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
2004 2003
----------- -----------
REVENUE
Software licenses .............................. $ 695,651 $ 1,203,632
Maintenance and support ........................ 287,771 250,361
Professional services .......................... 56,321 73,345
----------- -----------
TOTAL REVENUE ................................ 1,039,743 1,527,338
COST OF REVENUE .................................. 279,764 270,105
----------- -----------
GROSS PROFIT ................................. 759,979 1,257,233
----------- -----------
OPERATING EXPENSES
Salaries and employee benefits ................. 2,366,630 3,632,401
Selling, general and administrative expenses ... 694,208 907,291
Depreciation and amortization .................. 290,666 252,178
----------- -----------
TOTAL OPERATING EXPENSES ..................... 3,351,504 4,791,870
----------- -----------
LOSS FROM OPERATIONS ......................... (2,591,525) (3,534,637)
OTHER EXPENSE
Interest expense, net .......................... (454,415) (278,010)
----------- -----------
LOSS BEFORE INCOME TAXES ..................... (3,045,940) (3,812,647)
INCOME TAXES ..................................... -- --
----------- -----------
NET LOSS ..................................... $(3,045,940) $(3,812,647)
=========== ===========
25
IDK ENTERPRISES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
Additional
Common Stock Paid-in Deferred Accumulated
Shares Amount Capital Compensation Deficit Total
----------- ----------- ----------- ----------- ----------- -----------
BALANCE - January 1, 2003 ........... 100 $ 1 $ 224,484 $ -- $ (48,585) $ 175,900
Deferred compensation related to
the issuance of employee stock
options ........................... -- -- 1,657,977 (1,657,977) -- --
Amortization of deferred compensation -- -- -- 1,036,236 -- 1,036,236
Net loss ............................ -- -- -- -- (3,812,647) (3,812,647)
----------- ----------- ----------- ----------- ----------- -----------
BALANCE - December 31, 2003 ......... 100 $ 1 $ 1,882,461 $ (621,741) $(3,861,232) $(2,600,511)
=========== =========== =========== =========== =========== ===========
26
IDK ENTERPRISES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY), Continued
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
Additional
Common Stock Paid-in Deferred Accumulated
Shares Amount Capital Compensation Deficit Total
----------- ----------- ----------- ----------- ----------- -----------
BALANCE - January 1, 2004 ........... 100 $ 1 $ 1,882,461 $ (621,741) $(3,861,232) $(2,600,511)
Deferred compensation related to
the issuance of employee stock
options ........................... -- -- 176,380 (176,380) -- --
Amortization of deferred compensation -- -- -- 414,494 -- 414,494
Net loss ............................ -- -- -- -- (3,045,940) (3,045,940)
----------- ----------- ----------- ----------- ----------- -----------
BALANCE - December 31, 2004 ......... 100 $ 1 $ 2,058,841 $ (383,627) $(6,907,172) $(5,231,957)
=========== =========== =========== =========== =========== ===========
27
IDK ENTERPRISES, INC.
STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ..................................... $(3,045,940) $(3,812,647)
----------- -----------
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization .............. 570,430 522,283
Stock based compensation ................... 414,494 1,036,236
Non-cash interest expense .................. 451,276 276,877
Changes in assets and liabilities:
Accounts receivable ........................ (144,553) 51,475
Other current assets ....................... 11,511 41,766
Accounts payable ........................... (81,207) 117,840
Accrued compensation ....................... 18,723 124,685
Accrued expenses ........................... (32,276) (92,350)
Deferred revenue ........................... (4,932) 87,709
----------- -----------
TOTAL ADJUSTMENTS ........................ 1,203,466 2,166,521
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES .... (1,842,474) (1,646,126)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash advanced to acquiree business ........... -- (110,096)
Cash received upon foreclosure of business ... -- 1,359
Purchases of property and equipment .......... (5,920) --
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES .... $ (5,920) $ (108,737)
----------- -----------
28
IDK ENTERPRISES, INC.
STATEMENTS OF CASH FLOWS, Continued
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
2004 2003
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Bank overdraft ................................. $ -- $ (92)
Proceeds from issuance of Series A mandatorily
redeemable convertible preferred stock ....... 1,400,000 1,734,999
Fees paid to placement agent ................... (167,000) --
Advances from prospective acquirer ............. 657,847 --
Advances from officer .......................... 39,000 36,000
Repayment of advances from officer ............. (75,000) --
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES .. 1,854,847 1,770,907
----------- -----------
NET INCREASE IN CASH ....................... 6,453 16,044
CASH - Beginning ................................. 16,044 --
----------- -----------
CASH - Ending .................................... $ 22,497 $ 16,044
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the years for:
Interest ....................................... $ 3,279 $ 1,133
Supplemental non-cash investing and financial
activity:
Acquisition of business upon foreclosure of
notes in 2003:
Current tangible assets acquired ............. $ -- $ 181,036
Non-current tangible assets acquired ......... -- 60,000
Current liabilities assumed .................. -- (211,591)
Intangible assets acquired ................... -- 1,379,292
Carrying value of secured notes .............. -- (1,300,000)
Cash received upon foreclosure of business ... -- 1,359
----------- -----------
Cash advanced to acquiree business ......... $ -- $ 110,096
=========== ===========
29
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - THE COMPANY
ORGANIZATION
IDK Enterprises, Inc. (the "Company"), a Delaware corporation, was
founded on October 12, 2002 to acquire the operations of NETdelivery,
Inc. ("NETdelivery"), a developer of secure online forms and real-time
data collection software programs. The Company's products are
specifically designed for, and marketed to, federal, state and local law
enforcement agencies and commercial insurance companies. As described in
Note 2, the Company completed its acquisition of NETdelivery upon the
foreclosure of certain secured notes on January 31, 2003 and has
continued as the successor entity to NETdelivery's business.
NOTE 2 - ACQUISITION OF ASSETS AND BUSINESS OF NETDELIVERY, INC.
On January 31, 2003, the Company acquired the business and operations of
NETdelivery for $1,410,096. The Company acquired NETdelivery upon its
foreclosure of secured notes of NETdelivery that were held by the
Company's common stockholders and certain of its preferred stockholders.
Such stockholders assigned their notes and underlying rights to the net
assets of NETdelivery to the Company in exchange for 1,376,350 shares of
the Company's Series A Mandatorily Redeemable Preferred Stock ("Series A
Preferred") for $1,300,000 which was deemed to be equal to the fair value
of the notes, based on the value of the underlying collateral. In
addition, the Company made $110,096 in cash advances to NETdelivery prior
to the foreclosure that were accounted for as part of the aggregate cost
of acquiring NETdelivery's net assets.
The Company recorded the tangible assets acquired and liabilities assumed
from NETdelivery at their fair values at the date of the foreclosure. The
aggregate amount of the note plus the cash advances made to NETdelivery
in excess of the fair value of the net assets acquired was allocated to
NETdelivery's computer software and customer list. The following table
provides a breakdown of the Company's allocation of the cost of acquiring
NETdelivery to the fair values of assets acquired and liabilities assumed
from NETdelivery at the date of the foreclosure:
Fair Value of Tangible Assets
Cash ........................................ $ 1,359
Accounts receivable ......................... 181,036
Property and equipment ...................... 60,000
---------
Net Tangible Assets ................. 242,395
Liabilities Assumed:
Accrued expenses ............................ (149,091)
Deferred revenue ............................ (62,500)
---------
Liabilities assumed ......................... (211,591)
---------
Net Assets Acquired ................. $ 30,804
---------
30
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 2 - ACQUISITION OF ASSETS AND BUSINESS OF NETDELIVERY, INC., continued
Net Assets Acquired
(Balance brought forward) ........... $ 30,804
Value of Excess Over Purchase Price of Net
Assets Acquired Allocated to:
Computer software ........................... 839,292
Customer list ............................... 540,000
----------
Total ................................. $1,410,096
==========
NOTE 3 - LIQUIDITY AND FINANCIAL CONDITION
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal
course of business. The Company incurred a net loss of $3,045,940 for the
year ended December 31, 2004. In addition, the Company's working capital
deficiency amounted to $1,347,587 and its accumulated deficit amounted to
$6,907,172 at December 31, 2004. As described in Note 16, the Company
consummated a merger with Complete Security Solutions, Inc. ("CSSI"),
which subsequently merged with and into Patron Systems, Inc. (the
"Parent") on February 25, 2005. The Company will require substantial
additional working capital to sustain its operations, while the Parent
continues its efforts to integrate the business into its existing
operations.
The Company expects to continue incurring losses for the foreseeable
future and cannot provide any assurance as to when, if ever, it will
become a profitable enterprise due to the inherent uncertainty that is
related to establishing the commercial feasibility of technological
products and developing a presence in new markets. The Parent also has
limited capital resources and is subject to substantial contingencies
that also raise doubt as to its ability to continue as a going concern.
Neither the Parent nor the Company has obtained any commitments to
provide the Company with new financing. These matters raise substantial
doubt about the Company's ability to continue as a going concern. The
financial statements do not include any adjustments relating to the
recoverability of recorded asset amounts that might be necessary as a
result of the above uncertainty.
31
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTS RECEIVABLE
The Company has a policy of reserving for uncollectible accounts based on
its best estimate of the amount of probable credit losses in its existing
accounts receivable. The Company periodically reviews its accounts
receivable to determine whether an allowance is necessary based on an
analysis of past due accounts and other factors that may indicate that
the realization of an account may be in doubt. Account balances deemed to
be uncollectible are charged to the allowance after all means of
collection have been exhausted and the potential for recovery is
considered remote. As of December 31, 2004, the Company has had a low
occurrence of credit losses and, based on a review of balances
outstanding, has determined that an allowance for doubtful accounts is
not necessary.
REVENUE RECOGNITION
The Company derives its revenues from sales of computer software, post
contract customer support and professional consulting services.
The Company applies the revenue recognition principles set forth under
AICPA Statement of Position ("SOP") 97-2, "Software Revenue Recognition,"
with respect to its sales of computer software and post contract customer
support arrangements. Revenues from software license agreements are
generally recognized upon delivery of software to the customer. All of
the Company's software sales are supported by a written contract or other
evidence of a sale transaction such as a customer purchase order. These
forms of evidence clearly indicate the selling price to the customer,
shipping terms, payment terms (generally 30 days) and refund policy, if
any. The selling prices of these products are fixed at the time the sale
is consummated.
Revenue from post contract customer support arrangements or undelivered
elements are deferred and recognized at the time of delivery or over the
period in which the services are performed based on vendor specific
objective evidence of fair value for such undelivered elements. Vendor
specific objective evidence is typically based on the price charged when
an element is sold separately or, if an element is not sold separately,
on the price established by an authorized level of management, if it is
probable that the price, once established, will not change before market
introduction. The Company uses the residual method prescribed in SOP 98-9
to allocate revenues to delivered elements once it has established
vendor-specific evidence for such undelivered elements.
Professional consulting services are billed based on the number of hours
of consulting services hours provided and the hourly billing rates. The
Company recognizes revenue under these arrangements as the service is
performed.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated
depreciation and amortization. Depreciation and amortization are being
computed over the estimated useful lives of the assets, generally three
years, using the straight-line method. Repairs and maintenance costs are
expensed as incurred.
32
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
SOFTWARE DEVELOPMENT COSTS
In accordance with Statement of Financial Accounting Standard No.
("SFAS") 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed," software development costs incurred
subsequent to the establishment of technological feasibility through the
product's general availability are capitalized. The Company also
capitalizes the cost of improvements to its existing products that extend
the life or significantly improve the marketability of the original
product and enhancements that require a redesign of all or part of the
existing product.
The Company did not incur any capitalizable software development costs
during the years ended December 31, 2004 and 2003.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically reviews its long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying
amount of the assets may not be fully recoverable. The Company recognizes
an impairment loss when the sum of expected undiscounted future cash
flows is less than the carrying amount of the asset. The amount of
impairment is measured as the difference between the asset's estimated
fair value and its book value. The Company did not consider it necessary
to record any impairment charges during the year ended December 31, 2004.
STOCK-BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," allows companies
to account for stock-based compensation using either the provisions of
SFAS 123 or the provisions of Accounting Principles Board of Opinion
(APB) No. 25, "Accounting for Stock Issued to Employees," but requires
pro forma disclosure in the notes to the financial statements as if the
measurement provisions of SFAS 123 had been adopted. The Company accounts
for its stock-based employee compensation in accordance with APB No. 25.
The following table illustrates the effect on net loss for the years
ended December 31, 2004 and 2003, as if the Company had applied the fair
value recognition provisions of SFAS No. 123 to stock-based employee
compensation:
For the Years Ended
December 31,
--------------------------
2004 2003
----------- -----------
Net loss, as reported .......................... $(3,045,940) $(3,812,647)
Add: stock-based compensation cost reflected
in the financial statements ....... 414,494 1,036,236
Less: stock-based employee compensation
expense under the fair value method (446,733) (1,107,897)
----------- -----------
Pro-Forma Net Loss ................... $(3,078,179) $(3,884,308)
=========== ===========
RESEARCH AND DEVELOPMENT
Research and development costs, which consist of employee compensation,
amounted to $123,206 and $203,870 for the years ended December 31, 2004
and 2003, respectively. Research and development costs are expensed as
incurred.
33
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No.
109"). SFAS No. 109 requires the recognition of deferred tax assets and
liabilities for both the expected impact of differences between the
financial statements and tax basis of assets and liabilities and for the
expected future tax benefit to be derived from tax loss and tax credit
carry forwards. SFAS No. 109 additionally requires the establishment of a
valuation allowance to reflect the likelihood of realization of deferred
tax assets
ADVERTISING COSTS
Advertising costs are expensed as incurred and amounted to $76,426 and
$25,944 for the years ended December 31, 2004 and 2003, respectively.
USE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS
In preparing financial statements in conformity with accounting
principles generally accepted in the United States of America, management
is required to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets
and liabilities at the date of the financial statements and revenue and
expenses during the reporting period. Actual results could differ from
those estimates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In January 2003, Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities"
("FIN 46"). This interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," provides guidance for identifying a
controlling interest in a variable interest entity ("VIE") established by
means other than voting interest. FIN 46 also required consolidation of a
VIE by an enterprise that holds such controlling interest. In December
2003, the FASB completed its deliberations regarding the proposed
modifications to FIN No., 46 and issued Interpretation Number 46R,
"Consolidation of Variable Interest Entities - an Interpretation of ARB
51" ("FIN No. 46 R"). The decisions reached included a deferral of the
effective date and provisions for additional scope exceptions for certain
types of variable interests. Application of FIN No. 46R is required in
financial statements of public entities that have interests in VIEs or
potential VIEs commonly referred to as special-purpose entities for
periods ending after December 15, 2003. Application by public issuers'
entities is required in all interim and annual financial statements for
periods ending after December 15, 2004. The adoption of this
pronouncement did not have material effect on the Company's financial
statements.
34
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS, continued
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment."
This statement is a revision of SFAS Statement No. 123, "Accounting for
Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees" and its related implementation guidance.
SFAS 123R addresses all forms of share based payment ("SBP") awards,
including shares issued under employee stock purchase plans, stock
options, restricted stock and stock appreciation rights. Under SFAS 123R,
SBP awards result in a cost that will be measured at fair value on the
awards' grant date, based on the estimated number of awards that are
expected to vest and will result in a charge to operations for
stock-based compensation expense. The charge will be reflected in the
Company's Statements of Operations during periods in which such charges
are recorded, but will not affect its Balance Sheets or Statements or
Cash Flows. SFAS 123R is effective for public entities that file as small
business issuers - as of the beginning of the first annual reporting
period of the fiscal year that begins after December 15, 2005. The
Company is currently in the process of evaluating the effect that the
adoption of this pronouncement will have on its financial statements.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Non-monetary Assets." SFAS 153 amends APB Opinion No. 29 to eliminate the
exception for non-monetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of non-monetary assets
that do not have commercial substance. A non-monetary exchange has
commercial substance if the future cash flows of the entity are expected
to change significantly as a result of the exchange. The provisions of
SFAS 153 are effective for non-monetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005. Earlier application is
permitted for non-monetary asset exchanges occurring in fiscal periods
beginning after December 16, 2004. The provisions of this Statement are
intended to be applied prospectively. The adoption of this pronouncement
is not expected to have material effect on the Company's financial
statements.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 2004:
Amount
--------
Office equipment ................................. $ 65,920
Less: accumulated depreciation .................. (38,999)
--------
Property and Equipment, Net ............ $ 26,921
========
Depreciation expense amounted to $20,666 and $18,333 for the years ended
December 31, 2004 and 2003, respectively.
35
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 6 - DEFERRED FINANCING FEES
Deferred financing fees, which include fees paid in connection with the
issuance of Series A Preferred to certain of the Series A Preferred Stock
investors (Note 11) are as follows:
Amount
---------
Deferred financing fees .......................... $ 167,000
Less: accumulated amortization .................. (45,100)
---------
Deferred Financing Fees, Net ........... $ 121,900
=========
Deferred financing fees are being amortized over the term of the Series A
Preferred shares to their earliest mandatory redemption date of January
9, 2008. Amortization of deferred financing fees amounted to $38,400 and
$6,700 for the years ended December 31, 2004 and 2003, respectively, and
is included as a component of interest expense in the accompanying
statements of operations.
NOTE 7 - CUSTOMER LIST
The customer list, which amounted to $22,500, is presented net of
amortization and is being amortized over 2 years. Amortization expense
amounted to $270,000 and $247,500 for 2004 and 2003, respectively.
Amortization for 2005 is $22,500.
NOTE 8 - COMPUTER SOFTWARE
Computer software, which consists of software acquired from NETdelivery
amounts to $303,078 and is presented net of accumulated amortization of
$536,214. Computer software is being amortized over 3 years. Amortization
expense amounted to $279,764 and $256,450 for the years ended December
31, 2004 and 2003, respectively, and is included in cost of sales in the
accompanying statements of operations. Amortization of computer software
is $279,764 and $23,314 for 2005 and 2006, respectively.
NOTE 9 - ADVANCES FROM PROSPECTIVE ACQUIRER
In 2004, the Company received an aggregate of $657,847 in working capital
advances from CSSI. The advances, which are non-interest bearing, are
payable on demand (Note 16).
NOTE 10 - ADVANCES FROM OFFICER
In 2003, the Company received a working capital advance from an officer
amounting to $36,000. In 2004, the Company received an additional $39,000
from the officer as an advance. The advances bear interest at a rate of
10% per annum. The Company repaid the aggregate principal balance of
$75,000, plus accrued interest amounting to $4,412, in 2004.
36
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 11 - SERIES A MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Company is authorized to issue up to 10,000,000 shares of preferred
stock with a par value of $0.01 per share. The Company's board of
directors (the "Board") has designated 5,376,350 of these shares as
Series A Preferred, with voting rights equal to one vote for each share
of common stock into which the Series A Preferred is convertible.
As of December 31, 2004, the Company has issued an aggregate of 4,546,348
shares of its Series A Preferred including (1) 1,376,350 shares issued in
2002 in exchange for the rights to the net assets and business of
NETdelivery described in Note 2, and (2) 3,169,998 shares for net
proceeds of $2,966,661 ($3,134,999 gross proceeds less $68,338 of
placement agent's fees) in 2003 and 2004. In addition, the Company issued
to investors of 1,496,350 of the Series A Preferred shares, warrants to
purchase up to 449,088 shares of common stock at an exercise price of
$1.00 per share expiring at various times through February 6, 2007.
The Series A Preferred is convertible into common stock at any time at
the option of the holder based on a formula, which currently results in a
one-for-one exchange ratio of preferred for common, subject to certain
anti-dilution provisions. The Series A Preferred automatically converts
into shares of the Company's common stock upon the effectiveness of a
registration statement filed under the Securities Act of 1933, with an
offering price per share of at least five times the original issue price
of the Series A Preferred Stock that results in aggregate cash proceeds
of at least $20,000,000.
The Company has reserved 4,995,436 shares of its common stock for
issuance upon the conversion of its redeemable convertible preferred
stock and exercise of the related common stock purchase warrants.
The Series A Preferred also features (1) a liquidation preference
entitling the holders of the Series A Preferred to be paid an amount
equal to twice the original purchase price per share, plus any accrued
but unpaid dividends, upon a liquidation event as defined, (2) cumulative
dividends at the rate of 8% per annum, and (3) a right to participate in
dividends, on a pro rata basis with the common stockholders, based upon
the number of common shares into which the Series A are convertible, if
and when declared by the board of directors. The holders of the Series A
Preferred, voting together as a class, are entitled to elect two members
to the Board of Directors.
One or more holders of shares of the Series A Preferred can require the
Company at any time after January 9, 2008 to redeem their Series A
Preferred shares at the greater of their fair value or original issue
price, plus accrued but unpaid dividends. Redemption payments, if
demanded, would be payable in two annual installments of 50% each
beginning 120 days following the Company's receipt of a redemption notice
by the holders of the Series A Preferred Stock.
37
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 11 - SERIES A MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK, continued
The Company accounted for the issuance of 1,496,350 shares of its Series
A Preferred, with common stock purchase warrants, in accordance with EITF
00-27, "Convertible Securities with Beneficial Conversion Features and
Contingently Adjustable Conversion Ratios". Accordingly, the Series A
Preferred stock is presented in the accompanying balance sheet, net of
the unamortized portion of $300,834 of aggregate discounts resulting
from: (1) an allocation of the gross proceeds to the respective fair
values of the Series A Preferred and common stock purchase warrants and
(2) beneficial conversion features based on the "effective" conversion
prices of the Series A Preferred. The unamortized portion of the
aggregate discount amounts to $187,580 at December 31, 2004.
The Series A Preferred stock discount is being amortized over the term of
such shares to their earliest mandatory redemption date of January 9,
2008. The accretion of the Series A Preferred to its mandatory redemption
amount and contractual dividends are included in the accompanying
financial statements as a component of interest expense. The following
table presents a summary of the Series A Preferred stock contractual
dividends and accretion of the discount:
For the Year Ended
December 31,
-------------------
2004 2003
-------- --------
Contractual dividends at 8% per annum .......... $358,407 $215,708
Accretion of Series A Preferred to its mandatory
redemption amount ........................... 54,469 54,469
-------- --------
$412,876 $270,177
======== ========
The Company classified the Series A Preferred as a liability in the
accompanying balance sheet in accordance with SFAS 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities
and Equity," since it is mandatorily redeemable at the option of the
holder.
In addition to the above, the Company paid a 10% transaction fee in
connection with the issuance of Series A Preferred to certain of the
Series A Preferred investors, which amounted to an aggregate of $67,000
in 2003 and $100,000 in 2004 (Note 6).
38
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 12 - COMMITMENTS
The Company leases its facilities and other certain equipment under
non-cancelable operating lease agreements expiring at various other times
through August 2007. The future minimum lease payments as of December 31,
2004 are as follows:
For the Year Ended
December 31, Office Space Equipment Total
------------------ ------------ --------- -------
2005 $60,000 $3,240 $63,240
2006 -- 3,240 3,240
2007 -- 810 810
------- ------ -------
$60,000 $7,290 $67,290
======= ====== =======
Rent expense under these leases, including the Company's share of
operating expenses, amounted to $107,750 and $137,363 for the years ended
December 31, 2004 and 2003, respectively.
NOTE 13 - EMPLOYEE BENEFITS
EQUITY INCENTIVE PLAN
The Company adopted, effective in 2004, the IDK Enterprises, Inc. 2004
Equity Incentive Award Plan (the Plan) for eligible employees, officers,
directors, Board members and consultants to IDK. Under the Plan, the
Company may grant stock options, restricted stock awards, performance
share awards, dividend equivalents, restricted stock units, stock
payments and stock appreciation rights. A total of 2,743,697 shares of
common stock have been reserved for issuance under the Plan.
Options issued under the Plan generally expire ten years from the grant
date or three months after a participant's termination of employment and
vest as outlined in the individual grant agreements. These options may
only be issued at the discretion of the Board.
The Board may also provide in a participant's grant agreement that the
participant may exercise options granted at any time prior to their
termination, provided that shares of stock acquired upon exercise of an
option which have not been fully vested may be subject to any forfeiture,
transfer or other restrictions as the Board may determine in its sole
discretion.
39
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFITS, continued
EQUITY INCENTIVE PLAN, continued
The following is a summary of option activity of the Plan in 2003 and
2004:
2004 2003
--------------------------- ---------------------------
Weighted Weighted
Average Average
Options Exercise Price Options Exercise Price
--------------------------- ---------------------------
Outstanding - Beginning of Year 1,842,197 $0.10 -- $ --
Granted 195,978 0.10 1,842,197 0.10
Cancellations and forfeitures -- -- -- --
Exercised -- -- -- --
--------- ----------
Outstanding - End of Year 2,038,175 $0.10 1,842,197 $0.10
========= ===== ========= =====
Options Exercisable 1,611,922 1,151,373
========= =========
At December 31, 2004, all of the Company's stock options have an exercise
price of $0.10 per share and a fair value of $0.97. The weighted average
remaining contractual life of outstanding stock options is 9.5 years.
401(K) PLAN
The Company maintains a defined benefit plan (the Plan) established under
the provisions of Internal Revenue Code Section 401(k), covering all of
its full-time employees. Participants may make voluntary contributions to
the Plan up to the maximum amount allowed by law. The Company may also
make discretionary matching contributions. The Company did not make any
contributions to the Plan during 2004 or 2003.
NOTE 14 - INCOME TAXES
As of December 31, 2004, the Company has incurred book losses since its
inception of $6,907,172 and estimates that it has net operating loss
carryforwards of approximately $4,300,000 that may be available to offset
future taxable income, if any, through 2024. The Company has established
a 100% valuation allowance for the deferred tax assets arising from the
net operating loss and other temporary differences, including the book
and tax bases of its intangible assets, as management believes that it is
more likely than not that their benefit, if any, will not be realized in
the future.
The utilization of the net operating losses may be subject to substantial
limitations due to the "change of ownership" provisions under Section 382
of the Internal Revenue Code and similar state provisions, as a result of
the Company's merger with CSSI and CSSI's subsequent merger with the
Parent.
40
IDK ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 15 - MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
The Company is subject to credit risk concentrations primarily from cash
and cash equivalents and accounts receivable. The Company's management
believes the risk of loss associated with cash and cash equivalents is
very low since cash and cash equivalents are maintained in a financial
institution. Accounts receivable are due from commercial and government
organizations located both in the United States and internationally.
Accounts receivable are generally due within 30 days and no collateral is
required.
One customer accounted for 43% of the Company's revenue during the year
ended December 31, 2004. Two customers accounted for 69% of the Company's
revenue for the year ended December 31, 2003. Two customers accounted for
86% of the Company's accounts receivable at December 31, 2004
Sales to customer outside the United States, including Canada, Sweden and
Australia, amounted to $725,808 and $1,352,294 for the years ended
December 31, 2004 and 2003, respectively.
NOTE 16 - SUBSEQUENT EVENTS
MERGER OF IDK ENTERPRISES, INC. INTO COMPLETE SECURITY SOLUTIONS, INC.
On February 24, 2005, the Company merged with CSSI, pursuant to an
Agreement and Plan of Merger, by and between the Company, CSSI, IDK
Acquisition Sub, LLC, ("IDK LLC") and George M. Middlemas, representative
of the Company's stockholders. IDK LLC survived the merger as a
wholly-owned subsidiary of CSSI and all of the issued and outstanding
common and preferred stock of the Company was retired upon the
effectiveness of the merger,
MERGER OF COMPLETE SECURITY SOLUTIONS, INC. INTO PATRON SYSTEMS, INC.
On February 25, 2005, pursuant to the filing of an Agreement and Plan of
Merger, the merger, by and between the Parent and CSSI, became effective.
The merger was consummated, pursuant to a definitive Supplemental
Agreement, and the Agreement and Plan of Merger (collectively, the
"Merger Agreement") entered into as of February 24, 2005, by and between
the Parent, CSSI Acquisition Co. I. Inc., ("Acquisition Co."), a
wholly-owned subsidiary of the Parent and CSSI. Pursuant to the terms of
the Merger Agreement, Acquisition Co. merged with and into CSSI, with
CSSI surviving the merger as a wholly-owned subsidiary of the Parent.
41
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
LucidLine, Inc.
We have audited the accompanying balance sheet of LucidLine, Inc. as of December
31, 2004 and the related statements of operations, stockholders' deficiency and
cash flows for the years ended December 31, 2004 and 2003. 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 audit.
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 audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by the 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 above present fairly, in all
material respects, the financial position of LucidLine, Inc. as of December 31,
2004 and the results of its operations and its cash flows for the years ended
December 31, 2004 and 2003, in conformity with accounting principles generally
accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has had recurring losses since its inception
and has a working capital deficiency as of December 31, 2004. These conditions
raise substantial doubt about its ability to continue as going concern.
Management's plans regarding those matters also are described in Note 1. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Marcum & Kliegman LLP
-------------------------
Marcum & Kliegman LLP
June 22, 2005
New York, New York
42
LUCIDLINE, INC.
BALANCE SHEET
December 31, 2004
--------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Accounts receivable, less allowance for doubtful
accounts of $2,670 .......................................... $12,422
Other current assets .......................................... 2,200
-------
Total Current Assets ..................................... $14,622
PROPERTY AND EQUIPMENT, Net ..................................... 60,405
-------
TOTAL ASSETS ............................................. $75,027
=======
43
LUCIDLINE, INC.
BALANCE SHEET
December 31, 2004
--------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES
Notes payable ............................................ $ 577,000
Current maturities of capital lease ...................... 1,912
Cash overdraft ........................................... 863
Accounts payable and accrued expenses .................... 47,047
Loans payable to stockholders ............................ 19,581
Notes payable - stockholders ............................. 76,320
-----------
Total Current Liabilities ........................... $ 722,723
CAPITAL LEASE, Net of current maturities ................... 4,401
-----------
TOTAL LIABILITIES ................................... 727,124
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIENCY
Common stock, no par value, 10,000,000
shares authorized; 10,000,000 shares
issued and outstanding ................................. 663,022
Accumulated deficit ...................................... (1,315,119)
-----------
TOTAL STOCKHOLDERS' DEFICIENCY ...................... (652,097)
-----------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY ...... $ 75,027
===========
44
LUCIDLINE, INC.
STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
2004 2003
--------- ---------
REVENUES
Electronic data protection services .......... $ 143,915 $ 103,884
Consulting services .......................... 100,000 --
--------- ---------
TOTAL REVENUES .......................... 243,915 103,884
--------- ---------
COSTS OF REVENUES
Telecom and network .......................... 152,699 103,480
Cost of consulting services .................. 70,000 --
--------- ---------
TOTAL COSTS OF REVENUE .................. 222,699 103,480
--------- ---------
GROSS PROFIT ............................ 21,216 404
--------- ---------
OPERATING EXPENSES
Compensation costs and related
benefits (including stock-
based compensation of $84,470 and
$262,493, respectively) .................... 333,934 324,994
Professional fees ............................ 110,035 4,373
Consulting fees (including stock-
based compensation of $51,207 and
$0, respectively) .......................... 125,047 49,908
Occupancy costs .............................. 20,460 20,226
Depreciation ................................. 13,402 10,358
Other ........................................ 22,345 11,710
--------- ---------
TOTAL OPERATING EXPENSES ................ 625,223 421,569
--------- ---------
OPERATING LOSS .......................... (604,007) (421,165)
OTHER EXPENSE
Interest ..................................... 13,297 1,108
--------- ---------
NET LOSS ................................ $(617,304) $(422,273)
========= =========
45
LUCIDLINE, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY
For the Years Ended December 31, 2003 and 2004
--------------------------------------------------------------------------------
Total
Common Stock Accumulated Stockholders'
Shares Amount Deficit Deficiency
----------- ----------- ----------- -----------
BALANCE - January 1, 2003 ......................... 3,500,000 $ 13,022 $ (275,542) $ (262,520)
Common stock returned to founders ................. 1,500,000 150,000 -- 150,000
Stock-based compensation .......................... 1,148,000 114,800 -- 114,800
Conversion of trade payables into common stock .... 810,000 81,000 -- 81,000
Conversion of stockholders' loans into common stock 908,000 90,800 -- 90,800
Net loss .......................................... -- -- (422,273) (422,273)
----------- ----------- ----------- -----------
BALANCE - December 31, 2003 ....................... 7,866,000 449,622 (697,815) (248,193)
Common stock returned to founders ................. 735,000 73,500 -- 73,500
Stock-based compensation .......................... 121,000 12,100 -- 12,100
Conversion of trade payables into common stock .... 647,931 64,793 -- 64,793
Conversion of stockholders' loans into common stock 118,000 11,800 -- 11,800
Common stock issued for consulting services ....... 512,069 51,207 -- 51,207
Net loss .......................................... -- -- (617,304) (617,304)
----------- ----------- ----------- -----------
BALANCE - December 31, 2004 ....................... 10,000,000 $ 663,022 $(1,315,119) $ (652,097)
=========== =========== =========== ===========
46
LUCIDLINE, INC.
STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
2004 2003
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ........................................... $(617,304) $(422,273)
--------- ---------
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation ..................................... 13,402 10,358
Stock-based compensation ......................... 135,677 262,493
Bad debts ........................................ (6) 2,676
Changes in operating assets and liabilities:
Accounts receivable .............................. (9,321) (4,776)
Other current assets ............................. (2,200) --
Accounts payable and accrued expenses ............ (49,916) 120,337
--------- ---------
TOTAL ADJUSTMENTS ............................. 87,636 391,088
--------- ---------
NET CASH USED IN OPERATING ACTIVITIES ......... (529,668) (31,185)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES
Purchase of property and equipment ................. (34,830) (3,309)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of notes payable ............ 577,000 --
(Repayments) advances under bank line of credit .... (17,000) 17,000
Repayments under capital lease obligation .......... (1,262) --
Advances from stockholders ......................... 20,415 11,692
Repayments to stockholder .......................... (13,526) --
Proceeds from issuance of common stocks to founders 1,130 2,307
Cash overdraft ..................................... (2,259) 3,122
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES ..... $ 564,498 $ 34,121
--------- ---------
47
LUCIDLINE, INC.
STATEMENTS OF CASH FLOWS, Continued
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
2004 2003
-------- --------
NET DECREASE IN CASH ............................. $ -- $ (373)
CASH - Beginning of year ................................ -- 373
-------- --------
CASH - End of year ..................................... $ -- $ --
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the years for:
Interest ............................................ $ 2,596 $ 1,108
Income taxes ........................................ $ -- $ --
Non-cash investing and financing activities:
Stockholders' loans converted into 118,000 and
908,000 shares of common stock, respectively ...... $ 11,800 $ 90,800
Trade payables converted into 647,931 and 810,000
shares of common stock, respectively ............. $ 64,793 $ 81,000
Acquisition of property and equipment under capital
lease obligation .................................. $ -- $ 7,875
48
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - BUSINESS, GOING CONCERN AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
LucidLine, Inc. (hereinafter referred to as the "Company) is an Illinois
corporation formed in May 2001. The Company provides high speed
synchronized remote back-up, retrieval, and restoration services of
electronic information to small and mid-size businesses under a system
that accessible over the internet.
GOING CONCERN
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal
course of business. The Company has had recurring losses since its
inception. At December 31, 2004, the Company's current liabilities exceed
its current assets by approximately $708,000 and it has a stockholders'
deficiency of approximately $652,000. On February 25, 2005, the Company
entered into an Agreement and Plan of Merger with Patron Systems Inc.
(the "Parent") (See Note 9). The Parent also has limited capital
resources and is subject to substantial contingencies that also raise
doubt as to its ability to continue as a going concern. Neither the
Parent nor the Company has obtained any commitments to provide the
Company with new financing. These matters raise substantial doubt about
the Company's ability to continue as a going concern. The financial
statements do not include any adjustments relating to the recoverability
of recorded asset amounts that might be necessary as a result of the
above uncertainty.
REVENUE RECOGNITION
The Company provides its electronic information protection services under
contractual arrangements with terms ranging from 1 year to 5 years. At
the inception of each contract, the Company activates the customer's
account for a contractual fee that it amortizes over the term of the
contract in accordance with Emerging Issues Task Force Issue ("EITF")
00-21, "Revenue Arrangements with Multiple Deliverables." Thereafter, the
Company invoices its customers on a monthly basis for services rendered
at contractual rates provided for under the terms of its contracts. These
contracts are automatically renewable by the customer unless terminated
on 30 days written notice, in which case the Company charges the customer
an early termination fee equal to the lesser of six months of service or
the remaining term of the contract.
The Company also provided marketing consulting services to an unrelated
party during the year ended December 31, 2004, for an aggregate fixed fee
of $100,000 that it recorded as revenue at the time the services were
completed.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid securities purchased with
original maturities of three months or less to be cash equivalents. As of
December 31, 2004, the Company had no cash equivalents.
49
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - BUSINESS, GOING CONCERN AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
continued
ACCOUNTS RECEIVABLE
Accounts receivable have been adjusted for all known uncollectible
accounts. The allowance for doubtful accounts is the Company's best
estimate of the amount of probable credit losses in the Company's
existing accounts receivable. The Company reviews its allowance for
doubtful accounts on a monthly basis and determines the allowance based
on an analysis of its past due accounts. All past due balances that are
over 90 days are reviewed individually for collectibility. Accounts
balances are charged off against the allowance after all means of
collection have been exhausted and the potential for recovery is
considered remote.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets.
Maintenance and repairs are charged to expense as incurred; costs of
major additions and betterments are capitalized. When property and
equipment is sold, or otherwise disposed of, the cost and related
accumulated depreciation are eliminated from the accounts and any
resulting gains or losses are reflected in the statement of operations in
the period of disposal.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company groups and evaluates property and equipment and intangible
assets excluding goodwill, for impairment at the individual reporting
unit, which is the lowest level at which individual cash flows can be
identified. When evaluating assets for potential impairment, the Company
first compares the carrying amount of the asset to the asset's estimated
future cash flows (undiscounted and without interest charges). If the
estimated future cash flows used in this analysis are less than the
carrying amount of the asset, an impairment loss calculation is prepared.
The impairment loss calculation compares the carrying amount of the asset
to the asset's estimated future cash flows (discounted and with interest
charges). If the carrying amount exceeds the asset's estimated future
cash flows (discounted and with interest charges), the loss is allocated
to the long-lived assets of the group on a pro rata basis using the
relative carrying amounts of those assets.
INCOME TAXES
The Company provides for federal and state income taxes currently
payable, as well as for those deferred because of timing differences
between reporting income and expenses for financial statement purposes
versus tax purposes. Deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Deferred tax
assets and liabilities are measured using the enacted tax rates expected
to apply to taxable income in the years in which those temporary
differences are expected to be recoverable or settled. The effect of a
change in tax rates is recognized as income or expense in the period of
change. A valuation allowance is established, when necessary, to reduce
deferred income tax assets to the amount that is more likely than not to
be realized.
50
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - BUSINESS, GOING CONCERN AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
continued
FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of accounts
receivable, accounts payable and accrued expenses and debt, which
approximate fair value because of their short-term maturities. The fair
value of notes payable to stockholders is not reasonably determinable
based on the related party nature of transactions.
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 revenue and expenses
during the reporting period. Actual results could differ from those
estimates.
RECENT ACCOUNTING PRONOUNCEMENTS
In January, 2003, the FASB issued interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB
No. 51." FIN 46 requires certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the entity
investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional financial support
from other parties. FIN 46 is effective for all new variable interest
entities created or acquired after January 31, 2003. For variable
interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual
period beginning after December 15, 2003. In December 2003, the FASB
issued Interpretation No. 46(R) ("FIN 46R") which revised certain
provisions of FIN 46. Publicly reporting entities that are small business
issuers must apply FIN 46R to all entities subject to FIN 46R no later
than the end of the first reporting period that ends after December 15,
2004 (as of December 31, 2004, for a calendar year enterprise). The
effective date includes those entities to which FIN 46 had previously
been applied. However, prior to the application of FIN 46R, a public
entity that is a small business issuer shall apply FIN 46 or FIN 46R to
those entities that are considered special-purpose entities no later than
as of the end of the first reporting period that ends after December 15,
2003 (as of December 31, 2003 for a calendar year). The Company does not
have any entities that require disclosure or new consolidation as a
result of adopting the provisions of FIN 46 or FIN 46R.
In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities
under FASB statement No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES. The changes in this Statement improve financial
reporting by requiring that contracts with comparable characteristics be
accounted for similarly. This Statement is effective for contracts
entered into or modified after June 30, 2003. The adoption of this
statement did not have a material effect on the Company's results of
operations or financial position.
51
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - BUSINESS, GOING CONCERN AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
continued
RECENT ACCOUNTING PRONOUNCEMENTS, continued
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity." SFAS No. 150 is the first phase of the FASB's project on
liabilities and equity. SFAS No. 150 provides guidance on how an equity
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. Many of these instruments
were previously classified as equity. For example, if an employer's
issuance of its shares to a key employee requires the employer to redeem
the shares upon the employee's death, then those shares must be
classified as a liability, not as equity. For publicly-held companies,
SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003 and pre-existing instruments as of July 1,
2003. SFAS No. 150 requires companies to record the cumulative effect of
financial instruments existing at the adoption date. The adoption of this
statement did not have a material impact on the Company's results of
operations or financial position.
In December 2003, a revision of SFAS 132, "Employers' Disclosure about
Pension and Other Postretirement Benefits," was issued, revising
disclosure about pension loans and other post retirements benefits plans
and requiring additional disclosures about the assets, obligations, cash
flows, and net periodic benefit cost of defined benefit pension plans and
other defined benefit postretirement plans. The adoption of this
statement did not have a material impact on the Company's results of
operations or financial position.
In December 2004, the FASB issued SFAS No. 153, "Exchange of Nonmonetary
Assets." The Statement amends Opinion 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for 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 provisions of this Statement are
effective for nonmonetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges occurring in fiscal periods beginning after
December 16, 2004. The provisions of this Statement should be applied
prospectively. The adoption of this statement is not expected to have a
material impact on the Company's results of operations of financial
position.
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but
does not require, companies to record compensation cost for stock-based
employee compensation plans at fair value. The Company has chosen to
continue to account for stock-based compensation using the intrinsic
method prescribed in APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, compensation cost
for stock options issued to employees is measured as the excess, if any,
of the quoted market price of the Company's stock at the date of the
grant over the amount an employee must pay to acquire the stock.
52
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - BUSINESS, GOING CONCERN AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
continued
RECENT ACCOUNTING PRONOUNCEMENTS, continued
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123(R) ("FAS 123(R)"), Share-Based Payment, a revision of
FAS 123. FAS 123(R) requires an entity to measure the cost of employee
services received in exchange for an award of equity instruments based on
the grant date fair value of the award (with limited exceptions),
eliminating the alternative previously allowed by FAS 123 to use the
intrinsic value method of accounting. The grant date fair value will be
estimated using option-pricing models adjusted for the unique
characteristics of the instruments using methods similar to those
required by FAS 123 and currently used by the Company to calculate pro
forma net income and earnings per share disclosures. The cost will be
recognized ratably over the period during which the employee is required
to provide services in exchange for the award. For private entities, FAS
123(R) is effective as of the beginning of the first annual period that
begins after December 15, 2005. The Company plans to adopt FAS 123(R) as
of January 1, 2006. The Company is in the process of evaluating whether
FAS 123(R) will have a material impact on the Company's overall results
of operations or financial position.
NOTE 2 - PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2004 consists of the following:
Computers and furniture and equipment ........... $93,778
Less: accumulated depreciation ................. 33,373
-------
Property and equipment, Net ........... $60,405
=======
The estimated useful life used for computers and furniture and equipment
is five years. Depreciation expense for the years ended December 31, 2004
and 2003 was $13,402 and $10,358, respectively.
NOTE 3 - NOTES PAYABLE
During the year ended December 31, 2004, the Company borrowed $577,000
under various demand notes from Complete Security Solutions, Inc.
("CSSI"), an unrelated entity that was also acquired by the Parent on
February 25, 2005 (See Note 9). These loans are payable on demand and
bear interest at an annual rate of 10%. For the year ended December 31,
2004, interest expense on these notes approximated $10,700. The loans are
secured by all of the assets of the Company.
53
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 4 - STOCKHOLDERS' DEFICIENCY
The Company and its principal stockholder entered into a stock assignment
agreement (the "Assignment Agreement") effective July 17, 2002. The
Assignment Agreement provided for the Company's principal stockholder to
assign and transfer 4,500,000 shares of his common stock (the
"Accommodation Shares") to the Company and for the Company to use the
Accommodation Shares for working capital purposes. The Assignment
Agreement also provided for the Company to return, at its own discretion,
such number of Accommodation Shares that it determined it did not need
for working capital purposes.
In year 2002, the Company recorded the receipt of the Accommodation
Shares as treasury stock at an amount equal to the principal stockholders
basis of $6,923. The Company subsequently retired the aforementioned
shares. During the years ended December 31, 2004 and 2003, the Company
used (i) 647,931 and 810,000 shares of available Accommodation Shares to
settle certain trade payables, (ii) 118,000 and 908,000 shares of
available Accommodation Shares to convert stockholders' loan into common
stock and (iii) 121,000 and 1,148,000 shares of available Accommodation
Shares to compensate certain employees for services, respectively. During
the year ended December 31, 2004, the Company also used 512,069 shares of
available Accommodation Shares to compensate certain non-employees for
services.
In accordance with the terms of the Assignment Agreement, the Company
returned 735,000 and 1,500,000 shares of Accommodation Shares at various
times during the years ended December 31, 2003 and 2004, respectively, to
either the principal stockholder or certain designees. The Company
recorded the return of the unused Accommodation Shares at their fair
value of $.10 per share and recorded a stock-based compensation charge of
approximately $72,400 and $147,700 for the years ended December 31, 2004
and 2003, respectively, which represents the excess of the fair value of
the Accommodation Shares over the principal stockholder's original basis.
NOTE 5 - ECONOMIC DEPENDENCY
MAJOR CUSTOMERS
During the year ended December 31, 2004, revenues earned from two
customers totaled $100,000 (41%) and $54,279 (22%), respectively. As of
December 31, 2004, there were no amounts due from these customers.
During the year ended December 31, 2003, revenues earned from five
customers totaled $11,940 (11%), $11,940 (11%), $10,755 (10%), $12,567
(12%) and $14,000 (13%), respectively.
54
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 6 - COMMITMENTS AND CONTINGENCIES
CAPITAL LEASE OBLIGATION
The Company leases machinery and equipment under a capital lease expiring
in September 2007. The assets and liabilities under such capital lease
were recorded at the lower of the present value of the minimum lease
payments or the fair value of the assets. The assets are included in
property and equipment and are being depreciated over their useful lives.
Depreciation expense for the years ended December 31, 2004 and 2003 on
the leased equipment was $1,594 and $394, respectively.
At December 31, 2004, minimum future lease payments under this capital
lease are as follows:
Year Ending
December 31, Amount
-------------------------------------------- -------
2005 $ 3,133
2006 3,133
2007 2,611
-------
Total minimum lease payments 8,877
Less: amounts representing interest 2,564
-------
Present value of net minimum lease payments 6,313
Current maturities of lease payments 1,912
-------
Long-term Capital Lease Obligation $ 4,401
=======
OPERATING LEASES
In November 2004, the Company renewed its lease for office space in Palos
Heights, Illinois, expiring in October 2007, for a monthly rent of
approximately $2,000. Occupancy costs were $20,460 and $20,226 for the
years ended December 31, 2004 and 2003, respectively.
In addition, the Company leases internet network data center services and
bandwidth capacity under two different operating leases that expire at
various dates through November 2007 for a total monthly rent of
approximately $3,000. Rental expense for these operating leases was
approximately $38,000 and $35,000 for the years ended December 31, 2004
and 2003, respectively, and is included in telecom and network costs in
the statements of operations.
55
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 6 - COMMITMENTS AND CONTINGENCIES, continued
OPERATING LEASES, continued
As of December 31, 2004, the future minimum rental commitments under
non-cancelable operating leases are as follows:
Internet Network
Years Ended Date Center Bandwidth
December 31, Office Space Services Capacity
----------- ------------ ---------------- ---------
2005 $22,000 $ 8,572 $22,000
2006 22,000 -- 22,000
2007 18,000 -- 19,200
------- ------- -------
$62,000 $ 8,572 $63,200
======= ======= =======
NOTE 7 - INCOME TAXES
At December 31, 2004, the Company had approximately $1,315,000 of net
operating loss carryforwards for income tax purposes, which expire at
various times through December 31, 2024. As of December 31, 2004, the
Company has a deferred tax asset of approximately $473,000 representing
the benefits of its net operating loss and certain temporary differences,
which include differences in the tax bases of certain intangible assets.
The Company has established a full valuation allowance for its deferred
tax since it is more likely than not the Company will not realize this
benefit in future periods. The Company's ability to utilize its
carryforwards may be subject to an annual limitation in future periods,
pursuant to Section 382 of the Internal Revenue Code of 1986, as amended.
NOTE 8 - RELATED PARTY TRANSACTIONS
LOANS PAYABLE TO STOCKHOLDERS
Since inception, the Company has obtained financing from certain
stockholders for its working capital needs. At December 31, 2004, the
outstanding balance of stockholders' loans amounted to $19,581. These
loans are due on demand and are non-interest bearing. During the years
ended December 31, 2004 and 2003, the Company converted loans of $11,800
and $90,800 into 118,000 and 908,000 shares of Accommodation Shares,
respectively.
NOTES PAYABLE - STOCKHOLDERS
Since inception, the Company has obtained financing from certain
stockholders. At December 31, 2004, the principal and interest amount of
such notes are approximately $76,300. These notes carry an annual
interest rate of 5% and are payable on demand.
56
LUCIDLINE, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 9 - SUBSEQUENT EVENTS
On February 25, 2005, pursuant to the filing of an Agreement and Plan of
Merger, Patron Systems Inc.'s merger with the Company became effective.
The merger was consummated pursuant to the definitive Supplemental
Agreement and the Agreement and Plan of Merger, entered into as of
February 24, 2005, each among Patron Systems, Inc. ("Patron"), LL
Acquisition I Corp., a wholly-owned subsidiary of Patron and the Company.
Pursuant to the terms of the Supplemental Agreement and Agreement and
Plan of Merger with the Company, LL Acquisition I Corp. merged with and
into the Company, with the Company surviving the merger as a wholly-owned
subsidiary of Patron. In connection with the Company's merger, Patron
issued 4,400,000 shares of its common stock and paid $200,000 in cash, in
the aggregate, in exchange for all of the outstanding shares of the
capital stock of the Company. The cash portion of the merger
consideration was disbursed on February 28, 2005.
On April 1, 2005, the Company renewed its existing lease agreement for
its internet network data center services, expiring on March 31, 2006,
for a monthly rent of approximately $4,900.
57
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
To the Board of Directors and Stockholders
Entelagent Software Corp,
We have audited the accompanying balance sheet of Entelagent Software Corp. as
of December 31, 2004 and the related statements of operations, stockholders'
equity (deficiency) and cash flows for the years ended December 31, 2004 and
2003. 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 audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by the 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 above present fairly, in all
material respects, the financial position of Entelagent Software Corp. as of
December 31, 2004 and the results of its operations and its cash flows for the
years ended December 31, 2004 and 2003, in conformity with accounting principles
generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has had recurring losses since its inception
and has a working capital deficiency as of December 31, 2004. These conditions
raise substantial doubt about its ability to continue as a going concern.
Management's plans regarding those matters also are described in Note 2. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Marcum & Kliegman LLP
October 28, 2005
New York, New York
58
ENTELAGENT SOFTWARE CORP.
BALANCE SHEET
December 31, 2004
------------------------------------------------------------------------------------------
ASSETS
------
CURRENT ASSETS
--------------
Cash $ 9,750
Accounts receivable, net 106,832
------------
Total Current Assets $ 116,582
PROPERTY AND EQUIPMENT, Net 694
-----------------------
SECURITY DEPOSIT 5,000
----------------
TECHNOLOGY LICENSE 802,500
------------------ ------------
TOTAL ASSETS $ 924,776
------------
59
ENTELAGENT SOFTWARE CORP.
BALANCE SHEET
December 31, 2004
------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
----------------------------------------
CURRENT LIABILITIES
-------------------
Accounts payable $ 496,394
Accrued payroll 1,678,533
Payroll taxes payable 530,923
Deferred revenue 119,455
Accrued interest, including $426,251 due to related parties 664,065
Accrued expenses 74,181
Accrued technology license fees 450,000
Advances from prospective acquirer 943,241
Advances from prospective affiliate 788,270
Amounts due to officers and stockholders 962,520
Notes payable 542,414
------------
Total Current Liabilities $ 7,249,996
MANDATORILY REDEEMABLE CONVERTIBLE
----------------------------------
PREFERRED STOCK
---------------
Series A (Liquidation preference $192,500) 192,500
Series B (Liquidation preference $600,000) 600,000
Series C (Liquidation preference $1,610,448) 1,610,448
------------
Total Long-Term Liabilities 2,402,948
------------
TOTAL LIABILITIES 9,652,944
COMMITMENTS AND CONTINGENCIES
-----------------------------
STOCKHOLDERS' DEFICIENCY
------------------------
Common stock, par value $.01 per share, 10,000,000 shares
authorized; 3,278,900 shares issued and outstanding 32,789
Additional paid-in capital 748,999
Accumulated deficit (9,509,956)
------------
TOTAL STOCKHOLDERS' DEFICIENCY (8,728,168)
------------
TOTAL LIABILITIES AND STOCKHOLDERS'
DEFICIENCY $ 924,776
------------
The accompanying notes are an integral part of these financial statements
60
ENTELAGENT SOFTWARE CORP.
STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
2004 2003
--------------------------
REVENUE $ 538,539 $ 1,186,937
-------
COST OF REVENUE 100,214 170,859
--------------- ------------ ------------
GROSS MARGIN 438,325 1,016,078
------------ ------------
OPERATING EXPENSES
------------------
Payroll and related expenses 855,134 1,629,744
Legal and professional fees 22,440 93,477
Consulting fees - related party 10,000 120,000
Other general and administrative expenses 243,239 267,141
------------ ------------
TOTAL OPERATING EXPENSES 1,130,813 2,110,362
------------ ------------
OPERATING LOSS (692,488) (1,094,284)
OTHER EXPENSE
-------------
Interest expense, including $118,804 and
$113,424 to related parties during the
years ended December 31, 2004 and
2003, respectively (333,027) (396,036)
------------ ------------
LOSS BEFORE INCOME TAXES (1,025,515) (1,490,320)
INCOME TAXES -- --
------------ ------------ ------------
NET LOSS $(1,025,515) $(1,490,320)
============ ============
The accompanying notes are an integral part of these financial statements
61
ENTELAGENT SOFTWARE CORP.
STATEMENTS OF STOCKHOLDERS' DEFICIENCY
For the Years Ended December 31, 2004 and 2003
-------------------------------------------------------------------------------------------------------------------------
Common Stock Additional
--------------------------- Paid in Deferred Accumulated
Shares Par Value Capital Compensation Deficit Total
-------------------------------------------------------------------------------------------------------------------------
BALANCE - January 1, 2003 3,278,900 $ 32,789 $ 748,999 $ (7,085) $ (6,994,121) $ (6,219,418)
-------
Amortization of stock-based
deferred compensation -- -- -- 5,010 -- 5,010
Net loss -- -- -- -- (1,490,320) (1,490,320)
------------ ------------- ------------- -------------- -------------- --------------
BALANCE - December 31, 2003 3,278,900 32,789 748,999 (2,075) (8,484,441) (7,704,728)
-------
Amortization of stock-based
deferred compensation -- -- -- 2,075 -- 2,075
Net loss -- -- -- -- (1,025,515) (1,025,515)
------------ ------------- ------------- -------------- -------------- --------------
BALANCE - December 31, 2004 3,278,900 $ 32,789 $ 748,999 $ -- $ (9,509,956) $ (8,728,168)
------- ============ ============= ============= ============== ============== ==============
The accompanying notes are an integral part of these financial statements
62
ENTELAGENT SOFTWARE, INC.
STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2004 and 2003
-----------------------------------------------------------------------------------
2004 2003
--------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
------------------------------------
Net loss $(1,025,515) $(1,490,320)
------------ ------------
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 11,539 21,001
Deferred financing costs 2,916 1,029
Amortization of deferred stock-based compensation 2,075 5,010
Bad debt expense 39,772 10,000
Changes in operating assets and liabilities:
Accounts receivable (105,585) 574,976
Other assets 25,535 (11,059)
Accounts payable (59,222) 145,924
Accrued expenses 12,247 13,300
Accrued compensation 393,828 736,230
Accrued interest 327,494 303,959
Deferred revenue (55,115) (418,715)
Consulting agreement payable 10,000 90,000
------------ ------------
TOTAL ADJUSTMENTS 605,484 1,471,655
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (420,031) (18,665)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
------------------------------------
Purchase and development of licensed technology (352,500) --
Additions to fixed assets -- (1,659)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES $ (352,500) $ (1,659)
------------ ------------
The accompanying notes are an integral part of these financial statements
63
ENTELAGENT SOFTWARE, INC.
STATEMENTS OF CASH FLOWS, Continued
For the Years Ended December 31, 2004 and 2003
--------------------------------------------------------------------------------
2004 2003
---------------------
CASH FLOWS FROM FINANCING ACTIVITIES
------------------------------------
Advances made by officers and stockholders $ 10,524 $ 11,763
Advances from prospective acquirer 24,500 490,000
Advances from prospective affiliate 777,840 --
Note payable advance -- 2,000
Reductions in capital lease obligations (9,128) (12,205)
Repayments to officers and stockholders (22,730) (107,500)
Repayment of factoring arrangement -- (392,997)
--------- ----------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 781,006 (8,939)
--------- ----------
NET INCREASE (DECREASE) IN CASH 8,475 (29,263)
CASH - Beginning of Period 1,275 30,538
---- --------- ----------
CASH - End of Period $ 9,750 $ 1,275
---- --------- ----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
--------------------------------------------------
Cash paid during the years for:
Interest $ 483 $ 91,048
Income taxes $ -- $ --
The accompanying notes are an integral part of these financial statements
64
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - The Company
------------
Organization
------------
Entelagent Software Corp. (the "Company") is a California corporation
formed in 1996. The Company is a provider of e-mail monitoring and archive
software solutions designed to protect enterprises that use the Internet
for electronic commerce and secure communications.
NOTE 2 - Liquidity and Financial Condition
------------------------------------
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal
course of business. The Company has had recurring losses since its
inception. At December 31, 2004, the Company's working capital deficiency
amounted to $7,133,414 and its accumulated deficit amounted to $9,509,956.
On March 30, 2005, the Company entered into an Agreement and Plan of Merger
with Patron Systems Inc. ("Patron") (Note 17). The Company will require
substantial additional working capital to sustain its operations, while
Patron will continue its efforts to integrate the business into its
existing operations.
The Company expects to continue incurring losses for the foreseeable future
and cannot provide any assurance as to when, if ever, it will become a
profitable enterprise due to the inherent uncertainty that is related to
establishing the commercial feasibility of technological products and
developing a presence in new markets. Patron has limited capital resources
and is subject to substantial contingencies that raise doubt as to its
ability to continue as a going concern. The Company's continued existence
is dependent upon the ability of Patron to raise the additional capital
that it needs to sustain its operations while it continues to execute its
business plan and settle its outstanding legal contingencies in a manner
that will not have a material adverse affect on the Company.
Patron is currently in the process of attempting to raise additional
capital and its management has taken certain steps to conserve its
liquidity, while it continues to integrate the Company and other acquired
businesses into its existing operations. Neither Patron nor the Company has
obtained any commitments to provide the Company with new financing. These
matters raise substantial doubt about the Company's ability to continue as
a going concern. The financial statements do not include any adjustments
relating to the recoverability of recorded asset amounts that might be
necessary as a result of the above uncertainty.
65
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 3 - Summary of Significant Accounting Policies
----------------------------------------------
Revenue Recognition
--------------------
The Company derives its revenues from the licensing of computer software,
post contract customer support and professional consulting services.
The Company recognizes revenue in accordance with accounting standards for
software companies, including Statement of Position ("SOP") 97-2, "Software
Revenue Recognition," as amended by SOP 98-9, and related interpretations,
including Technical Practice Aids. In December 1999, the Securities and
Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") 101,
"Revenue Recognition in Financial Statements." SAB 101 summarizes certain
of the SEC's views in applying generally accepted accounting principles to
revenue recognition in financial statements.
Revenues from software license agreements are generally recognized upon
delivery of software to the customer. All of the Company's software sales
are supported by a written contract or other evidence of a sale transaction
such as a customer purchase order. These forms of evidence clearly indicate
the selling price to the customer, shipping terms, payment terms and refund
policy, if any. The selling prices of these products are fixed at the time
the sale is consummated.
Revenue from post contract customer support arrangements or undelivered
elements are deferred and recognized at the time of delivery or over the
period in which the services are performed based on vendor specific
objective evidence of fair value for such undelivered elements. Vendor
specific objective evidence is typically based on the price charged when an
element is sold separately, or, if an element is not sold separately, on
the price established by an authorized level of management, if it is
probable that the price, once established, will not change before market
introduction. The Company uses the residual method prescribed in SOP 98-9
to allocate revenue to delivered elements once it has established
vendor-specific evidence for such undelivered elements.
Professional consulting services are billed based on the number of hours of
consulting services provided and the hourly billing rates. The Company
recognizes revenue under these arrangements as the service is performed.
Accounts Receivable
--------------------
Accounts receivable have been adjusted for all known uncollectible
accounts. The allowance for doubtful accounts is the Company's best
estimate of the amount of probable credit losses in the Company's existing
accounts receivable. The Company reviews its allowance for doubtful
accounts on a monthly basis and determines the allowance based on an
analysis of its past due accounts. All past due balances that are over 90
days are reviewed individually for collectibility. Account balances are
charged off against the allowance after all means of collection have been
exhausted and the potential for recovery is considered remote.
66
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 3 - Summary of Significant Accounting Policies, continued
----------------------------------------------
Property and Equipment
------------------------
Property and equipment is stated at cost, net of accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, which is generally three years. Maintenance and
repairs are expensed as incurred. When property and equipment is sold, or
otherwise disposed of, the cost and related accumulated depreciation are
eliminated from the accounts and any resulting gains or losses are
reflected in the statement of operations in the period of disposal.
Software Development Costs
----------------------------
In accordance with Statement of Financial Accounting Standard ("SFAS") No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed," software development costs incurred subsequent to the
establishment of technological feasibility through the product's general
availability are capitalized. The Company also capitalizes the cost of
improvements to its existing products that extend the life or significantly
improve the marketability of the original product and enhancements that
require a redesign of all or part of the existing product. Any costs
incurred prior to the time in which the technological feasibility of a
product is established are expensed as research and development.
The Company did not incur any capitalizable software development costs or
research and development expenses with respect to internal development
activities during the years ended December 31, 2004 and 2003.
Amortization of software development costs commences when the related
products become available for general release to customers at the greater
of the amount computed using (a) the ratio that current gross revenue for a
product bears to the total of current and anticipated future revenues for
that product, or (b) the straight-line method over the remaining estimated
economic life of the product.
In December 2004, the Company purchased from a third party, a non-exclusive
perpetual license to certain software technology (Note 6). Such software is
designed to work in conjunction with the Company's existing e-mail
surveillance products. The third party has also been engaged to further
enhance the product under a development contract that is more fully
described in Note 6. The Company capitalized $802,500 of costs, which
includes $750,000 for the license and $52,500 of payments made to the third
party vendor for further development work. Management estimates that the
useful life of the product is five years beginning January 1, 2005.
Accordingly, the Company did not record any amortization with respect to
these costs for the year ended December 31, 2004.
67
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 3 - Summary of Significant Accounting Policies, continued
----------------------------------------------
Impairment of Long-Lived Assets
----------------------------------
The Company evaluates its long-lived assets for possible impairment
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. When evaluating assets for
potential impairment, the Company first compares the carrying amount of the
asset to the asset's estimated future cash flows (undiscounted and with
interest charges). If the estimated future cash flows used in this analysis
are less than the carrying amount of the assets, an impairment loss
calculation is prepared. The impairment loss calculation compares the
carrying amount of the asset to the asset's estimated future cash flows
(discounted and with interest charges). If the carrying amount exceeds the
asset's estimated future cash flows (discounted and with interest charges),
the loss is allocated to the long-lived assets of the group on a pro rata
basis using the relative carrying amounts of those assets. The Company did
not consider it necessary to record any impairment charges for the years
ended December 31, 2004 of 2003.
Income Taxes
-------------
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No.
109"). SFAS No. 109 requires the recognition of deferred tax assets and
liabilities for both the expected impact of differences between the
financial statements and tax basis of assets and liabilities and for the
expected future tax benefit to be derived from tax loss and tax credit
carry forwards. SFAS No. 109 additionally requires the establishment of a
valuation allowance to reflect the likelihood of realization of deferred
tax assets.
Stock-Based Compensation
------------------------
As permitted under SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," which amended SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company has elected to continue to follow
the intrinsic value method in accounting for its stock-based compensation
arrangements as defined by Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," ("APB No. 25") and related
interpretations including Financial Accounting Standards Board ("FASB")
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation," an interpretation of APB No. 25.
68
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 3 - Summary of Significant Accounting Policies, continued
----------------------------------------------
The following table summarizes the proforma operating results of the
Company had compensation expense for stock options granted to employees
been determined in accordance with the fair market value based method
prescribed by SFAS No. 123. The Company has presented the following
disclosures in accordance with SFAS No. 148.
For the Years Ended
December 31,
--------------------------
2004 2003
--------------------------
Net loss, as reported $(1,025,515) $(1,490,320)
------------ ------------
Add: stock-based compensation cost included in
the financial statements -- --
Less: stock-based employee compensation cost
under the fair value method of SFAS
No. 123 43,796 120,242
------------ ------------
Proforma Net Loss $(1,069,311) $(1,610,562)
============ ============
The following proforma information regarding stock-based compensation has
been determined as if the Company had accounted for its employee stock
option shares under the fair market value method of SFAS 123. The fair
value of the employee stock options was estimated at the date of grant
using the Black-Scholes pricing model.
No options were granted during the years ended December 31, 2004 and 2003.
Non-Employee Stock-Based Compensation
-------------------------------------
The cost of stock-based compensation awards issued to non-employees for
services is recorded at either the fair value of the services rendered, or
the instruments issued in exchange for such services, whichever is more
readily determinable, using the measurement date guidelines enumerated in
Emerging Issues Task Force Issue ("EITF") 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services."
Common Stock Purchase Warrants
------------------------------
The Company accounts for the issuance of common stock purchase warrants
issued with registration rights in accordance with the provisions of EITF
00-19, "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock."
Based on the provisions of EITF 00-19, the Company classifies as equity any
contracts that (i) require physical settlement or net-share settlement, or
(ii) give the Company a choice of net-cash settlement, or settlement in its
own shares (physical settlement or net-share settlement). The Company
classifies as assets or liabilities any contracts that (i) require net-cash
settlement (including a requirement to net cash settle the contract if an
event occurs and if that event is outside the control of the Company), or
(ii) give the counterparty a choice of net-cash settlement or settlement in
shares (physical settlement or net-share settlement).
69
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 3 - Summary of Significant Accounting Policies, continued
----------------------------------------------
Use of Estimates in Preparing Financial Statements
--------------------------------------------------
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required
to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and revenue and
expenses during the reporting period. Actual results could differ from
those estimates.
Fair Value of Financial Instruments
---------------------------------------
The Company's financial instruments consist primarily of accounts
receivable, accounts payable, accrued expenses, accrued interest, debt and
preferred stock redeemable during the next year's approximate fair value
because of their short-maturities. The carrying amounts of the Company's
demand notes, advances from prospective acquirer and affiliate and advances
from officers and shareholders approximate fair value as such instruments
feature contractual interest rates that are consistent with current market
rates of interest or have effective yields that are consistent with
instruments of similar risk, when taken together with equity instruments
issued to the holder.
Recently Issued Accounting Pronouncements
-----------------------------------------
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). This interpretation of Accounting
Research Bulletin No. 51, "Financial Statements," provides guidance for
identifying a controlling interest in a variable interest entity ("VIE")
established by means other than voting interest. FIN 46 also required
consolidation of a VIE by an enterprise that holds such controlling
interest. In December 2003, the FASB completed its deliberations regarding
the proposed modifications to FIN 46 and issued Interpretation Number 46R,
"Consolidation of Variable Interest Entities - an Interpretation of ARB 51"
("FIN 46R"). The decisions reached included a deferral of the effective
date and provisions for additional scope exceptions for certain types of
variable interests. Application of FIN 46R is required in financial
statements of public entities that have interests in VIEs or potential VIEs
commonly referred to as special-purpose entities for periods ending after
December 15, 2003. Application by privately held entities is required in
annual financial statements for periods beginning after December 15, 2004.
The adoption of this pronouncement is not expected to have material effect
on the Company's financial statements.
70
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 3 - Summary of Significant Accounting Policies, continued
----------------------------------------------
Recently Issued Accounting Pronouncements, continued
-----------------------------------------
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment".
This statement is a revision of SFAS Statement No. 123, "Accounting for
Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and its related implementation guidance.
SFAS 123R addresses all forms of share-based payment ("SBP") awards,
including shares issued under employee stock purchase plans, stock options,
restricted stock and stock appreciation rights. Under SFAS 123R, SBP awards
result in a cost that will be measured at fair value on the awards' grant
date, based on the estimated number of awards that are expected to vest and
will result in a charge to operations for stock-based compensation expense.
The charge will be reflected in the Company's Statements of Operations
during periods, in which such charges are recorded, but will not affect its
Balance Sheets or Statements of Cash Flows. SFAS 123R is effective for
public entities that file as small business issuers - as of the beginning
of the first interim or annual reporting period of the fiscal year that
begins after December 15, 2005. The Company is currently in the process of
evaluating the effect that the adoption of this pronouncement will have on
its financial statements.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary
Assets". SFAS 153 amends APB Opinion No. 29 to eliminate the exception for
non-monetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of non-monetary assets that do not have
commercial substance. A non-monetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as
a result of the exchange. The provisions of SFAS 153 are effective for
non-monetary asset exchanges occurring in fiscal periods beginning after
June 15, 2005. Earlier application is permitted for non-monetary asset
exchanges occurring in fiscal periods beginning after December 16, 2004.
The provisions of this statement are intended to be applied prospectively.
The adoption of this pronouncement is not expected to have a material
effect on the Company's financial statements.
NOTE 4 - Accounts Receivable
--------------------
Accounts receivable at December 31, 2004 consist of the following:
Amount
---------
Accounts receivable $156,604
Less: allowance for doubtful accounts (49,772)
---------
Accounts Receivable, Net $106,832
=========
71
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 5 - Property and Equipment
------------------------
Property and equipment at December 31, 2004 consists of the following:
Amount
----------
Office furniture $ 9,160
Computers 69,098
Communications system 35,995
----------
114,253
Less: accumulated depreciation (113,559)
----------
Property and Equipment, Net $ 694
==========
Depreciation expense for the years ended December 31, 2004 and 2003
amounted to $11,539 and $21,001, respectively.
NOTE 6 - Technology License, Development and Joint Sales Agreement
---------------------------------------------------------------
with encryptX Corporation
-------------------------
On December 29, 2004, the Company entered into an agreement to license and
resell encryptX Corporation's ("encryptX") technology for a fee of
$750,000. Such license provides the Company with a non-exclusive right to
market and sell encryptX's "BeCompliant" technology via its integration
into Entelagent's messaging platform. Revenues generated from cross-selling
this product will be shared in accordance with the revenue sharing
provisions of the agreement. Upon execution of the license agreement, the
Company made an initial payment to encryptX of $300,000 and accrued the
remaining $450,000. Patron assumed the liability for the remaining payments
due to encryptX upon its acquisition of the Company (Note 17).
The Company also engaged encryptX to make further enhancements to the
product in order to increase its usefulness, for an aggregate development
fee of $157,500, payable in six monthly installments of $26,250. As of
December 31, 2004, the Company made two payments to encryptX in the
aggregate amount $52,500, with respect to the development services. The
remaining payments, which amounted to $105,000, plus an additional $17,534
for additional consulting work, were made by Patron following its
acquisition of the Company in February 2005 (Note 17).
72
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 7 - Payroll Taxes Payable
-----------------------
Payroll taxes payable includes $348,828 of federal income taxes withheld
from certain current and former employees of the Company retroactively to
2001, plus $182,095 in estimated penalties and interest. The Company
determined that such amounts were due upon an evaluation of its previously
filed payroll tax returns that were found to include understatements of
reported amounts. The Company has not been contacted by the Internal
Revenue Service ("IRS") with respect to this matter, but is prepared to
remit the amount of its recorded obligation. The Company does not
anticipate having to pay more than the recorded amount, however, there can
be no assurance that the ultimate resolution of this matter will not result
in the Company having to make a payment that could substantially exceed the
amount of its estimate. Interest expense on this obligation amounted to
$38,371 for each of the years ended December 31, 2004 and 2003.
NOTE 8 - Advances from Prospective Acquirer
----------------------------------
Advances due to Patron include $770,000 of principal and $173,241 of
interest accrued at the rate of 10% per annum. The advances made to the
Company by Patron are payable on demand. Interest expense on these advances
amounted to $77,211 and $66,622 for the years ended December 31, 2004 and
2003, respectively. As described in Note 17, the Company merged into Patron
on March 30, 2005, at which time the Company became a wholly-owned
subsidiary of Patron.
NOTE 9 - Advances from Prospective Affiliate
--------------------------------------
Advances due to Complete Security Solutions, Inc. ("CSSI") include $777,840
of principal and $10,430 of interest accrued at the rate of 10% per annum.
The advances made to the Company by CSSI are payable on demand and are
secured by all the current and future assets of the Company. Interest
expense on these advances amounted to $10,430 and $-0- for the years ended
December 31, 2004 and 2003, respectively. CSSI merged into Patron on
February 25, 2005, at which time CSSI became a wholly-owned subsidiary of
Patron and an affiliate of the Company by common ownership.
NOTE 10 - Amounts Due to Officers and Stockholders
---------------------------------------------
Amounts due to officers and stockholders include:
Loans payable $651,270
Expense reimbursements 153,194
Accrued consulting fees 158,056
--------
$962,520
========
73
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 10 - Amounts Due to Officers and Shareholders, continued
---------------------------------------------
Loans Payable to Officers and Stockholders
-----------------------------------------------
Throughout its operating history, former officers (during the terms of
their employment), current officers and certain stockholders of the
Company, have provided financing to the Company for its working capital
needs. In certain cases, these individuals made payments directly to third
parties to assist the Company with covering its operating expenses during
times that its liquidity was constrained. The remaining balance of these
advances amounted to $651,270 as of December 31, 2004. These advances and
notes, accrued interest at various rates ranging from 8% to 24%, and the
accrued interest amounted to $426,251 as of December 31, 2004. Interest
expense on these loans amounted to $118,804 and $113,424 for the years
ended December 31, 2004 and 2003, respectively.
Subsequent to December, 31, 2004, as part of the merger with Patron on
March 30, 2005, the Company entered into notes payable with these officers
and shareholders to be repaid on or before February 28, 2006. The notes
accrue interest at a rate of 8% per annum and require quarterly interest
payments beginning June 30, 2005.
Expense Reimbursements to Officers and Stockholders
--------------------------------------------------------
Certain officers and stockholders incurred expenses on behalf of the
Company, which are to be reimbursed by the Company to these individuals.
These expenses are principally for travel and entertainment and
miscellaneous other business expenses. The amount due to be reimbursed to
these officers and stockholders at December 31, 2004 is $153,194.
Accrued Consulting Fees
-------------------------
In August 2001, the Company entered into an agreement with the Company's
founder upon his resignation and termination as Chief Executive Officer,
whereby the Company contracted with this individual to have him provide
certain consulting services to the Company. As of December 31, 2004, the
amount of accrued and unpaid consulting fees totaled $158,056. Upon his
resignation as Chief Executive Officer, this individual remained Chairman
of the Board of Directors.
NOTE 11 - Notes Payable
-------------
Notes payable include (a) a note payable to Lok Technologies, Inc. in the
amount of $312,557 bearing interest at 15%, (b) a note payable to Liberty
Information Management Solutions in the amount of $169,357 bearing interest
at 16.5%, and (c) an aggregate of $60,500 payable to three individuals
bearing interest from 10% to 15%. The Company is in default of each of
these obligations at December 31, 2004. Accordingly, they are payable on
demand and are classified as a current liability in the accompanying
balance sheet. Accrued interest on these notes amounted to $237,813 as of
December 31, 2004 and is included as a component of accrued interest in the
accompanying balance sheet. Interest expense on these notes amounted to
$82,678 and $85,542 for the years ended December 31, 2004 and 2003,
respectively.
74
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 12 - Accounts Receivable Factoring Arrangement
--------------------------------------------
The Company had an accounts receivable factoring arrangement with a
financial institution providing for the sale, with recourse of up to 80% of
eligible accounts receivable. The Company repaid the balance due under this
arrangement, which amounted to $392,997, which was terminated during the
year ended December 31, 2003.
NOTE 13 - Series A, Series B and Series C Preferred Stock
-------------------------------------------------------
Pursuant to the Company's restated certificate of incorporation, the
Company is authorized to issue up to 50,000 shares of its Series A
Convertible $0.01 par value Preferred stock ("Series A Preferred"), 15,000
shares of its Series B Convertible $0.01 par value Preferred stock ("Series
B Preferred"), and 100,000 shares of its Series C Convertible $0.01 par
value Preferred stock ("Series C Preferred").
As of December 31, 2004, the Company has outstanding 19,250 shares of
Series A Preferred, 12,000 shares of Series B Preferred and 20,277 shares
of Series C Preferred. In addition, the Company issued to investors of
6,286 of the Series C Preferred shares, warrants to purchase up to 29,900
shares of the Company's common stock ("Warrants"). The Warrants have a
five-year term expiring December 28, 2005 and an exercise price of $3.18
per share. The aggregate fair value of the Warrants, which amounted to
approximately $23,000, was accreted as interest expense to January 1, 2002,
the earliest date of redemption of the Series C Preferred.
The Series A Preferred is convertible into common stock at any time at the
option of the holder, based on a formula which results in a 44.14-to-1
exchange ratio of common stock for Series A Preferred. The Series B
Preferred is convertible into common stock at any time, at the option of
the holder, based on a formula which results in a 25 to 1 exchange ratio of
common stock for Series B Preferred. The Series C Preferred is convertible
into common stock, at the option of the holder, based on a formula equal to
the original Series C Preferred issuance price ("Original Issue Price")
divided by 25 multiplied by the number of Series C Preferred shares. The
formula for each of the three preferred stock series is subject to
adjustment for stock splits, stock dividends, recapitalizations, dilutive
issuances and other anti-dilution provisions. The shares of Series A
Preferred, Series B Preferred and Series C Preferred convert automatically
into shares of common stock immediately upon the sale of common stock,
pursuant to a registration statement under the Securities Act of 1933 where
the aggregate cash proceeds in such offering are at least $10,000,000.
The Company has reserved 1,655,350 shares of its common stock for issuance
upon the conversion of its redeemable convertible preferred stock.
75
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 13 - Series A, Series B and Series C Preferred Stock, continued
-------------------------------------------------------
In the event of any liquidation, dissolution or winding up of the Company,
the assets of the Company available for distribution to shareholders would
be distributed among the holders of the Series A Preferred, Series B
Preferred and Series C Preferred and common stock pro rata based on the
number of shares of common stock held by each, determined on an
as-converted basis (assuming conversion of all such Series A Preferred,
Series B Preferred and Series C Preferred) determined as follows: (i) the
initial Series A Liquidation Preference amount is $10.00 per share; (ii)
the initial Series B Liquidation Preference amount is $50.00 per share; and
(iii) the initial Series C Liquidation Preference amount is the Original
Issue Price for each share. The holders of Series C Preferred would first
receive no less than an amount equal to the Series C Liquidation Preference
amount for each share of Series C Preferred stock (as adjusted for any
stock splits, stock dividends or recapitalizations of the Series C
Preferred stock) before distributions are made to the holders of Series B
Preferred stock.
The holders of Series B Preferred would next receive no less than an amount
equal to the Series B Liquidation Preference amount for each share of
Series B Preferred stock (as adjusted for any stock splits, stock dividends
or recapitalizations of the Series B Preferred stock) before distributions
are made to the holders of Series A Preferred stock. The holders of Series
A Preferred would next receive no less than an amount equal to the Series A
Liquidation Preference amount for each share of Series A Preferred stock
(as adjusted for any stock splits, stock dividends or recapitalizations of
the Series A Preferred stock) before distributions are made to the holders
of the Company's common stock.
The holders of the Series C Preferred and the Series B Preferred are also
entitled to receive pari passu non-cumulative cash dividends, when and as
declared, in preference to any dividends declared on the Series A Preferred
and on the common stock of the Company.
One or more holders of shares of the Series A Preferred can require the
Company at any time after January 1, 1998 to redeem their Series A
Preferred shares (as adjusted for any stock dividends, combinations or
splits with respect to such shares) at the Series A Liquidation Preference
amount, plus accrued but unpaid dividends. Redemption payments, if
demanded, would be payable, at the Company's option, in twelve equal
quarterly installments, commencing on October 31, 2002, following the
Company's receipt of a redemption notice by the holders of the Series A
Preferred.
One or more holders of shares of the Series B Preferred can require the
Company at any time after January 31, 2000 to redeem their Series B
Preferred shares (as adjusted for any stock dividends, combinations or
splits with respect to such shares) at the Series B Liquidation Preference
amount, plus accrued but unpaid dividends. Redemption payments, if
demanded, would be payable, at the Company's option, in twelve equal
quarterly installments, commencing on January 1, 2003, following the
Company's receipt of a redemption notice by the holders of the Series B
Preferred.
76
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 13 - Series A, Series B and Series C Preferred Stock, continued
-------------------------------------------------------
One or more holders of shares of the Series C Preferred can require the
Company at any time after January 31, 2002 to redeem their Series C
Preferred shares (as adjusted for any stock dividends, combinations or
splits with respect to such shares) at the Series C Liquidation Preference
amount, plus accrued but unpaid dividends. Redemption payments, if
demanded, would be payable, at the Company's option, in twelve equal
quarterly installments, commencing on January 1, 2005, following the
Company's receipt of a redemption notice by the holders of the Series C
Preferred.
Holders of each share of Series A Preferred, Series B Preferred and Series
C Preferred have the right to one vote for each share of Common Stock, into
which such holders' shares of Series A Preferred, Series B Preferred and
Series C Preferred could then be converted. As long as the Company has
seven or fewer authorized directors, the holders of Series A Preferred and
Series B Preferred are entitled, voting each as a separate class, to elect
one director each (for a total of two) to the Board of Directors. In
addition, for as long as the Company has eight or more authorized
directors, the holders of Series A Preferred and Series B Preferred are
entitled, voting each as a separate class, to elect two directors each (for
a total of four) to the Board of Directors.
Holders of each of the Series A Preferred, Series B Preferred and Series C
Preferred have the right to demand registration of the common stock of the
Company issued or issuable for their preferred shares. The Company is
required, under the circumstances, to use its best efforts to effect as
soon as practicable the registration of the securities under the Securities
Exchange Act of 1934
The Company classified the Series A Preferred, the Series B Preferred and
the Series C Preferred as liability instruments in the accompanying balance
sheet in accordance with SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity," since
they are all mandatorily redeemable at the option of the holder.
NOTE 14 - Stockholders' Deficiency
------------------------
Stock Options
-------------
The Company's 1997 Stock Incentive Compensation Plan (the 1997 Plan)
provides for the grant of incentive and nonqualified stock options to
employees, officers, directors, agents, consultants and independent
contractors.
Options under the Plan are granted at fair market value on the date of
grant. The shares of common stock covered by options granted on the date of
hire generally vest at the rate of 12.5% 6 months from the date of grant,
and an additional 2.08% every month thereafter, with all shares becoming
fully vested on the fourth anniversary date of the date of grant. Options
granted other than on the date of hire generally vest at the rate of 2.08%
every month, commencing one month from the date of grant. The 1997 Plan
provides for grants with terms up to ten years. Option grants typically
have a term of five years.
77
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 14 - Stockholders' Deficiency, continued
------------------------
Weighted
Options Average Options
Shares Exercise Price Exercisable
----------------------------------------
Outstanding at December 31, 2002 1,174,564 $ 2.07 815,911
Granted --
Cancellations and forfeitures (71,916) 2.66
Exercised --
----------
Outstanding at December 31, 2003 1,102,648 $ 2.03 1,021,507
Granted --
Cancellations and forfeitures (197,250) 1.48
Exercised --
----------
Outstanding at December 31, 2004 905,398 $ 2.15 898,120
==========
The weighted average remaining contractual life and weighted average
exercise price of options outstanding and options exercisable at December
31, 2004 under all of the Company's stock option plans for selected
exercise price ranges is as follows:
Options Outstanding
Weighted Average
Options Remaining Options
Outstanding Contractual Life Exercisable
Exercise Price Shares (Years) Shares
--------------------------------------------------------------------------------
$1.44 250,000 4.82 250,000
2.00 379,150 1.00 379,150
2.88 175,000 0.92 175,000
3.18 70,000 1.53 62,722
3.20 31,248 0.92 31,248
Deferred Stock-Based Compensation
---------------------------------
The Company uses the intrinsic value-based method to account for all of its
employee stock-based compensation arrangements. The underlying fair value
of the Company's common stock did not exceed the exercise price of the
stock options at the date of grant and, therefore, no employee stock-based
compensation charges were recorded in 2004 and 2003.
Common Stock Purchase Warrants
------------------------------
At December 31, 2004, the Company had an aggregate of 57,138 outstanding
common stock purchase warrants. Such warrants include 6,250 with an
exercise price of $2.00 per share and a remaining contractual life of 3
months and 50,888 with an exercise price of $3.18 per share and a weighted
average remaining contractual life of 14 months. The Company did not issue
any common stock purchase warrants during the years ended December 31, 2004
and 2003.
78
ENTELAGENT SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 15 - Economic Dependency
-------------------
Major Customers
---------------
During the year ended December 31, 2004, revenues from one customer
amounted to $136,976, which is 25.4% of the Company's revenue for the year.
During the year ended December 31, 2003, revenues from two customers
amounted to $444,500 and $141,060, which are 37.4% and 11.9% of revenues
for the year, respectively.
NOTE 16 - Income Taxes
------------
At December 31, 2004, the Company has incurred book losses totaling nearly
$9.4 million and, as a result, believes that it has substantial net
operating loss carryforwards that may be available to offset future taxable
income, if any, through 2024. The Company is currently delinquent with
respect to filing its Federal and State income tax returns and, therefore,
has not quantified the amounts or nature of its deferred tax assets. The
Company has established a 100% valuation allowance for the deferred tax
assets arising from the net operating loss and other temporary differences
as management believes that it is more likely than not that their benefit,
if any, will not be realized in the future.
The utilization of the net operating losses may be subject to substantial
limitations due to the "change of ownership" provisions under Section 382
of the Internal Revenue Code and similar state provisions, as a result of
the Company's merger with Patron Systems, Inc.
NOTE 17 - Subsequent Events
------------------
On February 24, 2005, Patron entered into a definitive Amended and Restated
Supplemental Agreement, pursuant to which Entelagent Mergerco, a
wholly-owned subsidiary of Patron, would merge with and into the Company,
with the Company surviving the merger as a wholly-owned subsidiary of
Patron. On March 30, 2005, pursuant to the filing of an Amended and
Restated Agreement and Plan of Merger, Patron's merger with the Company
became effective.
79
(b) UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS.
Index of PRO FORMA FINANCIAL STATEMENTS
Unaudited Pro Forma Condensed Consolidated Statements . . . . . . . . . . . 81
Unaudited Pro Forma Condensed Consolidated Balance Sheet. . . . . . . . . . 82
Unaudited Pro Forma Condensed Consolidated Statement of Operations. . . . . 83
Notes to Unaudited Pro Forma Condensed Consolidated Balance Sheet at
December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
Notes to Unaudited Pro Forma Adjustments to Condensed Consolidated
Statement of Operations - Year Ended December 31, 2004 . . . . . . . . 86
80
As described in Item 2.01 of the Form 8-K, effective February 25, 2005, Patron's
subsidiary CSSI Acquisition Co. I, Inc. consummated a merger with Complete
Security Solutions, Inc. ("CSSI") and Patron's subsidiary LL Acquisition I Corp.
consummated a merger with LucidLine, Inc. ("LucidLine"). On February 24,2005
CSSI consummated a merger with IDK Enterprises, Inc. Additionally, on March 30,
2005, Patron's subsidiary ESC Acquisition, Inc. consummated a merger with
Entelagent Software Corp. ("Entelagent").
The following unaudited pro forma condensed consolidated financial statements
(the "Pro Forma Financial Statements') of Patron Systems, Inc. (the "Company")
are derived from the Company's audited financial statements as of and for the
year ended December 31, 2004 and give effect to (1) the Company's mergers with
CSSI, LucidLine and Entelagent (the "Transactions") and (2) the issuance of
$3,500,000 of Bridge Financing notes with warrants sold to thirty-three
accredited investors introduced by Laidlaw & Company (UK) Ltd. ("Laidlaw").
The unaudited pro forma condensed consolidated balance sheet gives effect to the
Transactions as if they had occurred on December 31, 2004 and the unaudited pro
forma condensed consolidated statement of operations gives effect to the
Transactions as if they had occurred on January 1, 2004. The pro forma
adjustments are based upon available information and certain assumptions that
management believes are reasonable.
The unaudited Pro Forma Financial Statements are presented for informational
purposes only and do not purport to represent what the Company's financial
position or results of operations would have been as of the date or for the
period presented had the Transactions in fact occurred on such date or at the
beginning of the period indicated, or to project the Company's financial
position or results of operations for any future date or period. The Pro Forma
Financial Statements do not reflect any operating efficiencies, cost savings or
opportunities that the Company may achieve in combining the operations of the
merged businesses. The Pro Forma Financial Statements are qualified by
reference to, and should be read in conjunction with , the Company's audited
financial statements included in its Annual Report on Form 10-KSB, filed with
the SEC on July 1, 2005.
The mergers are being accounted for as purchase business combinations.
Accordingly, the Company will establish a new basis of accounting for each of
the merged businesses by allocating their respective purchase prices (including
direct transaction costs), to the fair values of the assets acquired and
liabilities assumed as of the dates the mergers were consummated. A final
determination of the allocations of the purchase prices to the assets acquired
and liabilities assumed based on their respective fair values as of the dates of
the merges has not yet been completed. Accordingly, the purchase price
adjustments made in connection with the development of the Pro Forma Financial
Statements are preliminary and have been made solely for purposes of developing
such Pro Forma Financial Statements.
81
The Company is performing a valuation study to determine the fair value of the
assets and liabilities of CSSI, LucidLine and Entelagent and will make
appropriate purchase accounting adjustments upon the completion of the valuation
study.
UNAUDITED PROFORMA CONDENSED CONSOLIDATED BALANCE SHEET
AT DECEMBER 31, 2004
------------------------------------------------------------------------
COMPLETE
PATRON SECURITY IDK ENTELAGENT
SYSTEMS, SOLUTIONS, ENTERPRISES, LUCIDLINE SOFTWARE
INC. INC. INC. INC. CORPORATION
------------- ------------ -------------- ------------ -------------
Current Assets
Cash and cash equivalents $ 45,901 $ 1,447,885 $ 22,497 $ - $ 9,750
Restricted cash - - - - -
Accounts receivable, net - - 216,960 12,422 106,832
Other current assets 6,310 96,700 3,874 2,200 -
------------------------------------------------------------------------
sub-total current assets 52,211 1,544,585 243,331 14,622 116,582
Fixed assets, net - - 26,921 60,405 694
Advances to acquired entities 348,916 2,755,816
Intangible assets
Customer lists - - 22,500 - -
Tradename and trademarks - - - -
Technology - - 303,078 - 802,500
In-process R&D - - - - -
Goodwill - - - - -
Deferred financing fees - 85,167 121,900 - -
Other assets - - - - 5,000
------------------------------------------------------------------------
sub-total other assets 348,916 2,840,983 474,399 60,405 808,194
------------------------------------------------------------------------
Total Assets $ 401,127 $ 4,385,568 $ 717,730 $ 75,027 $ 924,776
========================================================================
Current Liabilities
Accounts payable $ 1,725,651 $ - $ 36,633 $ 47,047 $ 496,394
Cash overdraft - - - 863 -
Loan interest payable 277,169 - - - 664,065
Advances from acquired entity and affiliate - - 657,847 577,000 1,731,511
Accrued payroll taxes payable - - - - 530,923
Accrued compensation and payroll 2,100,778 - 143,408 - 1,678,533
Notes, loans and payables due to
officers/shareholders 1,565,898 100,000 95,901 962,520
Deferred revenue - - 145,275 - 119,455
Convertible notes payable - - - - -
Bridge notes payable - - - - -
Notes payable - - - - -
Notes and commitments payable 695,000 - - - 542,414
Accrued dividends - 34,539 583,291 - -
Current maturities of capital leases - - - 1,912 -
Accrued technology license fees - - - - 450,000
Other current and accrued liabilities - 43,750 24,464 - 74,181
------------------------------------------------------------------------
sub-total current liabilities 6,364,496 178,289 1,590,918 722,723 7,249,996
Demand notes payable 1,738,667 - - - -
Capital lease, net of current maturities - - - 4,401 -
Preferred stock - 3,877,219 4,358,769 - 2,402,948
------------------------------------------------------------------------
Total liabilities 8,103,163 4,055,508 5,949,687 727,124 9,652,944
Common stock subject to
Put Right (2,000,000 shares) 1,000,000 - - - -
Stockholders' Equity
(Deficiency)
Common stock 370,062 24,532 1 663,022 32,789
Additional paid in capital 28,973,711 673,643 2,058,841 - 748,999
Warrants to be issued - - - - -
Common stock to be issued 4,671,400 - - - -
Stock subscription receivable - (24,532) - - -
Common stock repurchase obligation (1,300,000) - - - -
Deferred compensation (1,475,333) - (383,627) - -
Accumulated deficit (39,941,876) (343,583) (6,907,172) (1,315,119) (9,509,956)
------------------------------------------------------------------------
Total Stockholders 'Equity (Deficiency) (8,702,036) 330,060 (5,231,957) (652,097) (8,728,168)
------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity (Deficiency) $ 401,127 $ 4,385,568 $ 717,730 $ 75,027 $ 924,776
========================================================================
PRO FORMA PRO FORMA
ADJUSTMENTS NOTE: CONSOLIDATED
------------- ----- --------------
Current Assets
Cash and cash equivalents $ (1,388,000) c $ 3,320,591
(863) d
3,183,421 l
Restricted cash 1,388,000 c 1,388,000
Accounts receivable, net - 336,214
Other current assets - 109,084
------------- --------------
sub-total current assets 3,182,558 5,153,889
Fixed assets, net 46,980 e 135,000
Advances to acquired entities (200,000) b (61,626)
(2,966,358) f
Intangible assets
Customer lists 157,500 g 180,000
Tradename and trademarks 161,000 g 161,000
Technology 1,464,422 g 2,570,000
In-process R&D 190,000 g 190,000
Goodwill 21,402,694 b 21,402,694
Deferred financing fees (207,067) h 869,079
614,079 l
255,000 m
Other assets - 5,000
------------- --------------
sub-total other assets 20,918,250 25,451,147
------------- --------------
Total Assets $ 24,100,808 $ 30,605,036
============= ==============
Current Liabilities
Accounts payable $ 657,633 b $ 2,797,106
(166,252) j
Cash overdraft (863) d -
Loan interest payable (461,523) j 479,711
Advances from acquired entity and affiliate (2,966,358) f -
Accrued payroll taxes payable 530,923
Accrued compensation and payroll (1,040,537) j 2,882,182
Notes, loans and payables due to
officers/shareholders (869,688) j 1,854,631
Deferred revenue - 264,730
Convertible notes payable 4,500,000 i 4,500,000
Bridge notes payable 2,456,140 l 2,456,140
Notes payable 2,613,000 j 2,613,000
Notes and commitments payable (75,000) j 1,162,414
Accrued dividends (617,830) k -
Current maturities of capital leases - 1,912
Accrued technology license fees - 450,000
Other current and accrued liabilities - 142,395
------------- --------------
sub-total current liabilities 4,028,722 20,135,144
Demand notes payable - 1,738,667
Capital lease, net of current maturities - 4,401
Preferred stock (10,638,936) a -
------------- --------------
Total liabilities (6,610,214) 21,878,212
Common stock subject to
Put Right (2,000,000 shares) - 1,000,000
Stockholders' Equity
(Deficiency)
Common stock (720,344) a 519,062
149,000 b
Additional paid in capital (3,481,483) a 41,744,711
12,516,000 b
255,000 m
Warrants to be issued 2,167,500 b 3,508,860
1,341,360 l
Common stock to be issued - 4,671,400
Stock subscription receivable 24,532 a -
Common stock repurchase obligation (1,300,000)
Deferred compensation 383,627 a (1,475,333)
Accumulated deficit 18,075,830 a (39,941,876)
------------- --------------
Total Stockholders' Equity (Deficiency) 30,711,022 7,726,824
------------- --------------
Total Liabilities and
Stockholders' Equity (Deficiency) $ 24,100,808 $ 30,605,036
============= ==============
See notes to proforma condensed consolidated financial statements.
82
UNAUDITED PROFORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2004
--------------------------------------------------------------------------
COMPLETE
SECURITY IDK ENTELAGENT
PATRON SOLUTIONS, ENTERPRISES, LUCIDLINE, SOFTWARE
SYSTEMS, INC. INC. INC. INC. CORPORATION
--------------- ------------ -------------- ------------ -------------
Revenue $ - $ - $ 1,039,743 $ 243,915 $ 538,539
Cost of Sales - - 279,764 222,699 100,214
--------------------------------------------------------------------------
Gross Profit - - 759,979 21,216 438,325
General and administrative 1,923,752 279,262 3,351,504 625,223 1,130,813
Stock-based penalty under accommodationg agreements 1,434,900 - - - -
Common stock issued to non-employees for services 767,567 - - - -
Loss associated with settlement agreement 438,667 - - - -
Charges associated with share-exchange transaction 45,215 - - - -
--------------------------------------------------------------------------
Total Operating Expenses 4,610,101 279,262 3,351,504 625,223 1,130,813
--------------------------------------------------------------------------
Loss from Operations (4,610,101) (279,262) (2,591,525) (604,007) (692,488)
Interest Income 77,000 21,129 - - -
Interest Expense (132,350) (85,450) (454,415) (13,297) (333,027)
--------------------------------------------------------------------------
Income (loss) before income taxes (4,665,451) (343,583) (3,045,940) (617,304) (1,025,515)
Provision for Income Taxes - - - - -
--------------------------------------------------------------------------
Net Loss $ (4,665,451) $ (343,583) $ (3,045,940) $ (617,304) $ (1,025,515)
=============== ============ ============== ============ =============
Net loss per share - Basic and Diluted $ (0.12)
Weighted average number of shares
outstanding - Basic and Diluted 38,808,280
Related party interest expense 33,490 - 4,412 - 206,445
PRO FORMA
CONSOLIDATED
PRO FORMA FULL YEAR
ADJUSTMENTS NOTE: P&L
------------- ----- --------------
Revenue $ - $ 1,822,197
Cost of Sales 234,236 n 836,913
------------- --------------
Gross Profit (234,236) 985,284
General and administrative (146,750) n 7,459,506
(107,300) p
23,490 q
379,512 r
Stock-based penalty under accommodationg agreements - 1,434,900
Common stock issued to non-employees for services - 767,567
Loss associated with settlement agreement - 438,667
Charges associated with share-exchange transaction - 45,215
------------- --------------
Total Operating Expenses 148,952 10,145,855
------------- --------------
Loss from Operations (383,188) (9,160,571)
Interest Income (77,000) o 21,129
Interest Expense 77,000 o (3,251,464)
(1,043,860) s
(614,079) t
(396,986) u
(255,000) v
------------- --------------
Income (loss) before income taxes (2,693,113) (12,390,906)
Provision for Income Taxes - -
------------- --------------
Net Loss $ (2,693,113) $ (12,390,906)
============= ==============
Net loss per share - Basic and Diluted $ (0.23)
Weighted average number of shares
outstanding - Basic and Diluted 14,900,000 53,708,820
Related party interest expense - 244,347
See notes to proforma condensed consolidated financial statements.
83
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET AT DECEMBER
31, 2004
a) Represents the elimination of the historical stockholders' equity
(deficiency) for each of the merged businesses
b) The mergers are being accounted for as purchase business combinations.
Accordingly, the Company (on a preliminary basis) established a new basis
of accounting for each of the merged businesses by allocating their
respective purchase prices (including direct transaction costs), to the
fair values of the assets acquired and liabilities assumed as of the dates
the mergers were consummated using estimates and assumptions it believes
are reasonable. A final determination of the allocations of the purchase
prices to the assets acquired and liabilities assumed based on their
respective fair values as of the dates of the mergers has not yet been
completed. Accordingly, the purchase price adjustments made in connection
with the development of the Pro Forma Financial Statements are preliminary
and have been made solely for purposes of developing such Pro Forma
Financial Statements. The Company is performing a valuation study to
determine the fair value of the assets and liabilities of CSSI, LucidLine
and Entelagent and will make appropriate purchase accounting adjustments
upon the completion of the valuation study. The actual results of the
allocation may differ significantly from management's estimates.
The following tables provide a breakdown of (a) the respective purchase
prices of each of the merged businesses including the fair value of
purchase consideration issued to the sellers plus direct transaction
expenses incurred by the Company in connection with consummating these
transactions, and (b) the Company's preliminary allocation of its purchase
prices.
84
Complete Entelagent
Security Software
Solutions, Inc. LucidLine, Inc. Corporation Total
---------------- ---------------- ------------ -----------
Cash $ - $ 200,000 $ - $ 200,000
Common Stock 6,375,000 3,740,000 2,550,000 12,665,000
Subordinated promissory notes 4,500,000 - - 4,500,000
Common stock warrants 1,912,500 - - 1,912,500
Transaction expenses 398,128 154,611 359,894 912,633
---------------- ---------------- ------------ -----------
Total Purchase Price $ 13,185,628 $ 4,094,611 $ 2,909,894 $20,190,133
================ ================ ============ ===========
Complete Entelagent
Security Software
Solutions, Inc. LucidLine, Inc. Corporation Total
----------------- ----------------- ------------- ------------
Fair value of tangible assets:
Cash $ 1,470,382 $ - $ 9,750 $ 1,480,132
Accounts receivable 216,960 12,422 106,832 336,214
Employee receivables - - 39,216 39,216
Other current assets 100,574 2,200 - 102,774
-----------------------------------------------------------------
Total current assets 1,787,916 14,622 155,798 1,958,336
Property and Equipment 26,921 60,405 694 88,020
Other assets - - 5,000 5,000
Advances to prospective affiliates 2,097,969 - - 2,097,969
-----------------------------------------------------------------
Total tangible assets 3,912,806 75,027 161,492 4,149,325
Liabilities assumed:
Accounts payable (36,633) (47,047) (496,394) (580,074)
Cash overdraft - (863) - (863)
Accrued compensation (143,408) - (1,731,511) (1,874,919)
Advances from prospective affiliate - (577,000) (1,717,749) (2,294,749)
Deferred revenue (145,275) - (119,455) (264,730)
Accrued expenses
and other current liabilities (168,214) (97,813) (3,224,103) (3,490,130)
-----------------------------------------------------------------
Total current liabilities (493,530) (722,723) (7,289,212) (8,505,465)
Long term liabilities - (4,401) - (4,401)
-----------------------------------------------------------------
Total liabilities assumed (493,530) (727,124) (7,289,212) (8,509,866)
-----------------------------------------------------------------
Net tangible assets acquired $ 3,419,276 $ (652,097) $ (7,127,720) $(4,360,541)
Increased valuation of fixed assets $ 35,079 $ 595 $ 11,306 $ 46,980
Value of excess allocated to:
Developed technology 670,000 - 1,900,000 2,570,000
Customer relationships 180,000 - - 180,000
Trademarks and tradenames 55,000 - 106,000 161,000
In-process research and
development 190,000 - - 190,000
Goodwill 8,636,273 4,746,113 8,020,308 21,402,694
(c) Represents $1,388,000 of funds set aside in a restricted cash escrow
account to pay certain Entelagent liabilities pursuant to the merger
agreement with Entelagent
(d) Adjustment to reclassify LucidLine's cash overdraft to cash and cash
equivalents
(e) Represents an increase in the historical basis of each of the acquired
businesses' property and equipment to their estimated fair values.
85
(f) Represents the advances made by Patron and CSSI to LucidLine and Entelagent
being eliminated against the LucidLine and Entelagent balance sheet
liability of advances from affiliate (Patron and CSSI).
(g) Represents the allocation of a portion of the excess of the purchase prices
over the fair value of assets acquired (liabilities assumed) of each of the
merged businesses to the estimated fair value of their amortizable
intangible assets.
(h) Represents the elimination of deferred financing costs of CSSI and IDK for
transactions that originated prior to, but did not survive, such mergers.
(i) Represents a note issued as purchase consideration to the preferred
stockholders of CSSI.
(j) Represents the conversion of $2,613,000 of certain Entelagent trade
payables and other amounts due to related parties into a note payable
bearing an interest rate of 8% per annum maturing one year after the
completion of the merger.
(k) Represents the elimination of accrued contractual dividends payable to the
preferred stockholders of CSSSI and IDK that the Company did not assume in
its acquisition of such businesses.
(l) Represents the $3,500,000 financing (the "Bridge Financing") completed in
conjunction with the mergers. This financing resulted in the issuance of
10% Senior Convertible Promissory Notes and warrants to purchase up to
1,750,000 shares of the Company's common stock. The Bridge Financing notes
have an initial term of 120 days. Additionally, the Bridge Financing notes,
if extended beyond the initial term of 120 days, will carry an interest
rate of 12% per annum. The Company allocated $2,456,140 of the proceeds to
the Bridge Notes and $1,043,860 of the proceeds to the warrants.
Additionally, the Company incurred deferred financing costs which amounted
to $614,079, including cash fees paid at closing from the financing
proceeds which totalled $316,579 and $297,500 representing the fair value
of 350,000 common stock purchase warrants issued to Laidlaw & Company (UK)
Ltd. in their capacity as the placement agent in the $3,500,000 Bridge
Financing transaction.
(m) Represents the aggregate fair value of 300,000 common stock purchase
warrants issued to Laidlaw & Co. (UK) Ltd. in connection with acquisition
related services.
NOTES TO UNAUDITED PRO FORMA ADJUSTMENTS TO CONDENSED CONSOLIDATED STATEMENT OF
OPERATIONS - YEAR ENDED DECEMBER 31, 2004
(n) Adjustment to record increased amortization of intangible assets of $87,486
for the year ended December 31, 2004. Recorded as $234,236 to Cost of Sales
for the amortization of developed technology and $(146,750) in General and
Administrative expenses for the amortization of other intangibles.
(o) Adjustment to eliminate the interest income at Patron on loans made to
Entelagent ($77,000) and elimination of the corresponding interest expense
at Entelagent.
(p) Adjustment to eliminate the $107,300 expense associated with acquisitions
not consummated.
(q) Adjustment to increase depreciation for the step-up in basis of fixed
assets.
(r) Adjustment to compensation for employment agreements issued to key
executives at Entelagent and LucidLine.
(s) Adjustment to record the accretion of the discount recorded on the Bridge
Financing notes. This accretion, amounting to $1,043,860, is included as a
component of interest expense.
86
(t) Adjustment to record the amortization of the deferred financing costs which
are being amortized over the minimum term of the debt instrument which is
120 days. This amortization expense is included as a component of interest
expense in the accompanying statement of operations.
(u) Adjustment to record the interest expense associated with the Bridge
Financing notes at 10% per annum for 120 days and 12% per annum for the
balance of the pro forma period to December 31, 2004.
(v) Adjustment to record the interest expense associated with the
amortization of the 300,000 common stock purchase warrants issued to
acquisition adviser Laidlaw & Company (UK) Ltd.
87
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
PATRON SYSTEMS, INC.
Date: December 8, 2005 By: /s/ Robert Cross
-------------------------------------
Robert Cross
Chief Executive Officer
88