-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KE5EYKRYVhgc//Hc2RuqkxRZuVJVb+ESCjOYCosDdYcGl4YNyeK8EeVnw5zFODN7 TU9TAA3GwOJaszu6MlI7bg== 0001144204-04-004791.txt : 20040414 0001144204-04-004791.hdr.sgml : 20040414 20040414165529 ACCESSION NUMBER: 0001144204-04-004791 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040414 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INNOVATIVE SOFTWARE TECHNOLOGIES INC CENTRAL INDEX KEY: 0001084047 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 954691878 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-27465 FILM NUMBER: 04733614 BUSINESS ADDRESS: STREET 1: 5072 NORTH 300 WEST CITY: PROVO STATE: UT ZIP: 84604 BUSINESS PHONE: 801-371-0755 MAIL ADDRESS: STREET 1: 5072 NORTH 300 WEST CITY: PROVO STATE: UT ZIP: 84604 10KSB 1 v02651_10ksb.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-KSB (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2003 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT COMMISSION FILE NUMBER: 000-1084047 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. ----------------------------------------------------------------- (Exact name of small business issuer as specified in its charter) CALIFORNIA 95-4691878 ------------------------------- ------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 204 NW PLATTE VALLEY DRIVE, RIVERSIDE, MO 64150 - ----------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) (801) 371-0755 ---------------------------------------------------- (Registrant's Telephone Number, Including Area Code) Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $.001 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ] The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of April 12, 2004 was approximately $16,754,461. The registrant had issued and outstanding 52,897,186 shares of its common stock on April 12, 2004. CONTENTS PART I ITEM 1. DESCRIPTION OF BUSINESS........................................1 ITEM 2. PROPERTIES.....................................................8 ITEM 3. LEGAL PROCEEDINGS..............................................9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...................................11 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........................13 ITEM 7. INDEX TO FINANCIAL STATEMENTS.................................20 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........................20 ITEM 8A CONTROLS AND PROCEDURES ......................................21 PART III ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTORS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT...........................................22 ITEM 10. EXECUTIVE COMPENSATION........................................26 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....................................................28 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................31 ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.......................................31 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES........................31 SIGNATURES....................................................32 EXHIBIT INDEX.................................................33 CAUTIONARY STATEMENTS ABOUT FORWARD LOOKING INFORMATION AND STATEMENTS This Report, including all documents incorporated herein by reference, includes certain "forward-looking statements" within the meaning of that term in Section 13 or 15(d) of the Securities Act of 1934, and Section 21E of the Exchange Act, including, among others, those statements preceded by, followed by or including the words "believes," "expects," "anticipates" or similar expressions. These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Our actual results could differ materially from these forward-looking statements. In addition to the other risks described in the "Factors That May Affect Future Results" discussion under Item 1, Description of Business, important factors to consider in evaluating such forward-looking statements include: o changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the market, o various competitive factors that may prevent us from competing successfully in the marketplace, and o changes in external competitive market factors which might impact trends in our results of operations. In light of these risks and uncertainties, there can be no assurance that the events contemplated by the forward-looking statements contained in this Report will, in fact, occur. PART I ITEM 1. DESCRIPTION OF BUSINESS (a) Development of Our Business Innovative Software Technologies, Inc. (the "Company") was incorporated in the State of California in May 1998. On April 16, 2001, we acquired 100% of the outstanding common stock of Hackett Media, Inc. (Hackett). The acquisition resulted in the owners and management of Hackett having effective operating control of the combined entity after the acquisition, with the existing Innovative investors continuing as only passive investors. On December 31, 2001, we purchased all of the outstanding shares of Energy Professional Marketing Group, Inc. (EPMG), a technology marketing company specializing in product fulfillment for outside vendors and technology and database marketing, based in Provo, Utah. In connection with the acquisition, we issued 1,500,000 and 3,529,412 of Series A preferred and common shares, respectively. Following the purchase, EPMG became a wholly owned subsidiary of the Company. On September 26, 2003, legal counsel representing the former principals of EPMG, who are currently officers of our EPMG subsidiary, notified us with the allegation that the former principals were entitled to rescind the 2001 acquisition of EPMG, discussed above. The notification alleges that the former principals were defrauded in connection with our acquisition of EPMG, Inc. and that they would seek litigation to effect a rescission of the 2001 purchase. On January 2, 2004, the Company and these former principals entered into a 1 Memorandum of Understanding that provides for the settlement of the principals' claims through exchange of certain of the Company's operating assets of EPMG for the return of the common and preferred stock previously issued to them by the Company in connection with the merger. However, a definitive agreement for this transaction has not been entered into yet. The former principals have had the right since March 15, 2004 to terminate their obligations under the Memorandum of Understanding, but have not notified us of their intent to do so. The former principals currently serve the Company in their capacities as officers of EPMG, which corporate entity contributes the majority of our consolidated revenues and controls the majority of our operating assets. In the event that the final settlement is executed in the form described in the Memorandum of Understanding, dated January 2, 2004, our operations will be significantly curtailed and our consolidated assets will be significantly diminished. While the divestiture will result in the retention of sufficient operating assets to support the Company's operating needs in the foreseeable future, management's plans for the future of the Company include (i) aggressively developing and marketing existing proprietary platforms and (ii) seeking merger candidates. Also see our Business Strategies, discussed below. There can be no assurances that management will be successful in these plans. In the event that the Company does not enter into a final settlement with the former principals of EPMG, then it is possible that the former principals of EPMG will file a rescission action against the Company. The Company has reviewed and analyzed with legal counsel the allegations made by the former principals and has concluded that such allegations are without merit. Accordingly, the Company will vigorously defend any such action. Nonetheless, the time and expense associated with the defense of any such action could have a material adverse effect on the business, operations and financial condition of the Company. (b) Our Business We are currently engaged in the development, marketing and delivery Internet websites, database management programs, and of business educational programs, generally to individuals, throughout the United States of America. Our educational programs combine both self-training by our clients and personal coaching by our employees. During 2003, our educational programs were concentrated in two product lines: Real Estate and Internet Marketing, which together comprised approximately 94% of 2003 revenues. Our current management team combines expertise in the fields of direct marketing, software development, coaching, and sales management, to small businesses and consumers. PRODUCTS AND SERVICES Business Education and Coaching Services - We sell business education and coaching services in the areas of real estate investing, stock market investing, and Internet business operations, principally to individual customers throughout the United States of America. This offering represents over 90% of our consolidated revenues during the fiscal year ended December 31, 2003. These offerings are typically rendered over a six to ten week period. Coaching services are either provided internally by our employees or outsourced to a third-party vendor for fulfillment of the coaching service. Multimedia educational materials used by our clients and coaches in connection with the business education and coaching services are generally sold as a bundled package along with our coaching services. However, clients may and often do acquire only the coaching sessions or only the multimedia educational materials. Recently, the Company developed its "Triad Learning System(TM)" comprising one-on-one coaching sessions, mentor conference calls with industry experts, and web-based 2 interactive learning sessions with experts and other program participants. This three-tiered approach offers an individually tailored and effective educational process. Enterprise Management System (EMS) - EMS provides small businesses with an integrated website and backend business management solution. This product empowers business owners to manage, control, automate, and regulate all business related operations. It also assists in organizing and tracking workflow, processes and order procurement. It also provides a website builder, email marketing tool, and accounting system. We also provide the same system tailored to real estate professionals which contains tools to post properties for sale, amortization calculators and sample contracts. The Financial Toolkit 1.0 - The Financial Toolkit is financial planning software tool for investors who want to maximize their current income and create long-term wealth for a more comfortable future. The Financial Toolkit has proven financial strategies for maximizing any income level and eliminating debt. It offers assistance in developing a lifetime financial plan. The eService platform offers on-line stock trading, insurance quotes, credit services as well as multimedia- based education. Skills in Demand - Skills in Demand delivers e-learning certification courses catering to small businesses and technical professionals. The eLearning software products offer a wide range of interactive self-study courses to meet the training and pre-certification needs at affordable prices via the Internet. The courses supply training to small businesses and enhance the careers of technical professionals, including PC technicians, network engineers, administrators, and IT managers. The computer-based courses incorporate training methods aimed toward the highest rate of information retention for each student. Each has been designed to accommodate multiple learning styles from visual to auditory. Most of the courses have been reviewed or approved by industry leaders including Microsoft, Novell, Cisco, Lotus and IBM/Javasoft/Netscape. The training courses map directly to the certification exams for each title. One Crypt - One Crypt for Email and One Crypt for Files scramble email messages and reorganize the data only for registered recipients, without using complicated passwords. One Crypt for Files also compresses large files to share and send them more easily, and offers a small banner ad of unique design with every message sent. Designed with the office or the home PC in mind, both tools encrypt and decrypt email to make it more private while still working in conjunction with all the most popular mail programs. BUSINESS STRATEGIES Internal Growth - We believe that the Company can achieve internal growth in both revenue and profitability by continuing to develop and market its software products and by aggressively growing its sales and coaching staff. The Company intends to expand its offering of higher-margin products and services and to focus on increasing productivity and efficiency. We are currently reviewing and modifying our operational processes and internal reporting to take advantage of low-cost accounting and operations software enabling real-time management reporting and cost controls. In addition, we are implementing programs to take advantage of economies of scale in employee benefits, insurance, and sales lead generation. We are training our sales associates to emphasize customer service and to improve sales via ancillary products and services. Acquisitions - We will continue to explore potential acquisitions when we can do so on advantageous terms. In particular, the Company is focusing on complimentary and higher-margin businesses. In evaluating potential acquisitions, we will consider the potential for operating cost reductions, revenue growth through existing sales personnel, managerial efficiencies, and other relevant factors. As consideration for future acquisitions, we intend to continue to use combinations of common and preferred stock and cash. The 3 consideration for each future acquisition will vary on a case-by-case basis depending on our financial interests, the historical operating results of the acquisition target, and the growth potential of the business to be acquired. Sale of Subsidiary - On January 2, 2004, we executed a Memorandum of Understanding to sell our EPMG, Inc. subsidiary to two former officers and directors, although a definitive agreement has not been entered into yet for this transaction. This transaction comprises (1) the transfer of certain assets to the parent company, (2) the assumption of certain liabilities by the parent company, (3) the exchange of all shares held by the parent in the subsidiary for all of the capital stock originally issued in the purchase of EPMG. COMPETITIVE BUSINESS CONDITIONS The markets for our products and services are highly competitive, continuously evolving and subject to rapid change, technological or otherwise. In addition, barriers to entry for potential competitors are low, although we believe our solutions currently compete favorably with those offered by our competitors. We may not be able to maintain our competitive position against current and potential competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Additional competition could result in a reduction of our margins and/or loss of market share. Furthermore, a significant portion of the sales leads upon which the Company depends to generate sales is generated by a small number of parties. Any change in the relationship with these lead providers, or any significant drop in the number and/or quality of leads provided, could have serious adverse effects on our business unless they were rapidly replaced. In conjunction with the Sale of the EPMG Subsidiary (SEE 8K FILING UNDER ITEM 13-B) the Company intends to rely more on internally generated leads and products which also results in higher margin sales. GOVERNMENT REGULATION The products we provide over the Internet are subject to federal, state and local laws and regulations governing the conduct of e-commerce and use of the Internet. E-commerce is new and rapidly changing, and government regulations relating to the Internet and e-commerce are still evolving. Currently, there are few laws and regulations directly applicable to access of the Internet or conduct of e-commerce on the Internet. However, due to the increasing popularity and use of the Internet and on-line services, many laws relating to the Internet are being debated at the state and federal levels (both in the U.S. and abroad), and it is possible that laws and regulations will be adopted with respect to the Internet and online services. These laws and regulations may cover issues such as user privacy, freedom of expression, pricing, fraud, content and quality of products and services, taxation, advertising, intellectual property rights and information security. Additionally, the rapid growth of e-commerce may trigger the development of tougher consumer protection laws. The adoption of such laws and regulations could reduce the rate of growth of the Internet, which could potentially decrease the usage of our products and could otherwise have a material adverse effect on our business. In addition, applicability to the Internet of existing laws governing issues such as intellectual property issues, taxation and personal property is uncertain. The vast majority of these laws were adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique issues associated with operating an Internet-related business. Those laws that do reference the Internet, such as the Digital Millennium Copyright Act, are only beginning to be interpreted by the courts and their applicability and scope are, therefore, uncertain. Several states have proposed legislation that would limit the uses of personal user information gathered online or require online services to establish privacy policies. The Federal Trade Commission also has settled several proceedings regarding the manner in which personal information is collected from users and 4 provided to third parties. Specific statutes intended to protect user privacy have been passed in many non-U.S. jurisdictions. Changes to existing laws or the passage of new laws intended to address these issues could directly affect the way we do business or could create uncertainty on the Internet. This could reduce demand for our services, increase the cost of doing business as a result of increased litigation costs or increased service delivery costs, or otherwise harm our business. INSURANCE We maintain various insurance coverage for our assets and operations. Coverage includes general liability, property and workers' compensation insurance. We maintain coverage in the amount of $1,000,000 per occurrence and $2,000,000 in the aggregate with an umbrella policy, which provides coverage up to $5,000,000. We also maintain workers' compensation policies in every state in which we operate. Nevertheless, there can be no assurance that our insurance will provide sufficient coverage in the event of a claim is made against us, or that we will be able to maintain in place such insurance at reasonable prices. An uninsured or under insured claim against us of significant magnitude could have a material adverse effect on our business and results of operations. U.S. BASED BUSINESS We currently conduct, and since inception, have conducted, substantially all of our business in the United States. We currently do not derive any material revenue from countries other than the United States and do not have long-term assets or customer relationships outside of the United States. Accordingly, we are not currently subject to any material risks associated with any foreign operations. EMPLOYEES As of March 31, 2004 Innovative and its subsidiaries employed a total of 238 persons. Following the sale of our EPMG subsidiary (SEE FORM 8-K FILING UNDER ITEM 13-B) we will employ approximately 35 persons. Depending on timing and cash flow from operations, we intend to hire up to 40 new sales and marketing personnel and 15 coaching/mentoring personnel over the next twelve months. None of our employees are represented by a labor union. We have not experienced any work stoppage and consider relations with our employees to be good. FACTORS AFFECTING FUTURE RESULTS Factors that could cause the Company's actual results to differ materially from what is expressed or forecasted in our forward-looking statements include, but are not limited to, the following: We are in an Intensely Competitive Industry. The direct marketing of computer-based educational programs is a highly competitive industry with many players and with few barriers to entry. Consequently, our ability to remain competitive will depend in large part on our ability to strengthen our sales and marketing efforts and to introduce new and complementary products that are appealing to consumers. Strengthening our sales and marketing efforts will in large part depend on our ability to attract and retain marketing and sales personnel more effectively than our competitors. We May Not be Able to Successfully Identify, Consummate, or Integrate Acquired Businesses. As a part of our business strategy, we intend to increase our size by pursuing potential acquisitions of complementary and higher-margin businesses that will expand our product offerings and enable us to achieve economies of scale. However, we may not be able to successfully identify any potential acquisition candidates, and even if we do, we may not be able to consummate the acquisition on favorable terms or obtain the benefits we anticipate from such a transaction. 5 Even if we consummate any acquisitions, the transactions could pose significant integration challenges. For example, we may not be able to integrate the sales and marketing functions of any acquired businesses with our then-existing sales and marketing function. The Contemplated Sale of EPMG Will Substantially Reduce our Revenues. We have entered into a Memorandum of Understanding with the former principals of our EPMG subsidiary to sell our EPMG stock back to them in exchange for all of their capital stock in the Company and other consideration. Although the completion of this transaction will be subject to the receipt of an independent fairness opinion stating that the sale of EPMG is fair to the shareholders of the Company, substantially all of our revenues are derived from EPMG. Therefore, if the sale of EPMG is completed, our operations, revenues, and consolidated assets will be significantly diminished. If We Do Not Complete the Sale of EPMG in a Negotiated Transaction,We Could Be Subject to the Risk of Litigation that Could Have a Material Adverse Effect on our Business,Ooperations, and Financial Condition. The former principals of EPMG have alleged that they are entitled to rescind the Company's original acquisition of EPMG due to fraudulent inducement. Although the Company believes that these allegations do not have any merit, if the proposed sale of the EPMG subsidiary is not accomplished, it is possible that the former principals will file an action against the Company, and the time and expense associated with the defense of any such action could have a material adverse effect on the business, operations, and financial condition of the Company. Moreover, such an action could divert management's time and efforts away from the business of the Company. Our Success Will Be Dependent In Part On Our Ability To Develop Strategic Relationships With Other Businesses. One of our primary goals is to increase market awareness and market penetration of our products. Because of our limited financial resources and marketing and sales personnel, this will likely require us to form strategic marketing and sales relationships with one or more companies whose resources can be used to supplement and expand our own, with such entities either acting as distributors or resellers of our products, or including our products as complements to or components of their own product offerings. Our Quarterly Operating Results May Fluctuate. Based on our business and industry, we expect to experience significant fluctuations in our future quarterly operating results due to a variety of factors, many of which are outside our control. Factors that may adversely affect our quarterly operating results include: o our ability to attract new customers at a steady rate and maintain customer satisfaction, o the demand for the products and services we intend to market, and o the introduction of new or enhanced services by us or our competitors, and o economic conditions specific to our business. 6 We Must Continue to Attract, Train, Motivate and Retain Qualified Personnel. We must attract, train, motivate and retain highly qualified personnel, particularly in the areas of sales and marketing. Because the competition for effective sales and marketing employees is intense, hiring, training, motivating, retaining and managing employees with the strategic and technical skills we need is both time-consuming and expensive. If we fail to attract, train and retain key personnel, we may experience delays in marketing and commercialization of our products and services. Because Our Products Rely on Technology That We Own, Our Business Will Suffer If We Fail to Protect Our Intellectual Property Rights to That Technology Against Infringement by Competitors. To protect our intellectual property rights in our product offerings, we rely on a combination of copyright and trade secret laws and restrictions on disclosure. Despite our efforts to protect our proprietary rights, unauthorized parties may copy or otherwise obtain and use our technology and solutions. Monitoring unauthorized use or copying of our products is difficult and the steps we have taken may not prevent unauthorized use or copying, particularly in foreign countries where the laws may not protect our proprietary results as fully as in the United States. If we fail to protect our intellectual property from infringement, other companies may use our intellectual property to offer competitive products at lower prices. If we fail to compete effectively against these companies, we could lose customers and experience a decline in sales of our solutions and revenues. Efforts to Protect our Intellectual Property or Our Misuse of the Intellectual Property of Others May Cause us to Become Involved in Costly and Lengthy Litigation. Although we are not currently involved in any intellectual property litigation, we may become party to litigation in the future either to protect our intellectual property or as a result of an alleged infringement by us of the intellectual property of others. These claims and any resulting litigation could subject us to significant liability or invalidate our ownership rights in the technology used in our solutions. Litigation, regardless of the merits of the claim or outcome, could consume a great deal of our time and money and would divert management time and attention away from our core business. Any potential intellectual property litigation could also force us to do one or more of the following: o stop using the challenged intellectual property or selling our products or services that incorporate it o obtain a license to use the challenged intellectual property or to sell products or services that incorporate it, which could be costly or unavailable o redesign those products or services that are based on or incorporate the challenged intellectual property, which could be costly and time consuming or could adversely affect the functionality and market acceptance of our products If we must take any of the foregoing actions, we may be unable to sell our solutions, which would substantially reduce our revenues. The Volatility of Our Securities Prices May Increase. The market price of our common stock has in the past been, and may in the future continue to be, volatile. A variety of events may cause the market price of our common stock to fluctuate significantly, including: o quarter-to-quarter variations in operating results, o adverse news announcements, 7 o the introduction of new products and services, and o market conditions in our industry. In addition, the stock market in recent years has experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of many companies in our business and that often have been unrelated to the operating performance of such companies. These market fluctuations may adversely affect the price of our common stock. We Must Develop, Produce and Establish New Products and Services That Keep Up With Consumer Tastes and Demands. The market for computer-based business education programs is characterized by frequent software changes, frequent new products and service introductions and evolving industry standards. The introduction of services embodying new processes and technologies and the emergence of new industry standards can rapidly render existing services obsolete and unmarketable. Our success in adjusting to rapid technological change will depend on our ability to: o develop and introduce new services that keep pace with consumer tastes and demands regarding computer-based educational programs; and o address the increasingly sophisticated and varied needs of customers. Due to inadequate technical expertise, insufficient finances or other reasons, we may be unable to accomplish these tasks. Such failure could have a material adverse effect on our operating results and financial condition. The SEC Investigation of Activity in Our Securities May Adversely Affect the Company. The Securities and Exchange Commission (SEC) issued a formal order of investigation with respect to the Company, authorizing the investigation of certain securities matters relating to the Company. The Company cannot predict the length or potential outcome of the SEC investigation, or the potential impact of the investigation on the Company. If the SEC's investigation results in any formal adverse determination, which may include a fine or other remedies, the Company's financial condition, results of operations and business could be materially adversely affected. The Company has incurred, and may continue to incur, significant legal and other costs in connection with this investigation. ITEM 2. PROPERTIES On January 20, 2004, in conjunction with expected sale of its EPMG subsidiary (SEE FORM 8-K FILING UNDER ITEM 13-B), the Company announced the relocation of its corporate headquarters to 204 NW Platte Valley Drive, Riverside, MO 64150. Previously, in February 2003, the Company had relocated its corporate headquarters to 5072 North 300 West, Provo, UT 84604, the headquarters of its EPMG subsidiary. At our Riverside location we lease an aggregate of 3,842 square feet. This lease commenced in March 2002 and expires February 2005. The Company believes that this property is suitable for our immediate needs. However, if the Company grows, there may be a need for a larger facility. 8 Our EPMG subsidiary relocated to a newer, larger facility in 2002 located at 5072 North 300 West, Provo, UT 84604, where they leased two separate spaces (1st and 2nd floor) within this facility amounting to an aggregate of approximately 13,357 square feet. The 2nd floor space, which comprises approximately 8,000 square feet, commenced May 2002 and expires April 30, 2005. The 1st floor space, which comprises approximately 5,357 square feet, commenced September 2002 and expires August 2005. The Company currently subleases the first floor space to a third party. We believe that if the Company grows, there will be a need for additional space. Our former facility was located at 1160 S. State Street, Orem, UT 84097-7160. Subsequent to December 31, 2002, EPMG extended the term of its lease at 5072 North 300 West, Provo, UT 84604 (2nd floor) for one additional year or until April 30, 2006, and also increased the amount of rentable office space by 700 square feet. This additional space is currently subleased to a related entity, Education Success Institute, Inc. (ESI), for $700 per month. ESI is owned and operated by two directors of the Company (Ethan Andrew Willis and James Randolph Garn). In addition, EPMG entered into an operating lease for certain office space at 625 South State Street, Orem, UT 84058. The Company leased an aggregate of 3,000 square feet with a term of January 1, 2003 to December 31, 2003. The leased office space is to be utilized by the Company's coaching/mentoring staff members. This operating lease was subsequently amended in March 2003 to increase the number of rentable square feet to 4,000 square feet with all other terms of the lease remaining unchanged. The Company is not named in the contracts between EPMG and its landlords and does not guarantee any of EPMG's leases. EPMG is not named in the contracts between the Company and its landlord and does not guarantee any of the Company's leases. ITEM 3. LEGAL PROCEEDINGS SEC Investigation On June 24, 2003 the Securities and Exchange Commission ("SEC") issued a formal order of investigation with respect to the Company, authorizing the investigation of certain securities matters relating to the Company. The SEC staff has taken the testimony of certain officers of the Company and has informed the Company that it intends to take additional testimony. The SEC staff has also issued additional requests for the voluntary production of documents. Prior to the issuance of the order, the Company had voluntarily provided documents and information to the SEC staff in response to informal, non-public inquiries by the staff. The Company intends to fully cooperate with the SEC in its investigation. Independent Marketing, Inc. On or about September 5, 2003, a lawsuit was filed by Independent Marketing, Inc. (IMI) against certain employees of the Company. The lawsuit was filed in the Fourth Judicial District Court of Utah County, State of Utah as Case No. 030403929. While the Company was initially named as a Defendant, the Company was not named as a defendant in the Amended Complaint filed in this lawsuit. In the lawsuit, IMI is claiming that these employees have breached certain employment and non-compete agreements and that IMI is seeking compensatory damages and injunctive relief. Although the Company is not a party to the litigation, because the lawsuit affects certain employees of the Company, some or all of whom are key employees, the Company's operating results and competitive position may be adversely affected in the event of a Court ruling which limits those employees' involvement with the Company. 9 Resignation of Garn & Willis and Threatened Litigation. On September 26, 2003, the Company received, by certified mail and hand delivery, letters from James Randolph Garn and Ethan Andrew Willis stating that each was resigning immediately as an officer of the Company and as a member of the Company's Board of Directors (the "Letters"). The Letters also indicate that neither Garn nor Willis is resigning from positions as an officer or director of the operating subsidiary, Energy Professional Marketing Group, Inc. (EPMG). The Letters did not state a reason for the resignations of Garn or Willis; however, the Company did receive a Memorandum dated September 26, 2003 ("Memorandum") from the law firm of Holme Roberts & Owen LLP, which represents Garn and Willis. The Memorandum alleges that Garn and Willis are entitled to rescind the Company's December 31, 2001 acquisition of EPMG from Garn and Willis because they were defrauded in connection with this acquisition. This acquisition was reported in the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on January 15, 2002. The Memorandum states that Garn and Wills are prepared to file a suit to effect this rescission unless the Company reaches a negotiated compromise with Garn and Willis affecting a rescission of the acquisition. The Company is not aware of any such complaint being filed. The Company has reviewed and analyzed with legal counsel the allegations made by Garn and Willis and has concluded that such allegations are without merit. Accordingly, the Company currently intends to vigorously defend any action that is filed by Garn and Willis. Effective January 2, 2004, the Company, EPMG, and Garn and Willis entered into a Memorandum of Understanding ("MOU") relating this matter (SEE 8K FILING UNDER ITEM 13-B). In the MOU, the parties agree to an adjustment of the business of EPMG and the establishment of an ongoing business relationship as described therein as a complete settlement of the disputed claims among them. The MOU provides, among other things, that the Company will cause EPMG to transfer certain assets to the Company and the Company will assume certain liabilities from EPMG and that at closing, the Company will transfer 100% of the EPMG stock to Garn and Willis in exchange for all of the capital stock of the Company owned by Garn and Willis. The MOU provides that a final Settlement and Reorganization Agreement will be prepared to implement the MOU. Under the MOU, the Company has engaged a qualified investment bank satisfactory to Garn and Willis to render a Fairness Opinion on the agreement. The MOU requires that the parties will work in good faith to complete closing within 30 days of the issuance of a Fairness Opinion. Should the proposed transaction not be completed the Company may face litigation which could negatively impact its operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Price Range of Common Stock The Company's common stock is traded in the over-the-counter market and quoted on the OTC Bulletin Board under the trading symbol "INIV". The common stock prices reflect inter-dealer prices, do not include retail markups, markdowns or commissions and do not necessarily represent actual transactions. The following table sets forth, for the quarters indicated, the high and low closing sales price per share for the Company's common stock, as reported by the OTC Bulletin Board: High Low YEAR ENDING DECEMBER 31, 2002: First Quarter....................................... $ 3.74 3.19 Second Quarter...................................... 3.92 0.92 Third Quarter....................................... 1.00 0.38 Fourth Quarter...................................... 0.48 0.07 YEAR ENDING DECEMBER 31, 2003: First Quarter....................................... $ 0.14 0.06 Second Quarter...................................... 0.17 0.06 Third Quarter....................................... 0.58 0.09 Fourth Quarter...................................... 0.44 0.20 The closing price for the common stock on April 12, 2004 was $0.50 per share. The Company's Board of Directors authorized a three-for-one stock split on July 11, 2001. This was effected on August 10, 2001 to stockholders of record on July 31, 2001. We have restated all share and per share amounts referred to in the financial statements, notes, and above table to reflect this stock split. HOLDERS As of December 31, 2003 the Company had 1,258 holders of record of its common stock. DIVIDENDS The Company does not anticipate paying any cash dividends in the foreseeable future and intends to retain all working capital and earnings, if any, for use in the Company's operations and in the expansion if its business. Any future determination with respect to the payment of dividends will be at the discretion of the Board of Directors and will depend upon, among other things, the Company's results of operations, financial condition and capital requirements, general business conditions, and such other factors as the Board of Directors deems relevant. The holders of the shares of Series A Preferred are entitled to receive dividends at the rate of 4% per annum of the liquidation preference per share payable yearly in fully paid and non-assessable shares of the Corporation's common stock. The number of shares of common stock to be distributed as a dividend is calculated by dividing such payment by 95% of the Market Price on the first five trading days after January 1 of each year. The term "Market Price" means, as of any date, the average of the daily closing price for the 11 five consecutive trading days ending on such date. As such, on April 13, 2004 the Board of Directors of the Company declared an issuance of 198,557 shares of the Company's common stock as dividend payment to the holders of the Series A Preferred Stock. The holders of the shares of Series B Preferred are entitled to receive dividends at the rate of 4% per annum of the liquidation preference per share payable yearly in fully paid and non-assessable shares of the Corporation's common stock. The number of shares of common stock to be distributed as a dividend is calculated by dividing such payment by 100% of the Market Price on the first five trading days after January 1 of each year. The term "Market Price" means, as of any date, the average of the daily closing price for the five consecutive trading days ending on such date. As such, on April 13, 2004 the Board of Directors of the Company declared an issuance of 51,255 shares of the Company's common stock as dividend payment to the holders of the Series B Preferred Stock. RECENT SALES OF UNREGISTERED SECURITIES On February 13, 2003 we issued 100,000 shares of our Series B Preferred Stock to certain directors and officers of the Company as compensation for services provided to the Company for the year ended December 31, 2003. These issuances were exempt from registration pursuant to Section 4(2) under the Securities Act of 1933 as a transaction by an issuer not involving a public offering. On April 23, 2003, we issued 233,333 shares of our common stock to a public relations firm in consideration of an agreement by the firm to provide services to the Company, and on May 20, 2003, we issued 49,231 shares of our common stock to an attorney for professional services rendered during the second quarter of 2003. Both of these issuances were exempt from registration pursuant to Section 4(2) under the Securities Act of 1933 as a transaction by an issuer not involving a public offering. 12 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion includes statements that are forward looking in nature. The accuracy of such statements depends on a variety of factors that may affect the business and operations of the Company. Certain of these factors are discussed under "Business - Factors Influencing Future Results and Accuracy of Forward-Looking Statements" included in Part 1 of this report. When used in this discussion, the words "expect(s)", "feel(s)", "believe(s)", "will", "may", "anticipate(s)" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, and actual results could differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, and are urged to carefully review and consider the various disclosures elsewhere in this Form 10-KSB. OVERVIEW The following discussion summarizes information about our accounting policies and practices and information about our operations in a comparative manner for the two years ended December 31, 2003 and 2002. Our management's discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere herein. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The discussion and analysis of our financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the Company's financial statements. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company believes that its critical accounting policies include those described below. Allowances for Doubtful Accounts Our notes receivable amounted to $949,891 as of December 31, 2003 and relate to product financing arrangements entered into with our clients. These notes are unsecured, bear interest at 15% and have terms ranging between one and two years. The Company has not and does not intend to sell or otherwise transfer these receivables. The allowance for doubtful accounts is based upon our best estimate of the amount of probable credit losses in the existing notes based upon our historical loss rates experienced on such financing arrangements. A note is considered impaired pursuant to Financial Accounting Standards Board Statement 114, Accounting by Creditors for Impairment of a Loan. Pursuant to Statement 114, a note is impaired if it is probable that the Company will not collect all principal and interest contractually due. The impairment is measured based on the present value of expected future cash flows discounted at the note's effective interest rate. The Company does not accrue interest when a note is considered impaired. When ultimate collectibility of the principal balance of the impaired note is in doubt, all cash receipts on impaired notes are applied 13 to reduce the principal amount of such notes until the principal has been recovered and are recognized as interest income thereafter. Impairment losses are charged against the allowance when all possible means of collection have been exhausted and the potential for recovery is considered remote. We commenced client-financing activities during 2002 and, as a result, lacked a sufficient history of financing transactions to make a reasonable estimate of uncollectible amounts during 2002. As a result, all financing balances, amounting to $718,690 were fully reserved as of December 31, 2002 and through and including the third fiscal quarter of 2003. During the fourth quarter of 2003, we were able to develop a reasonable estimate of uncollectible amounts, based upon actual experience, and we changed our estimate as of December 31, 2003 to reflect this better information. On a pro forma unaudited basis assuming that the current estimate had been available at the end of 2002, the allowance on December 31, 2002 would have been $179,672. Pro forma information is not necessarily indicative of the results that would have occurred had the information been available at that time. Revenue Recognition and Returns and Allowances We have evaluated our product offerings in the context SAB 101 Revenue Recognition and EITF 00-21 Revenue Arrangements with Multiple Deliverables and have determined that revenues associated with the multimedia educational materials (product sales) require accounting separate from the educational and coaching services (services revenue). The fair value of these offerings is established through separate third party sales of each of these products and services. Product Sales: We recognize product sales upon delivery to our students, as evidenced by third party shipping providers, which is the point where the student assumes ownership and risk of loss. Shipping costs are billed to students and are included as a component of revenue and cost of product sales. Returns are provided for based upon the Company's historical return experience. Services Revenues: The educational offering includes multiple sessions with a Company employed coach. We recognize services revenue pro rata as coaching/training sessions are rendered. Deferred revenue represents the fair value of future coaching sessions that students have paid for ($4,461,883), less the applicable commissions to lead generators and content providers ($1,701,016) and sales commissions ($903,620). Our obligation to provide coaching and training ceases one year following the sale. Refunds for unused courses are not provided for in the sales arrangement with the student. However, the Company offers refunds in certain circumstances for which a history has been developed to estimate and reserve such amounts. RESULTS OF OPERATIONS Year ended December 31, 2003 compared to the year ended December 31, 2002. Revenues Revenues for the years ended December 31, 2003 and 2002 were $26,884,246 and $14,778,814, respectively, which represents an 82% increase. The Company's principal source of revenue for the year ended December 31, 2003 and 2002 consisted of business education and coaching services, which represented 98% of consolidated revenues. Our business education and coaching services revenues increased substantially as a result of increasing our sales staff and focusing on the offerings that, based upon our accumulated experience, have the higher sales rate among our targeted customer base. 14 We record revenues for multimedia education materials (product sales) upon delivery of the material to our students. We record revenues for coaching sessions rendered and we defer revenue for coaching sessions that are paid for but have not yet been rendered. We deferred $4,461,883 of services revenue as of December 31, 2003 and $1,024,590 as of December 31, 2002. Our deferral as of December 31, 2003 was larger than the amount deferred as of December 31, 2002 because of the increase in our sales and the additional time and effort that is afforded our clients and their schedules by our in-house coaching staff. Substantially all of our revenues are derived from the EPMG subsidiary. On September 26, 2003, legal counsel representing the former principals of EPMG, who are currently officers of our EPMG subsidiary, notified us with an allegation that they were entitled to rescind the 2001 acquisition of EPMG. The notification alleges that the former principals were defrauded in connection with our acquisition of EPMG, Inc. and that they would seek litigation to affect a rescission of the 2001 purchase. On January 2, 2004, the Company and these former principals entered into a Memorandum of Understanding that provides for the settlement of the principals' claims through exchange of certain operating assets for the common and preferred stock previously issued in connection with the merger. The former principals have had the right since March 15, 2004 to terminate their obligations under the Memorandum of Understanding, but have not notified us of their intent to do so. The former principals currently serve the Company in their capacities as officers of EPMG, which corporate entity contributes the majority of our consolidated revenues and controls the majority of our operating assets. In the event that the final settlement is executed in the form described in the Memorandum of Understanding, dated January 2, 2004, our operations will be significantly curtailed and our consolidated assets will be significantly diminished. While the divestiture will result in the retention of sufficient operating assets to support the Company's operating needs in the foreseeable future, management's plans for the future of the Company include (i) aggressively developing and marketing existing proprietary platforms and (ii) seeking merger candidates. Also see our Business Strategies, discussed below. There can be no assurances that management will be successful in these plans. In the event that the Company does not enter into a final settlement with the former principals of EPMG, then it is possible that the former principals of EPMG will file a rescission action against the Company. The Company has reviewed and analyzed with legal counsel the allegations made by the former principals and has concluded that such allegations are without merit. Accordingly, the Company will vigorously defend any such action. Nonetheless, the time and expense associated with the defense of any such action could have a material adverse effect on the business, operations and financial condition of the Company. Cost of Sales and Margins Cost of sales for the years ended December 31, 2003 and 2002 were $13,318,323 and $5,594,234, respectively, representing an increase of 138%. Cost of sales include (i) the cost of the multimedia educational materials that we ship to our students, (ii) the wages paid to our coaches and (iii) the commissions that we pay to lead sources. Our costs increased during the year ended 2003 relative to our sales revenue, resulting in an overall reduction in our gross margins from 62% in 2002 to 50% in 2003. Our cost increases occurred in two categories. First, our cost for fulfillment of our coaching costs increased when we brought this function in house. During 2002 and the first month of 2003, we had largely outsourced our fulfillment. While we pay less for coaching to our employees, our overhead increased greatly due to this action. We are committed to an in-house coaching function for many reasons, including our ability to monitor the quality of the service, and believe that our overhead will have less effect in future 15 periods as our revenue continues to grow. Second, we pay commissions to Education Success Institute, Inc. ("ESI") (a Company owned by Ethan Willis and Randy Garn, officers of our EPMG subsidiary) at a higher rate (approximately 40%) than other lead providers. During the year ended December 31, 2003, ESI leads increased from 40% of our revenue sources at the beginning of the year to 90% at the end of the year. This increase and the higher associated commission resulted in lower margins. Selling Expenses Selling expenses for the years ended December 31, 2003 and 2002 were $6,094,250 and $3,307,000, respectively, representing an increase of 84%. Selling expenses consisted primarily of commissions paid to sales associates as well as marketing and advertising expenses associated with key products and services. The increase in selling expenses is attributed to the increase in sales of products and services and remained relatively constant at 23% as a percentage of sales. General and Administrative Expenses General and administrative expenses for the year ended December 31, 2003 and 2002 were $7,533,571 and $4,509,291, respectively, representing an increase of 67%. The Company's general and administration expenses consisted primarily of salaries and wages, professional fees, rent, travel expenses, payroll taxes, telephone expenses and other general and administrative expenses necessary to support the operations of the Company in the current period. The reason for the increase in general and administrative expenses was attributable to higher administrative wages and legal fees. Other Operating Charges During the year ended December 31, 2002, we reported operating charges of (i) $12,461,246 related to goodwill impairment; (ii) $1,629,250 related to permanent impairments of investment securities and (iii) other non-recurring charges of $169,578. There were no similar charges recorded in 2003. We completed our annual impairment analysis of goodwill as of December 31, 2003, which did not result in the identification of any impairment. We will continued to consider the recoverability of goodwill. All of our investment securities were permanently impaired in 2002. Therefore, no charges occurred during 2003 nor are any anticipated in future periods. Other Income (Expense) Other income, net of other expenses for the years ended December 31, 2003 and 2002 were $246,100 and $209,939, respectively, representing an increase of 17%. The increase is attributable to the increase in interest on our financing notes receivable of $358,635, offset by our recognition of $218,950 of interest and penalties related to non-payment of our Federal and state income taxes for the years ended December 31, 2002 and 2003. We expect to be fully current on the payment of our income taxes before the end of our second fiscal quarter of the year ended December 31, 2004. Income Taxes Our provision for income taxes amounted to $346,955 for the year ended December 31, 2003. Our current provision, representing the amounts due to taxing authorities, amounted to $226,176 and $592,637 for the years ended December 31, 2003 and 2002, respectively. Our current income taxes are higher than amounts calculated by applying the statutory rates to our net income because tax law prohibits our ability to deduct certain material reserves related to our notes receivable and our reserve for returns and refunds. Such amounts are deductible when actually incurred. 16 As of December 31, 2003 and 2002 our net deferred tax assets amounted to $475,578 and $596,357, respectively. Deferred tax assets represent the value of future tax deductions and are net of a valuation allowance that is estimated by management. The valuation allowance, which is included in the above amounts, amounted to $331,851 and $113,154, as of December 31, 2003 and 2002, respectively. The valuation allowance was increased in 2003 to fully reserve deferred taxes associated with long-term capital loss carry-forwards which are only deductible to the extent of capital gains. Net Loss Our net loss for the year ended December 31, 2003 amounted to ($202,752), compared to ($12,681,846) for the year ended December 31, 2003. As previously mentioned, approximately $14,090,000 of charges related to goodwill and security impairments that did not reoccur in 2003. In 2003, we reported income taxes of $346,955 (none in 2002). Excluding these differences our pretax income as a percentage of revenues decreased from 9.5% to 1.3%. This decrease was attributable to the matters discussed in our cost of sales section above. We continue to believe that the actions taken to bring the coaching services in-house and the use of ESI for high-quality sales leads continues to be our best course of action. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2003 we had current assets of $6,568,628, which represents and increase of $4,022,175 over current assets as of December 31, 2002. Much of the increase is attributable to an increase in cash. At December 31, 2003 we had cash on hand of $3,890,929, which represents an increase of $2,552,584 over the balances as of December 31, 2002. Other material increases in current assets resulted from notes receivable and deferred income taxes. Notes receivable of $949,891 as of December 31, 2003 is net of our estimated reserve of $454,529 for bad debts. Due to insufficient experience in finance sales losses in 2002, we reserved the entire outstanding notes receivable balance of $718,690. Our finance activity increased substantially in 2003, resulting in gross notes receivable of $1,404,420 as of December 31, 2003 compared to $718,690 as of December 31, 2002. At December 31, 2003 we had current liabilities of $6,088,913, which represents an increase of $4,582,921 over current liabilities as of December 31, 2002. Our current liabilities include significant amounts associated with deferred revenue, commissions and reserves for returns. These accounts require complex subjective estimates. Our deferred revenue of $1,857,247, which will not require cash outlays, increased $1,601,099 over the balance as of December 31, 2002. This increase is attributable to our increase in revenues. We are liable for commissions to our sales force and to lead providers. Commissions included as a component of accounts payable and accrued liabilities increased to $1,255,770 as of December 31, 2003 compared to $83,278 as of December 31, 2002. Finally, current liabilities include an outstanding balance of $3,440 on a $50,000 credit facility that we intend to pay off and not use further. As December 31, 2003 our working capital increased marginally to $479,715 from $444,104. We believe that our operating activities in 2004 will be sufficient to fulfill our obligations as they become due in the normal course of business. We have no material commitments for capital expenditures. Capital expenditures in 2003 of $417,129 related to our expansion efforts. We may require additional facilities and support equipment if our growth rate continues at the current rate. We have not filed our 2003 and 2002 Federal and State of Utah income tax returns. Combined current income taxes payable for these periods are currently estimated to be $226,176 and $596,357, respectively. Interest and penalties have been recorded in the amount of approximately $218,950. 17 In February 2003 we issued 100,000 shares and 80,000 shares of our Series B preferred stock to certain directors and officers of the Company for compensation during the years ended December 31, 2003 and 2002, respectively. The value of these shares was determined based upon the number of common shares into which the preferred shares are convertible into, using the closing market prices on the date of issuance. We issued 233,333 shares of our common stock during the first quarter 2003 for prepaid public relation services to be provided in future periods. Theses shares were subsequently returned to treasury. We issued 133,333 shares of our common stock as a charitable contribution during the first quarter 2003. Finally, we issued 49,231 shares of our common stock for professional services provided during the second quarter 2003. We may from time to time use our common stock to compensate other parties for services. We currently do not have a stock option or stock purchase plan. We also currently do not have any employee benefit plans that would require the use of our securities. EPMG TRANSACTION AND POSSIBLE FUTURE EFFECTS On September 26, 2003, counsel representing the former principals of EPMG, Inc., who are currently officers of EPMG, Inc., notified the Company that they were allegedly entitled to rescind the Company's 2001 acquisition of EPMG, Inc., which was accomplished in a stock-for-stock exchange, accounted for as a purchase business combination. The notification alleges that the former principals were defrauded in connection with the Company's acquisition of EPMG, Inc. and that they would seek litigation to effect a rescission of the 2001 purchase. On January 2, 2004, the Company and these former principals entered into a Memorandum of Understanding that provides for the settlement of the principals' claims through exchange of certain operating assets for the Company's common stock previously issued in connection with the merger. The former principals have had the right since March 15, 2004 to terminate their obligations under the Memorandum of Understanding, but have not notified the Company of their intent to do so. The former principals currently serve the Company in their capacities as officers of EPMG, Inc., which corporate entity contributes the majority of the Company's consolidated revenues and controls the majority of the Company's operating assets. In the event that the final settlement is executed in the form described in the Memorandum of Understanding, dated January 2, 2004, the Company's operations will be significantly curtailed and the Company's consolidated assets will be significantly diminished. The Company does not believe that the current terms of the settlement will result in reporting the EPMG, Inc. component as a discontinued operation in future reports. The criteria for reporting the EPMG, Inc. results as discontinued include the requirement that the Company will not have any significant continuing involvement in the operations of EPMG, Inc. after the disposition date. Since the current settlement arrangement provides for a continuing business relationship and exchange of products and services, this criteria has not been achieved. OFF BALANCE-SHEET ARRANGEMENTS The Company has no material off-balance sheet arrangements as of December 31, 2003. 18 RECENT ACCOUNTING STANDARDS In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The statement amends and clarifies accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. This statement is designed to improve financial reporting such that contracts with comparable characteristics are accounted for similarly. The statement, which is generally effective for contracts entered into or modified after June 30, 2003, is not anticipated to have a significant effect on our financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The statement was considered in regard to our Series A and Series B Preferred Stock and, as a result, is not anticipated to have a significant effect on our financial position or results of operations. In December 2003, the FASB issued FASB Interpretation No. 46 (REVISED), Consolidation of Variable Interest Entities. This interpretation clarifies rules relating to consolidation where entities are controlled by means other than a majority voting interest and instances in which equity investors do not bear the residual economic risks. We currently have no ownership in variable interest entities and therefore adoption of this standard currently has no financial reporting implications. 19 ITEM 7. FINANCIAL STATEMENTS Our consolidated financial statements for the years ended December 31, 2003 and 2002 are included elsewhere in this annual report. The contents of our financial statements are as follows: 2003 CONSOLIDATED FINANCIAL STATEMENTS Page ---- Report of Aidman, Piser & Company, P.A.......................................F-2 Consolidated Balance Sheet as of December 31, 2003...........................F-3 Consolidated Statement of Operations for the Year Ended December 31, 2003.................................................F-4 Consolidated Statement of Stockholders' Equity for the Year Ended December 31, 2003.................................................F-5 Consolidated Statement of Cash Flow for the Year Ended December 31, 2003.................................................F-6 Notes to 2003 Consolidated Financial Statements..............................F-7 2002 CONSOLIDATED FINANCIAL STATEMENTS Report of Robison, Hill & Co................................................F-19 Consolidated Balance Sheet as of December 31, 2002..........................F-20 Consolidated Statement of Operations for the Year Ended December 31, 2002................................................F-21 Consolidated Statements of Stockholders' Equity for the Year Ended December 31, 2002................................................F-22 Consolidated Statement of Cash Flow for the Year Ended December 31, 2002................................................F-23 Notes to 2002 Consolidated Financial Statements.............................F-24 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On April 23, 2003, Innovative Software Technologies, Inc. dismissed Grant Thornton LLP as the Company's independent accountant. The Company dismissed Grant Thornton based on certain correspondence received from Grant Thornton on April 4, 2003, pursuant to Section 10A of the Securities Exchange Act of 1934 in which Grant Thornton expressed concern as to the propriety of certain transactions, notified the Company that the firm could not continue to be associated with the Company's December 2001 and 2000 financial statements and that the reports thereon could no longer be relied upon. The Company took strong exception to such correspondence and filed a Current Report on Form 8-K dated April 23, 2003 presenting its position on the matter. On April 11, 2003, the Company engaged the accounting firm of Robison, Hill & Co., as the Company's new independent accountants to audit its financial statements for the fiscal years ended December 31, 2002 and 2001, and filed a Current Report on Form 8-K dated April 23, 2003 presenting this matter. On January 26, 2004, the Company engaged the accounting firm of Aidman, Piser & Company, P.A. to audit the consolidated financial statements for the year ended December 31, 2003. In connection with the appointment the audit committee 20 terminated the firm of Robison, Hill & Co. In connection with this change, there were no disagreements between the Company and the former auditors. ITEM 8A CONTROLS AND PROCEDURES (a) As of December 31, 2003, the Chief Executive Officer and Chief Financial Officer of the Company, with the participation of the Company's management, carried out and evaluation of the effectiveness of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that, as of the date of the evaluation, the Company's disclosure controls and procedures are effective in making known to them material information relating to the Company (including its consolidated subsidiaries) required to be included in this report. (b) There were no changes in the Company's internal controls or in other factors that could significantly affect internal controls, known to the Chief Executive Officer or the Chief Financial Officer, subsequent to the date of the evaluation. 21 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. Name Age Position - ------------------ ---- -------------------------------------------- Peter M. Peterson (47) Chairman of the Board of Directors (1) Douglas S. Hackett (40) President, Chief Executive Officer, Director Linda W. Kerecman (41) Chief Financial Officer Ethan A. Willis (29) President of EPMG, Inc., Director (2) Randy R. Garn (29) Vice President of EPMG, Inc., Director (2) Peter A. Justen (47) Director William E. Leathem (42) Director (1) Mr. Peterson was appointed Chairman of the Board of Directors on November 24, 2003. (2) Mr. Willis and Mr. Garn resigned as officers and directors of the Company on September 26, 2003 but continue to be officers and directors of our EPMG subsidiary. All of Innovative's directors serve for terms of one year each until their successors are elected and qualified. Peter M Peterson has served as Chairman of the Board of Directors of Innovative since his election in November of 2003. Mr. Peterson is President, CEO and founder of Aspen Capital Partners, LLC. He is also a partner in Spartan Securities Group, Ltd., a full service broker dealer and investment banking firm. Prior to founding Aspen Capital Partners, Mr. Peterson was Managing Director of Investment Banking with H. C. Wainwright & Co. He was also president of First American Holdings and Managing Director of Investment Banking for the firm. Prior to First American, he served as Vice President of Investment Banking with Josephthal, Lyons and Ross, A New York Stock Exchange member firm. Previous to Josephthal, Mr. Peterson was President of Triad Capital Partners and was responsible for assisting companies in going public, mergers and acquisitions, leveraged buyouts, recapitalizations, and private placements. Mr. Peterson has experience in arranging private placements, SEC documentation and reporting, financial consulting, real estate financings, securitized receivable and asset financings, strategic planning, transaction structuring, and negotiating. 22 Douglas S. Hackett has served as President and Chief Executive Officer of Innovative Software Technologies, Inc. since April 2001 and also served as Chairman until November 2003. Mr. Hackett spent much of his career in the electronic media field as President/General Manager of the radio stations KGU-AM and KTSS-FM in Honolulu, Hawaii, and WTIX-AM in New Orleans. He served as Director of Continuity and Executive Producer of Gannett and was Vice President/General Manager at United Syndication. Mr. Hackett held the post of President, CEO and Director of Ensurge, Inc., and as Vice President/Director of Fortune Financial. Additionally, he created several nationally syndicated radio shows, including "Baseball Sunday with Joe Garagiola," "Football Sunday" and "NBA Basketball Sunday." Mr. Hackett graduated from William Jewel College in Liberty, Missouri with a Bachelor of Arts degrees in communication and public relations. Additionally, he studied international business and literature at Harlaxton College in Grantham, England. Linda W. Kerecman has served as Chief Financial Officer for Innovative since October 2002. Ms. Kerecman most recently worked as accounting manager for Innovative's wholly owned subsidiary, EPMG. Prior to her positions with Innovative, Ms. Kerecman worked as accounting supervisor for the Utah Department of Transportation where she led a team which prepared the financial statements for the 2002 Winter Olympics. Previously, Ms. Kerecman was controller for Crossroads Engineering, Inc., a Utah-based engineering consulting firm, and an accountant for Granite Hollow Financial Services. Ethan A. Willis has served as Director and President for EPMG, Inc., a subsidiary of the Company, since January 2002 and served as Vice President and Director of the Company since that time until his resignation in September 2003. Mr. Willis was formerly the founder, CEO, and President of Energy Marketing Group, Inc., a technology-based product development, education, and support company that Innovative acquired on December 31, 2001. Prior to founding EPMG, Mr. Willis served as Vice President of Marketing for MIT, Inc., a financial services company, where he was responsible for marketing and product development. During his three-year tenure, MIT's revenues increased from four million to over $88 million. Mr. Willis previously served as Area Manager for Eclipse Marketing. While with Eclipse, he was responsible for the recruiting and training of both sales representatives and management, which helped generate revenues of over $20 million in just over four months. He has recruited, trained, and managed over 1,500 individuals, on both a national and international scale. He has traveled throughout the United States and Brazil executing training programs in English, Portuguese and Spanish. James R. Garn has served as Director and Vice President for EPMG, Inc., a subsidiary of the Company, since April 2002 and served as Vice President, Director and Secretary of the Company since that time until his resignation in September 2003. Mr. Garn was formerly the co-founder and Vice President of Energy Marketing Group, Inc., a technology-based product development, education, and support company that Innovative acquired on December 31, 2001. Prior to founding EPMG, Mr. Garn held the position of Sales Manager with MIT, Inc., a financial company whose revenues increased from $4 million to $88 million during his tenure. He was responsible for the development and implementation of the sales and marketing divisions. Mr. Garn has recruited, trained and managed over 2,500 individuals throughout the United States and parts of Asia, including South Korea and the Philippines. Peter A. Justen has served as a Director of Innovative since his election in April 2001. Mr. Justen possesses over 25 years of experience in the areas of real estate financing, marketing, and corporate management. Mr. Justen has served as a senior executive with Countrywide Funding Corporation, Pasadena, California, then the nation's largest residential mortgage lender. While at Countrywide, he was responsible for all phases of designing and building a telephone-based mortgage banking operation, which under his guidance generated over $1.4 billion in new mortgages in its first 12 months of operation. William E. Leathem has served as a Director of Innovative since his election in April 2003. Mr. Leathem is owner of Kansas City based Prospero's Books and recently founded Spartan Press, a national publishing company. Mr. Leathem brings with him over 15 years of hands-on governmental leadership experience, 23 including service with Missouri Senators Christopher Bond, current U.S. Attorney General John Ashcroft, former Kansas Senator Bob Dole, Congressman Roy Blunt, former Congressman Mel Hancock, and most recently served as Missouri's Director of Elections under Secretary of State Matt Blunt in 2001. As Deputy Campaign Manager of the 2000 Ashcroft for Senate Campaign, Mr. Leathem served as the chief implementation officer of a $10,000,000 U.S. Senate Campaign. Prior to 2000, Mr. Leathem served six years as Regional Director for U.S. Senator John Ashcroft. In that position, Mr. Leathem assisted in the design and implementation of office structures and technology-based day-to-day management systems, including the first ever, joint Senate office and the first Senate paperless office. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING REQUIREMENTS Based solely upon the written representations of our executive officers and directors and upon copies of the reports that they have filed with the Securities and Exchange Commission ("SEC"), during the year ended December 31, 2003, our executive officers and directors filed with the SEC on a timely basis all required reports relating to transactions involving shares of our common stock beneficially owned by them, except as follows: 1. Ethan Willis and Randy Garn, each of whom were directors and officers of the Company through September 23, 2003 and who continue to be directors of officers of the Company's material EPMG subsidiary, have not filed Form 3s and have not filed a Form 4 for their acquisition of common stock and Series A Preferred Stock of the Company received in conjunction with the Company's acquisition of EPMG, Inc., effective December 31, 2001. Mr. Willis and Mr. Garn have also not filed a Form 4 (or a Form 5 to the extent permitted) for the following transactions: their sale of a portion of their shares of Series A Preferred Stock in May 2002 in a private transaction, a change in form of their beneficial ownership through the conversion into common stock of a portion of their Series A Preferred Stock in October 2002, and their receipt of shares of the Company's Series B Preferred Stock as directors' compensation in February 2003. 2. Robin Hackett, a greater-than-10% shareholder of the Company, filed a late Form 3 in 2003 and filed a late Form 4 for a gift of 265,000 shares of our common stock made on March 8, 2002. 3. David Bird, the Chief Executive Officer of our PMG subsidiary, filed a late Form 3 in 2003. 4. Peter Justen, a director of our company, filed a late Form 3 in 2003 and filed a late Form 4 for the acquisition of 24,000 shares of our common stock in July 2001 and 20,000 shares of our Series B Preferred Stock in each of December 2002 and January 2003. 5. Shawn Thomas, a former director and executive officer of our company, filed a late Form 3 in 2003 and filed a late Form 4 for the acquisition of 1,451,652 and 25,000 shares of our common stock in April 2001 and May 2002, respectively. 6. Shane Hackett, President, CEO, and director of our Company, filed a late Form 3 in 2003 and filed a late Form 4 for the following transactions: the acquisition of 12,751,008 shares of common stock in April 2001, the disposition of 12,000 shares of common stock in August 2001, the disposition of 265,000 shares of common stock in May 8, 2002, the acquisition of 248,491 shares of Series B Preferred Stock in December 2001, and the acquisition of 40,000 shares of Series B Preferred Stock in January 2003. 7. Margie Hackett, a former executive officer of the Company, filed a late Form 3 in 2003 and filed a late Form 4 for the acquisition of 1,451,652 and 5,000 shares of our common stock in April 2001 and October 2002, respectively. 24 8. Pete Peterson, the Chairman of our Board of Directors, filed a late Form 3 in 2003 and filed a late Form 4 for the acquisition of 20,000 shares of our Series B Preferred Stock in January 2003. 9. Hans Beyer, a former director of the Company, filed a late Form 3 in 2003 and filed a late Form 4 for the acquisition of 20,000 shares of our Series B Preferred Stock in January 2003. 10. Linda Kerecman, our Chief Financial Officer, filed a late Form 3 in 2003 and filed a late Form 4 for the acquisition 30,000 shares of our common stock in October 2002. 11. Jade Koyle, an executive officer of the Company, filed a late Form 3 in 2003 and filed a late Form 4 for the acquisition 13,000 shares of our common stock in October 2002. AUDIT COMMITTEE In August 2003 the Board of Directors of the Company formed a standing Audit Committee consisting of Messrs. Justen, Leathem, and Peterson. The Audit Committee has not yet adopted a formal charter but is responsible for overseeing the accounting and financial reporting processes of the Company, the appointment and oversight of the Company's independent auditor, consulting with the independent auditor regarding the adequacy of internal accounting controls, and reviewing the scope of the audit and results of the audit examination. The Securities and Exchange Commission recently adopted new regulations relating to audit committee composition and functions, including disclosure requirements relating to the presence of an "audit committee financial expert" serving on its Audit Committee. In connection with these new requirements, the Company's Board of Directors examined the Commission's definition of "audit committee financial expert" and concluded that the Company does not currently have a person that qualifies as such an expert. Presently, the Company is not in a position to attract, retain and compensate additional directors in order to acquire a director who qualifies as an "audit committee financial expert", but the Company intends to retain an additional director who will qualify as such an expert, as soon as reasonably practicable. CODE OF ETHICS The Company has not yet adopted a formal written code of ethics that applies to its principal executive, financial and accounting officers as described in Item 406 of Regulation S-B, although a draft of a Code of Ethics has been prepared and will be presented for adoption at the next meeting of the Company's Board of Directors. 25 ITEM 10. EXECUTIVE COMPENSATION The table below details all plan and non-plan compensation awarded to, earned by, or paid to the persons serving as named executive officers for the fiscal years 2002 and 2003 per Item 402 of Regulation S-B. No person serving as officer received over $100,000 in compensation in 2001.
- ----------------------- ------- -------------------------------- ------------------------------------- ---------- Annual Compensation Long-Term Compensation - ----------------------- ------- -------------------------------- ------------------------------------- ---------- Awards Payouts - ----------------------- ------- ---------- ---------- ---------- -------------------------- ---------- ---------- Other Securities All Name Annual Restricted Underlying Other and Compen- Stock Options/ LTIP Compen- Principal Salary Bonus sation Award(s)(1) SARs Payouts sation Position Year ($) ($) ($) ($) (#) ($) ($) - ----------------------- ------- ---------- ---------- ---------- ------------ ------------- ---------- ---------- Douglas S. Hackett President & CEO 2003 120,000 150,378 26,771 20,000 0 0 0 ------- ---------- ---------- ---------- ------------ ------------- ---------- ---------- 2002 130,349 14,964 22,209 20,000 0 0 0 - ----------------------- ------- ---------- ---------- ---------- ------------ ------------- ---------- ---------- Ethan A. Willis Vice President 2003 253,890 200,378 17,501 20,000 0 0 0 ------- ---------- ---------- ---------- ------------ ------------- ---------- ---------- 2002 159,615 64,964 23,441 20,000 0 0 0 - ----------------------- ------- ---------- ---------- ---------- ------------ ------------- ---------- ---------- James R. Garn Vice President 2003 253,890 200,378 17,561 20,000 0 0 0 ------- ---------- ---------- ---------- ------------ ------------- ---------- ---------- 2002 159,615 64,964 20,161 20,000 0 0 0 - ----------------------- ------- ---------- ---------- ---------- ------------ ------------- ---------- ---------- Aaron Peterson Sales Manager 2003 592,080 0 7316 0 0 0 0 ------- ---------- ---------- ---------- ------------ ------------- ---------- ---------- 2002 210,692 0 7316 0 0 0 0 - ----------------------- ------- ---------- ---------- ---------- ------------ ------------- ---------- ----------
(1) Comprising shares of the Company's series B preferred stock at a stated value of $1.00 per share. 26 DIRECTORS' COMPENSATION Our non-employee directors receive an annual fee of $50,000 for their service to our board and are reimbursed for expenses incurred in attending board and committee meetings. Our Chairman of the Board of Directors has also received an additional fee of $15,000 per month beginning in November 2003. This additional compensation is approved on a month by month basis. In addition to the annual fees, each non-employee director is entitled to receive a per-meeting fee of $1,500 for each meeting of the board of directors or any board committee attended in person. Except for Mr. Leathem, we also compensated each non-employee director through the issuance of 20,000 shares of the Company's Series B Preferred Stock in 2003. No director who is an employee will receive separate compensation for services rendered as a director. EMPLOYMENT AGREEMENTS D. Shane Hackett. On April 15, 2001 we entered into an employment agreement with Shane Hackett that, as amended, provides for his employment as President and Chief Executive Officer of the Company. Mr. Hackett's employment agreement expires on April 15, 2007. Mr. Hackett receives an annual base salary equal to $120,000 per year, and his employment will terminate upon the earlier of his death, resignation, disability, or termination by the board of directors for any reason. Mr. Hackett also receives quarterly bonuses as additional compensation which is determined by the Company's management team. Ethan Willis, Randy Garn and Aaron Peterson do not currently have employment agreements with the Company. 27 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth, as of April 13, 2004, the number and percentage of shares of Common Stock of the Company, owned of record and beneficially, by each person known by us to own 5% or more of such stock, each director of the Company and by all executive officers and directors of the Company as a group.
Name and Address Amount Percent Title of Class of Owner Owned (1) of Class (2) - -------------- ----------------------------- ------------- ------------ Common Douglas S. Hackett President and CEO 6500 N.W. Turnberry Ct. Parkville, MO 64152 12,536,502(3) 23.70% Common James R. Garn Vice President and Director of EPMG, Inc. 1214 North 70 East American Fork, UT 84003 3,392,381 6.41% Common Ethan A. Willis President and Director of EPMG, Inc. 1354 South 1370 East Provo, UT 84604 3,392,381 6.41% Common Linda Kerecman Chief Financial Officer 1553 East 1860 North Lehi, UT 84043 30,000 0.06% Common Jade Koyle Director of Operations 10945 East 230 South Provo, UT 84606 13,000 0.02% Common Peter Justen Director 14711 Kamputa Drive Centerville, VA 20120 24,000 0.05% All Officers and Directors as a group (6 persons) 19,388,264 36.65%
(1) Information with respect to beneficial ownership is based upon information furnished by each stockholder or contained in filings made with the Securities and Exchange Commission. Unless otherwise indicated, beneficial ownership includes both sole investment and voting power. (2) Based upon 52,897,186 shares of Common Stock outstanding as of April 12, 2004 and, with respect to each stockholder, the number of shares which would be outstanding upon the exercise by such stockholder of outstanding rights to acquire stock, either upon exercise of outstanding options, warrants or conversion of other securities. (3) 12,536,502 shares represents shares of common stock beneficially owned by Douglas S. Hackett under common ownership: Douglas S. Hackett - 4,711,729 common shares or 9.0%, Harlaxton Limited Partnership - 6,865,926 common shares or 13.1 %, and Douglas Shane Hackett IRA - 958,847 common shares or 1.8%. 28
Name and Address Amount Percent Title of Class of Owner Owned (1) of Class (2) - -------------- ----------------------------- ------------- ------------ Series A James R. Garn Preferred Stock Vice President and Director of EPMG, Inc. 1214 North 70 East American Fork, UT 84003 600,250(3) 36.37% Series A Ethan A. Willis Preferred Stock President and Director of EPMG, Inc. 1354 South 1370 East Provo, UT 84604 600,250(3) 36.37% Series A Glendower Holdings, Ltd. Preferred Stock Shareholder 36 Hilgrove Street St. Helier, Jersey JE4 8TR Channel Islands 350,000 21.21% Series A Jarbridge, Ltd. Preferred Stock Shareholder 1934 Driftwood Bay Belize City, Belize Central America 100,000 6.06% All Officers and Directors as a group (2 persons) 1,200,500 72.74%
(1) Information with respect to beneficial ownership is based upon information furnished by each stockholder or contained in filings made with the Securities and Exchange Commission. Unless otherwise indicated, beneficial ownership includes both sole investment and voting power. (2) Based upon 1,650,500 shares of Series A Preferred Stock outstanding as of April 12, 2004 and, with respect to each stockholder, the number of shares which would be outstanding upon the exercise by such stockholder of outstanding rights to acquire stock, either upon exercise of outstanding options, warrants or conversion of other securities. (3) 600,250 shares represents shares of Series A Preferred shares beneficially owned by Ethan A. Willis and James R. Garn as a direct result of the acquisition of EPMG, Inc. as of December 31, 2001. 29
Name and Address Amount Percent Title of Class of Owner Owned (1) of Class (2) - -------------- ----------------------------- ------------- ------------ Series B Douglas S. Hackett 288,491(3(4) 67.33% Preferred Stock President and CEO 6500 N.W. Turnberry Ct. Parkville, MO 64152 Series B James R. Garn 40,000(4) 9.34% Preferred Stock Vice President and Director of EPMG, Inc. 1214 North 70 East American Fork, UT 84003 Series B Ethan A. Willis 40,000(4) 9.34% Preferred Stock President and Director of EPMG, Inc. 1354 South 1370 East Provo, UT 84604 Series B Peter Justen 40,000(4) 9.34% Preferred Stock Director 14711 Kamputa Drive Centerville, VA 20120 Series B Peter M. Peterson 20,000(4) 4.67% Preferred Stock Chairman of the Board of Directors 2402 South Ardson Place Tampa, FL 33629 All Officers and Directors as a group (5 persons) 468,491 100.00%
(1) Information with respect to beneficial ownership is based upon information furnished by each stockholder or contained in filings made with the Securities and Exchange Commission. Unless otherwise indicated, beneficial ownership includes both sole investment and voting power. (2) Based upon 468,491 shares of Series B Preferred Stock outstanding as of April 12, 2004 and, with respect to each stockholder, the number of shares which would be outstanding upon the exercise by such stockholder of outstanding rights to acquire stock, either upon exercise of outstanding options, warrants or conversion of other securities. (3) 248,491 shares represent Mr. Hackett's note payable conversion to Series B Preferred stock of $248,491 at a conversion rate of a $1 per share stated value as well as 40,000 shares issued as executive compensation at a stated value of $1 per share. (4) Includes shares issued as board of directors' compensation at a stated value of $1 per share. 30 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS During 2001, the Company sold four software platforms to NowSeven.com, Inc., Ziabon, Inc., SF Acquisition Corp., Inc., and Ishopper Internet Services, Inc. in exchange for investment securities amounting to $308,000, $133,000, $147,000, and $140,000, respectively. The President and Chief Executive Officer of the Company is the former President and Chief Executive Officer of Ensurge, Inc., which is the parent company of the wholly-owned subsidiaries listed above. Due to the decline in market value of Knowledge Transfer Systems, Inc. common stock, the Company considered the value of these securities permanently impaired and wrote down the entire carrying value of these investment securities as of December 31, 2002. During the 3rd quarter 2002, the Company initiated the purchase of sales leads from Education Success Institute, Inc. (ESI). ESI is owned and operated by two directors of the Company (Ethan Andrew Willis and James Randolph Garn). Expenses incurred by the Company for leads provided by ESI totaled $663,159 for the year ended December 31, 2002 and $5,961,306 for the year ended December 31, 2003. The President and Chief Executive Officer of the Company is the former President and Chief Executive Officer of Ensurge, Inc., which was the parent company of KT Solutions, Inc. At the time of the sale of the Business Development Series to Knowledge Transfer Systems, Inc. for 875,000 Knowledge Transfer Systems, Inc. preferred shares, there was no related party relationship between the companies and/or the officers and directors of the companies at the time of the transaction. ITEM 13. EXHIBITS AND REPORTS ON 8-K a. Exhibits The exhibits required by this item are listed in the Index to Exhibits set forth at the end of this Form 10-QSB. b. Reports of Form 8-K During the fourth quarter of the period covered by this report, the Company filed the following report on Form 8-K: On October 3, 2003, the Company filed a Form 8-K (Item 6) disclosing the resignation of Randy Garn and Ethan Willis as officers and directors of the Company and threatened legal action by them. ITEM 14. PRINCIPAL AUDITOR FEES AND SERVICES During the year ended December 31, 2003 and 2002 the Company paid Robison, Hill and Co. $27,790 and $0, respectively, for audit services in connection with the Company's annual report on Form 10-KSB and Quarterly Filings on Form 10-QSB. During the year ended December 31, 2003 and 2002 the Company paid Grant Thornton $5,444 and $60,826, respectively, for audit services in connection with the Company's annual report on Form 10-KSB and Quarterly Filings on Form 10-QSB. During the years ended December 31, 2003 and 2002, the Company did not pay Robison, Hill & Company or Grant Thornton fees for non-audit or tax services. 31 SIGNATURES In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. INNOVATIVE SOFTWARE TECHNOLOGIES, INC. April 14, 2004 /s/ Douglas S. Hackett -------------- ---------------------- Douglas S. Hackett President, Chief Executive Officer and Director April 14, 2004 /s/ Linda W. Kerecman -------------- --------------------- Linda W. Kerecman Chief Financial Officer April 14, 2004 /s/ Peter M. Peterson -------------- --------------------- Peter M. Peterson Chairman of the Board of Directors April 14, 2004 /s/ Peter Justen -------------- --------------------- Peter Justen Director April 14, 2004 /s/ William E. Leathem -------------- ---------------------- William E. Leathem Director 32 INDEX TO EXHIBITS Exhibit Number Description - ------- ----------- 3.1 Amendment to the Articles of Incorporation of Innovative Software Technologies, Inc.* 3.2 Articles of Incorporation of Innovative Software Technologies, Inc., as amended.* 3.3 Certificate of Designation of the Series A Preferred Stock of Innovative Software Technologies, Inc. (incorporated by reference from Exhibit 2.2 to the Company's Current Report on Form 8-K/A filed March 14, 2002). 3.4 Certificate of Designation of the Series B Preferred Stock of Innovative Software Technologies, Inc.* 3.5 By-laws of Innovative Software Technologies, Inc. (incorporated by reference from Exhibit 3(b) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1999). 4.1 Specimen Certificate of Common Stock (incorporated by reference from Exhibit 4(a) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1999). 4.2 Articles FOURTH and FIFTH of the Articles of Incorporation of Innovative Software Technologies, Inc., as amended (incorporated by reference from Exhibit 3.2 to this Quarterly Report on Form 10-QSB). 4.3 Certificate of Designation of the Series A Preferred Stock of Innovative Software Technologies, Inc. (incorporated by reference from Exhibit 2.2 to the Company's Current Report on Form 8-K/A filed March 14, 2002). 4.4 Certificate of Designation of the Series B Preferred Stock of Innovative Software Technologies, Inc. (incorporated by reference from Exhibit 3.4 to this Quarterly Report on Form 10-QSB). 4.5 Sections 3 - 17, 28, 39 - 46 and 51 - 53 of the By-laws of Innovative Software Technologies, Inc. (incorporated by reference from Exhibit 3(b) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1999). 4.6 Financing Agreement dated January 25, 2001 among Iwasaka Investments Limited, Shane Hackett and Hackett Media, Inc.* 4.7 Amendment to Finance Agreement dated December 31, 2001 between Iwasaka Investments Limited and Innovative Software Technologies*** 33 Executive Compensation Plans and Arrangements: Exhibits 10.2, 10.3, 10.4, 10.5 and 10.6 to the Quarterly Report on Form 10-QSB for fiscal quarter ended September 30, 2003 10.1 Opportunity and Strategic Alliance Agreement dated September 1, 2002 by and between Energy Professional Marketing Group, Inc. and Education Success, Inc.* 10.2 Employment Agreement dated April 15, 2001 between Innovative Software Technologies, Inc. and Douglas S. Hackett.* 10.3 Employment Agreement dated December 31, 2001 between Energy Professional Marketing Group, Inc. and James R. Garn.* 10.4 Amendment dated July 15, 2002 to the Employment Agreement between Energy Professional Marketing Group, Inc. and James R. Garn.* 10.5 Employment Agreement dated December 31, 2001 between Energy Professional Marketing Group, Inc. and Ethan A. Willis.* 10.6 Amendment dated July 15, 2002 to the Employment Agreement between Energy Professional Marketing Group, Inc. and Ethan A. Willis.* 10.7 Indemnity Agreement dated August 17, 2001 between Innovative Software Technologies, Inc. and Douglas Shane Hackett.* 10.8 Indemnity Agreement/Hold Harmless Agreement dated August 17, 2001 among Innovative Software Technologies, Inc. and Scott Mehaffey, Shawn M. Thomas, Margie Hackett and Douglas S. Hackett.* 10.9 Indemnity Agreement dated August 17, 2001 between Innovative Software Technologies, Inc. and Margie Hackett.* 10.10 Indemnity Agreement dated August 17, 2001 between Innovative Software Technologies, Inc. and Scott Mehaffey.* 10.11 Indemnity Agreement dated August 17, 2001 between Innovative Software Technologies, Inc. and Margie Hackett.* 10.12 Indemnity Agreement dated August 17, 2001 between Innovative Software Technologies, Inc. and Shawn M. Thomas.* 10.13 Indemnity Agreement dated January 9, 2002 among Innovative Software Technologies, Inc. and Ethan Willis and Randy Garn.* 10.14 Indemnity Agreement dated August 16, 2002 among Innovative Software Technologies, Inc. and Ethan Willis and Randy Garn.* 10.15 Indemnity Agreement dated August 15, 2002 among Innovative Software Technologies, Inc. and Douglas Shane Hackett.* 34 10.16 Director Indemnification Agreement dated September 15, 2003 between Innovative Software Technologies, Inc. and Peter Justen*** 10.17 Director Indemnification Agreement dated August 14, 2003 between Innovative Software Technologies, Inc. and Peter M. Peterson*** 10.18 Director Indemnification Agreement dated August 4, 2003 between Innovative Software Technologies, Inc. and William E. Leathem*** 10.19 Exchange Agreement dated February 26, 2004 between Innovative Software Technologies, Inc., EPMG, Inc., James R. Garn and Ethan A. Willis. 10.20 Indemnification Agreement dated December 15, 2003 between Innovative Software Technologies, Inc. and Linda W. Kerecman. 21 Subsidiaries of the Registrant.* 31.1 Certification of Chief Executive Officer of Innovative Software Technologies, Inc. dated April 12, 2004. 31.2 Certification of Chief Financial Officer of Innovative Software Technologies, Inc. dated April 12, 2004. 32.1 Certification of Chief Executive Officer of Innovative Software Technologies, Inc. dated April 12, 2004, which is accompanying this Yearly Report on Form 10-KSB for the year ended December 31, 2003 and is not treated as filed in reliance on Section 601(b)(32) of Regulation S-B. 32.2 Certification of Chief Financial Officer of Innovative Software Technologies, Inc. dated April 12, 2004, which is accompanying this Yearly Report on Form 10-KSB for the year ended December 31, 2003 and is not treated as filed in reliance on Section 601(b)(32) of Regulation S-B. 99.1 Resignation Letter dated September 26, 2003 from James Randolph Garn to the Company.** 99.2 Resignation Letter dated September 26, 2003 from Ethan Andrew Willis to the Company.** 99.3 Memorandum of Holme Roberts & Owen LLP dated September 26, 2003.** * Incorporated by reference from the exhibit to the Company's Quarterly Report on Form 10-QSB for the fiscal quarter ended June 30, 2003 which bears the same exhibit number. ** Incorporated by reference from the exhibit to the Company's Current Report on Form 8-K filed with the Commission on October 3, 2003 which bears the same exhibit number. *** Incorporated by reference from the exhibit to the Company's Quarterly Report on Form 10-QSB for the fiscal quarter ended September 30, 2003 which bears the same exhibit number. 35 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS 2003 CONSOLIDATED FINANCIAL STATEMENTS Page Report of Aidman, Piser & Company, P.A.......................................F-2 Consolidated Balance Sheet as of December 31, 2003...........................F-3 Consolidated Statement of Operations for the Year Ended December 31, 2003.................................................F-4 Consolidated Statement of Stockholders' Equity for the Year Ended December 31, 2003.................................................F-5 Consolidated Statement of Cash Flow for the Year Ended December 31, 2003.................................................F-6 Notes to 2003 Consolidated Financial Statements..............................F-7 2002 CONSOLIDATED FINANCIAL STATEMENTS Report of Robison, Hill & Co................................................F-19 Consolidated Balance Sheet as of December 31, 2002..........................F-20 Consolidated Statement of Operations for the Year Ended December 31, 2002................................................F-21 Consolidated Statement of Stockholders' Equity for the Year Ended December 31, 2002................................................F-22 Consolidated Statement of Cash Flow for the Year Ended December 31, 2002................................................F-23 Notes to 2002 Consolidated Financial Statements.............................F-24 F-1 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Stockholders Innovative Software Technologies, Inc. We have audited the accompanying consolidated balance sheet of Innovative Software Technologies, Inc. and Subsidiaries as of December 31, 2003, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Innovative Software Technologies, Inc. and Subsidiaries as of December 31, 2003 and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. /s/ Aidman, Piser & Company, P.A. Tampa, Florida April 7, 2004 F-2 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET DECEMBER 31, 2003
ASSETS CURRENT ASSETS Cash $ 3,890,929 Accounts receivable: Merchant accounts receivable 1,104,051 Other receivables 101,590 Notes receivable, net of allowance for doubtful accounts of $454,529 949,891 Inventory 48,291 Prepaid expenses and other current assets 15,986 Deferred income taxes 457,890 ------------ Total current assets 6,568,628 ------------ PROPERTY AND EQUIPMENT, NET 574,291 GOODWILL 1,088,686 DEFERRED INCOME TAXES 17,688 DEPOSITS 43,965 ------------ Total assets $ 8,293,258 ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses $ 3,342,084 Deferred revenue 1,857,247 Accrued income taxes 822,533 Current maturities of capital lease obligations 67,049 ------------ Total current liabilities 6,088,913 CAPITAL LEASE OBLIGATIONS 126,336 ------------ Total liabilities 6,215,249 ------------ COMMITMENTS AND CONTINGENCIES (NOTE 7) -- STOCKHOLDERS' EQUITY Series A preferred stock; issued and outstanding, 1,650,500 shares 1,650,500 Series B preferred stock; issued and outstanding, 428,491 shares 448,491 Common stock - authorized, 100,000,000 shares of $.001 par value; issued and outstanding, 52,897,186 52,897 Additional paid-in capital 13,163,749 Accumulated deficit (13,237,628) ------------ Total stockholders' equity 2,078,009 ------------ Total liabilities and stockholders' equity $ 8,293,258 ============
See accompanying notes. F-3 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 2003 REVENUE Services revenue $ 10,879,121 Product sales 15,547,838 Other revenue 417,287 ------------ Total revenue 26,844,246 COST OF REVENUE Cost of services revenue 5,745,871 Cost of product sales and other revenue 7,572,452 ------------ Total cost of revenue 13,318,323 ------------ GROSS PROFIT 13,525,923 ------------ OPERATING EXPENSES General and administrative 7,533,571 Commissions and other selling expenses 6,094,250 ------------ Total operating expenses 13,627,820 ------------ LOSS FROM OPERATIONS (101,897) ------------ OTHER INCOME (EXPENSES) Interest and penalties on late tax payments (218,950) Other income 58,274 Interest income, deposits 92,671 Interest income, financing arrangements 358,635 Interest expense (44,530) ------------ Total other income (expense) 246,100 ------------ INCOME BEFORE INCOME TAXES 144,203 INCOME TAXES (346,955) ------------ NET LOSS (202,752) UNDECLARED PREFERRED STOCK DIVIDENDS & ACCRETIONS (76,195) ------------ LOSS APPLICABLE TO COMMON STOCKHOLDERS $ (278,947) ============ BASIC AND DILUTED LOSS PER COMMON SHARE $ (0.00) ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES USED IN PER SHARE CALCULATION (BASIC AND DILUTED) 52,859,490 ============ See accompanying notes. F-4 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEAR ENDED DECEMBER 31, 2003
Preferred Stock Preferred Stock Series A Series B Common Stock ---------------------- ---------------------- ---------------------- Shares Amount Shares Amount Shares Amount ---------- ---------- ---------- ---------- ---------- ---------- Balance as of December 31, 2002 1,650,500 1,650,500 328,491 $ 328,491 52,481,289 $ 52,481 ---------- ---------- ---------- ---------- ---------- ---------- Issuance of Common stock for services and charitable donation 415,897 416 Issuance of Series B Preferred Stock for Compensation 100,000 126,315 Net loss Preferred Stock Accretions (6,315) ---------- ---------- ---------- ---------- ---------- ---------- Balance as of December 31, 2003 1,650,500 1,650,500 428,491 $ 448,491 52,897,186 $ 52,897 ========== ========== ========== ========== ========== ==========
Retained Additional Earnings Total paid-in- (Accum. Stockholders' capital Deficit) Equity ----------- ------------ ----------- Balance as of December 31, 2002 $13,119,719 $(13,041,191) $ 2,110,000 ----------- ------------ ----------- Issuance of Common stock for services and charitable donation 44,030 44,446 Issuance of Series B Preferred Stock for Compensation 126,315 Net loss (202,752) (202,752) Preferred Stock Accretions 6,315 -- ----------- ------------ ----------- Balance as of December 31, 2003 $13,163,749 $(13,237,628) $ 2,078,009 =========== ============ ===========
See accompanying notes. F-5 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2003 CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (202,752) Adjustments to reconcile net loss to net cash provided by operating activities Depreciation and amortization 222,188 Stock based compensation 170,762 Deferred income taxes 120,779 Net change in operating assets and liabilities Merchant account receivables (1,104,051) Other receivables (41,818) Inventory (48,291) Prepaid expenses and other current assets 762,412 Accounts payable and accrued expenses 2,136,514 Deferred revenue 1,601,099 Accrued income taxes 226,176 ----------- Net cash flows from operating activities 3,843,018 ----------- CASH FLOWS FROM INVESTING ACTIVITIES Change in notes receivable from financed sales (935,191) Capital expenditures (326,380) ----------- Net cash flows from investing activities (1,261,571) ----------- CASH FLOWS FROM FINANCING ACTIVITIES Payments on capital lease obligations (28,862) ----------- Net cash flows from financing activities (28,862) ----------- NET INCREASE IN CASH 2,552,584 CASH AT BEGINNING OF PERIOD 1,338,345 ----------- CASH AT END OF PERIOD $ 3,890,929 =========== SUPPLEMENTAL CASH FLOW INFORMATION Issuance of common stock for services/charitable contributions $ 44,446 =========== Issuance of Series B Preferred Stock as Compensation $ 126,315 =========== Property and equipment acquired under capital leases $ 90,750 =========== See accompanying notes. F-6 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 (1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Organization and Description of Business: Innovative Software Technologies, Inc. (the "Company") was incorporated in the State of California in May 1998. The Company is engaged in the development, marketing and delivery of business-type educational programs, generally to individuals, throughout the United States of America. The Company's educational programs combine both self-training and coaching by Company employees. During 2003, the Company's educational programs were concentrated in two product lines, Real Estate and Internet Marketing, which together comprised approximately 94% of 2003 revenues. (b) Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, EPMG, Inc. and Hacket Media, Inc. All significant intercompany balances and transactions have been eliminated in consolidation. (c) Cash and Cash Equivalents: The Company considers all highly liquid financial instruments with a maturity when acquired of three months or less to be cash equivalents. Cash is concentrated in three regional financial institutions, in each case in amounts in excess of Federally-Insured levels. (d) Accounts Receivable: Trade accounts receivable are comprised of hold-back amounts due from merchant credit card processing providers ("merchant accounts") and trade customers (also referred to as "students."). Trade accounts receivable are recorded at invoiced amounts and do not bear interest. The Company reviews its allowances for doubtful accounts monthly. Past due balances over ninety days and over a specified amount are reviewed individually for collectibility. All other balances are reviewed on a pooled basis. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance-sheet credit exposure related to these customers or the merchant accounts as of December 31, 2003. (e) Notes Receivable: Notes receivable relate to product financing arrangements entered into with the Company's students that meet certain credit qualifications. These notes are unsecured, bear interest at 15% and have terms ranging F-7 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 between one and two years. The Company has not and does not intend to sell or otherwise transfer these receivables. The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses in the Company's existing notes based upon the Company's historical loss rates experienced on its financing arrangements. A note is considered impaired pursuant to Financial Accounting Standards Board Statement 114, Accounting by Creditors for Impairment of a Loan. Pursuant to Statement 114, a note is impaired if it is probable that the Company will not collect all principal and interest contractually due. The impairment is measured based on the present value of expected future cash flows discounted at the note's effective interest rate. The Company does not accrue interest when a note is considered impaired. When ultimate collectibility of the principal balance of the impaired note is in doubt, all cash receipts on impaired notes are applied to reduce the principal amount of such notes until the principal has been recovered and are recognized as interest income thereafter. Impairment losses are charged against the allowance when all possible means of collection have been exhausted and the potential for recovery is considered remote. The Company commenced student financing activities during 2002 and, as a result, lacked a sufficient history of financing transactions to make a reasonable estimate of uncollectible amounts during 2002. As a result, all financing balances, amounting to $718,690 were fully reserved as of December 31, 2002 and through and including the third fiscal quarter of 2003. During the fourth quarter of 2003, the Company was able to develop a reasonable estimate of uncollectible amounts, based upon actual experience, and changed its estimate as of December 31, 2003 to reflect this revised estimate. On a pro forma unaudited basis assuming that the current estimate had been available at the end of 2002, the allowance on December 31, 2002 would have been $179,672. Pro forma information is not necessarily indicative of the results that would have occurred had the information been available at that time. Also see Note 8. (f) Inventories: Inventories consist of multimedia educational materials available for delivery to the Company's students. Inventories are carried at the lower of cost or market, where cost is determined using the weighted average method. (g) Property and Equipment: Property and equipment are stated at cost. Property and equipment acquired under capital leases are stated at the present value of the minimum lease payments. The Company incurs significant costs associated with developing and upgrading its websites. The Company follows the accounted guidance for website development costs described F-8 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 in Emerging Issues Task Force Opinions ("EITF") 00-2 Accounting for Website Development Costs. Depreciation on property and equipment is calculated on the straight-line method over the estimated useful lives of the assets, generally 5-15 years for machinery and equipment, 5 years for furniture and fixtures, 3 years for software (which includes the Company's websites), and the lease term for property and equipment acquired pursuant to capital leases. (h) Goodwill: Goodwill at December 31, 2003 represents the remaining excess of the purchase price over the fair values of net assets acquired in connection with the EPMG, Inc. acquisition. In accordance with Statement of Financial Accounting Standards Board Statement No. 142, Goodwill and Other Intangible Assets (SFAS142), goodwill resulting from the purchase will not be amortized into operations. Rather, such amounts will be tested for impairment at least annually. This impairment test is calculated at the reporting unit level, which, for the Company is at the enterprise level. The annual goodwill impairment test has two steps. The first, identifies potential impairments by comparing the fair value of the Company, as determined using its trading market prices, with its carrying value, including goodwill. If the fair value exceeds the carrying amount, goodwill is not impaired and the second step is not necessary. If the carrying value exceeds the fair value, the second step calculates the possible impairment loss by comparing the implied fair value of goodwill with the carrying amount. If the implied goodwill is less than the carrying amount, a write-down will be recorded. In the event that management of the Company determines that the value of goodwill has become impaired using this approach, an accounting charge for the amount of the impairment will be recorded. No impairment of goodwill resulted from this measurement approach during 2003. The Company performed its test annually, on the last day of the fourth fiscal quarter of each year. (i) Impairments of Long-lived Assets Other Than Goodwill: The Company adopted Financial Accounting Standards Board Statement No. 144 on January 1, 2002. In accordance with Statement 144, long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the F-9 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. (j) Income Taxes: Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (k) Revenue Recognition: The Company has evaluated its educational offerings in the context of EITF 00-21 Revenue Arrangements with Multiple Deliverables and has determined that revenues associated with the multimedia educational materials (product sales) require accounting separate from the educational and coaching services (services revenue). The fair value of these offerings is established through actual separate third party sales of each of these products and services. Product Sales: The Company recognizes product revenue upon delivery, as evidenced by third party shipping providers, which is the point where the student assumes ownership and risk of loss. Shipping costs are billed to students and are included as a component of revenue and cost of product sales. Returns are provided for based upon the Company's historical return experience. Services Revenues: The educational offering includes ten or more sessions with a Company employed coach. The Company recognizes services revenue pro rata as coaching/training sessions are rendered. Deferred revenue represents the fair value of future coaching sessions that students have paid for ($4,461,883), less the applicable commissions to lead generators and content providers ($1,701,016) and sales commissions ($903,620). The Company's obligation to provide coaching and training ceases one year following the sale. Refunds for unused courses are not provided for in the sales arrangement with the student. However, the Company offers refunds in certain circumstances for which a history has been developed to estimate and reserve such amounts. F-10 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 Other Revenue: Other revenues consist of website hosting services, charged to customers monthly, lead sales and other product offerings that are not currently material to the Company's consolidated revenue. (l) Earnings Per Common Share: Basic net income (loss) per common share is computed by dividing (i) the net income (loss), as adjusted for the effects of cumulative dividends and accretions on the Series A and B Preferred Stock by (ii) the weighted average common shares outstanding during the period. Diluted net income (loss) per share is computed similarly but includes the effects of dilutive securities in the denominator. The loss per common share for the year ended December 31, 2003 excludes the effects of 7,125,605 common shares into which the Company's Series A and Series B Convertible Preferred Stock is convertible because the inclusion of these securities would have an anti-dilutive effect. (m) Stock-Based Compensation: Compensation expense related to the grant of equity instruments and stock-based awards to employees are accounted for using the intrinsic method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. Stock based compensation arrangements involving non-employees are accounted for using the fair value methodology under Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. For purposes of stock-based compensation, the Company treats its Board of Directors as non-employees because the shareholders of the Company did not elect them. (n) Use of Estimates: The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include the (i) carrying amount of property, plant and equipment, (ii) carrying amount of goodwill, (iii) valuation allowances for notes and accounts receivables (iv) valuation of net deferred income tax assets, and (v) estimates for the deferral of services revenue. Actual results could differ from those estimates. (o) Recent Accounting Standards: In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The statement amends and clarifies accounting and F-11 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. This statement is designed to improve financial reporting such that contracts with comparable characteristics are accounted for similarly. The statement, which is generally effective for contracts entered into or modified after June 30, 2003, is not anticipated to have a significant effect on our financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The statement was considered in regard to our Series A and Series B Preferred Stock and, as a result, is not anticipated to have a significant effect on our financial position or results of operations. In December 2003, the FASB issued FASB Interpretation No. 46 (REVISED), Consolidation of Variable Interest Entities. This interpretation clarifies rules relating to consolidation where entities are controlled by means other than a majority voting interest and instances in which equity investors do not bear the residual economic risks. We currently have no ownership in variable interest entities and therefore adoption of this standard currently has no financial reporting implications. (2) PROPERTY AND EQUIPMENT Property and equipment consist of the following as of December 31, 2003: Machinery and Equipment $ 514,060 Computer Software (Website) 324,782 Furniture and Fixtures 65,263 Leasehold improvements 36,018 ----------- 940,122 Accumulated depreciation and amortization (365,832) ----------- $ 574,291 =========== F-12 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 (3) ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consist of the following as of December 31, 2003: Accrued commissions $ 1,255,770 Accrued wages and other 773,707 Reserves for returns and refunds 742,568 Accounts payable 351,089 Interest and penalties on late tax payments 218,950 Credit facility (a) 3,440 ------------ $ 3,342,084 ============ (a) The Company has a credit facility that provides for borrowings up to $50,000, with interest at Prime Rate, plus 2%. (4) STOCKHOLDERS' EQUITY (a) Convertible Preferred Stock: The Company has 25,000,000 shares of preferred stock authorized and has designated 1,500,000 shares as $1.00 stated value Series A Preferred and 3,000,000 shares as $1.00 stated value Series B Preferred. The Series A and Series B Preferred Stock (collectively "Preferred Stock") have the same terms and conditions. The Preferred Stock is (i) entitled to cumulative dividends at a rate of 4.0% of the liquidation value ($1.00 per share), (ii) convertible at any time into common stock at a rate of 95% of the average closing market price of the common stock for five days preceding conversion (7,125,605 common shares as of December 31, 2003), (iii) redeemable at any time by the Company for $1.00 per share, (iv) entitled to one vote per share. As of December 31, 2003, the Company has cumulative, undeclared dividends in arrears on the Preferred Stock of $82,510. (b) Stock-Based Compensation: During the year ended December 31, 2003, the Company issued 49,231 shares of common stock to non-employees for services. These shares were valued at $44,446 based upon the closing market prices for the Company's common stock on the dates issued or committed. During the year ended December 31, 2003, the Company issued 100,000 shares of Series B Preferred Stock to officers and certain directors for services. These shares were valued at $126,315 based upon the value of the closing market prices of the common stock into which the F-13 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 Series B Preferred Stock was immediately convertible. The premium of $6,315 over the redemption value was accreted through credits to retained earnings during the year ended December 31, 2003. The Company has not issued any warrants or options. (5) RELATED PARTY TRANSACTIONS The Company purchases sales leads from Education Success Institute, Inc. (ESI), which is owned by two former officers of the Company. The cost of sales leads purchased during the year ended December 31, 2003, which is based upon a percentage of revenue, amounted to $5,961,306. As of December 31, 2003, the Company owed $15,173 related to this arrangement. In addition, ESI subleases office space from the Company. Sub-rental receipts amount to $700 each month through August 2005. See Note 7. (6) INCOME TAXES The Company's taxing jurisdictions are Federal and the State of Utah. The provision (benefit) for these income taxes for the year ended December 31, 2003 is as follows: Current provision $ 226,176 Deferred benefit (97,918) Change in valuation allowance 218,697 ----------- Net provision for income taxes $ 346,955 =========== The components of the Company's deferred income taxes as of December 31, 2003 are as follows: Deferred tax assets: Capital loss carryforwards $ 331,851 Allowances for returns and refunds 284,032 Allowances on notes receivable 173,857 Depreciation 17,689 ----------- Total deferred tax assets 807,429 Less: valuation allowances (331,851) ----------- $ 475,578 =========== Net current deferred tax asset $ 457,889 Net non current deferred tax asset 17,689 ----------- $ 475,578 =========== F-14 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 Income tax expense attributable to the Company's operations for the year ended December 31, 2003 differed from amounts computed using the U.S. Federal statutory rate of 35% as a result of the following: Computed "expected" tax expense (35%) $ 50,471 Change in valuation allowance 218,697 Nondeductible permanent differences 72,100 State income taxes, net of federal benefit 13,023 Other, net (7,336) ----------- $ 346,955 =========== (7) COMMITMENTS AND CONTINGENCIES (a) Leases: Future minimum lease payments under noncancelable operating leases (with initial terms in excess of one year) and future minimum capital lease payments as of December 31, 2003 are as follows: Capital Operating Year ending December 31: Leases Leases ----------- ----------- 2004 $ 77,899 $ 223,517 2005 59,908 137,853 2006 39,812 2007 36,491 ----------- ----------- Total noncancelable lease payments 214,110 $ 361,370 =========== Less amount representing interest 20,725 ----------- $ 193,385 =========== Principal amount due in one year $ 67,049 Principal amount due after one year 126,336 ----------- $ 193,385 =========== Rent expense under all operating leases for the year ended December 31, 2003 was $229,959. This amount was exclusive of $8,400 of sub-lease payments received from a related party. See Note 5. (b) Lead Arrangements: The Company is a party to several lead agreements with Education Success, Inc. and certain other lead generators. The continuous generation of sales leads is a critical element to the Company's continuing viability. The agreements provide for the transfer of sales leads to EPMG, Inc. for commissions of, generally, 34% of gross revenue, subject to certain adjustments. The ESI agreement was executed in 2002 and has a term coextensive with the terms of the related party officers' contracts. F-15 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 (c) Content Providers: The Company is a party to several agreements that provide for the educational content and multimedia materials used in the educational offerings. Generally, these agreements provide for a commission, generally 8% to 10% of actual sales. The maintenance of content agreements is a critical element to the Company's continuing viability. (d) Servicing Arrangements: The Company is a party to a servicing agreement with a third party financial institution for the servicing of the Company's financed sales. The agreement provides for the collection, servicing and remittance of notes receivable as an agent to the Company. The counterparty receives certain fees for this servicing arrangement, which is included as a reduction of the interest income on the notes receivable. (e) SEC Investigation: On June 24, 2003, the Securities and Exchange Commission issued a formal order of investigation authorizing subpoenas for documents and testimony in connection with the investigation of certain securities matters. The Company has and intends to continue to fully cooperate with the SEC in its investigation. (f) Litigation: On September 26, 2003, counsel representing the former principals of EPMG, Inc., who are currently officers of EPMG, Inc., notified the Company that they were entitled to rescind the Company's 2001 acquisition of EPMG, Inc. which was accomplished in a stock-for-stock exchange, accounted for as a purchase business combination. The notification alleges that the former principals were defrauded in connection with the Company's acquisition of EPMG, Inc. and that they would seek litigation to affect a rescission of the 2001 purchase. On January 2, 2004, the Company and these former principals entered into a Memorandum of Understanding that provides for the settlement of the principals' claims through exchange of certain operating assets for the Company's common and preferred stock previously issued in connection with the merger. The former principals have had the right since March 15, 2004 to terminate their obligations under the Memorandum of Understanding, but have not notified the Company of their intent to do so. The former principals currently serve the Company in their capacities as officers F-16 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2003 of EPMG, Inc. which corporate entity contributes the majority of the Company's consolidated revenues and controls the majority of the Company's operating assets. The Company does not believe that the current terms of the settlement will result in reporting the EPMG, Inc. component as a discontinued operation in future reports. The criteria for reporting the EPMG, Inc. results as discontinued include the requirement that the Company will not have any significant continuing involvement in the operations of EPMG, Inc. after the disposition date. Since the current settlement arrangement provides for a continuing business relationship and exchange of products and services, this criteria has not been achieved. (g) Income Tax Returns: The Company has not filed its 2003 and 2002 Federal and State of Utah income tax returns. Combined current income taxes payable for these periods are currently estimated to be $226,176 and $596,357, respectively. Interest and penalties have been recorded in the amount of approximately $218,950. (8) Unaudited Quarterly Results and Restatements. The following table reflects the quarterly net income of the Company as previously reported by the Company in its quarterly reports on Form 10-QSB and as restated for the matters discussed below:
March 31, June 30, September 30, December 31, 2003 2003 2003 2003 ----------- ----------- ----------- ----------- Net income (loss) before adjustments $ 100,000 $ 253,000 $ 523,000 $(1,079,000) Reserve for notes receivable (a) (230,000) (78,000) (114,000) 422,000 Deferred revenue (b) 86,000 (5,000) (156,000) 75,000 Stock compensation (c) (58,357) (31,579) (31,579) 121,515 Penalties and interest (d) -- (73,000) (73,000) 146,000 Income taxes (e) 125,000 (55,000) (733,000) 663,000 ----------- ----------- ----------- ----------- Net income (loss), adjusted $ 23,000 $ 10,000 $ (584,000) $ 348,000 =========== =========== =========== ===========
(a) The Company changed its estimate of reserve for bad debts in the fourth quarter based upon historical performance. This adjustment gives effect to the estimate change for each quarter using that annual rate applied in the fourth quarter. (b) This adjustment adjusts the quarterly deferred revenue calculation for the following matter: Prior to February 2003, the Company outsourced coaching to a third party contractor who was responsible for delivery of the services and who provided the Company with records for accounting purposes. Since February 2003, the Company has employed its internal coaching staff and has developed internal operations databases to track coach-student encounters. During the fourth fiscal quarter of 2003, the Company began utilizing the populated operations databases to calculate the number of future coaching sessions for purposes of deferred revenue. Other estimates of future coaching sessions were used during the prior quarters. (c) This adjustment allocates certain stock based compensation that was recorded in the fourth fiscal quarter of 2003 to the quarters to which such compensation was earned. (d) This adjustment reflects the allocation of the penalties and interest for non-payment of the Company's 2002 Federal and state income taxes that were recorded in the fourth quarter, to the appropriate quarters. (e) This adjustment includes the tax effects for the aforementioned adjustments, plus the allocation of income taxes to the quarterly periods based upon the effective tax rate applicable to the year ended December 31, 2003. The Company intends to amend its previous filings on Form 10-QSB for the quarterly periods ended March 31, 2003, June 30, 2003 and September 30, 2003 for these matters. F-17 F-18 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Innovative Software Technologies, Inc. We have audited the accompanying consolidated balance sheet of Innovative Software Technologies, Inc. and Subsidiaries (the "Company") as of December 31, 2002, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2002 and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. /s/ Robison, Hill & Company Certified Public Accountants Salt Lake City, Utah April 29, 2003 F-19 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET DECEMBER 31, 2002
ASSETS CURRENT ASSETS Cash $ 1,338,345 Accounts Receivable 14,700 Other Receivables 59,772 Prepaid Expenses 67,179 Other Assets 706,486 Deferred income taxes 359,971 ------------ Total Current Assets 2,546,453 ------------ PROPERTY AND EQUIPMENT, NET 379,349 OTHER ASSETS GOODWILL 1,088,686 DEPOSITS 236,386 48,698 ------------ Total Assets $ 4,299,572 ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Line of Credit $ 40,660 Current maturities of long-term debt 44,274 Accounts payable and accrued expenses 861,366 Deferred revenue 256,148 Other current liabilities 83,278 Accrued income taxes 596,357 Reserve for sales returns and allowances 220,266 ------------ Total current liabilities 2,102,349 ------------ NOTE PAYABLE - LONG TERM 87,223 ------------ Total liabilities 2,189,572 ------------ STOCKHOLDERS' EQUITY Preferred stock - authorized, 25,000,000 shares of $1.00 stated value; Series A preferred stock; issued and outstanding, 1,650,500 shares 1,650,500 Series B preferred stock; issued and outstanding, 328,491 shares 328,491 Common stock - authorized, 100,000,000 shares of $.001 per value; issued and outstanding, 52,481,289 52,481 Additional paid-in capital 13,119,719 Accumulated deficit (13,041,191) ------------ Total Stockholders' Equity 2,110,000 ------------ Total Liabilities and Stockholders' Equity $ 4,299,572 ============
The accompanying notes are an integral part of these statements. F-20 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 2002 REVENUE $ 14,778,814 COST OF REVENUE 5,594,234 ------------ GROSS PROFIT 9,184,580 ------------ OPERATING EXPENSES General and administrative 4,509,291 Selling 3,307,000 Loss on investment securities 1,629,250 Non-recurring expenses 169,578 Loss on impairment of goodwill 12,461,246 ------------ Total Operating Expenses 22,076,365 ------------ INCOME (LOSS) FROM OPERATIONS (12,891,785) ------------ OTHER INCOME (EXPENSE) Other income 238,333 Interest income -- Interest expense (14,197) ------------ Total Other Income (Expense) 224,136 ------------ INCOME (LOSS) BEFORE INCOME TAXES (12,667,649) INCOME TAXES -- ------------ NET LOSS $(12,667,649) ============ BASIC AND DILUTED LOSS PER SHARE $ (0.26) ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES USED IN PER SHARE CALCULATION (BASIC AND DILUTED) 48,944,102 ============ The accompanying notes are an integral part of these statements. F-21 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEAR ENDED DECEMBER 31, 2002
Preferred Stock Preferred Stock Series A Series B Common Stock --------------------- ------------------- --------------------- Shares Amount Shares Amount Shares Amount --------- ---------- -------- --------- ---------- --------- Balance - December 31, 2001 1,850,000 $1,850,000 248,491 $ 248,491 48,285,283 $ 48,285 Issuance of Common stock for services provided -- -- 4,000 4 Issuance of Common stock -- -- 40,730 41 Issuance of Common stock for services provided 6,125 6 Issuance of Common Stock for software 53,845 54 Issuance of Common stock 24,375 24 Issuance of Common Stock for services provided 291,250 291 Conversion of Series A Preferred Stock to Common Stock (199,500) (199,500) 3,000,000 3,000 Issuance of Common stock for services provided 5,000 5 Issuance of Common stock 76,960 77 Issuance of Common stock 23,169 23 Issuance of Common stock for services provided 39,702 40 Series A Preferred Stock Dividend 107,568 108 Series A Preferred Stock Dividend 30,734 31 Series A Preferred Stock Dividend 420,054 420 Series B Preferred Stock Dividend 72,494 72 Issuance of Series B Preferred Stock for Executive Compensation 80,000 80,000 Unrealized loss on investments Unrealized loss on investments recognized in income due to other than temporary impariment Net income for the year ended ended December 31, 2002 --------- --------- -------- --------- ---------- --------- Balance as of December 31, 200 1,650,500 1,650,500 328,491 $ 328,491 52,481,289 $ 52,481 ========= ========= ======== ========= ========== =========
Retained Additional Accum. Earnings Total paid-in- Comprehen- (Accum. Stockholders' capital sive Loss Deficit) Equity ----------- ----------- ------------ ------------ Balance - December 31, 2001 $12,626,679 $ (204,354) $ (290,941) $ 14,278,160 Issuance of Common stock for services provided 14,196 -- -- 14,200 Issuance of Common stock 36,951 -- -- 36,992 Issuance of Common stock for services provided 20,644 -- -- 20,650 Issuance of Common Stock for software 69,946 70,000 Issuance of Common stock 23,219 23,243 Issuance of Common Stock for services provided 21,553 21,844 Conversion of Series A Preferred Stock to Common Stock 196,500 -- Issuance of Common stock for services provided 370 375 Issuance of Common stock 18,939 19,016 Issuance of Common stock 3,992 4,015 Issuance of Common stock for services provided 4,760 4,800 Series A Preferred Stock Dividend 13,892 (14,000) 0 Series A Preferred Stock Dividend 3,969 (4,000) (0) Series A Preferred Stock Dividend 54,250 (54,670) -- Series B Preferred Stock Dividend 9,859 (9,931) 1 Issuance of Series B Preferred Stock for Executive Compensation 80,000 Unrealized loss on investments (1,424,896) (1,424,896) Unrealized loss on investments recognized in income due to other than temporary impariment 1,629,250 1,629,250 Net income for the year ended ended December 31, 2002 (12,667,649) (12,667,649) ----------- ----------- ------------ ------------ Balance as of December 31, 200 $13,119,719 $ -- $(13,041,191 $ 2,110,000 =========== =========== ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-22 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2002
CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $(12,667,649) Adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation and amortization 122,257 Deferred Income taxes, net (592,637) Sale of software platform for investment securities (875,000) Write down on investment securities 1,629,250 Provision for returns and allowances 120,266 Write-down on impairment of goodwill 12,461,246 Non-cash expenses 141,869 Net change in operating assets and liabilities Accounts receivable 34,692 Prepaid expenses (60,608) Other receivables (57,229) Other current assets (682,676) Deposits and other assets (44,207) Accounts payable and accrued expenses 705,352 Accrued income taxes 596,357 Other current liabilities 83,278 Deferred revenue 256,148 ------------ Net cash flows from operating activities 1,170,709 ------------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures 370,094 ------------ Net cash flows from investing activities 370,094 ------------ CASH FLOWS FROM FINANCING ACTIVITIES Issuance of common stock 83,266 Proceeds from borrowings on line of credit 50,000 Repayments under line of credit agreement (9,340) Proceeds from borrowings under note payable 155,360 Repayments on notes payable (23,863) ------------ Net cash flows from financing activities 255,423 ------------ NET INCREASE IN CASH 1,056,038 CASH AT BEGINNING OF PERIOD 282,307 ------------ CASH AT END OF PERIOD $ 1,338,345 ============ SUPPLEMENTAL CASH FLOW INFORMATION Issuance of common stock for services provided $ 61,869 ============ Issuance of common stock for software $ 70,000 ============ Issuance of Series B Preferred Stock as executive Compensation $ 80,000 ============ Conversion of Series A Preferred Stock to Common stock $ 199,500 ============ Issuance of common stock for Series A & B Preferred Stock Dividend $ 82,601 ============
The accompanying notes are an integral part of these statements. F-23 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 NOTE A - COMPANY DESCRIPTION Innovative Software Technologies, Inc. (the "Company" or the "Innovative"), operating in one business segment, is a software company specializing in small business and financial eLearning tools and consulting services. The Company's main products are The Financial Toolkit 1.0, an integrated financial services and education program; EMS, a turnkey web builder, e-commerce solution and data management system targeted to small businesses, Skills in Demand, consisting of eLearning courses that cater to small business owners and entreprenuers, and eTaxNet, a provider of online tax and consulting services. In addition, the Company offers, for most of its software and learning products, technical support and coaching services. The Company's management combines its expertise in the field of direct marketing, software, coaching and sales management to small businesses and consumers. The combination of marketing and technological support offers clients complete end-to-end business services solutions designed to fit their ebusiness transactional technology needs. On April 16, 2001, Innovative, with immaterial net assets, acquired 100% of the outstanding common stock of Hackett Media, Inc. (Hackett). The acquisition resulted in the owners and management of Hackett having effective operating control of the combined entity after the acquisition, with the existing Innovative investors continuing as only passive investors. Under accounting principles generally accepted in the United States (US GAAP), the above noted acquisition is considered to be a capital transaction in substance, rather than a business combination. That is, the acquisition is equivalent to the issuance of stock by Hackett for the net monetary assets of Innovative, accompanied by a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the acquisition is identical to that resulting from a reverse acquisition, except that no goodwill intangible is recorded. Under reverse takeover accounting, the post reverse-acquisition comparative historical financial statements of the "legal acquirer" (Innovative Software Technologies), are those of the "legal acquiree" (Hackett) (i.e. the accounting acquirer). On December 31, 2001, the Company purchased all of the outstanding shares of Energy Professional Marketing Group, Inc.'s (EPMG), a technology marketing company specializing in product fulfillment for outside vendors and technology and database marketing, based in Provo, Utah. In connection with the acquisition, the Company issued 1,500,000 and 3,529,412 of Series A preferred and common shares, respectively. F-24 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 The purchase price for the acquisition of EPMG has been allocated on the fair value basis on the acquisition date as follows: ASSETS ACQUIRED: Goodwill...................................... $ 13,549,932 Net assets acquired........................... 25,068 ------------- TOTAL ASSETS ACQUIRED......................... $ 13,575,000 ============= TOTAL PURCHASE PRICE.......................... $ 13,575,000 ============= The acquisition described above was accounted for as a purchase transaction in accordance with Statement of Financial Accounting Standards No. 141 (SFAS 141), "Business Combinations," and, accordingly, the results of operations and assets and liabilities of the acquired company are included in the consolidated financial statements from the acquisition date. The following are the unaudited pro forma results of operations for the year ended 2001 assuming the above had occurred at the beginning of that fiscal year: 2001 ---- SALES................................. $ 5,449,680 NET EARNINGS.......................... 80,075 EARNINGS PER SHARE.................... $ 0.00 NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the Company's significant accounting policies applied in the preparation of the accompanying financial statements follows. 1. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") 141, Business Combinations, and SFAS 142, Goodwill and Intangible Assets. SFAS 141 is effective for all business combinations completed after June 30, 2001. SFAS 142 is effective for fiscal years beginning after December 15, 2001; however, certain provisions of this Statement apply to goodwill and other intangible assets acquired between July 1, 2001 and the effective date of SFAS 142. Major provisions of these Statements and their effective dates for the Company are as follows: F-25 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 o All business combinations initiated after June 30, 2001 must use the purchase method of accounting. The pooling of interests method of accounting is prohibited except for transactions initiated before July 1, 2001. o Intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability. o Goodwill, as well as intangible assets with indefinite lives, acquired after June 30, 2001, will not be amortized. o Effective January 1, 2002, all previously recognized goodwill and intangible assets with indefinite lives will no longer be subject to amortization. o Effective January 1, 2002, goodwill and intangible assets with indefinite lives will be tested for impairment annually and whenever there is an impairment indicator. o All acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting. As of January 1, 2002, which is the beginning of fiscal 2002, the Company will not amortize the goodwill which it recognized in connection with the acquisition of EPMG. The Company's goodwill is subject to a transitional impairment test as of December 31, 2001 and an annual impairment test, using a two-step process prescribed by SFAS No. 142. The Company has completed the transitional impairment test for EPMG at June 30, 2002, the applicable reporting unit, and no impairment of goodwill was found to exist as of the beginning of fiscal 2002. During 2002, the trading price of the Company's stock declined significantly, raising questions about whether the fair value of goodwill exceeds its carrying amount. An evaluation of the carrying amount of goodwill was conducted during the 4th quarter 2002, which included an evaluation of whether the decline in the trading price of the Company's stock is other than temporary. The Company determined that the decline in its trading price was other than temporary and subsequent to December 31, 2002, engaged an independent valuation firm to perform a valuation of the Company. This resulted in a write-down in goodwill by the Company of $12,461,246 as of December 31, 2002. In August 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement Obligations". SFAS 143 applies to all entities, including rate-regulated entities, that have legal obligations associated with the retirement of a tangible long-lived asset that result from acquisition, construction or development and (or) normal operations of the long-lived asset. A liability for an asset retirement obligation should be recognized if the obligation meets the definition of a liability and can be reasonably estimated. The initial recording should be at fair value. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002, with earlier application encouraged. The provisions of the Statement are not expected to have a material impact on the financial condition or results of operations of the Company. F-26 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144 retains the existing requirements to recognize and measure the impairment of long-lived assets to be held and used or to be disposed of by sale. However, SFAS 144 makes changes to the scope and certain measurement requirements of existing accounting guidance. SFAS 144 also changes the requirements relating to reporting the effects of a disposal or discontinuation of a segment of a business. SFAS 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of this Statement did not have a significant impact on the financial condition or results of operations of the Company. In April 2002, the FASB issued SFAS No. 145 (SFAS 145). Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. SFAS 145 also amends SFAS 13, Accounting for Leases as well as other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. Certain provisions of SFAS 145 are effective for transactions occurring after May 15, 2002 while other are effective for fiscal years beginning after May 15, 2002. The Company does not expect SFAS 145 to have a material effect on its financial condition or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146). This standard addresses financial accounting and reporting for costs associated with exit or disposal activities. SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated by the Company after December 31, 2002. The Company does not expect SFAS 146 to have a material effect on its financial condition or results of operations. In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions" (SFAS 147). This standard relates to the application of the purchase method of accounting to all acquisitions of financial institutions, except transactions between two or more mutual enterprises. This standard also relates to the application of SFAS 144 to certain long-term customer-relationship intangible assets recognized in an acquisition of a financial institution, including those acquired in transactions between mutual enterprises. SFAS 147 is effective on October 1, 2002. The Company does not expect SFAS 147 to have a material effect on its financial condition or results of operations. In December 2002, the FASB issued SFAS No. 148 Accounting for Stock-Based Compensation--Transition and Disclosure (SFAS 148). This standard amends the disclosure and certain transition provisions of SFAS 123, Accounting for Stock-Based Compensation. Its disclosure provisions are effective for 2002 annual financial statements for calendar year-end companies. The Company does not expect that adoption of SFAS 148 will have a material impact on its financial condition or results of operations. F-27 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 2. Principles of Consolidation The accompanying consolidated financial statements includes the accounts of Innovative Software Technologies, Inc. and the accounts of its wholly-owned subsidiaries Energy Professional Marketing Group, Inc. (EPMG) and Hackett Media, Inc. as of and for the year ended December 31, 2002. All significant intercompany transactions and balances have been eliminated in consolidation. 3. Revenue Recognition The Company recognizes revenue after delivery of the product. To the extent the Company sells software, revenue is recognized in accordance with Statement of Position 97-2, Software Revenue Recognition. In most cases this occurs the same day payment is received from our customers. The Company also reserves for sales returns and allowances based upon historical experience. The Company provides support services for some of its products. Payments received by the Company for these services are generally recorded as deferred revenue and recognized over the term of the services. The Company also provides extended payment terms on the sale of its software and related coaching for up to two years. Since payments terms on these sales exceed 12 months, the fee for the software and license is presumed not to be determinable. In addition, the probability of collection decreases as the payment terms are extended. As a result, the Company recognizes revenue on these sales as the payments are collected from the customer. 4. Investments Securities All investment securities are classified as available-for-sale. These investment securities have been adjusted to their fair market value based upon quoted market prices. Unrealized holding gains and losses are reported as a separate component of stockholder's equity. The Company will regularly perform reviews of the fair value of its investment securities and assess whether there exists any other than temporary impairment. 5. Property and Equipment Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is recognized using the straight-line and double-declining balance method over the estimated useful lives of the assets, which range from three to seven years. Leasehold improvements are amortized using the straight-line method over the lesser of the estimated useful lives or remaining lease term. F-28 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 6. Use of Estimates To comply with US GAAP, the Company makes estimates and assumptions that effect the amounts reported in the financial statements and disclosures made in the accompanying notes. Estimates are used for, but not limited to reserves for product returns, the collectibility of accounts receivable and deferred taxes. The Company also uses estimates to determine the remaining economic lives and carrying value of goodwill and fixed assets. Despite our intention to establish accurate estimates and assumptions, actual results may differ from our estimates. 7. Software Development Costs In accordance with Statement of Financial Accounting Standards No. 86, "Accounting for Costs of Computer Software to be Sold, Leased, or otherwise Marketed," software development costs are expensed as incurred until the product is available for general release to customers. To date, the Company's software has been available for general release concurrent with the establishment of technological feasibility and, accordingly, no development costs have been capitalized. The Company capitalizes costs related to the development of computer software developed or obtained for internal use in accordance with the American Institute of Certified Public Accountants Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Costs incurred in the application development phase are capitalized and amortized over their useful life, not to exceed five years. 8. Advertising Costs Advertising and promotion costs are expensed as incurred. 9. Impairment and Long-lived Assets The Company will regularly perform reviews to determine if the carrying values of our long-lived assets are impaired. The reviews take into account facts or circumstances, either internal or external, which indicate that the carrying value of the asset cannot be recovered. NOTE C - INVESTMENT SECURITIES The Company currently holds three investment securities, which the Company acquired in connection with strategic business transactions and relationships. Our available-for-sale securities are carried at fair value and unrealized gains or losses are included in stockholders' equity. The Company held the following investment securities at December 31, 2002 and 2001. The cost basis of our investment securities reflects adjustments for other than temporary impairments in value. F-29 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002
INVESTMENT COST GROSS UNREALIZED ESTIMATED SECURITIES BASIS GAINS LOSSES FAIR VALUE --------- --------- --------- --------- DECEMBER 31, 2002 EnSurge, Inc. common stock $ -- $ -- $ -- $ -- Knowledge Transfer Systems, Inc. common stock -- -- -- -- Knowledge Transfer Systems, Inc. preferred stock -- -- -- -- --------- --------- --------- --------- $ -- $ -- $ 0 $ -- ========= ========= ========= ========= INVESTMENT COST GROSS UNREALIZED ESTIMATED SECURITIES BASIS GAINS LOSSES FAIR VALUE --------- --------- --------- --------- DECEMBER 31, 2001 EnSurge, Inc. common stock $ 26,250 $ -- $ (25,950) $ 300 Knowledge Transfer Systems, Inc. common stock 728,000 10,500 (188,904) 549,596 --------- --------- --------- --------- $ 754,250 $ 10,500 $(214,854) $ 549,896 ========= ========= ========= =========
The Knowledge Transfer Systems, Inc. common stock was received in consideration for the sale of four software coaching platforms to Ensurge, Inc. These investment securities were recorded at a 30% discount due to restrictions and limitations contained in Rule 144 of the Securities and Exchange Commission. The primary restriction relates to the one-year holding period of the investment securities after the effective date of sale. As of December 31, 2002, the one-year holding period on these investment securities expired and the investment securities were recorded at 100% of their fair market value. Due to the decline in market value of Knowledge Transfer Systems, Inc. common stock, the Company considered the value of these securities permanently impaired and wrote down the entire carrying value of these investment securities as of December 31, 2002. The reduction in carrying value on these investment securities resulted in a loss on investment of $728,000 during the year ended December 31, 2002. The Company received Ensurge, Inc. common stock in consideration for the sale of certain vintage furniture in 2000. Due to the decline in market value of Ensurge, Inc. common stock, the Company considered the carrying value of $26,250 permanently impaired which resulted in a loss on investment securities of $26,250 during the year-ended December 31, 2002. On September 23, 2002, the Company sold the Business Development Series, e-learning content and software to Knowledge Transfer Systems, Inc. in exchange for 875,000 Knowledge Transfer Systems, Inc. preferred shares with a stated value of $1.00 per share. The preferred shares are convertible, at the discretion of the Company, to Knowledge Transfer Systems, Inc. common stock at 95% of the fair market value of Knowledge Transfer System's common stock based F-30 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 on a five day average proceeding the date of conversion. Due to the disclosure by the management of Knowledge Transfer Systems, Inc. of a possible bankcruptcy by its wholly-owned subsidiary, KT Solutions, Inc., the Company considered the value of these securities permanently impaired and wrote down the entire carrying value of these investment securities as of December 31, 2002. The reduction in carrying value on these investment securities resulted in a loss on investment of $875,000 during the year ended December 31, 2002. The President and Chief Executive Officer of the Company is the former President and Chief Executive Officer of Ensurge, Inc., which was the parent company of KT Solutions, Inc. At the time of the sale of the Business Development Series to Knowledge Transfer Systems, Inc. for 875,000 Knowledge Transfer Systems, Inc. preferred shares, there was no related party relationship between the companies and/or the officers and directors of the companies at the time of the transaction. The above common stock investment securities are traded on the OTC Bulletin Board. All of the Company's investment securities are stocks of high technology companies whose market prices have been extremely volatile. The market prices of these companies' stocks have declined substantially in the past two years. NOTE D - PROPERTY AND EQUIPMENT Property and equipment are stated at cost, net of accumulated depreciation as follows: December 31, 2002 ------------ Machinery and Equipment........................ $ 246,594 Furniture and Fixtures......................... 51,683 Computer Software.............................. 190,624 Leasehold improvements......................... 34,092 ------------ 522,993 Accumulated depreciation and amortization...... (143,644) ----------- PROPERTY AND EQUIPMENT, NET.................... $ 379,349 ============ Depreciation and amortization expense for the year ended December 31, 2002 was $122,257. NOTE E - OTHER ASSETS The Company has established several merchant service accounts whereby the Company processes a high volume of customer sales transactions through certain credit card vendors. These merchant service companies typically hold a percentage of each sales transaction as a reserve against future cancellations. The amount held by these merchant service companies amounts to $706,486 as of December 31, 2002. F-31 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 NOTE F - LONG-TERM DEBT Long-term debt consists of the following: December 31, 2002 --------- Notes payable, financial institution, collaterized by telephone equipment, principal and imputed interest payable in monthly installments of $1,250 due in August 2004 $ 20,469 Notes payable, financial institution, secured by a lien on certain furniture and equipment, principal and interest payable in monthly installments of $2,464 due in July 2005 67,175 Notes payable, financial institution, collaterized by Vehicles, principal and accrued interest at 7.78% payable in monthly installments of principal and imputed interest maturing from $217 to $655 from November 2006 to February 2007 43,853 --------- 131,497 Less Current Maturities 44,274 --------- Long-term - net of current maturities $ 87,223 ========= The Company has an unsecured line of credit facility with a financial institution for borrowings up to $50,000 expiring August 31, 2005. Borrowings under the line bear interest at Prime plus 2% (the Prime rate of interest as of December 31, 2002 was 4.75%). As of December 31, 2002, there was $9,340 available on the credit facility. NOTE G - CAPITAL TRANSACTIONS Stock-split - Innovative's Board of Directors authorized a three-for-one stock split on July 11, 2001. This was effective on August 10, 2001 to stockholders of record on July 31, 2001. All share and per share amounts referred to in the financial statements and notes have been restated to reflect this stock split. Issuance of common stock - The Company issued 40,730 shares of its common stock in the second quarter 2002 through private placements to individual foreign investors. Issuance of common stock - The Company issued 24,375 shares of its common stock in the third quarter 2002 through private placements to individual foreign investors. F-32 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 Issuance of common stock - The Company issued 76,960 and 23,169 shares of its common stock in the fourth quarter 2002 through private placements to individual foreign investors. Issuance of Series B preferred stock - The Company issued 80,000 shares of its Series B preferred stock to certain directors of the Company as compensation at a stated value of $1.00 per share in the fourth quarter 2002. Issuance of common stock for software - The Company issued 53,845 shares of its common stock in the second quarter 2002 as part of payment under the terms of a software purchase agreement entered into by the Company. The agreement stipulates that the Company receives business management software for both the Internet and real estate markets as well as hosting and maintenance services. Stock issued for services - The Company issued 4,000 shares of its common stock at a fair market value of $3.55 per share in the first quarter 2002. In addition, the Company issued 6,125 shares of its common stock during the second quarter 2002 at fair market value of $3.37 per share. Stock issued for services - The Company issued 291,250 and 5,000 shares of its common stock at a fair market value of $0.075 per share in the fourth quarter 2002. In addition, the Company issued 39,702 shares of its common stock during the fourth quarter 2002 at an average fair market value of $0.121 per share. Conversion of Series A Preferred Stock - Two directors of the Company converted 199,500 shares of Series A preferred stock to 3,000,000 shares of common stock during the fourth quarter 2002. The Series A preferred stock is convertible to the Company's common stock at 95% of the fair market value of the common stock at the date of conversion. The Market Price of the Company's common stock on the date of conversion was $0.07. Series A Preferred Stock Dividend - The Company issued 558,356 shares of its common stock as a Series A preferred stock dividend during the fourth quarter 2002. The holders of the shares of Series A Preferred received dividends at the rate of 4% per annum payable in shares of the Company's common stock. The number of shares of common stock distributed as a dividend was calculated by dividing such payment by 95% of the Market Price on the average of the first five trading days after January 1 of each year. The term "Market Price" means, as of any date, the average of the daily closing price for the five consecutive trading days ending on such date. Series B Preferred Stock Dividend - The Company issued 72,494 shares of its common stock as a Series B preferred stock dividend during the fourth quarter 2002. The holders of the shares of Series B Preferred received dividends at the rate of 4% per annum payable in shares of the Company's common stock. The number of shares of common stock distributed as a dividend was calculated by dividing such payment by 100% of the Market Price on the average of the first five trading days after January 1 of each year. The term "Market Price" means, as of any date, the average of the daily closing price for the five consecutive trading days ending on such date. F-33 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 Finance Agreement - During 2001, the Company financed its operation primarily through a Finance Agreement of convertible debt and securities. The Finance agreement calls for financing of up to $2.5 million of which $1 million would be received in increments in 2001, if necessary, and the remaining $1.5 million would be received based upon the Company's performance. As of September 30, 2002, $700,000 of the initial $1 million investment was received by the Company. These proceeds were converted to equity securities during 2001. During the fourth quarter 2001, all of the common shares issued in connection with the conversion of debt in connection with the Finance Agreement above were reissued as Series A preferred shares and common shares as follows: Of the initial $700,000 invested in 2001, $350,000 was converted to Series A preferred shares at a stated value of $1 per share. The remaining $350,000 was reissued as 700,000 shares of common stock at $0.50 per share. During the fourth quarter 2002, the Company passed a Board of Directors' Resolution to formally terminate the Finance Agreement with Iwasaka Investments, Ltd. due to the non-compliance by the lender under the terms of the agreement. The Company believes that the termination of this agreement will have no adverse effect on the operations of the Company. NOTE H - RELATED PARTY TRANSACTIONS On December 31, 2001, a Company executive and shareholder converted a non-interest bearing note payable amounting to $248,491 to Series B preferred stock at a conversion rate of a $1 per share stated value. There was no formal maturity date and there was no interest associated with the note. Also, during 2001, the Company sold four software platforms to NowSeven.com, Inc., Ziabon, Inc., SF Acquisition Corp., Inc., and Ishopper Internet Services, Inc. in exchange for investment securities amounting to $308,000, $133,000, $147,000, and $140,000, respectively. The President and Chief Executive Officer of the Company is the former President and Chief Executive Officer of Ensurge, Inc., which is the parent company of the wholly-owned subsidiaries listed above. Due to the decline in market value of Knowledge Transfer Systems, Inc. common stock, the Company considered the value of these securities permanently impaired and wrote down the entire carrying value of these investment securities as of December 31, 2002. During the 3rd quarter 2002, the Company initiated the purchase of sales leads from Education Success Institute, Inc. (ESI). ESI is owned and operated by two directors of the Company (Ethan Andrew Willis and James Randolph Garn). Expenses incurred by the Company totaled $663,159 for the year ended December 31, 2002. In addition, the Company will purchase certain operating supplies for ESI. As of December 31, 2002, the amount owed the Company for these supplies amounted to $5,417. The President and Chief Executive Officer of the Company is the former President and Chief Executive Officer of Ensurge, Inc., which was the parent company of KT Solutions, Inc. At the time of the sale of the Business Development Series to Knowledge Transfer Systems, Inc. for 875,000 Knowledge Transfer Systems, Inc. preferred shares, there was no related party relationship between the companies and/or the officers and directors of the companies at the time of the transaction. F-34 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 NOTE I - COMMITMENTS AND CONTINGENCIES In March, May and September 2002, the Company entered into operating leases for certain office space. Future minimum lease payments under these operating leases as of December 31, 2002 are as follows: YEAR ENDING DECEMBER 31: 2003............................................ 215,598 2004............................................ 215,598 2005............................................ 99,432 2006............................................ -- --------- TOTAL........................................... $ 530,628 ========= Rent expense for the years ended December 31, 2002 and 2001 was $137,724 and $16,919, respectively. NOTE J - PROVISION FOR INCOME TAXES The Company's taxing jurisdictions are Federal and the State of Utah. The provision (benefit) for these income taxes for the year ended December 31, 2002 is as follows: Current provision $ 592,637 Deferred benefit (662,441) Change in valuation allowance 69,804 --------- Net provision for income taxes $ -- ========= F-35 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 The components of the Company's deferred income taxes as of December 31, 2002 are as follows: Deferred tax assets: Capital loss carryforwards $ 331,851 Reserves for returns and refunds 84,251 Reserves on notes receivable 274,898 Depreciation 17,689 Other 822 ------------ Total deferred tax assets 709,511 Less: valuation allowances (113,154) ------------ $ 596,357 ============ Net current deferred tax asset $ 359,971 Net non current deferred tax asset 236,386 ------------ $ 596,357 ============ Income tax expense attributable to the Company's operations for the year ended December 31, 2002 differed from amounts computed using the U.S. Federal statutory rate of 35% as a result of the following: Computed "expected" tax expense (35%) $(4,433,677) Nondeductible goodwill impairment 4,797,580 Change in valuation allowance 69,804 State income taxes, net of federal benefit (443,367) Other, net 9,660 ------------ $ -- ============ NOTE K - PENDING ACQUISITION On March 12, 2002, the Company entered into a definitive agreement to acquire iCrypt, Inc. ("acquiree"), a Torrance, California, technology company. The Company completed the due diligence process in both the financial and technical areas and determined that the terms and conditions of the agreement could not be renegotiated. The Company elected not to move forward in its acquisition of iCrypt, Inc. as certain terms and conditions of the original or modified agreement were not met by the acquiree. F-36 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 NOTE L - SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Year ended December 31, 2002 -------------------------------------------------------- Net Diluted net Gross income income (Loss) Revenues profit (loss) per share (a) ------------ ------------ ------------ ------------- 1st Quarter $ 2,794,696 $ 1,672,241 $ 196,308 $ -- 2nd Quarter 2,994,339 1,995,110 152,026 -- 3rd Quarter 4,225,488 2,696,954 225,182 -- 4th Quarter 4,764,291 2,820,275 (13,241,165) (0.26) ------------ ------------ ------------ ---------- Total $ 14,778,814 $ 9,184,580 $(12,667,649) $ (0.26) ============ ============ ============ ========== (a) Each quarterly amount is based upon separate calculations of weighted average shares outstanding. NOTE M - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share for the year ended December 31, 2002: 2002 ---- Numerator Net loss $(12,667,649) ============ Denominator Denominator for basic and income per share - weighted average shares 48,944,102 ============ Basic and diluted income per share $ (0.26) ============ NOTE N - SUBSEQUENT EVENTS On April 23, 2003, Innovative Software Technologies, Inc. dismissed Grant Thornton LLP as the Company's independent accountant. The Company dismissed Grant Thornton based on certain correspondence received from Grant Thornton pursuant to Section 10A of the Securities Exchange Act of 1934 in which Grant Thornton expressed concern as to the propriety of certain transactions, notified the Company that the firm could not continue to be associated with the Company's December 2001 and 2000 financial statements and that the reports thereon could no longer be relied upon. The Company took strong exception to such correspondence and filed a Current Report on Form 8-K dated April 24, 2003 presenting its position on the matter. F-37 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 On April 11, 2003, the Company engaged the accounting firm of Robison, Hill & Co., as the Company's new independent accountant to audit its financial statements for the fiscal years ended December 31, 2002 and 2001. The Company entered into arbitration with a vendor concerning the cancellation of a contract which resulted in a settlement in April 2003 of $20,000. This settlement amount between the two parties was fully accrued for as of December 31, 2002. Subsequent to December 31, 2002, EPMG extended the term of their lease at 5072 North 300 West, Provo, UT 84604 for one additional year or until April 30, 2006. In addition, EPMG increased the amount of their rentable office space by 700 square feet which is currently subleased to a related entity, Education Success Institute, Inc. (ESI) for $700 per month. ESI is owned and operated by two directors of the Company (Ethan Andrew Willis and James Randolph Garn). In addition, the Company entered into an operating lease for certain office space at 625 South State Street, Orem, UT 84058. The Company leased an aggregate of 3,000 square feet with a term of January 1, 2003 to December 31, 2003. The leased office space is to be utilized by the Company's coaching/mentoring staff members. This operating lease was subsequently amended in March 2003 to increase the number of rentable square feet to 4,000 square feet with all other terms of the lease remaining unchanged. F-38 EX-10.19 3 v02651_ex10-19.txt Exhibit 10.19 EXCHANGE AGREEMENT THIS EXCHANGE AGREEMENT ("Agreement") is made as of the 26th day of February, 2004, by and between INNOVATIVE SOFTWARE TECHNOLOGY, INC ("IST"), a California corporation, ENERGY PROFESSIONAL MARKETING GROUP, INC ("EPMG"), a Utah corporation which is a wholly owned subsidiary of IST, and JAMES R. GARN ("Garn') and ETHAN A WILLIS ("Willis") Recitals A. Garn and Willis formed EPMG in 1999; B. Subsequently, Garn and Willis entered into a Stock Purchase Agreement dated December 31, 2001, whereby IST acquired all of the capital stock of EPMG from Garn and Willis in exchange for voting stock of IST; C. Simultaneously with their sale of EPMG to IST, Garn and Willis entered into identical employment agreements with EPMG, which employment agreements were amended on July 15, 2002 (collectively, the "Employment Agreements"); D. Garn and Willis have since asserted a number of breach of contract claims against IST, many of which are based on IST's representations to Garn and Willis; E. Garn and Willis have also asserted that the Employment Agreements are void and are not enforceable under Utah law, and F. Garn and Willis have agreed to waive, release and compromise their breach of contract claims against IST with respect to the Stock Purchase Agreement in exchange for the cancellation by EPMG of, and IST's waiver of any rights it holds in the Employment Agreements. NOW, THEREFORE, in consideration of the mutual covenants and promises set forth herein, together with other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Exchange. IST, as parent of EPMG, hereby releases and disclaims any interest it has relating to the Employment Agreements and waives any claim it may have against EPMG, its officers or directors relating to EPMG's cancellation of the Employment Agreements as set forth herein. EPMG hereby cancels the Employment Agreements Each of Garn and Willis releases IST and EPMG and their respective officers and directors from any and all causes of action, judgments, executions, claims and demands, of every kind and nature whatsoever, based upon IST's alleged breaches of contract under the terms of the Stock Purchase Agreement. 2. Effective Date. The foregoing exchange transaction is effective immediately upon the parties' execution of this Exchange Agreement and the delivery by each party of an executed copy of this Agreement to each other party. 3. Further Assurances. Each party shall execute and deliver such documents as any other party shall reasonably deem necessary or appropriate to cause the parties to obtain the benefits contemplated by this Agreement 4. Representations and Warranties of IST and EPMG. Each of IST and EPMG hereby represents and warrants to each of Garn and Willis that: 2 (a) IST and EPMG have full legal authority to enter into this Agreement and upon execution and delivery hereof this Agreement will be a valid and binding obligation of IST and EPMG, enforceable against them in accordance of its terms. (b) IST and EPMG are not required to give any notice to or obtain any consent from any person in connection with the execution and delivery of this Agreement or the consummation and performance of the exchange contemplated hereby. (c) Neither the execution and delivery of this Agreement, nor the consummation or performance of the exchange contemplated hereby, will contravene, conflict with or result in a violation of any contract or organizational document applicable to IST. (d) Neither IST, EPMG nor their agents have incurred any obligation or liability, contingent or otherwise, for a brokerage or finders fee or agent's commission or other similar payment in connection with this Agreement for which Garn or Willis may be liable. 5. Representations and Warranties of the Shareholders. Each of Garn and Willis hereby severally represents and warrants to IST that: (a) He has full legal authority to enter into this Agreement and upon execution and delivery hereof this Agreement will be his valid and binding obligation, enforceable against him in accordance of its terms. (b) He is not required to give any notice to or obtain any consent from any person in connection with the execution and delivery of this Agreement or the consummation and performance of the exchange contemplated hereby. 3 (c) Neither the execution and delivery of this Agreement, nor the consummation or performance of the exchange contemplated hereby, will contravene, conflict with or result in a violation of any contract applicable to him. (d) Neither he nor any of his affiliates has incurred any obligation or liability, contingent or otherwise, for brokerage or finder's fees or agent's commissions or similar payments in connection with this Agreement for which IST may be liable. 6. Notice. Any notice which is required or permitted to be given to any party to this Agreement shall be deemed to have been given only if such notice is reduced to writing and delivered, either personally or by a reputable courier, with return receipt delivered, to the appropriate party as set forth below Innovative Software Technology, Inc. 204 N W Platte Valley Drive Riverside, MO 64150 James R. Garn 5072 North 300 West Provo, UT 84604 Ethan A. Willis 5072 North 300 West Provo, UT 84604 With a copy to J. Gordon Hansen Holme Roberts & Owen LLP 299 South Main Street, Suite 1800 Salt Lake City, UT 84111 7 Miscellaneous Matters (a) This Agreement shall not be assigned by any party without the prior written consent of each other party. 4 (b) The Agreement shall be binding upon and shall inure to the benefit of the parties hereto, their successors and assigns. (c) Should a default occur in the performance of any obligation set forth in this Agreement, the defaulting party shall pay to the other party, in addition to any damages which result from such default, the related costs and expenses, including reasonable attorneys' fees, incurred by the non-defaulting party in enforcing his or its rights hereunder. (d) This Agreement shall be construed in accordance with and governed by the internal laws of the State of Utah. (e) This Agreement constitutes the complete and entire statement of all terms, conditions and representations of the agreement between IST, on the one hand, and Garn and Willis on the other, with respect to its subject matter. (f) Nothing in this Agreement, express or implied, is intended to confer upon any person not a party to this Agreement any rights or remedies of any nature whatsoever under or by reason of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement upon the date first herein written. Seller ENERGY PROFESSIONAL MARKETING GROUP, a Utah corporation By /s/ Ethan A. Willis ----------------------------- Name Ethan A. Willis Title CEO Seller INNOVATIVE SOFTWARE TECHNOLOGIES, INC., a California corporation By /s/ Douglas Shane Hackett ----------------------------- Name Douglas Shane Hackett Title President /s/ James R. Garn ----------------------------- James R. Garn /s/ Ethan A. Willis ----------------------------- Ethan A Willis 6 EX-10.20 4 v02651_10-20.txt Exhibit 10.20 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. ---------- Officer Indemnification Agreement THIS AGREEMENT is executed and entered into by and between INNOVATIVE SOFTWARE TECHNOLOGIES, INC., a California corporation (the "Company"), and the individual identified below who has signed this Agreement as an Officer of the Company (the "Officer"). WHEREAS, the Company has requested the Officer to serve as Chief Financial Officer of the Company; and WHEREAS, certain risks are associated with serving as a Chief Financial Officer of a corporation; and WHEREAS, the Officer has indicated that the Officer is willing to serve as Chief Financial Officer of the Company, but only if the Company agrees to indemnify the Officer against certain of the risks associated with serving in such capacity; and WHEREAS, the Company desires to provide the rights of indemnification and other rights as set forth herein as an inducement to the Officer to serve as a Chief Financial Officer of the Company. NOW, THEREFORE, in order to induce the Officer to serve as a Chief Financial Officer of the Company, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the Company and the Officer, the parties agree as follows: 1. Definitions. For purposes of this Agreement, "Action" means any threatened, pending or completed claim, action, suit or proceeding, whether civil, criminal, administrative or investigative, and whether or not such action is by or in the right of the Company or such other enterprise with respect to which the Officer serves or has served as an officer, that arises by reason of the fact that the Officer is or was an director or officer of the Company, or is or was serving at the request of the Company as a director or officer of any other corporation, partnership, joint venture, trust or other enterprise; "Expenses" means any and all expenses (including attorneys' fees), costs, judgments, fines or amounts paid in settlement and that are actually and reasonably incurred by the Officerr in connection with any Action; "Charter Indemnification Provision" means any provisions of the Company's articles of incorporation or bylaws (as now in effect or hereafter amended) providing for the indemnification of and advancement of expenses to directors and officers of the Company; and "California Indemnification Statute" means Section 317 of California Corporations Code or any successor statute thereto; and any other terms used herein that are not defined herein shall be used within the meaning of such terms in the California Indemnification Statute. 1 2. Indemnification. 2.1 Notwithstanding any amendment or modification of the Charter Indemnification Provisions or the California Indemnification Statute, the Company hereby indemnifies and shall hold harmless the Officer from and against any and all Expenses, except for the Expenses expressly identified in Section 2.2. 2.2 The indemnification provided for in Section 2.1 shall not apply to any of the following Expenses: (i) Expenses for which the Officer is indemnified pursuant to any directors and officers insurance policy purchased and maintained by the Company (the indemnification provided in this Agreement is intended to be in excess of any such directors and officers insurance policy, and the Officer must look first to the directors and officers insurance policy); (ii) remuneration paid to the Officer if it shall be determined by a final judgment or other final adjudication that such remuneration was in violation of law; (iii) Expenses incurred on account of any Action in which judgment is rendered against the Officer for an accounting of profits made from the purchase or sale by the Officer of securities of the Company, pursuant to the provisions of Section 16(b) of the Securities Exchange Act of 1934 or any amendments thereto or similar provisions of any federal, state or local law; (iv) Expenses incurred on account of the Officer's conduct that is finally adjudged to have been (or the Officer has admitted facts sufficient to conclude that the Officer's conduct was): (1) a breach of the duty of loyalty to the Company or its shareholders; (2) an act or omission that was not in good faith; (3) an act or omission that involved intentional misconduct or a knowing violation of law; or (4) a transaction from which the Officer derived an improper personal benefit; (v) if a final decision by a court having jurisdiction in the matter shall determine that such indemnification is not lawful as against public policy; and (vi) any income taxes, or any interest or penalties related to them, in respect of compensation received for services as an director or officer of the Company. 3. Continuation of Indemnity. All agreements and obligations of the Company contained in this Agreement shall continue during the period the Officer is a director, officer, employee or agent of the Company (or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise), and shall continue so long as the Officer shall be subject to any possible Action by reason of the fact that the Officer was a director or officer of the Company or serving in any other capacity referred to in this Agreement. 4. Notice to the Company. The Company shall perform its obligations under this Agreement on receipt of written demand for such performance from the Officer and, if the Company fails to perform its obligations under this Agreement on demand, then the Officer may then or at any time bring legal action against the Company to obtain full and complete performance of its obligations under this Agreement. In any action brought to enforce this Agreement, on a showing by the Officer that a claim has been asserted against the Officer with respect to or in connection with any alleged act or omission by the Officer as a director or officer of the Company, or any alleged neglect or breach of duty by the Officer as a director or officer of the Company or otherwise in the Officer's capacity as a director or officer of the Company, there shall be a presumption that the Officer is entitled to indemnification and advancement of costs and expenses from the Company in respect to indemnification. 5. Control of Defense. If an Action shall be threatened or commenced against the Officer that has given rise to, or may give rise to, a right to indemnification under Section 2, or a right to advancement of costs and expenses under Section 6, and provided that the Action is not threatened or commenced in the name or on behalf of the Company and there is no other conflict of interest between the Company and the Officer with respect to the Action, then: (i) the Company shall have the right to participate, at its own cost and expense, in the investigation, defense or other contest of the Action; and (ii) the Company shall have the right to elect to assume the defense of the Action on behalf of the Officer (if applicable, jointly with any third party who may have an obligation to hold harmless or indemnify the Officer with respect to the Action). If a conflict of interest of the type contemplated herein should develop, then the Officer shall control the defense of any Action against the Officer that may give rise to a right of indemnification under this Agreement, subject to the following: (A) if the insurance carrier that shall have supplied any directors and officers insurance policy shall be willing to conduct the defense without any reservation as to coverage, then, unless on written application by the Officer concurred in by the board of directors of the Company, in which the Officer and the board of directors deem it undesirable, the insurance carrier shall select counsel to conduct the defense; (B) if the insurance carrier shall not assume responsibility for the defense without any reservation of rights as to coverage, then the defense shall be conducted by experienced and able counsel selected by the Officerand reasonably acceptable to the board of directors; and (C) separate counsel will be used by the Officer and other parties indemnified by the Company and subject to the same Action only to the extent necessary, in the reasonable opinion of the Officer, to avoid conflict of interest. If the Company should elect to assume the defense of an Action on behalf of the Officer as provided herein, then: (1) the Company shall give the Officer prompt written notice of the election; (2) the Company shall be obligated to defend the Action in good faith and in a manner consistent with the best interests of the Officer; (3) provided that the Company defends the Action in good faith and in a manner consistent with the best interests of the Officer and no conflict of interest develops between the Company and the Officerr with respect to the Action, the Company shall not be liable for any costs or expenses (including attorneys' fees) incurred by the Officer in connection with defending or otherwise contesting the Action after the Officer has received written notice of the election; and (4) the Company shall not settle or compromise the Action on any basis or in any manner that would impose any liability, limitation or restriction of any kind on, or admit any fault or guilt on behalf of, the Officer without the Officer's express written consent. 2 6. Advancement of Expenses. On written request to the Company by the Director, the Company shall advance to the Officeramounts of money sufficient to cover Expenses in advance of the final disposition of them, on receipt of (i) an undertaking by or on behalf of the Officerto repay such amounts if it shall ultimately be determined by final judgment of a court of competent jurisdiction that the Officeris not entitled to be indemnified by the Company under this Agreement, and (ii) satisfactory evidence as to the amount of such Expenses. The Director's written certification, together with a copy of the statement paid or to be paid by the Director, shall constitute satisfactory evidence, absent manifest error. 7. Directors and Officers Liability Insurance. Unless otherwise agreed by the Officer in the Officer's sole discretion, the Company shall use reasonable efforts to provide the Officer with directors and officers insurance coverage ("Directors and Officers Coverage") providing to the such coverage then available in the insurance industry in such amounts and with such exclusions and other conditions to coverage as shall in the sole judgment of the Company provide reasonable coverage to the Officer in light of the cost to the corporation and any other relevant consideration, it being expressly intended that the foregoing shall not obligate the Company to obtain Directors and Officers Coverage for the Director. The Officer shall not settle any matter for which the Officer intends to seek indemnification under this Agreement without first attempting to obtain any approval required with respect to such settlement by the insurance carrier of any applicable Directors and Officers Coverage. If the Officer seeks such approval, but the approval is not granted by the insurance carrier of any applicable Directors and Officers Coverage, then the Officer shall be entitled to indemnification to the fullest extent provided by this Agreement. Except as otherwise set forth in Section 2.2(i), the provisions of Directors and Officers Coverage, or the failure to so provide Directors and Officers Coverage, shall in no way limit or diminish the obligation of the Company to indemnify the Officer as provided elsewhere in this Agreement. 3 8. Non-Exclusivity. The indemnification rights granted to the Officer under this Agreement shall not be deemed exclusive of, or in limitation of, any rights to which the Officer may be entitled under California law (including but not limited to the California Indemnification Statute), the Charter Indemnification Provisions, vote of shareholders, determination by the Company's board of directors or otherwise. 9. Miscellaneous. The rights granted to the Officer under this Agreement shall inure to the benefit of the Director, the Director's personal representatives, heirs, executors, administrators and beneficiaries, and this Agreement shall be binding on the Company, its successors and assigns. To the extent permitted by applicable law, the parties by this Agreement waive any provision of law that renders any provision in this Agreement unenforceable in any respect. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision shall be held to be prohibited by or invalid under applicable law, then such provision shall be deemed amended to accomplish the objectives of the provision as originally written to the fullest extent permitted by law, and all other provisions shall remain in full force and effect. Any notice, demand, or other communication to the Company under this Agreement may be addressed to the Company at its registered office in California to the attention of the Company's registered agent in California at such office, and to the Officer under this Agreement may be addressed to the Officer at the address indicated below next to the Director's signature. This Agreement shall be governed by and interpreted in accordance with the laws of the State of California, without reference to its principles of conflicts of laws. [The remainder of this page is intentionally left blank.] 4 IN WITNESS WHEREOF, the parties have duly executed and delivered this Agreement as of the date set forth below. Date: December 15th, 2003 INNOVATIVE SOFTWARE TECHNOLOGIES, INC. By /s/ Douglass Shane Hackett ------------------------------ Name: Douglass Shane Hackett Title: President Officer's Name (type or print): Linda W. Kerecman - ------------------------------- /s/ Linda W. Kerecman (Officer's Signature) Address: 1553 East 1860 North Lehi, UT 84043 5 EX-31.1 5 v02651_ex31-1.txt EXHIBIT 31.1 CHIEF EXECUTIVE OFFICER CERTIFICATION I, Douglas S. Hackett, President, Chief Executive Officer and Director of Innovative Software Technologies, Inc., certify that: 1. I have reviewed this Annual Report on Form 10-KSB of Innovative Software Technologies, Inc. (the "Registrant"); 2. Based on my knowledge, this Annual Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Annual Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Annual Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Annual Report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Annual Report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Annual Report (the "Evaluation Date"); and c) presented in this Annual Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this Annual Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: April 14, 2004 /s/ Douglas S. Hackett ----------------------------------------------- Douglas S. Hackett President, Chief Executive Officer and Director (Principal Executive Officer) EX-31.2 6 v02651_ex31-2.txt EXHIBIT 31.2 CHIEF FINANCIAL OFFICER CERTIFICATION I, Linda W. Kerecman, Chief Financial Officer of Innovative Software Technologies, Inc., certify that: 1. I have reviewed this Annual Report on Form 10-KSB of Innovative Software Technologies, Inc. (the "Registrant"); 2. Based on my knowledge, this Annual Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Annual Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Annual Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Annual Report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Annual Report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Annual Report (the "Evaluation Date"); and c) presented in this Annual Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this Annual Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: April 14, 2004 /s/ Linda W. Kerecman -------------------------------------------- Linda W. Kerecman Chief Financial Officer (Principal Financial and Accounting Officer) EX-32.1 7 v02651_ex32-1.txt EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SS. 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Innovative Software Technologies, Inc (the "Company") on Form 10-KSB for the period ending December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Douglas S. Hackett, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge and belief: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. - ----------------------- Douglas S. Hackett Chief Executive Officer April 14, 2004 EX-32.2 8 v02651_ex32-2.txt EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SS. 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Innovative Software Technologies, Inc. (the "Company") on Form 10-KSB for the period ending December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Linda W. Kerecman, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge and belief: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. - ----------------------- Linda W. Kerecman Chief Financial Officer April 14, 2004 -----END PRIVACY-ENHANCED MESSAGE-----