10-K/A 1 v184145_10ka.htm Unassociated Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K/A

AMENDMENT NO. 1

x
ANNUAL REPORT UNDER SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended                  December 31, 2009                   

¨
TRANSITION REPORT UNDER SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                                                                                                      
Commission file number                  000-53475                

CYBERDEFENDER CORPORATION
(Name of registrant in its charter)

California
  
65-1205833
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification No.)
     
617 West 7th Street, Suite 401, Los Angeles, California
  
90017
(Address of principal executive offices)
  
(Zip Code)

Issuer’s telephone number (213) 689-8631

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, no par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the last 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-K or any amendment to this Form 10-K. ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.
 
Large accelerated filer ¨
Accelerated filer ¨
   
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
¨ Yes x No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.  On June 30, 2009, the aggregate market value of the voting and non-voting common equity held by non-affiliates was $48,575,761.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of March 26, 2010 the number of shares of the registrant’s classes of common stock outstanding was 25,829,675.

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (eg., Part I, Part II, etc.) into which the document is incorporated:  (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933.  The listed documents should be clearly described for identification purposes.  None

 
 
 

EXPLANATORY NOTE

On April 29, 2010 we received a comment letter from the Securities and Exchange Commission relating to our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 which we filed with the Securities and Exchange Commission on March 31, 2010 (the “Original Report”).  The primary purpose of this amendment to the Original Report (the “Amendment”) is to respond to the comment letter.

In this Amendment we have revised the following:

 
·
Item 7. Management’s Discussion of Financial Condition and Results of Operations.  We have revised this disclosure to clearly label certain gross sales information as non-GAAP, disclose why management believes the information is useful and provide a table that clearly reconciles the non-GAAP measure to GAAP.

 
·
Item 9A. Disclosure Controls and Procedures.  We have included additional information relating to our disclosure controls and procedures.

 
·
Item 15. Exhibits.  We have included our amended bylaws as an exhibit to this amendment.

 
·
Signatures.  We have included the signature of our Principal Accounting Officer, who is also our Chief Financial Officer.

This Amendment includes information contained in the Original Report, and we have made no attempt in the Amendment to modify or update the disclosures presented in the Original Report, except as identified above.  The disclosures in this Amendment continue to speak as of the date of the Original Report, and do not reflect events occurring after the filing of the Original Report.  Accordingly, this Amendment should be read in conjunction with our other filings made with the Securities and Exchange Commission subsequent to the filing of the Original Report, including any amendments to those filings.  The filing of this Amendment shall not be deemed to be an admission that the Original Report, when made, included any untrue statement of a material fact or omitted to state a material fact necessary to make a statement not misleading.

 
 
 

Forward-Looking Statements

This Amendment contains forward-looking statements throughout and in particular in the discussion at Item 7 titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.  These are statements regarding financial and operating performance and results and other statements that are not historical facts.  The words “expect,” “project,” “estimate,” “believe,” “anticipate,” “intend,” “plan,” “forecast,” and similar expressions are intended to identify forward-looking statements.  Certain important risks, including those discussed in the risk factors set forth in Item 1A of the Original Report, could cause results to differ materially from those anticipated by some of the forward-looking statements.  Some, but not all, of these risks include, among other things:

 
·
our lack of capital and whether or not we will be able to raise capital when we need it;

 
·
changes in local, state or federal regulations that will adversely affect our business;

 
·
our ability to market and distribute or sell our products;

 
·
whether we will continue to receive the services of certain officers and directors;

 
·
our ability to protect our intellectual property and operate our business without infringing upon the intellectual property rights of others; and

 
·
other uncertainties, all of which are difficult to predict and many of which are beyond our control.

We do not intend to update forward-looking statements.  You should refer to and carefully review the information in future documents we file with the Securities and Exchange Commission.

 
 
 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the notes to those statements included in the Original Report.  In addition to the historical financial information, the following discussion and analysis contains forward-looking statements that involve risks and uncertainties.  Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Risk Factors” at Item 1A of the Original Report.
 
Overview
 
We are a provider of security software and services to the consumer and small business market. We are located in Los Angeles, California.  Our mission is to bring to market advanced solutions to protect computer users against identity theft, Internet viruses, spyware and related security threats and provide support services to assist customers with their technology needs.

We have developed a collaborative Internet security network, which we refer to as earlyNETWORK, which is based on certain technology principles commonly found in a peer-to-peer network infrastructure.  A peer-to-peer network does not have the notion of clients or servers, but only equal peer nodes that simultaneously function as both “clients” and “servers” to the other nodes on the network.  This means that when a threat is detected from a computer that is part of the earlyNETWORK™, the threat is relayed to our Early Alert Center.  The Early Alert Center tests, grades and ranks the threat, automatically generates definition and signature files based on the threat, and relays this information to the Alert Server, in some cases after a human verification step.  The Alert Server will relay the information it receives from the Early Alert Center to other machines in the earlyNETWORK™, and each machine that receives the information will, in turn, relay it to other machines that are part of the earlyNETWORK™.  This protocol allows us to rapidly distribute alerts and updates regarding potentially damaging viruses, e-mails and other threats to members of the earlyNETWORK™, without regard for the cost of the bandwidth involved.  Because cost is not a factor, updates can be continuous, making our approach significantly faster than the client/server protocols used by traditional Internet security companies that provide manual broadcast-updated threat management systems.  Computer users join the earlyNETWORK™ simply by downloading and installing our software.

Historically, our revenues were derived from subscriptions to our single software product, CyberDefender Anti-Spyware 2006, which included the initial download and one year of updates.  The license to use the software was renewed annually, with incentives for early renewals.  On November 20, 2006 we stopped licensing this product to new subscribers (although we continue to support and upgrade it for existing users).  We now offer several products and services including our core product, CyberDefender Early Detection Center V2.0.  EDC is a complete Internet security suite that protects home computer users against spam, spyware, viruses and scams.  The annual license fee varies depending on the marketing and distribution channels that we use.

On September 27, 2007, we announced the launch of CyberDefenderULTIMATE and CyberDefenderCOMPLETE.  These are bundled products that include EDC as well as support services.  CyberDefenderULTIMATE provides year round support for any software or hardware connected to a subscriber’s computer while CyberDefenderCOMPLETE provides a one time live technical support call.  These products also include 2 gigabytes of online backup.  We also offer a free Internet security toolbar called MyIdentityDefender (“MyID”).  MyID is free to use and generates revenue through search advertising. On November 20, 2008, the Company announced the launch of CyberDefender Registry Cleaner.  CyberDefender Registry Cleaner eliminates clutter and junk that builds up within a computer's registry due to the installation and removal of programs, deletion and creation of files and cached records from Web surfing.  The annual subscription rate varies depending on the marketing or distribution channels we use. Additionally, we offer stand alone technical support services available as a one-time call or as an annual subscription.
 
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CyberDefender Early Detection Center V2.0 is typically marketed to consumers via a free download of a trial version of the software.  Using the trial version, users scan their computer for threats for free and then have the option to upgrade to a fully featured version of the software to remove the threats from their PCs, for a fee.

In the past, we marketed solely online.  The offer, to scan a computer for spyware and then pay for removal of the spyware found, was broadcast in e-mails, banners and search ads.  In 2009, we migrated to off-line marketing channels as we believe these channels are more effective in driving new business.  Specifically, we are selling our products through direct response marketing by partnering with other businesses, such as Guthy-Renker, a leader in the direct response industry and Allianex, a leader in retail distribution.  Additionally, we have been expanding our product offering through the licensing of the For Dummies® brand.

The development of our newer products and services combined with the use of off-line marketing channels has resulted in a significant growth in sales, which increased 285% for the year ended December 31, 2009 as compared to the year ended December 31, 2008.  Accompanying this growth was an expected increase in our related operating expenses as more fully described below in Result of Operations.  However, operating expenses as a percentage of sales decreased from the year ended December 31, 2009 as compared to the year ended December 31, 2008.  As a result, we achieved operating profitability in the fourth quarter of 2009.  For the full year, our expenses still exceeded our revenues.  We engaged in five offerings of our debt and/or equity securities during the 2009 fiscal year to expand our business. On March 15, 2010, we executed a non-binding term sheet with GRM, for a strategic investment of $5 million. This investment will be used to continue to grow our business. 

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses for each period.  The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Revenue recognition.  The Company sells products and services and packages that include both.

The Company recognizes revenue from the sale of software licenses under the guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 985, “Software.”

Specifically, the Company recognizes revenues from its products when all of the following conditions for revenue recognition are met:

i.
  
persuasive evidence of an arrangement exists,
ii.
  
the product or service has been delivered,
iii.
  
the fee is fixed or determinable, and
iv.
  
collection of the resulting receivable is reasonably assured.

As part of the sales price of its software licenses, the Company provides renewable product support and content updates, which are separate components of product licenses and sales. Term licenses allow customers to use the Company’s products and receive product support coverage and content updates for a specified period, generally twelve months. The Company invoices for product support, content updates and term licenses at the beginning of the term. These revenues contain multiple element arrangements where “vendor specific objective evidence” (“VSOE”) may not exist for one or more of the elements. EDC is in substance a subscription and the entire fee is deferred and is recognized ratably over the term of the arrangement.
 
2
 
Revenue is recognized immediately for the sale of products that do not require product updates and services that are performed when purchased.  Additionally, the Company recognizes the portion of the sale of bundled products and one of its services at the time of purchase when all of the elements necessary for revenue recognition have occurred.

The Company also uses third parties to sell its software and therefore evaluates the criteria of FASB ASC Topic 605, “Revenue Recognition,” in determining whether it is appropriate to record the gross amount of revenue and related costs or the net amount earned as commissions. The Company is the primary obligor, is subject to inventory risk, has latitude in establishing prices and selecting suppliers, establishes product specifications, and has the risk of loss. Accordingly, the Company's revenue is recorded on a gross basis.

During 2009, the Company also offered two products which were free to the subscriber, CyberDefender FREE 2.0 and MyIdentityDefender Toolbar. Revenues are earned from advertising networks which pay the Company to display advertisements inside the software or through the toolbar search. The Company recognizes revenue from the advertising networks monthly based on a rate determined either by the quantity of the ads displayed or the performance of the ads based on the amount of times the ads are clicked by the user. Furthermore, advertising revenue is recognized provided that no significant Company obligations remain at the end of a period and collection of the resulting receivable is probable. The Company’s obligations do not include guarantees of a minimum number of impressions.

Product returns are generally received within 30 days of the original sale and are charged against the associated sale upon receipt of the return.  A chargeback occurs after a customer is automatically charged for a renewal license and subsequently, within 30 days of renewal, decides not to continue using the license or the credit card processed for renewal is no longer valid.  The third party processor of renewal sales is usually notified within 30 days by a customer that the customer no longer wishes to license our product.  The third party processor reduces the amounts due to us as a result of any chargebacks during the preceding 30 day period.  As a result, a majority of chargebacks occur within 30 days of the rebilling event and are recorded prior to closing the previous month’s accounting records.  As stated in our revenue recognition policy, revenue is deferred and recognized ratably over the term of the arrangement.
 
Advertising Costs. The Company expenses most advertising costs as they are incurred. Beginning in the fourth quarter of 2009, per ASC Topic 340-20, Capitalized Advertising Costs, the Company began capitalizing its direct-response advertising costs and amortizing them over their expected period of future benefits, generally twelve months. 

Software Development Costs.  The Company accounts for software development costs in accordance with FASB ASC Topic 985, “Software.” Such costs are expensed prior to achievement of technological feasibility and thereafter are capitalized. There have been very limited software development costs incurred between the time the software and its related enhancements have reached technological feasibility and its general release to customers. As a result, all software development costs have been charged to product development expense.

Stock Based Compensation and Fair Value of our Shares. The Company applies FASB ASC Topic 718, “Compensation – Stock Compensation,” which requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. For non-employee stock based compensation, the Company recognizes an expense in accordance with FASB ASC Topic 505, “Equity,” and values the equity securities based on the fair value of the security on the date of grant. For stock-based awards the value is based on the market value of the stock on the date of grant or the value of services, whichever is more readily available. Stock option awards are valued using the Black-Scholes option-pricing model.
 
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The Company accounts for equity instruments issued to consultants and vendors in exchange for goods and services in accordance with the provisions of FASB ASC Topic 505, “Equity.” The measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement. An asset acquired in exchange for the issuance of fully vested, non-forfeitable equity instruments should not be presented or classified for accounting purposes as an offset to equity on the grantor’s balance sheet once the equity instrument is granted. Accordingly, the Company records the fair value of the fully vested, non-forfeitable common stock issued for future consulting services as prepaid expense in its balance sheet.

Contractual Obligations
 
We are committed under the following contractual obligations:

   
Payments Due By Period
  
   
Total
    
Less than 1
year
    
1 to 3 Years
    
3 to 5
Years
    
Over 5
Years
  
Long-term debt obligations
   $ 2,214,000     $ —     $ 2,214,000     $ —     $ —  
Capital lease obligations
   $ 22,391     $ 9,447     $ 12,944     $ —     $ —  
Operating lease obligations
   $ 4,449,789     $ 24,503     $ 772,475     $ 925,315     $ 2,727,496  

Off-Balance Sheet Arrangements

We do not have off-balance sheet arrangements.  As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, often established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Indemnities

During the normal course of business, we have agreed to certain indemnifications.  In the future, we may be required to make payments in relation to these commitments.  These indemnities include agreements with our officers and directors which may require us to indemnify these individuals for liabilities arising by reason of the fact that they were or are officers or directors.  The duration of these indemnities varies and, in certain cases, is indefinite.  There is no limit on the maximum potential future payments we could be obligated to make pursuant to these indemnities.  We hedge some of the risk associated with these potential obligations by carrying general liability insurance.  Historically, we have not been obligated to make any payments for these obligations and no liabilities have been recorded for these indemnities in our financial statements.

Trends, Events and Uncertainties

As described above in the discussion of revenue recognition, we receive payment upon the sale of our products and defer the revenue over the life of the license agreement, which is generally one year.

The following table summarizes our GAAP revenue and deferred revenue for each quarter of the two most recently completed fiscal years.

 
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Quarter Ended
  
Net Revenue
    
Deferred
Revenue
  
31-Mar-08
   $ 475,046     $ 1,019,071  
30-Jun-08
     742,862     $ 1,673,889  
30-Sep-08
     1,202,715     $ 3,220,738  
31-Dec-08
     2,467,136     $ 4,552,953  
Fiscal Year 2008 Totals
   $ 4,887,759          
                 
31-Mar-09
   $ 3,191,630     $ 6,687,198  
30-Jun-09
     3,686,644     $ 8,139,384  
30-Sep-09
     4,427,404     $ 9,656,352  
31-Dec-09
     7,536,215     $ 10,779,146  
Fiscal Year 2009 Totals
   $ 18,841,893          

The following table summarizes our gross sales by category for each quarter of the two most recently completed fiscal years.  Gross sales are a non-GAAP measure that we use in assessing our operating performance.  We define gross sales as total sales before refunds and chargebacks and before deferring revenue for GAAP purposes.  We reference this non-GAAP financial measure frequently in our decision-making because it gives a better indication of our operating performance and the profitability of our marketing initiatives.  We include this non-GAAP financial measure in our earnings announcements in order to provide transparency to our investors and enable investors to better understand our operating performance.  However, gross sales alone should not be used to assess our financial performance or to formulate investment decisions.

Quarter Ended
  
Software
          
Services
          
Ancillary
          
Renewals
          
Total
  
31-Mar-08
   $ 147,423       25 %   $ 68,597       11 %   $ 72,858       12 %     311,470       52 %   $ 600,348  
30-Jun-08
     680,606       41 %     300,939       18 %     225,910       14 %     445,790       27 %     1,653,245  
30-Sep-08
     1,652,904       49 %     853,629       26 %     475,971       14 %     358,434       11 %     3,340,938  
31-Dec-08
     2,107,307       49 %     1,493,234       35 %     669,477       16 %     -       0 %     4,270,018  
Fiscal Year 2008 Totals
   $ 4,588,240       47 %   $ 2,716,399       28 %   $ 1,444,216       15 %   $ 1,115,694       11 %   $ 9,864,549  
                                                                         
31-Mar-09
   $ 2,475,095       40 %   $ 2,645,857       43 %   $ 606,051       10 %   $ 463,948       7 %   $ 6,190,951  
30-Jun-09
     2,501,266       40 %     2,678,978       43 %     584,144       9 %     466,747       8 %     6,231,135  
30-Sep-09
     2,666,274       40 %     2,915,731       43 %     461,120       7 %     699,068       10 %     6,742,193  
31-Dec-09
     4,401,569       45 %     3,705,830       38 %     982,460       10 %     717,949       7 %     9,807,808  
Fiscal Year 2009 Totals
   $ 12,044,204       42 %   $ 11,946,396       41 %   $ 2,633,775       9 %   $ 2,347,712       8 %   $ 28,972,087  

The tables above indicate an upward trend in gross sales, GAAP revenue and deferred revenue resulting from our focus on promoting our new products and services and the addition of our new marketing channels, as discussed below.  We cannot guarantee that this upward trend will continue, even with increased spending on advertising.

The following is a reconciliation of gross sales to net revenue for the years ended December 31,  2009 and 2008:
 
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2008
    
2009
  
Gross Sales
     9,864,549       28,972,087  
Less: Returns and chargebacks
     (1,053,279 )     (3,904,001 )
Less: Change in deferred revenue
     (3,923,511 )     (6,226,193 )
Net revenue
     4,887,759       18,841,893  

Other trends, events and uncertainties that may impact our liquidity are included in the discussion below.

RESULTS OF OPERATIONS

Fiscal Year Ended December 31, 2009 Compared to the Fiscal Year Ended December 31, 2008

Revenue
               
Change in
  
   
2009
    
2008
    
$
    
%
  
                           
Revenue
   $ 18,841,893     $ 4,887,759     $ 13,954,134       285 %

This increase in net revenue was primarily attributable to the increase in new product sales and services that have resulted from our expanded product offerings as well as an increase in direct advertising expenditures associated with customer acquisition and an increase in renewals as a result of our larger customer base.

Cost of Sales

               
Change in
  
   
2009
    
2008
    
$ 
    
%
  
                           
Cost of Sales
   $ 4,182,462     $ 767,115     $ 3,415,347       445 %

This increase in cost of sales was primarily attributable to the increase in sales of our technical support service products which were primarily serviced by a third party, an increase in sales of the CD-ROMs that backup our EDC software and sales of third party products that require a per sale royalty.

Operating Expenses

Advertising
               
Change in
  
   
2009
    
2008
    
$
    
%
  
                           
Advertising
   $ 13,081,509     $ 7,106,455     $ 5,975,054       84 %

Advertising costs are comprised primarily of media and channel fees, including online and offline advertising and related functional resources. Media and channel fees fluctuate by channel.  This increase was primarily attributable to the launch of our new products, expanding our direct marketing efforts to include traditional media, such as radio and television, and our decision to use advertising as a customer acquisition strategy. Advertising purchased from four vendors accounted for 68% and 92% of the Company’s total advertising expense for the years ended December 31, 2009 and 2008, respectively.
 
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Product Development
               
Change in
  
            
2009
    
2008
  
 
$
    
%
    
                           
Product Development
   $ 1,851,931     $ 530,010     $ 1,321,921       249 %

Product development expenses are primarily comprised of research and development costs associated with the continued development of our products. This increase is primarily attributable to the increase in the number of products offered and the ongoing support and improvement of these products.

Selling, General and Administrative
               
Change in
  
   
2009
    
2008
    
$
    
%
  
                           
S,G & A
   $ 6,566,661     $ 3,727,253     $ 2,839,408       76 %

Selling, general and administrative expenses are primarily comprised of salaries and wages, third party credit card processing fees, legal and professional fees, rent and other normal operating expenses.

This increase was primarily attributable to two factors.  The first is an increase in third party credit card processing fees due to the increase in sales. The second is an increase in salaries and wages due to the increase in staffing required as a result of the increase in sales.  Additionally, there was an overall increase in all areas due to the increased sales activities in the current period.  S,G & A has decreased as a percentage of net sales to 35% for the year ended December 31, 2009 from 76% for the year ended December 31, 2008.

Investor Relations and Other Related Consulting
               
Change in
  
   
2009
    
2008
    
$
    
%
  
                           
Investor relations and other related consulting
   $ 3,203,788     $ 1,265,616     $ 1,938,172       153 %

This increase was primarily attributable to the value of warrants issued to various consultants for investor relation services and creative services during the period as more fully described in the notes to the financial statements.

Loss From Operations
               
Change in
  
   
2009
    
2008
    
$
    
%
  
                           
Loss from operations
   $ 10,081,575     $ 8,548,098     $ 1,533,477       18 %

This increase in Loss from operations was primarily attributable to the significant increases in advertising, selling, general and administrative costs and the value of warrants granted for investor relations and consulting services, as more fully described above, offset by the increase in net revenue.
 
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Other Income/(Expense)

Change in fair value of derivative liabilities
               
Change in
  
   
2009
    
2008
    
$
    
%
  
                           
Change in fair value of derivative liabilities
   $ 109,058     $ -0-     $ 109,058       100 %

As more fully described in the notes to the financial statements, on January 1, 2009 we adopted the provisions of FASB ASC Topic 815, “Derivatives and Hedging,” that apply to any freestanding financial instruments or embedded features that have the characteristics of a derivative.  As such, we were required to reclassify certain amounts from the equity section of the balance sheet to the liabilities section.  In addition, the value of these instruments must be reassessed by us as of each balance sheet date.  During August 2009, the Company obtained waivers from the warrant and note holders that forever waive, as of and after April 1, 2009, any and all conversion or exercise price adjustments that would otherwise occur, or would have otherwise occurred on or after April 1, 2009, as a result of certain anti-dilution provisions included in the warrants and notes. As a result of obtaining the waivers, the warrants and notes are now afforded equity treatment. The change in fair value of these instruments for the year ended December 31, 2009 resulted in a gain of $109,058.

Interest expense, net
               
Change in
  
   
2009
    
2008
    
$
    
%
  
                           
Interest expense, net
   $ 3,729,814     $ 2,486,334     $ 1,243,480       50 %

The increased interest expense was primarily attributable to the issuance of additional warrants as part of a warrant tender offer that we completed on August 17, 2009, the amortization of debt discounts and deferred financing costs and interest on the 10% Convertible Promissory Notes and the vesting of the GRM warrants offset by the decrease in the interest and amortization expense related to our 10% Secured Debentures and our 7.41% Original Issue Discount Notes.


In November 2006 we changed our operating strategy by deciding to introduce a suite of security products instead of just a single product.    This change in our business resulted in a significant decrease in our revenues from 2006 to 2007 since we stopped selling our CyberDefender AntiSpyware 2006 product while we developed and rolled-out our new products.  Since late 2007, we have launched several new products and services and subsequently our revenues have been increasing on a quarterly basis since January 2008, with the Company reporting positive operating income for the quarter ended December 31, 2009.

To help with our cash flow, we occasionally sell our debt or equity securities.  We currently have outstanding $2,214,000 in principal amount of our 8% convertible debt securities.  According to the terms of these debentures, the principal amount and all accrued interest is due on April 1, 2011.

At December 31, 2009, we had cash totaling $3,357,510.  In the fiscal year ended December 31, 2009, we generated positive cash flows of $2.6 million.  In addition, on March 15, 2010, we executed a non-binding term sheet with GRM, for a strategic investment of $5 million into the Company.  The investment is to be in the form of a 9% convertible promissory note due 24 months from issuance. The note will not be convertible during the first 180 days after its issuance.  If the note is not repaid within the first 180 days, then it would become convertible into common stock at $3.50 per share.  CyberDefender would have the right to prepay the note without penalty during the first 180 days.

Cash provided/(used) during the fiscal year ended December 31, 2009 included:
 
8
 
Operating Activities

Net cash used in operating activities during the fiscal year ended December 31, 2009 was primarily the result of our net loss of $13.7 million.  Net loss for the fiscal year ended December 31, 2009 was adjusted for non-cash items such as amortization of debt discount of $1.2 million, compensation expense for vested stock options of $0.3 million, amortization of deferred financing fees of $0.4 million, shares and warrants issued for penalties and interest of $1.4 million, shares and warrants issued for services of $3.2 million and warrants issued in connection with our warrant tender offer of $0.5 million. Other changes in working capital accounts include an increase in restricted cash of $1.6 million, an increase in accounts receivable of $0.3 million, an increase in prepaid and other assets of $0.2 million, an increase in deferred charges of $5.2 million, an increase in accounts payable and accrued expenses of $1.7 million and an increase of $6.2 million in deferred revenue resulting from higher new customer and renewal sales.
 
Our primary source of operating cash flow is the collection of license fee revenues from our customers and the timing of payments to our vendors and service providers.  In 2009 and 2008, we did not make any significant changes to our payment terms for our customers, which are generally credit card based.

The increase in cash related to accounts payable and accrued expenses was $1.7 million.  Our operating cash flows, including changes in accounts payable and accrued liabilities, are impacted by the timing of payments to our vendors for accounts payable.  We typically pay our vendors and service providers in accordance with invoice terms and conditions.  The timing of cash payments in future periods will be impacted by the nature of accounts payable arrangements.  In the fiscal years ended December 31, 2009 and 2008, we did not make any significant changes to the timing of payments to our vendors.

Our working capital deficit at December 31, 2009, defined as current assets minus current liabilities, was $3.9 million as compared to a working capital deficit of $7.8 million at December 31, 2008.  The increase in working capital of approximately $3.9 million from December 31, 2008 to December 31, 2009 was primarily attributable to an increase in cash of $2.6 million, an increase in restricted cash of $1.6 million, an increase in deferred charges of $5.2 million, a decrease in the current portion of notes payable of $2.4 million offset by an increase in accounts payable and accrued expenses of $1.7 million and an increase in deferred revenue of $6.2 million, resulting from increased sales.

Investing Activities

Net cash used in investing activities during the fiscal year ended December 31, 2009 was $0.2 million, which was used for property and equipment purchases.  We expect to continue to purchase property and equipment in the normal course of our business.  The amount and timing of these purchases and the related cash outflows in future periods is difficult to predict and is dependent on a number of factors, including but not limited to any increase in the number of our employees and changes in computer hardware and software used in our business.  Net cash used in investing activities during the fiscal year ended December 31, 2008 was $0 and also related to the purchase of property and equipment.

Financing Activities

Cash provided by financing activities during the fiscal year ended December 31, 2009 was primarily the result of the sale of common stock of $3.6 million, issuances of notes payable, net of commissions, totaling $2.7 million and the exercise of common stock warrants and options totaling $2.5 million.  Cash used in financing activities was for payments on capital lease obligations.  Cash provided by financing activities during the fiscal year ended December 31, 2008 was primarily the result of issuances of notes payable, net of commissions, totaling $1.0 million and the sale of stock net of offering costs totaling $1.0 million.  Cash used in financing activities was primarily used for payment of notes payable totaling $0.3 million and payments on capital lease obligations.
 
9
 
Other than as discussed above, we know of no trends, events or uncertainties that are reasonably likely to impact our future liquidity.
 
Item 9A. Controls and Procedures

Disclosure Controls and Procedures

Regulations under the Securities Exchange Act of 1934 (the “Exchange Act”) require public companies to maintain “disclosure controls and procedures,” which are defined as controls and other procedures that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

We conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of December 31, 2009.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2009, our disclosure controls and procedures were not effective at the reasonable assurance level due to a significant deficiency described below.

In light of the significant deficiency described below, we performed additional analysis and other post-closing procedures to ensure our financial statements were prepared in accordance with generally accepted accounting principles.  Accordingly, we believe that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented.

A significant deficiency is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 5), that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.  Management has identified the following significant deficiency which has caused management to conclude that, as of December 31, 2009, our disclosure controls and procedures were not effective at the reasonable assurance level:

1.           Due to the small size of our accounting department, our internal control policies and procedures are not, and from the date of our inception have not been, documented in a formalized manner.  This deficiency was first noted in the Quarterly Report on Form 10-Q for the period ended June 30, 2007 that we filed with the Securities and Exchange Commission on September 11, 2007.  Written documentation of our policies and procedures is required for our disclosure controls and procedures to be effective.  Management evaluated the impact of our failure to have formalized documentation of our internal controls and procedures on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a significant deficiency.

To address this significant deficiency, management performed additional analysis and other procedures to ensure that the financial statements included herein fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented.  There were no changes to our financial statements as a result of performing the additional analysis and procedures.
 
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Remediation of Significant Deficiency

We have attempted to remediate the deficiency in our disclosure controls and procedures identified above by hiring a full-time CFO, with SEC reporting experience, in January 2009 and two additional accounting personnel during 2009 to allow us to refine and document our internal controls and procedures.  During the next fiscal year we also intend to implement the remediation initiatives discussed below, in the section titled “Management’s Remediation Initiatives”, which we believe will significantly strengthen our controls and procedures.

Management's Report on Internal Control Over Financial Reporting


 
·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer;

 
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the issuer; and

 
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  All internal control systems, no matter how well designed, have inherent limitations.  Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.  Because of the inherent limitations of internal control, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting.  However, these inherent limitations are known features of the financial reporting process.  Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

As of the end of our most recent fiscal year, management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") and SEC guidance on conducting such assessments.  Based on that evaluation, they concluded that, as of December 31, 2009, such internal control over financial reporting was not effective.  This was due to a deficiency that existed in the design or operation of our internal control over financial reporting that adversely affected our internal controls and that may be considered to be material weakness.

The matter involving internal control over financial reporting that our management considered to be a material weakness under the standards of the Public Company Accounting Oversight Board was the lack of a functioning audit committee due to a lack of a majority of independent members and a lack of a majority of outside directors on our board of directors, resulting in ineffective oversight in the establishment and monitoring of required internal controls and procedures.  The aforementioned material weakness was identified by our Chief Financial Officer in connection with the review of our financial statements as of December 31, 2009.
 
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Management believes that the lack of a functioning audit committee and the lack of a majority of outside directors on our board of directors results in ineffective oversight in the establishment and monitoring of required internal controls and procedures, which could result in a material misstatement in our financial statements in future periods.

This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting.  Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only the management's report in this annual report.

Management's Remediation Initiatives

In an effort to remediate the identified material weakness and significant deficiency and enhance our internal controls, we have initiated, or plan to initiate, the following series of measures:

We will increase our personnel resources and technical accounting expertise within the accounting function when funds are available to us. First, we will create a senior position to focus on financial reporting and standardizing and documenting our accounting procedures with the goal of increasing the effectiveness of the internal controls in preventing and detecting misstatements of accounting information. Second, we plan to appoint outside directors to our board of directors who shall be appointed to an audit committee resulting in a fully functioning audit committee who will undertake the oversight in the establishment and monitoring of required internal controls and procedures such as reviewing and approving estimates and assumptions made by management when funds are available to us. We anticipate the costs of implementing these remediation initiatives will be approximately $100,000 to $125,000 a year in increased salaries and $50,000 to $100,000 a year in increased legal and accounting expenses.

Management believes that the appointment of outside directors, who shall be appointed to a fully functioning audit committee, will remedy the lack of a functioning audit committee and a lack of a majority of outside directors on our Board.

We anticipate that these initiatives will be at least partially, if not fully, implemented by December 31, 2010.  Additionally, we plan to test our updated controls and remediate our deficiencies by December 31, 2010.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15 (f) under the Exchange Act) during the fourth quarter of 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART IV
Item 15. Exhibits, Financial Statement Schedules
 
3.2
Bylaws of the registrant(1)
3.2.1
Amendment No. 1 to Bylaws*
3.2.2
Amendment No. 2 to Bylaws*
31.1
Certification Pursuant to Rule 13a-14(a) and 15d-14(a) (4)*
31.2
Certification Pursuant to Rule 13a-14(a) and 15d-14(a) (4)*
32
Certification Pursuant to Section 1350 of Title 18 of the United States Code*

*Filed herewith.
(1) Incorporated by reference from the registrant’s SB-2 registration statement filed with the Securities and Exchange Commission on November 3, 2006 as file number 333-1318430.
 
 
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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date:  May 10, 2010
CYBERDEFENDER CORPORATION
   
 
By: 
/s/ Gary Guseinov
   
Gary Guseinov
   
Chief Executive Officer
     
 
By: 
/s/ Kevin Harris
   
Kevin Harris
   
Chief Financial Officer

Pursuant to the requirements of 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 indicated below on this 10th day of May 2010.

SIGNATURE, TITLE

/s/ Gary Guseinov
Gary Guseinov
President, Chief Executive Officer, and Director

/s/ Kevin Harris
Kevin Harris
Chief Financial Officer, Principal Accounting Officer and Director