-----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, MOt8N83sz1bskO+D8uB4iBm4eBiHkFtjEi8qEsluc15Kdm58OJIteHz8ysCDJlB4 qjjKvmP4vvjS+RSNLSrsYA== 0000950116-02-002683.txt : 20021119 0000950116-02-002683.hdr.sgml : 20021119 20021119163533 ACCESSION NUMBER: 0000950116-02-002683 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021119 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL DESCRIPTOR SYSTEMS INC CENTRAL INDEX KEY: 0000927454 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 232770048 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-26604 FILM NUMBER: 02833337 BUSINESS ADDRESS: STREET 1: 2010F CABOT BLVD WEST CITY: LANGHORNE STATE: PA ZIP: 19047 BUSINESS PHONE: 2157520963 MAIL ADDRESS: STREET 1: 2010 F CABOT BLVD WEST CITY: LANGHORNE STATE: PA ZIP: 19047 10QSB 1 ten-qsb.txt FORM 10-QSB U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30,2002 ----------------- OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to _______________ Commission file number 0-21384 ------- Digital Descriptor Systems, Inc. -------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 23-2770048 - ------------------------------- --------------------- (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification number) 446 Lincoln Highway, Fairless Hills, PA 19030 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's Telephone number, including area code: (267) 580-1075 -------------- ---------------------------------------------------------------------------- (former, name, address and former fiscal year, if changed since last report) 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 --- --- State the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock November 15, 2002 --------------------- ----------------- $.001 par value 61,351,387 shares Transitional Small Business Disclosure Format Yes No X --- --- -1- FORM 10-QSB Securities and Exchange Commission Washington, D.C. 20549 DIGITAL DESCRIPTOR SYSTEMS, INC. Index PART I - FINANCIAL INFORMATION Item 1. Financial Statements Balance Sheets at September 30, 2002 (unaudited) and December 31, 2001 Statements of Operations for the three and nine months ended September 30, 2002 and 2001 (Unaudited) Statements of Cash Flows for the nine months ended September 30, 2002 and 2001 (Unaudited) Notes to Financial Statements (Unaudited) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Item 3. Controls and Procedures PART II. - OTHER INFORMATION Item 1. Legal Proceedings Item 2. Changes in Securities and Use of Proceeds Item 3. Defaults Upon Senior Securities: Item 4. Submission of Matters of a Vote to Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES -2- PART I. FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS DIGITAL DESCRIPTOR SYSTEMS, INC. BALANCE SHEETS
September 30 December 31 2002 2001 ---------- ---------- (Unaudited) ASSETS Current assets: Cash $ 102,865 $ 435,662 Restricted cash 1,051 5,969 Investments - - Accounts receivable, less allowance for uncollectible account of $54,092 (unaudited) and $87,930 in 2002 and 2001, respectively 7,820 107,948 Inventory 13,998 5,665 Prepaid expenses 160,676 267,534 Advance - employees 200,716 - Debt discount and deferred financing costs 160,562 807,014 ---------- ---------- Total current assets 647,688 1,629,792 Note receivable - Former officer, less allowance for uncollectible notes of $163,092 and $177,400 in 2002 and 2001, respectively - - Furniture and equipment, net 15,772 37,090 Deposits and other assets 24,395 24,395 ---------- ---------- Total assets $ 687,855 $1,691,277 ========== ========== LIABILITIES AND SHAREHOLDERS' DEFICIENCY Current liabilities: Accounts payable $ 369,054 $ 418,764 Accrued expenses 212,692 175,742 Accrued payroll and related withholdings 289,247 - Deferred income 497,943 854,618 Current portion of equipment loan 7,260 7,211 Convertible debentures 1,106,731 965,000 ---------- ---------- Total current liabilities 2,482,927 2,421,335 Equipment Loan, net of current portion 14,615 20,066 ---------- ---------- Total liabilities $2,497,542 $2,441,401 ---------- ----------
-3- DIGITAL DESCRIPTOR SYSTEMS, INC. BALANCE SHEETS (continued)
September 30 December 31 2002 2001 ---------- ---------- (Unaudited) Shareholders' equity (deficiency): Preferred Stock, $.01 par value, authorized shares - 1,000,000; issued and outstanding - none Common Stock, $.001 par value, authorized shares - 58,156 48,045 150,000,000; issued and outstanding shares - 58,156,490 (unaudited) and 48,045,610 at September 30, 2002 and December 31, 2001, respectively Additional paid-in capital 16,782,748 16,726,819 Accumulated deficit (18,650,591) (17,524,988) ----------- ----------- Total shareholder's equity (deficiency) (1,809,687) (750,124) =========== =========== Total liabilities and shareholders' equity (deficiency) $ 687,855 $ 1,691,277 =========== ===========
The accompanying notes are an integral part of these financial statements. -4- DIGITAL DESCRIPTOR SYSTEMS, INC. STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Nine Months Ended September 30 September 30 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Revenues: Software $ 386,448 $ 249,755 $ 439,390 $ 591,066 Hardware 36,022 19,751 63,984 68,325 Maintenance 139,877 127,756 454,469 396,674 Consulting - 20,968 - 55,468 Other 11,545 9,313 30,208 41,268 ----------- ----------- ----------- ----------- Total Revenues 573,892 427,543 988,051 1,152,801 Costs and expenses: Cost of revenues 294,847 164,722 376,860 434,510 General and administrative 212,808 403,357 723,373 1,320,601 Sales and marketing 18,268 56,044 75,505 362,605 Research and development 16,716 144,724 168,091 284,818 Depreciation and amortization 3,103 68,119 21,318 189,055 Interest and amortization of deferred debt costs 257,240 195,613 772,809 484,281 Other (income) expense, net (7) (5,898) (24,302) (20,288) ----------- ----------- ----------- ----------- Total Costs and expenses 802,975 1,026,681 2,113,654 3,055,582 ----------- ----------- ----------- ----------- Net loss $ (229,083) $ (599,138) $(1,125,603) $(1,902,781) =========== =========== =========== =========== Net loss per common share (basic and diluted) $ (0.00) $ (0.03) $ (0.02) $ (0.09) =========== =========== =========== =========== Weighted average number of common shares outstanding (basic and diluted) 58,156,490 22,776,744 55,297,784 21,708,767 =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements -5- DIGITAL DESCRIPTOR SYSTEMS, INC. STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended September 30 2002 2001 ----------- ----------- Cash flows from operating activities: Net loss $(1,125,603) $(1,902,781) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 21,318 189,055 Compensation expense in connection with issuance 14,400 266,781 of common stock Amortization of debt discount 684,201 440,444 Accrued interest converted into Common Stock - 5,077 Changes in operating assets and liabilities: Accounts receivable 100,128 (29,439) Inventory (8,333) (25,391) Prepaid expenses, deposits and other assets 106,858 (319,797) Advances - employees (200,716) - Accounts payable (49,710) 175,877 Accrued expenses 55,323 (19,906) Accrued payroll and related withholdings 289,247 - Deferred income (356,675) 548,349 ----------- ----------- Net cash used in operating activities (469,562) (671,731) Cash flows from investing activities: Purchase of furniture and equipment - (3,766) Increase in officer note receivable - (8,906) Decrease in restricted cash 4,918 10,452 ----------- ----------- Net cash provided by (used in) investing activities 4,918 (2,220) Cash flows from financing activities: Proceeds from issuance of convertible debentures 175,000 755,000 Debt issuance costs (37,750) (121,000) Repayment of equipment loan (5,402) (5,354) ----------- ----------- Net cash provided by financing activities 131,848 628,646 ----------- ----------- Net (decrease) increase in cash (332,796) (45,305) Cash at beginning of period 435,661 202,877 ----------- ----------- Cash at end of period $ 102,865 $ 157,572 =========== =========== Supplemental disclosure of cash flow information: Cash paid during the year for: Interest $ 3,694 $ 5,036 =========== =========== Income Tax $ - $ - =========== =========== Supplemental disclosure of non-cash investing and Financial activities: Conversion of debentures and accrued interest into common stock $ 51,640 $ 155,077 =========== ===========
The accompanying notes are an integral part of these financial statements -6- DIGITAL DESCRIPTOR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS (Unaudited) September 30, 2002 1. BUSINESS Digital Descriptor Systems, Inc. incorporated in Delaware in 1994, develops, assembles and markets computer installations consisting of hardware and software, which capture video and scanned images, link the digitized images to text and store the images and text on a computer database and transmit this information to remote locations. The principal product of the Company is the Compu-Capture Law Enforcement Program, which is marketed to law enforcement agencies and jail facilities and generated the majority of the Company's revenues during the quarters ended September 2002 and 2001. Substantially all of the Company's revenues are derived principally from U.S. government agencies. 2. BASIS OF PRESENTATION The financial statements and disclosures included herein for the three and nine months ended September 30, 2002 and 2001 are unaudited. These financial statements and disclosures have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of adjustments of a normal and recurring nature) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2002 and 2001 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. 3. ACCOUNTING POLICIES Use of Estimates The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Revenue Recognition The Company derives revenue from the sale of hardware, software, post customer support (PCS), and other related services. PCS includes telephone support, bug fixes, and rights to upgrades on a when-and-if-available basis. Other related services include basic consulting and training. Included with the hardware is software that is not considered to be incidental. Revenue from transactions with customers where the software component is not considered to be incidental is allocated between the hardware and software components based on the relative fair value of the respective components. The Company also derives revenue from the sale of software without a related hardware component. Revenue allocable to software components is further allocated to the individual deliverable elements of the software portion of the arrangement such as PCS and other services. In arrangements that include rights to PCS for the software and/or other services, the software component arrangement fee is allocated among each deliverable based on the relative fair value of each of the deliverables determined using vendor-specific objective evidence, which has been established by the separate sales of these deliverables. The Company recognizes the revenue allocable to hardware and software licenses upon delivery of the product to the end-user, unless the fee is not fixed or determinable or collectibility is not probable. If collectibility is not considered probable, revenue is recognized when the fee is collected. Revenue allocable to PCS is recognized on a straight-line basis over the period the PCS is provided. Revenue allocable to other services is recognized as the services are provided. -7- Software Development Costs The Company capitalizes software development costs after technological feasibility of the software is established and through the product's availability for general release to the Company's customers. Technological feasibility of the Company's software development costs is determined when the planning, designing, coding, and testing activities are completed, and the Company has established that the product can be produced to meet its design specifications. All costs incurred in the research and development of new software products and costs incurred prior to the establishment of technological feasibility are expensed as incurred. During 1999, $413,604 was capitalized as software development costs in connection with the Company's new product entitled Compu-Scan, a computerized inkless fingerprint device. The Company awarded a contract to Titan Systems Corporation's DBA division for technical assistance in achieving final compliance with the FBI certification process. During December 2001, DDSI revised its anticipated certification date for its Compu-Scan product indefinitely after its submission was not accepted by the FBI. Additionally, there are no assurances that the FBI will ever certify the technology. As such, and since DDSI is unable to forecast any revenues from the product, DDSI wrote off the investment in Software Development of $413,604 in the fourth quarter of 2001. Advances/Accrued Payroll The Company has made advances to its employees which total $200,716 at September 30, 2002. Advances have ceased as of September 30, 2002. In addition the Company has accrued payroll and related withholdings of $289,247 for the nine months ended September 30, 2002. Net Loss Per Common Share Basic loss per share is calculated by dividing the net loss by the weighted average common shares outstanding for the period. Diluted loss per share is calculated by dividing the net loss by the weighted average common shares outstanding of the period plus the dilutive effect of common stock equivalents. No exercise of common stock equivalents were assumed during any period because the assumed exercise of these securities would be antidilutive. 4. CONVERTIBLE DEBENTURES During March 2001, the Company issued $200,000 of convertible debentures to two investors. These debentures matured on March 4, 2002; however, the parties have entered into an agreement to extend the maturity date for another year, and accrue interest at 12% per annum. The holder has the right to convert the debentures to common shares at any time through maturity at the conversion price as described in the note agreement. The debenture holders received warrants to purchase 200,000 common shares at an exercise price the lesser of: $0.036 per share or the average of the lowest three trading prices during the 20 days preceding the exercise date. Such warrants expire March 4, 2004. The debentures are collateralized by substantially all of the Company's assets. During April 2001, the Company issued two convertible notes for $100,000 and $15,000, and one convertible note in May 2001 for $40,000 respectively, with interest at 10% per annum. Interest on these Notes shall be payable quarterly commencing June 30, 2001. The holder has the right to convert the debentures and interest accrued into shares of the Company's Common Stock at a conversion price per share that shall be an amount equal to 50% of the mean average price of the Common Stock for the ten (10) trading days prior to notice of conversion per share. The intrinsic value of the beneficial conversion features relating to the convertible notes issued in 2001 of $155,000 has been allocated to paid in capital. This resulting debt discount will be amortized over the term of the debentures During September 2001, the Company issued $400,000 of convertible debentures to the same investors under the same terms as the debentures issued in March 2001. However, there were no warrants attached to these debentures. The intrinsic value of the beneficial conversion feature relating to these debentures of $350,000 has been allocated to paid in capital. This resulting debt discount will be amortized over the life of the debentures. -8- During September 2001, $35,000 of the convertible debentures issued in December 2000 were converted into Common Stock. The debentures were converted in accordance with the terms of the agreements. Subsequent to September 30, 2001, an additional $35,000 of the convertible debentures issued in December 2000 were converted into 1,232,396 shares of Common Stock. The investors also converted interest accrued into 1,012,494 shares of Common Stock. During September 2001, the holder of the $100,000 note issued in April 2001 converted the note into 1,428,571 shares of free trading Common Stock and 1,252,069 shares of restricted stock. The conversion price was valued at $.03895 per share in accordance with the agreement terms. During September 2001, the $15,000 note issued in April 2001 was also converted into 214,286 shares of free trading Common Stock and 246,471 shares of restricted stock. The conversion price for this transaction was valued at $.034 per share in accordance with the agreement terms During October through December 2001, the remaining $165,000 of the convertible debentures issued in December 2000, as well as $160,000 of the convertible debentures issued in March 2001 were converted into 10,551,280 shares of Common Stock. Additionally, accrued interest relating to these notes was converted into an additional 1,012,49 shares of Common Stock. The underlying shares were registered August 29, 2001 file number 33359888. On December 31, 2001, DDSI issued three convertible debentures for an aggregate amount of $500,000, with simple interest accruing at the annual rate of 12%. A $125,000 note was issued to New Millennium Capital Partners II, LLC, a $125,000 note to AJW Partners, LLC and a $250,000 note to Bristol Investment Fund, Ltd. These debentures are due December 31, 2002. Interest payable on the Debentures shall be paid quarterly commencing March 31, 2002. The holders shall have the right to convert the principal amount and interest due under the debentures into shares of DDSI's Common Stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $.043 and (2) 50% of the average of the lowest three inter-day sales prices of the Common Stock during the twenty Trading Days immediately preceding the applicable Conversion Date. The shares that will be issued upon conversion of these debentures are being registered for resale purposes by a recent registration statement. DDSI also issued common stock purchase warrants for the right to purchase 1,500,000 shares of Common Stock of DDSI at an exercise price per share equal to the lesser of (i) $.02 and (ii) the average of the lowest three inter-day sales prices during the twenty (20) Trading Days immediately prior to exercise. During January through March 2002, $14,000 of the convertible debentures issued in March 2001 were converted into 2,456,140 shares of Common Stock. Additionally, accrued interest of $18,371 relating to these notes was converted into an additional 2,203,828 shares of Common Stock. In April 2002, the Company entered into an agreement to extend the maturity date of the convertible debenture issued in March 2001 in the amount of $200,000 with a maturity date of March 4, 2002 for an additional year. During April through June 2002, $19,269 of the convertible debentures issued in March 2001 were converted into 5,090,912 shares of Common Stock. In June 2002, a 12% convertible promissory note for $75,000 was issued to two investors. The conversion price is (i) 50% of the average of the lowest three inter-day sales prices, or (ii) if the common stock is then traded on the OTC Bulletin Board or Pink Sheets, the prices asked by any person or entity acting as a market maker in the common stock during the twenty trading days immediately preceding the relevant date upon which a conversion is effected. -9- On September 30, 2002, DDSI issued two convertible debentures for an aggregate amount of $100,000, with simple interest accruing at the annual rate of 12%. These debentures are due September 30, 2003. Interest payable on the Debentures shall be paid quarterly commencing December 31, 2002. The holders shall have the right to convert the principal amount and interest due under the debentures into shares of DDSI's common stock. The conversion price in effect on any Conversion Date shall be the lesser of (1) $.005 and (2) 50% of the average of the lowest three inter-day sales prices of the Common Stock during the twenty Trading Days immediately preceding the applicable Conversion Date. 5. EQUITY TRANSACTIONS See Note 4. 6. SUBSEQUENT EVENTS Mr. Randolph Hall, Vice President of Sales and an Officer of the Company resigned from Digital Descriptor Systems, Inc. effective October 18, 2002. On October 28, 2002, $5,333 of convertible debentures issued in December 2001, were converted into 3,194,897 shares of common stock. -10- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Plan of Operations The short-term objectives of DDSI are the following: 1. The short-term objective of DDSI is to continue to expand the sale and acceptance of its core solutions by offering new and synergistic biometric (i.e. FMS) security products to its installed base in the criminal justice market. The Company's objective is to expand with these, and additional products, into much larger commercial and federal markets. DDSI's long-term objectives are as follows: 1. To seek additional products to sell into its basic business market--Criminal Justice -- so that DDSI can generate sales adequate enough to allow for profits. New products include FMS (Fingerprint Matching System), and Identify on Demand. 2. Continue pursuing the FBI certification of the Compu-Scan 3000 fingerprint capturing device. This would include redesigning the slap unit of the Compu-Scan to capture a palm print as well as a fingerprint. In addition consideration will be given to the creation of a contactless single digit reader that would not require FBI certification. There is no guarantee that the company will be able to raise sufficient funding to complete this project or that it will ever be able to meet FBI certification DDSI believes that it will not reach profitability until the year 2003. Over the next twelve months, management is of the opinion that sufficient working capital will be obtained from operations and external financing to meet the Company's liabilities and commitments as they become payable. DDSI has in the past successfully relied on private placements of common stock securities, bank debt, loans from private investors and the exercise of common stock warrants in order to sustain operations. If DDSI is unable to obtain additional funding in the future, it may be forced to curtail or terminate operations. DDSI is doing the following in its effort to reach profitability: o Cut costs in areas that add the least value to DDSI. o Derive funds through investigating business alliances with other companies who may wish to license the Compu-Scan device or the FMS SDK (software developers kit). o Increase revenues through the introduction of Compu-Capture, specifically towards kindergarten through twelfth grades, for the creation of ID cards. o Increase revenues through the introduction of a scaled down version of our Compu-Capture product. Results of Operations Nine Months September 30, 2002 Compared to the Nine Months Ended September 30, 2001 Revenues for the nine months ended September 30, 2002 of $988,051 decreased $164,750 or 14% from the nine months ended September 30, 2001. DDSI generates its revenues through software licenses, hardware, post customer support arrangements and other services. The decrease in DDSI's revenue is attributed to discontinued sales of the SI-3000 product line at the end of the first quarter in 2001. SI-3000 products' largest revenue impact was in software sales. These revenues are included in deferred revenue until the job has been completed and "signed-off" by the client. Once that job is completed, revenue is then recognized on the income statement. During the first nine months of 2002, DDSI recognized revenue of $211,500 from software sales and software maintenance agreements from previous installations of SI-3000. Maintenance revenues increased $57,795 or 14% from the nine months ended September 30, 2001 primarily due to an increase in DDSI's customer's service and additional stations being purchased by customers which include software maintenance agreements. -11- Cost of goods for the period ended September 30, 2002 was $376,860 a decrease of $57,650 or 13% from the same period, prior year. The decrease was attributable to the decrease in SI-3000 projects. Cost of goods sold as a percentage of revenue for the period ended September 30, 2002 was 38% of total revenues, versus 38% in the same period a year earlier. Costs and expenses decreased $938,604 or 34% during the nine months ended September 30, 2002 versus the nine months ended September 30, 2001. The decrease is due primarily to the cost containment efforts of the Company. This decrease was offset by an increase in interest and amortization of deferred debt cost of $772,809 in connection with the convertible debentures issued in 2001. All other expenses of the Company experienced decreases for the nine months ended September 30, 2002 versus the nine months ended September 30, 2001. General and Administrative expenses for the nine month period ending September 30, 2002 was $723,373 versus $1,320,601 for the same period prior year for a decrease of $597,228 or 45%. This decrease was mainly attributable to a decrease in salaries and related payroll expenses of $170,606, a prior year charge in miscellaneous of $266,780 for services paid in stock, a decrease in accounting fees of $68,812, a decrease in insurance costs of $22,344, and miscellaneous items for $55,000. Sales and Marketing expenses decreased $287,100 for the nine-month period ended September 30, 2002 from $362,605 (2001) to $75,505 (2002) or a 79% decrease. This decrease was mainly attributable to a decrease in salaries, commissions, benefits and payroll taxes in the aggregate of $167,034, travel expenses of $47,361, a decrease in public relations / advertising costs of $18,380, a reduction in trade show expenses of $4,303, a decrease in hiring expenses of $36,300, a cost cut in computer expenses of $5,529 and miscellaneous items for $8,152. Research and development for the nine months ended September 30, 2002 was $168,091 compared to $284,818 for the same period prior year for a decrease of $116,727, which was due in part to a decrease in research and development consulting costs of $15,099. Also contributing to the overall decrease was the decline in salaries, benefits and payroll taxes in the aggregate of $69,433, travel expenses by $27,630 and miscellaneous items of $4,100. The net loss for the Company decreased 41% for the nine months ending September 30, 2002 to ($1,128,926) from ($1,902,781) for the nine months ending September 30, 2001. This was principally due to the decrease in expenses during the period. Net cash used in operating activities for the nine months ended September 30, 2002 and 2001 was ($469,562) and ($671,731), respectively. The decrease in cash used from operating activities in the nine months ended September 30, 2002 versus 2001 of $202,169 was principally due to the decrease in net loss for the nine months. Net cash provided by (used in) investing activities nine months ended September 30, 2002 and 2001 was $4,918 and $(2,220) respectively, reflecting a change of $7,138. This change is due to lack of purchases of furniture and equipment for the nine months ended September 30, 2002 as compared to the same period prior year. Net cash provided by financing activities was $131,848 and $628,646 for the nine months ended September 30, 2002 and 2001, respectively, reflecting a decrease of 496,798. This decrease was principally due to decrease in proceeds from issuance of convertible debenture. -12- Three Months September 30, 2002 Compared to the Three Months Ended September 30, 2001 Revenues for the three months ended September 30, 2002 of $573,892 versus three months ended September 30, 2001 of $427,543 increased $146,349 or 34%. As indicated above, the Company generates its revenues through software licenses, hardware, post customer support arrangements and other services. The increase in the Company's revenue is attributed to the completion of a SI-3000 project. Maintenance revenues increased $12,121 or 9% from the three months ended September 30, 2001 primarily due to an increase in the Company's customers entering into such arrangements and the revenue sharing agreement with Itx on maintenance of the SI-3000 product. Other revenues consist of sales of supplies that the Company makes available to its customers, such as wristbands, ID cards and print packs. More customers ordered such items in the three months ended September 30, 2002 versus 2001. Cost of goods increased $130,125 or 79% due to the completion of the SI-3000 project; whereas there was less SI-3000 activity during the same period in 2001. Cost of goods consisted of 51% of total revenues for 2002; whereas cost of goods in 2001 consisted of 39% of the revenues. Costs and expenses decreased $256,334 or 41% during the three months ended September 30, 2002 versus the three months ended September 30, 2001. The decrease is due to reduction of general and administrative related expenses such as stock for services ($80,250), salaries ($40,844), insurance costs ($9,989). A decrease of ($37,776) in the sales and marketing departments was a result of lower costs. The research and development department also contributed to the overall decrease in reducing consulting costs of ($86,426). The net loss for the Company decreased 61% for the three months ending September 30, 2002 to ($232,406) from ($599,138) for the three months ending September 30, 2001. This was principally due to the decrease in cost of goods and overall operating costs during the period. Liquidity and Capital Resources The Company's revenues have been insufficient to cover the cost of revenues and operating expenses. Therefore, the Company has been dependent on private placements of its common stock and issuance of convertible notes in order to sustain operations. In addition, there can be no assurances that the proceeds from private or other capital will continue to be available, or that revenues will increase to meet the Company's cash needs, or that a sufficient amount of the Company's common stock or other securities can or will be sold or that any common stock purchase options/warrants will be exercised to fund the operating needs of the Company. Over the next twelve months, management is of the opinion that sufficient working capital will be obtained from operations and external financing to meet the Company's liabilities and commitments as they become payable. DDSI has in the past relied on private placements of common stock securities, and loans from private investors to sustain operations. However, if DDSI is unable to obtain additional funding in the future, it may be forced to curtail or terminate operations. DDSI is doing the following in its effort to reach profitability and positive cash flow: o Cut costs in areas that add the least value to DDSI. o Derive funds through investigating business alliances with other companies who may wish to license the Compu-Scan device or the FMS SDK (software developers kit). o Increase revenues through the introduction of Compu-Capture in the education industry, specifically towards kindergarten through twelfth grades, for the creation of ID cards. o Increase revenues through the introduction of a scaled down version of our Compu-Capture product. Item 3. CONTROL AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, under the supervision and with the participation of our chief executive officer and chief financial officer, conducted an evaluation of our "disclosure controls and procedures" (as defined in Securities Exchange Act of 1934 (the "Exchange Act") Rules 13a-14(c)) within 90 days of the filing date of this Quarterly Report on Form 10-QSB (the "Evaluation Date"). Based on their evaluation, our chief executive officer and chief financial officer have concluded that as of the Evaluation Date, our disclosure controls and procedures are effective to ensure that all material information required to file in this Quarterly Report on Form 10-QSB has been made known to them in a timely fashion. Changes in Internal Controls There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date set forth above. -13- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Robert Martin - Shareholder Threatened Lawsuit On January 19, 2002, DDSI's Board of Directors received a letter threatening legal action from Mr. Robert P. Martin who purchased shares pursuant to a private placement offering in October 2001. The letter alleged false and misleading representations made to Mr. Robert Martin by Mr. Garrett Cohn and Mr. Scott Gallagher (About Face Communications) involving convertible debenture funding. The shareholder has threatened a direct and derivative action suggesting the convertible debt was not legally authorized. Upon receipt of the threatened complaint, DDSI's Board of Directors had a discussion with Mr. Martin where DDSI represented that it was in compliance with the Company Bylaws, state and federal securities laws and that the current Board of Directors were unaware of any fraudulent representations. Therefore, DDSI disputes the allegations made in the complaint for the following reasons, 1) the Company is unaware of any false and misleading misrepresentation made by Mr. Garrett Cohn, 2) the threatened complaints received contained insufficient information to make a determination of any wrong doing and 3) the convertible debt was legally authorized by DDSI Board of Directors. Concerning the legality of the convertible debt, there were three members on the Board of Directors at the time this issue was voted on. Two board members were present and voted on behalf of accepting the convertible debenture. In addition, corporate counsel was contacted prior to the vote and after review of the corporate bylaws indicated that pursuant to DDSI bylaws there was a quorum present, therefore the business transacted by the Board would be legal and binding. Thus, DDSI would vigorously defend itself against the allegations if such actions were pursued. Currently there has been no action filed. AccuSoft - Action to Terminate Product Licenses On July 16, 2001, AccuSoft Corporation filed a complaint against DDSI in the United States District Court for the Central District of Massachusetts, Civil Action No. 0140132-NMG. AccuSoft sought the following relief: A. The termination of the following license agreements: ImageGear 6.0, 95 and 98. B. A preliminary injunction enjoining DDSI from using the above licenses in the sales of their products. Since the initial filing of the action by AccuSoft Corporation, DDSI has stopped using AccuSoft's ImageGear 6.0, 95 and 98 software and have replaced AccuSoft's controls. The parties reached an agreement on October 28, 2002, whereas DDSI has agreed to pay AccuSoft $7,500. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS During January through March 2002, $14,000 of the convertible debentures issued in March 2001 were converted into 2,456,140 shares of Common Stock. Additionally, accrued interest of $18,371 relating to these notes was converted into an additional 2,203,828 shares of Common Stock. -14- In April 2002, the Company entered into an agreement to extend the maturity date of the convertible debenture issued in March 2001 in the amount of $200,000 with a maturity date of March 4, 2002 for an additional year. During April through June 2002, $19,269 of the convertible debentures issued in March 2001 were converted into 5,090,912 shares of Common Stock. The outstanding shares of 61,351,387 as of November 15, 2002 excludes the authorized and unissued Common Redeemable Class A and Class B Warrants numbering one million four hundred eighty-three thousand and seven hundred fifty (1,483,750) of each class. Each Class A Warrant entitled the holder to purchase one share of Common Stock for a period of four years commencing August 15, 1996, subject to earlier redemption, and would have been exercisable at a price of $1.00 a unit. Each Class B Warrant entitled the holder to purchase one share of Common Stock for a period of four years commencing August 15, 1996, subject to earlier redemption, and would have been exercisable at a price of $1.50 a unit. During July 2000, both the Class A Warrants and the Class B Warrants expiration dates were extended to August 15, 2002. No further action was taken and both the Class A Warrants and the Class B Warrants expired on August 15, 2002 ITEM 3. DEFAULTS UPON SENIOR SECURITIES: None. ITEM 4. SUBMISSION OF MATTERS OF A VOTE TO SECURITY HOLDERS The Company filed a Preliminary Proxy with the SEC on September 11, 2002, and an amended Proxy on October 31, 2002, requesting the following pending SEC review: o The election of four directors. o To approve and adopt an amendment to the Company's Restated Certificate of Incorporation to increase the authorized number of shares of Common Stock from 150,000,000 to 750,000,000. o To approve an amendment to the Certificate of Incorporation in order to provide for a stock combination (reverse split) of the Common Stock in an exchange ratio to be approved by the Board, from one newly issued share for each ten outstanding shares of Common Stock to one newly issued share for each twenty outstanding shares of Common Stock o To approve the appointment of WithumSmith+Brown as auditors for Digital Descriptor Systems, Inc. ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K: Reports on Form 8-K: July 29, 2002 Item 6 Resignation of Garrett U. Cohn for personal reasons. -15- 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. DIGITAL DESCRIPTOR SYSTEMS, INC. -------------------------------- (Registrant) Date: November 19, 2002 By: /s/ MICHAEL J. PELLEGRINO ------------------------------------------- Michael J. Pellegrino (President, Chief Operating Officer & Chief Financial Officer) Date: November 19, 2002 By: /s/ ROBERT GOWELL ------------------------------------------- Robert Gowell (Chief Executive Officer and Chairman of the Board of Directors) Date: November 19, 2002 By: /s/VINCENT MORENO ------------------------------------------- Vincent Moreno. Date: November 19, 2002 By: /s/ANTHONY SHUPIN ------------------------------------------- Anthony Shupin -----END PRIVACY-ENHANCED MESSAGE-----