10QSB/A 1 v031998_10qsba.txt FORM 10-QSB/A 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 March 31, 2005 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) 2150 Highway 35, Sea Girt, New Jersey 08750 ------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's Telephone number, including area code: (732) 359-0260 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 May 1, 2005 --------------------- -------------- $.001 par value 363,831,439 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 3 Item 1. Financial Statements 3 Consolidated Condensed Balance Sheet 3 Consolidated Condensed Statements of Operations 4 Consolidated Condensed Statements of Cash Flows 5 Notes to the Consolidated Condensed Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Control and Procedures 13 PART II - OTHER INFORMATION 14 Item 1. Legal Proceedings 14 Item 2. Changes in Securities and Use of Proceeds 14 Item 3. Defaults Upon Senior Securities 14 Item 4. Submission of Matters to a Vote of Security Holders 14 Item 5. Other Information 14 Item 6. Exhibits 14 -2- PART I. FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS Digital Descriptor Systems, Inc. and Subsidiary Condensed Consolidated Balance Sheet March 31, 2005 (Unaudited) As Restated Assets Current Assets Cash and cash equivalents $ 823,485 Restricted cash 50,000 Accounts receivable, less allowance of $38,084 98,432 Inventory 365,963 Prepaid expenses 1,794 Deferred financing costs,net 889,544 ------------ Total Current Assets 2,229,218 Property and equipment, net of accumulated depreciation of $618,031 410,901 Intangible assets, net of accumulated amortization of $25,310 202,178 Deposits 1,730 Goodwill 4,054,998 ------------ Total Assets $ 6,899,025 ============ Liabilities and Shareholders' Deficit Current Liabilities Accounts payable $ 202,193 Accrued expenses 305,634 Accrued interest 862,332 Due to officer and director 20,115 Deferred income 169,204 Convertible debentures, current 1,873,211 ------------ Total Current Liabilities 3,432,689 Note payable 3,500,000 Convertible debentures 2,237,235 ------------ Total Liabilities 9,169,924 ------------ Shareholders' deficit Preferred stock, $.01 par value 1,000,000 shares authorized, 0 issued and outstanding -- Common stock, par value $.01; authorized 9,999,000,000 shares; 319,466,359 issued and outstanding 292,512 Additional paid-in capital 19,400,888 Retained earnings (21,964,299) ------------ Total Shareholders' Deficit (2,270,899) ------------ Total Liabilities and Shareholders' Deficit $ 6,899,025 ============ See notes to the condensed consolidated financial statements. -3- Digital Descriptor Systems, Inc. and Subsidiary Condensed Consolidated Statements of Operations (Unaudited)
As Restated Three Months Ended March 31, ------------------------------ 2005 2004 ------------- ------------- Net Sales $ 148,875 $ 106,975 Cost of goods sold 44,702 4,948 ------------- ------------- Gross profit 104,173 102,027 Operating expenses General and administrative 259,701 113,129 Selling and marketing 25,332 18,807 Research and development 3,848 9,318 ------------- ------------- Loss from operations (184,708) (39,227) ------------- ------------- Interest and amortization of financing costs 457,531 211,445 Provision for income taxes 780 1,664 ------------- ------------- Net income (loss) (643,019) (252,336) ============= ============= Net income (loss) per common share: Basic and diluted $ (0.00) $ (0.00) ============= ============= Weighted average number of common shares outstanding Basic and diluted 251,049,692 143,980,401 ------------- -------------
See notes to the condensed consolidated financial statements. -4- Digital Descriptor Sysytems, Inc. and Subsidiary Condensed Consolidated Statements of Cash Flows (Unaudited)
As Restated Three Months Ended March 31, ---------------------------- 2005 2004 ------------ ------------ Cash Flows from operating activities Net income (loss) $ (643,019) $ (252,336) Adjustments to reconcile net income (loss) to Net cash used in operating activities Amortization of deferred financing costs and debt discounts related to the beneficial conversion feature of debentures 275,266 146,244 Changes in operating assets and liabilities Accounts receivable (29,903) 63,185 Inventory (31,211) -- Prepaid expenses (1,794) 2,360 Accounts payable 64,611 8,469 Accrued expenses (4,140) (14,508) Accrued interest 182,265 65,201 Deferred income (20,249) (43,280) ------------ ------------ Net cash used in operating activities (208,174) (24,665) ------------ ------------ Cash flows from investing activities Puchase assets from CGM Security Solutions (1,500,000) -- ------------ ------------ Net cash used by financing activities (1,500,000) -- ------------ ------------ Cash flows from financing activities Payment of financing costs (504,962) -- Proceeds from the issuance of convertible debentures -- 31,680 Due to officer and director 6,285 2,670 ------------ ------------ Net cash (used) provided by financing activities (498,677) 34,350 ------------ ------------ (Decrease) increase in cash and cash equivalents $ (2,206,851) $ 9,685 Cash and cash equivalents - beginning 3,080,336 51,288 ------------ ------------ Cash and cash equivalents - ending $ 873,485 $ 60,973 ============ ============
See notes to the condensed consolidated financial statements. -5- Digital Descriptor Systems, Inc. and Subsidiary Notes to Condensed Consolidated Financial Statements Note 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Item 310 of Regulation S-B. 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 normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-KSB for the year ended December 31, 2004. Principles of Consolidation. The consolidated financial statements include the accounts of CGM Security Solutions, a wholly owned subsidiary. All intercompany balances and transactions have been eliminated in consolidation. Note 2. Supplemental Cash Flows Disclosures There were no cash payments for interest during the first quarter of 2005 or 2004. Cash payments for income taxes were $780 and $1,664 in the first quarter of 2005 and 2004 respectively. During the first quarter of 2005, $13,420 of the convertible debentures issued in September 2001, were converted into 72,375,000 shares of common stock. During the first quarter of 2005, 36,375,000 shares of common stock were issued for liquidated damages relating to the notes issued December 2001. The Compnay issued a Note Payable for $3,500,00 for the acquisition of certain CGM Security Solution assets aquired by our wholly owned subsidairy. During the first quarter of 2004, $42,000 of outstanding compensation expense related to an officer and director was converyted into the Company's common stock. -6- Digital Descriptor Systems, Inc. and Subsidiary Notes to Condensed Consolidated Financial Statements Note 3. Related Party Transactions The Company owes the former chief executive officer, who is presently a director, and Senior Vice President & CFO, $20,115 at March 31, 2005, for back payroll and sundry expenses with no repayment terms. For the three-month period ended March 31, 2005, the director provided consulting services amounting to $8,000. Issuance of 15,000,000 shares of common stock was executed January 7, 2004, to satisfy partial payment relating to the outstanding debt for services and accrued payroll provided and owed to the above mentioned director for prior year's services and expenses. Note 4. Subsequent Events During April 2005, $3,000 of the convertible debentures issued in September 2001, were converted into 15,000,000 shares of common stock. During April 2005, $3,700 of the convertible debentures issued in September 2001, were converted into 14,682,540 shares of common stock. And 14,682,540 shares were issued for liquidated damages relating to the notes issued December 2001. Note 5. Goodwill and Acqusition of CGM On March 1, 2005, our wholly owned subsidiary acquired substantially all of the assets of CGM Security Solutions, Inc. ("CGM") for $1,500,000 in cash and a $3,500,00 promissory note at 2.86% interest, subject to adjustment. CGM is a manufacturer and distributor of barrier security seals, security tapes and related packaging security systems for palletized cargo, physical security systems for tractors, trailers and containers. The company has not had the fair market value of the acquired assets appraised as of the date of this filing. Therfore, the assets acquired from CGM were recorded by the Company at CGM's book value (until the fair market value appraisal is completed). The Company recorded the excess of the cost of the CGM assets acquired over their book values as goodwill in the amount of $4,054,998. In accordance with SFAS No.142, no amortization was recorded for goodwill as it is deemed to have an infinite life. The goodwill, subject to adjustment as described in the preceeding paragraph, will be assessed annually for impairment. Note 6. Restatement We have restated the financial statements for the three months ended March 31, 2005 as a result of changes made to the amortization period for the intrinsic value of the beneficial convertion feature of notes payable. -7- The intrinsic value of the benefical conversion feature of the notes was previously recorded as interest expense during 2004. The amount previously expensed has been reclassified to debt disounts and is being amoritized over the life of the notes. The impact of this adjustment on the financial statements as originally reported is summarized below: March 31, 2005 ------------------------------- As reported As restated ----------- ----------- Deferred financing cost 897,122 889,544 Total assets 6,906,603 6,899,025 Total liabilities 10,682,655 5,737,235 Accumulated deficit (23,469,452) (21,964,299) Interest and amortization of debt costs 221,521 457,531 Net loss (407,009) (643,019) Net loss per share (0) (0) -8- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following is management's discussion and analysis of certain significant factors that will have affected our financial condition and results of operations. Certain statements under this section may constitute "forward-looking statements". The following discussion should be read in conjunction with our financial statements and notes thereto included in this report. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Critical Accounting Policies No material changes have occurred in the disclosure with respect to our critical accounting policies set forth in our Annual Report form 10-KSB for the fiscal year ended December 31, 2004. Results of Operations Three Months Ended March 31, 2005 Compared to the Three Months Ended March 31, 2004 Revenues for the three months ended March 31, 2005, of $148,875 increased $41,900 or 39% from the three months ended March 31, 2004. The Company generates its revenues through software licenses, hardware, post customer support arrangements security tape and other security related items and other services. The increase in the Company's revenue is attributed to the acquisition of CGM, on March 1, 2005. DDSI is still experiencing a decrease in software maintenance contract dollar amount, a loss in client base, and the lack of new product offerings to their clients. Cost of goods sold increased by $39,754 due to the higher cost of sales in CGM Sub. General and Administrative expenses for the three month period ending March 31, 2005, was $259,701 versus $113,129 for the same period prior year for a increase of $146,571 or 130%. This increase was mainly attributable to the acquisition of CGM which added costs of $102,314, an increase in salaries, and an increase in accounting and legal costs. Sales and Marketing expenses increased $6,526 for the three months period ended March 31, 2005 to $25,332 from $18,807 for the same period in 2004, which represents a 37% increase. This increase was mainly attributable to costs associated with CGM Sub. Research and development for the three months ended March 31, 2005, was $3,848 compared to $9,318 for the same period prior year for a decrease of $5,470. The decrease was due to the decline in development expenses as the Company looks for other ways to expand its revenue bases. The net loss for the Company increased 155% for the three months ending March 31, 2005, to $643,019 from $252,336 for the three months ending March 31, 2004. This was principally due to the increase in expenses, mainly from CGM. -9- Plan of Operations Acquisition of CGM On March 1, 2005, DDSI and CGM Sub acquired substantially all of the assets of CGM, for (i) $1,500,000 in cash and (ii) a 2.86% promissory note (the "Note") in the principal amount of $3,500,000, subject to adjustment (the "Acquisition"). The assets of CGM were acquired pursuant to an Asset Purchase Agreement among DDSI, CGM Sub and CGM dated as of February 25, 2005. The principal amount of the Note is subject to adjustment based upon the average of (i) the gross revenues of CGM Sub for the fiscal year ending December 31, 2007 and (ii) an independent valuation of CGM Sub based upon the consolidated audited financial statements of the Company and CGM Sub for the fiscal years ended December 31, 2006 and 2007. In addition, the Company has granted CGM a secondary security interest in substantially all of its assets and intellectual property. In connection with the Acquisition, the Company entered into a letter agreement with certain of its investors (the "Investors") which extended the maturity date of debt instruments issued on November 30, 2004 until March 1, 2008, and amended the conversion price of the debt that is held by the Investors to the lower of (i) $0.0005 or (ii) 60% of the average of the three lowest intraday trading prices for the Company's common stock during the 20 trading days before, but not including, the conversion date. In addition, the exercise price of the warrants held by the Investors was amended to $.001 per share. The short-term objective of DDSI is the following: o To continue to expand the sale and acceptance of its core solutions by offering new and synergistic biometric (a measurable, physical characteristic or personal behavioral trait used to recognize the identity, or verify the claimed identity, of an individual) (i.e. FMS) security products to its installed base in the criminal justice market. DDSI's objective is to expand with these, and additional products, into much larger commercial and federal markets. Additionally, DDSI plans to execute an acquisition strategy based upon the availability of financing. We also plan to add additional product lines as a Value Added Reseller. Technologies related to DDSI's core business can bring additional cash flow with relatively small internal development capital outlay. DDSI's long-term objective is as follows: o 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 biometric devices such as FMS (Fingerprint Matching System) and our integrated digital image and fingerprint package, Identify on Demand. -10- DDSI believes that it will not reach profitability until the year 2006. Over the next twelve months, management is of the opinion that sufficient working capital will be obtained from operations and external financing to meet DDSI'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 Cutting costs in areas that add the least value to DDSI. o Deriving funds through investigating business alliances with other companies who may wish to license the FMS SDK (software developer's kit). o Increasing revenues through the introduction of Compu-Capture(R), specifically towards kindergarten through twelfth grades, for the creation of ID cards. o Increasing revenues through the introduction of a scaled down version of our Compu-Capture(R) product. o Increasing revenues through the addition of innovative technologies as a Value Added Seller. o Acquiring and effectively adding management support to profitable companies complementary to its broadened target markets. Liquidity and Capital Resources We had net losses of $643,019 and $252,336 during the three months ended March 31, 2005 and 2004, respectively. As of March 31, 2005, we had a cash balance in the amount of $873,485 and current liabilities of $3,432,689, which includes $20,115 due to officers and directors. The total amount of notes payable and debentures is $7,610,446. We may not have sufficient cash or other assets to meet our current liabilities. In order to meet these obligations, we may need to raise cash from the sale of securities or from borrowings. 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 placements 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. -11- The Company has contractual obligations of $9,000,720 as of March 31, 2005. These contractual obligations, along with the dates on which such payments are due are described below:
Contractual Obligations Total One Year or Less More Than One Year ----------------------- ------------ ---------------- ------------------ Due to Related Parties $ 20,115 $ 20,115 $ 0 Accounts Payable and Accrued Expenses 507,827 507,827 0 Accrued interest on loans 862,332 862,332 0 Note payable 3,500,000 0 3,500,000 Convertible Debentures 4,110,446 1,873,211 2,237,235 Total Contractual Obligations $ 9,000,720 $ 3,263,485 $ 5,737,235
Below is a discussion of our sources and uses of funds for the three months ended March 31, 2005 and 2004. Net Cash from Operating Activities Net cash used in operating activities for the three months ended March 31, 2005 and 2004 was $208,174 and $24,665, respectively. The increase in cash used from operating activities in the three months ended March 31, 2005 versus 2004 of $183,509 was principally due to the increase in net operating costs associated with CGM for the three months. Net Cash from Investing Activities Net cash used by investing activities for the three months ended March 31, 2005 was $1,500,000, which reflects the cash paoid for the acquisition of CGM's assets. Net Cash from Financing Activities Net cash provided by financing activities was $3,481,510 and $221,447 for the three months ended March 31, 2005 and 2004, respectively, reflecting a decrease of $3,260,063. This is mainly reflected in the note payable to CGM and Erik Hoffer for the purchase of CGM. -12- Off Balance Sheet Arrangements We do not have any off balance sheet arrangements as of March 31, 2005 or as of the date of this report. Item 3. Control and Procedures (a) Evaluation of Disclosure Controls and Procedures As of March 31, 2005, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective in timely alerting them to material information required to be included in our periodic reports that are filed with the Securities and Exchange Commission in that we were required to make certain revisions to our financial statements. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, reglardless of how remote. In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their last valuation. (b) Changes in Internal Controls There were no significant changes in the Company's internal controls or in other factors that could significantly affect those controls during the quarter covered by this Report or from the end of the reporting period to the date of this Form 10-QSB. -13- PART II. OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities: The Company is in default of $1,744,238 of outstanding debentures. Although the debenture holders have not pursued their rights under such debentures, there can be no assurances that such rights will not be exercised. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits 4.1 Security Agreement dated February 25, 2005 by and between CGM Applied Security Technologies, Inc. and CGM Security Solutions, Inc. (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 4.2 Intellectual Property Security Agreement dated February 25, 2005 by and between CGM Applied Security Technologies, Inc and CGM Security Solutions, Inc. (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 4.3 Letter Agreement, by and among the Company, AJW Partners, LLC, New Millennium Capital Partners II, LLC, AJW Offshore, Ltd. and AJW Qualified Partners, LLC, dated January 31, 2005 (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 4.4 2.86% Secured Convertible promissory Note in the name of CGM Security Solutions, Inc. dated February 25, 2005 (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) -14- 10.1 Asset Purchase Agreement dated February 25, 2005 by and among the Company, CGM Applied Security Technologies, Inc. and CGM Applied Security Solutions. (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 10.2 Employment Agreement, dated February 25, 2005, by and among the Company, CGM Applied Security Technologies, Inc. and CGM Security Solutions, Inc. and Eric Hoffer (incorporated herein by reference to the Current Report on Form 8-K, dated March 3, 2005) 10.3 Employment Agreement dated February 25, 2005 by and among the Company and Anthony Shupin (incorporated herein by reference to the Current Report on Form 8-K, dated April 15, 2005) 10.4 Employment Agreement dated February 25, 2005 by and among the Company and Michael J. Pellegrino (incorporated herein by reference to the Current Report on Form 8-K, dated April 15, 2005) 31.1 Certification by Chief Executive Officer pursuant to Sarbanes-Oxley Section 302 31.2 Certification by Chief Financial Officer pursuant to Sarbanes-Oxley Section 302 32.1 Certification by Chief Executive Officer pursuant to 18 U.S.C., Section 1350 32.2 Certification by Chief Financial Officer pursuant to Sarbanes-Oxley Section 1350 -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: December 29, 2005 By: /s/ ANTHONY SHUPIN --------------------------------------- Anthony Shupin (President, Chief Executive Officer) (Chairman) Date: December 29, 2005 By: /s/ MICHAEL J. PELLEGRINO --------------------------------------- Michael J. Pellegrino Senior Vice President & CFO (Director) -16-