UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER ________________________________
Science Dynamics Corporation
----------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 22-2011859
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
7150 N. Park Drive, Suite 500
Pennsauken, NJ 08109
(Address of principal executive offices)
(856) 910-1166
(Issuer's telephone number)
WITH COPIES TO:
Gregory Sichenzia, Esq.
Sichenzia Ross Friedman Ference LLP
1065 Avenue of the Americas
New York, New York 10018
(212) 930-9700
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: As of November 22, 2005, the
issuer had 89,016,140 outstanding shares of Common Stock.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.......................................... 1
Consolidated Balance Sheets................................ 1
Consolidated Statements of Operations...................... 2
Consolidated Statements of Cash Flows...................... 3
Notes to Consolidated Financial Statements................. 4
Item 2. Management's Discussion and Analysis or Plan of Operation..... 10
Item 3. Controls and Procedures....................................... 13
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................. 14
Item 2. Unregistered Sales of Equity 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
SIGNATURES.................................................................. 15
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2005 December 31, 2004
Unaudited Audited
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents ............... $ 5,854 $ 192,681
Accounts receivable - trade ............. 825,969 56,922
Inventories ............................. 3,000 51,018
Other current assets .................... 85,374 2,812
---------------- ----------------
Total current assets ................. 920,197 303,433
---------------- ----------------
Property and equipment, net ................ 43,953 39,347
Other assets ............................... 21,313 2,812
Goodwill ................................... 3,327,892
---------------- ----------------
Total assets ......................... $ 4,313,355 $ 345,592
================ ================
LIABILITIES AND SHAREHOLDERS' (DEFICIT)
Current liabilities:
Short Term Notes Payable ................ $ 200,000 $ 300,000
Revolving Credit Line ................... 291,000 550,763
Loan payable stockholders/Officers ...... 275,027 244,240
Accounts payable ........................ 1,006,170 834,456
Accrued expenses ........................ 982,706 839,689
Convertible Debenture - Current ......... 545,454 965,113
Warrants Payable ........................ 279,402 --
Long Term Notes - Current ............... 33,750
---------------- ----------------
Total current liabilities ............ 3,613,509 3,734,261
Long term liabilities:
Convertible Debenture - Non Current ...... 1,857,727
Long Term Notes Payable - Non Current .... 71,250 --
---------------- ----------------
Total long term liabilities ................ 1,928,977 --
---------------- ----------------
Total liabilities .......................... 5,542,486 3,734,261
Minority interest ......................... --
Shareholders' (Deficit)
Preferred stock - .01 par value
10,000,000 shares authorized ........ -- --
No shares issued
Common stock - .01 par value,
200,000,000 shares authorized,
89,016,140 and 53,964,167 issued and
88,890,340 and 53,838,367 outstanding
in 2005 and 2004 respectively ....... 890,162 539,642
Additional paid-in capital .............. 18,983,390 16,080,961
(Deficit) ............................... (20,704,850) (19,611,439)
---------------- ----------------
(831,298) (2,990,836)
Common stock held in treasury, at cost .. (397,833) (397,833)
---------------- ----------------
Total shareholders' (Deficit) ........... (1,229,131) (3,388,669)
---------------- ----------------
Total liabilities and shareholders'
(Deficit) .............................. $ 4,313,355 $ 345,592
================ ================
The accompanying notes are an integral part of these consolidated financial
statements.
1
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Month's Ended Three Month's Ended
September 30, September 30,
2005 2004 2005 2004
Sales - Software Technology Products ........... $ 1,027,779 $ 1,325,633 $ 272,565 $ 476,427
Sales - Software Consulting Services ........... 2,220,920 415,000 846,570 125,000
-------------- -------------- -------------- --------------
Total Sales ........................ 3,248,699 $ 1,740,633 1,119,135 $ 601,427
Cost of Sales - Software Technology Products ... 334,663 253,173 120,657 63,653
Cost of Sales - Software Consulting Services ... 1,277,563 78,750 517,322 23,750
-------------- -------------- -------------- --------------
Total Cost of Sales: ............... 1,612,226 331,923 637,979 87,403
Total Gross Profit ................ 1,636,473 1,408,710 481,156 514,024
Operating Expenses:
Research and development .......... 323,063 125,467 127,097 27,044
Selling, general and administrative 1,930,264 964,171 647,085 362,911
-------------- -------------- -------------- --------------
2,253,327 1,089,638 774,182 389,955
Operating Income (Loss) before other income .... (616,854) 319,072 (293,026) 124,069
(expenses)
Other income (expenses):
Sale of Intangible ................. -- 60,000 -- --
Other Income ....................... -- 22,000 -- 22,000
Interest Expense ................... (227,607) (204,732) (88,391) (129,326)
Finance Expense .................... -- (66,847) -- (21,954)
Settlement of events of default .... (262,667) -- (120,000) --
Minority interest .................. 13,717 -- -- --
-------------- -------------- -------------- --------------
Total Other Expense ........... (476,557) (189,579) (208,391) (129,280)
Net Income (Loss) before Discontinued Operations (1,093,411) 129,493 (501,417) (5,211)
Discontinued Operations ........................ -- (189,041) -- 8,509
Gain on Sale ................................... -- 285,310 -- 285,310
-------------- -------------- -------------- --------------
Income (Loss) from Discontinued Operations ..... -0- 96,269 -- 293,819
-------------- -------------- -------------- --------------
Net Income (Loss) .............................. $ (1,093,411) $ 225,762 $ (501,417) $ 288,608
-------------- -------------- -------------- --------------
Net Loss per Common Share -Basic ............... $ (0.01) $ 0.01 $ (0.01) $ 0.01
Net Loss per Common Share -Diluted ............. $ (0.01) $ 0.00 $ (0.00) $ 0.00
Weighted average shares outstanding -Basic ..... 82,537,162 47,490,590 89,016,140 51,264,167
Weighted average shares outstanding -Diluted ... 82,537,162 66,906,732 89,016,140 70,680,309
The accompanying notes are an integral part of these consolidated financial
statements.
2
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30,
2005 2004
--------------- ---------------
Cash flows from operating activities:
Net (Loss) $ (1,093,411) $ 225,762
--------------- ---------------
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation 91,023 84,727
Adjustments relating to Discontinued operations 189,041
Financing expense non cash 66,847
Warrants Payable 262,667
Minority interest (13,717)
Gain on Sale of Discontinued Operations (285,310)
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable 416,039 $ (487,531)
Inventories 48,018 6,001
Other assets (51,771) --
Increase (decrease) in:
Accounts Payable and
accrued expenses 406,537 157,031
Customer Deposits (82,300)
--------------- ---------------
Total adjustments 1,158,796 (351,494)
--------------- ---------------
Net cash provided by
operating activities 65,385 (125,732)
--------------- ---------------
Cash flows used in investing activities:
Investment in SMEI (1,655,325) --
Acquired Cash SMEI 5,159 --
Purchase of property and equipment (7,875) --
--------------- ---------------
Net cash (used) in investing activities (1,658,041) --
--------------- ---------------
Cash flows from financing activities:
Loans from Stockholders /Officers (4,213) 36,540
Bank note UB term Loan (26,250)
Issuance of Convertible Debt net of fees 1,870,292 --
Short term notes payable (100,000) 178,750
Revolving AR Credit facility (334,000)
(108,311) --
Conversion of Stock Options 3,000
--------------- ---------------
Net cash provided by (used in) financing activities 1,405,829 109,979
--------------- ---------------
Net increase (decrease) in (186,827) (15,753)
cash and cash equivalents
Cash and cash equivalents - 192,681 21,032
--------------- ---------------
beginning of period
Cash and cash equivalents -
end of period $ 5,854 $ 5,279
=============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
3
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Operations and Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited financial statements include the accounts of Science
Dynamics Corporation and its majority owned subsidiaries (The Company) and have
been prepared by management in accordance with generally accepted accounting
principles in the United States of America for interim financial information and
with the instructions to Form 10-QSB and Item 310(b) of Regulation S-B. The
financial information furnished herein reflects all adjustments, which in the
opinion of management are necessary for a fair presentation of the Company's
financial position, the results of operations and the cash flows for the periods
presented.
Certain information and footnote disclosures, normally included in financial
statements prepared in accordance with generally accepted accounting principles,
have been condensed, or omitted, pursuant to such rules and regulations.
These interim statements should be read in conjunction with the audited
financial statements and notes thereto included in the Company's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 2004. The Company presumes
that users of the interim financial information herein have read or have access
to the audited financial statements for the preceding fiscal year and that the
adequacy of additional disclosure needed for a fair presentation may be
determined in that context. The results of operations for any interim period are
not necessarily indicative of the results for the full year.
The accompanying unaudited financial statements include the operating results of
Systems Management Engineering Systems, Inc. (SMEI), a majority owned (85%)
subsidiary of Science Dynamics from February 14, 2005 (Acquisition Date) to
September 30, 2005. On February 14, 2005 the Company has recorded on its Balance
Sheet a Minority Interest Liability of $13,717 representing the net asset value
not acquired by the Company. The carrying value of the minority interest of
$13,717 has since been reduced to zero in the nine moths ended September 30,
2005 giving effect to the Company's year to date net operating losses.
Use of Estimates
Our consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States (US GAAP). The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts in the financial statements and
accompanying notes. These estimates form the basis for judgments we make about
the carrying values of assets and liabilities that are not readily apparent from
other sources. We base our estimates and judgments on historical experience and
on various other assumptions that we believe are reasonable under the
circumstances. However, future events are subject to change and the best
estimates and judgments routinely require adjustment. US GAAP requires us to
make estimates and judgments in several areas, including those related to
impairment of goodwill and equity investments, revenue recognition,
recoverability of inventory and receivables, the useful lives of long lived
assets such as property and equipment, the future realization of deferred income
tax benefits and the recording of various accruals. The ultimate outcome and
actual results could differ from the estimates and assumptions used.
Note 2- Acquisition of "SMEI" Stock
On February 14, 2005 , Science Dynamics Corporation, entered into a Stock
Purchase Agreement with Systems Management Engineering, Inc. ("SMEI") and the
holders of a majority of the outstanding common stock of SMEI. On February 14,
2005, the Company completed the acquisition of 4,177,500 shares of the
outstanding common stock of Systems Management Engineering, Inc. ("SMEI"), which
shares constitute approximately 85% of the issued and outstanding shares of
capital stock of SMEI on a fully diluted basis. As consideration for such shares
of SMEI, the Company issued an aggregate of 16,553,251 shares of the Company's
common stock to twelve accredited investors pursuant to Section 4(2) of the
Securities Act and Regulation D under the Securities Act and $1,655,325 in cash,
for a total cost of $3,310,650. The Company acquired $1,230,584 in assets,
4
assumed $1,155,326 in liabilities (inclusive of a minority interest of $13,717)
and incurred $92,500 in financing costs resulting in the recording of goodwill
totaling $3,327,892. SMEI will continue to operate as an independent subsidiary
of the Company. Reported loss of $13,717 was allocated to minority interest on
the statement of operations and was limited to the extent of any remaining
minority interest on the balance sheet related to SMEI.
As part of the agreement, upon SMEI reaching certain performance goals for
the period ending December 31, 2005, the Company could be required to pay
additional compensation to the former 85% shareholders of SMEI. As stated
in the agreement, if SMEI's adjusted EBITDA (as defined in the Purchase
Agreement) is less than $500,000, then the Company shall not be obligated
to pay any additional Purchase Price to the Sellers. For the nine months
ended September 30, 2005, SMEI's adjusted EBITDA was $191,227.
Accordingly, the Company has not made any accruals for additional
compensation.
The Acquisition was accounted for under the purchase method of accounting. The
following unaudited pro-forma information for the nine months ended September
30, 2005 is presented as if the acquisition took place as of January 1, 2004:
Nine Months Ended September 30,
2005 2004
------------ ------------
NET SALES $ 3,647,818 $ 4,690,889
------------ ------------
Net Income (Loss) $ (1,211,758) $ 227,191
------------ ------------
------------ ------------
Net Income (loss) per common share Basic $ (0.01) $ --
------------ ------------
Net Income (loss) per common share Diluted $ 0.00 $ 0.00
------------ ------------
------------ ------------
Weighted average shares outstanding Basic 89,016,140 47,490,590
------------ ------------
Weighted average shares outstanding Diluted 89,016,140 66,906,732
============ ============
5
Note 3- Segment Reporting Management views its business in two divisions, the
software technology division and the software consulting division.
Nine Months Nine Months
Ended Ended
September 30, 2005 September 30, 2004
----------------- -----------------
Revenue
Software Consulting Services $ 2,220,920 (a) 415,000
Software Technology Products 1,027,779 1,325,633
----------------- -----------------
Total Consolidated Revenue $ 3,248,699 (a) $ 1,740,633
----------------- -----------------
Net Income (loss)
Software Consulting Services $ (230,496) (a) --
Software Technology Products (862,915) 129,493
----------------- -----------------
Total Consolidated Net Income (Loss) $ (1,093,411) (a) $ 129,493
----------------- -----------------
Assets
Software Consulting Services $ 4,056,752 (b) --
Software Technology Products 256,603 659,270
----------------- -----------------
Total Consolidated Assets $ 4,313,355 (b) $ 659,270
----------------- -----------------
(a) - Operating results reflect the period from February 14, 2005, the date of
the SMEI acquisition, to September 30, 2005
(b) - Includes $3,327,892 of Goodwill related to the SMEI acquisition.
Note 4 - Employment Contracts
On March 7, 2005, the Company signed a three year employment contract with Joe
Noto to be its Vice President of Finance and Administration, at an initial
annual base salary of $130,000, He is also entitled to a cash incentive bonus
equal to 20% of Base Salary based on meeting predetermined company objectives.
As part of the agreement he will receive medical, vacation and profit sharing
benefits consistent with the Company's current policies. Effective May 12, 2005,
Joe Noto assumed the position as Chief Financial Officer of the Company at an
annual base salary of $150,000.
On July 14, 2005, Science Dynamics Corporation (the "Company") entered into an
agreement dated July 1, 2005 terminating the Company's consulting agreement with
Calabash Consultancy, Ltd ("Calabash"). Calabash is owned and controlled by Alan
C. Bashforth, Secretary and a director of the Company. Notwithstanding the
termination, the 6,000,000 seven-year warrants (the "Warrants") with a strike
price of $0.10 per share and the 2,000,000 options (the "Options") with a strike
price of $0.05 granted to Calabash under the consulting agreement will remain in
effect, subject to the following amendments:
(a) the right to exercise the Warrants will commence on March 31, 2006; and (b)
the right to exercise the Options will expire March 31, 2008. The Company owes
Calabash $125,000 in consulting fees under the consulting agreement. The Company
agreed to pay such amount upon the earlier of: (a) the Company raising $1
million in new equity; or (b) March 31, 2006. Except as described above, the
Company has no further obligations to Calabash or to Mr. Bashforth. In
conjunction with this agreement, $25,000 of additional Selling, General and
Administrative expense was recorded in the quarter ended June 30, 2005 thereby
adjusting the total amount of recorded liability to Calabash to the $125,000
stipulated in the agreement.
6
Note 5 - Notes payable
September 30, 2005
(i) Long Term Note $ 105,000
(ii) Revolving Line of Credit 291,000
(iii) Convertible debentures 2,403,181
(iv) Short Term Notes 200,000
----------
Total Outstanding Balance 2,999,181
----------
Convertible debentures - non-current 1,857,727
Long term note -non-current portion 71,250
----------
Total Non-current liabilities 1,928,977
----------
Total current portion notes payable $1,070,204
----------
Aggregate maturities for long-term debt:
2006 772,272
2007 753,522
2008 403,183
(i) Long term note -As part of the "SMEI" acquisition, the Company assumed a 5
year term note bearing interest at the variable rate of Prime plus 1.5% points
(per annum) subject to a minimum rate of 6.25%. The Note matures January 28,
2008. Monthly payments consist of principal of $3,750 plus interest. The
outstanding balance on the note as of September 30, 2005 was $105,000. The note
was paid in full on October 28, 2005 from the proceeds of a Demand Note provided
by a Director of the Company.
(ii)Revolving Line of credit - As part of the "SMEI" acquisition the Company
assumed a Revolving Line of Credit with United Bank for the lesser of $700,000
or 85%-90% of eligible billed government receivables and 75% of eligible billed
commercial receivables bearing interest at the prime plus 1.0% with a minimum
rate of 5.25% per annum. The rate at September 30, 2005 was 8.00%. The line of
credit is secured by substantially all of "SMEI" assets and is guaranteed by two
former stockholders of "SMEI". The Credit agreement is subject to a Working
Capital Current ratio of 1.2 to 1, Net Worth Covenants (in excess of $300,000)
and Debt to Worth ratios in excess of 2.5 to 1.0. The Company is in violation of
the Net Worth Covenants, working capital current ratio and Debt to Worth ratios.
The total outstanding balance on this facility as of September 30, 2005 was
$291,000.
The Revolving Line of credit with United Bank was refinanced November 7, 2005
with a new Line of Credit with Presidential Financial Group. The Line of Credit
with Presidential is for a period of 12 months and is a credit facility up to
$1,000,000 and is secured by SMEI's accounts receivables. The Advance Rate on
the Company's government receivables is 85%. Interest on the line will be
charged at the rate of prime plus 2% on the average daily loan balance with a
minimum monthly loan balance requirement of $200,000. Additionally, a monthly
service charge will be charged at a rate of 1.00% of the average daily loan
balance.
7
(iii) Convertible Debentures - On February 14, 2005, the Company entered into a
Securities Purchase Agreement, dated February 11, 2005, with Laurus Master Fund,
Ltd. ("Laurus") for the sale of a $2,000,000 principal amount Secured
Convertible Term Note (the "Note") convertible at $0.10 per share and a Common
Stock Purchase Warrant to purchase 6,000,000 shares of the Company's common
stock at $0.11 that expire February 11, 2012. The sale of the Note and the
Warrant were made pursuant to the exemption from registration provided by
Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"),
and Regulation D under the Securities Act. The Company believes that there was
no beneficial conversion option because the conversion price of $0.10 per share
specified in the agreement equaled the fair value of its common stock on the
commitment date.
The Company received net proceeds of $1,868,896 from the sale of the Note and
the Warrant. The Company may only use such proceeds for (i) general working
capital purposes, (ii) no less than 80% of the equity interests of Systems
Management Engineering, Inc. ("SMEI") pursuant to the Stock Purchase Agreement,
as amended, dated as of December 16, 2004 by and among the Company, SMEI and the
shareholders of SMEI identified therein, and (iii) the acquisition of 100% of
the remaining equity interests of SMEI pursuant to a transaction in form and
substance reasonably satisfactory to Laurus.
The Note bears interest at a rate per annum equal to the prime rate published in
The Wall Street Journal from time to time, plus 3%, but shall not be less than
8%. Interest is payable monthly in arrears commencing March 1, 2005 and on the
first business day of each consecutive calendar month thereafter until the
maturity date, February 11, 2008 (each a "Repayment Date"). Amortizing payments
of the aggregate principal amount outstanding under the Note must begin on June
1, 2005 and recur on the first business day of each succeeding month thereafter
until the maturity date (each an "Amortization Date"). Beginning on the first
Amortization Date, the Company must make monthly payments to Laurus on each
Repayment Date, each in the amount of $60,606.06, together with any accrued and
unpaid interest to date on such portion of the principal amount plus any and all
other amounts which are then owing under the Note, the Purchase Agreement or any
other related agreement but have not been paid (collectively, the "Monthly
Amount"). Any principal amount that remains outstanding on the maturity date is
due and payable on the maturity date.
In order to secure payment of all amounts due under the Note, as well as the
Company's other obligations to Laurus: (i) the Company granted Laurus a lien on
all of the Company's assets and also on all assets of the Company's
subsidiaries; (ii) the Company pledged all of the capital stock that it owns of
each of its subsidiaries; and (iii) each of the Company's subsidiaries executed
a Subsidiary Guaranty of such obligations.
Pursuant to the terms of a registration rights agreement, the Company
agreed to include the shares of common stock issuable upon conversion of the
Note in a registration statement to be filed not later than March 13, 2005 and
to use its reasonable commercial efforts to cause such registration statement to
be declared effective no later than May 12, 2005. The Company has been in
default on the note by not filing the registration statement by the filing date
and by not making the required monthly principal payments to Laurus since June
1, 2005. On November 21, 2005, the Company signed an amendment and waiver with
Laurus waiving each Event of Default for our failure to pay accrued interest
,and principal through November 1, 2005 and the failure to timely file a
Registration Statement with the SEC.. As consideration of the waiver, the
Company issue to Laurus a seven year warrant to purchase 3,000,000 shares of the
common stock of the Company with an exercise price of $0.075 per share. The
Company further agreed to file a Registration Statement to register the shares
of Common Stock that may be issued upon exercise of the Additional Warrant
within 90 days of the date of the waiver. The Amendment and Waiver agreement was
effective November 22, 2005 when the Company paid Laurus $32,236.25 of overdue
interest under the secured convertible term note and issued Laurus the
Additional Warrant.
On February 10, 2005, the Company amended (the "Amendment") the conversion price
of each of the Company's outstanding convertible term notes held by Laurus to a
fixed conversion rate of $0.05. Laurus converted $547,988.78 principal amount of
convertible notes of the Company and $223,447.28 of interest on such convertible
notes into an aggregate of 15,428,722 shares of the Company's common stock. As a
result of the conversion by Laurus of the term notes, there is a remaining
balance of $400,389 on these convertible notes. In consideration for the
Amendment and the conversion by Laurus of the term notes, $550,762.95 of
outstanding principal and accrued and unpaid interest on a convertible note
dated March 31, 2003 by the Company to Laurus was also re-paid. Total repayment
amounted to $1,322,199. The Company is in default on the remaining balance of
these notes, and working on a payment schedule.
8
(iv) Short term notes - In February 2005, the Company renegotiated a short term
note in the amount of $100,000. In addition, the Company received an additional
$100,000 for a total due of $200,000, which bears interest at the rate of 27%
per annum. The note is secured by the future sale of the Company's net operating
losses from the state of New Jersey.
Note 6 - Notes Payable Stockholders/officers
As part of the "SMEI" acquisition the Company assumed a short term note from one
of the former stockholders of "SMEI" in the amount of $35,000. The loan bears
interest at 18% per annum. An additional loan of $70,000 was advanced to the
Company by the same former stockholder of SMEI on July 27, 2005 which bears
interest at 10% per annum. This increased the total amount owing under the notes
to $105,000 as of September 30, 2005. The notes are unsecured demand notes and
may be collected by the lender at any time. The notes are subordinated to the
bank line of credit.
Note 7 - Related Party Transactions
In April of 2004 Alan Bashforth, the former President and CEO of the Company,
and Paul Burgess, CEO of the Company, formed Strategic Telecom Financing.
Strategic has provided equipment lease financing to the Company's customers who
were unable to obtain financing with an outside leasing company. The terms of
the sales would have been the same if our customers were able to obtain other
financing arrangements. The leasing agreements are for 5 years at an interest
rate of 18% payable monthly. The Company has recorded revenue from sales to
Strategic totaling $124,234 in the nine month's ending September 30, 2005.
During the three months ended September 30, 2005, payments were made to the
Company by Strategic reducing any amounts owed to the Company. As of September
30, 2005, the Company does not have any outstanding balances owed or due
pertaining to these transactions.
Note 8 - Recent Accounting Pronouncements.
The Company believes that any new accounting pronouncements since December 31,
2004, will not have an affect on the Company's financial statements.
Note 9 - Subsequent Event
On November 21, 2005, the Company entered into an Amendment and Waiver
agreement with Laurus Master Fund, Ltd. whereby Laurus waived each Event of
Default for our failure to pay principal and interest on our outstanding secured
convertible term note through November 1, 2005 and for our failure to timely
file a registration statement with the SEC. As consideration for the waiver, we
issued Laurus a seven-year warrant to purchase 3,000,000 shares of common stock
with an exercise price of $0.075 per share. The Company also agreed to file a
registration statement registering the resale of the shares issuable upon
exercise of the Additional Warrant no later than February 16, 2006, subject to
the terms of the Registration Rights Agreement dated as of February 11, 2005
with Laurus. The Amendment and Waiver agreement was effective November 22, 2005
when the Company paid Laurus $32,236.25 of overdue interest under the secured
convertible term note and issued Laurus the Additional Warrant.
Laurus further agreed that we are not required to pay principal due
December 1, 2005 on the secured convertible term note provided that such
principal payment and all overdue principal payments shall by paid in full on
the maturity date.
9
Item 2. Management's Discussion and Analysis or Plan of Operation.
Forward Looking Statements
This Form 10-QSB includes forward-looking statements relating to the
business of Science Dynamics Corporation (the "Company" or "Science Dynamics").
Forward-looking statements contained herein or in other statements made by
Science Dynamics are made based on management's expectations and beliefs
concerning future events impacting the Company and are subject to uncertainties
and factors relating to the Company's operations and business environment, all
of which are difficult to predict and many of which are beyond the control of
the Company, that could cause actual results of the Company to differ materially
from those matters expressed in or implied by forward-looking statements. The
Company believes that the following factors, among others, could affect its
future performance and cause actual results of the Company to differ materially
from those expressed in or implied by forward-looking statements made by or on
behalf of the Company: (a) the effect of technological changes; (b) increases in
or unexpected losses; (c) increased competition; (d) fluctuations in the costs
to operate the business; (e) uninsurable risks; and (f) general economic
conditions.
General Overview
Science Dynamics was incorporated in the State of Delaware in May 1973 and
commenced operations in July 1977. The Company has been developing and
delivering technologically advanced telecommunication solutions for over
twenty-five years.
Traditionally, the Company has been providing telecom service providers
with its transaction based technology systems and more recently, via its
acquisition of Systems Management Engineering, Inc., a Virginia corporation
("SMEI"), in the first quarter of 2005, is now providing software solutions to
federal, state and local government utilizing a proprietary application
development platform (Department of Defense "DOD" Certified) called "Aquifer".
Business Overview
During the first quarter of 2005 the Company completed the acquisition of
approximately 85% of SMEI. SMEI provides proprietary software and advanced
technology services to the federal government, primarily the Department of
Defense. The acquisition is consistent with management's strategy to diversify
the Company's software solutions into a broader market base.
SMEI's product offering includes Aquifer, a software product that enables
government departments and businesses to efficiently manage distributed
computing applications in a secure environment. The Aquifer product has DOD
certification and is already in use at various governmental agencies.
In addition to the stand-alone sale ability of its product offering, the
Company has identified potential in combining Aquifer's application management
qualities with the IP based transaction processing capabilities of the Company's
BubbleLink technology. Management believes this will provide Science Dynamics
with a dynamic product offering that can be used to develop vertical
applications encompassing a multitude of industries. The Company's management
has begun working with key government clients to explore new applications that
can be developed using a combination of the two products.
As the Company continues to identify opportunities utilizing either its
combined or stand-alone technologies the Company will be working to integrate
the product offerings through a single brand. The Company's branding and
marketing initiatives will include its two core product offerings, BubbleLink
and Aquifer. Management believes selling the Company's product offering through
a single brand will enable the Company to market enabling technologies that
provide customers an enterprise solution with global networking capabilities.
10
RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED
TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004
Sales:
Sales were $1,119,135 during the three months ended September 30, 2005,
compared to $601,427 for the three months ended September 30 2004, representing
an increase of $517,708 or 86%. The increase includes the results of SMEI which
was acquired in the first quarter of this year. The increase in revenues
attributable to the SMEI acquisition was $846,570. Excluding SMEI, revenues
declined in the Company's Technology Products unit by $328,862. The Technology
Product's year ago quarter included revenues attributable to the Evercom
contract of $125,000 and $200,000 related to a one-time sale to T-Netix of the
Company's 3-way calling software. Excluding the Evercom contract (which ended in
the fourth quarter of 2004) and the T-Netix sale, the Technology Product
revenues were in line with the prior year results.
Sales during the nine months ended September 30, 2005 were $3,248,699
compared to $1,740,633 during the nine months ended September 30, 2004,
representing an increase of $1,508,066 or 87% in sales year over year. The
increase in the period attributable to the SMEI acquisition was $2,220,920.
Excluding the revenues attributable to the SMEI acquisition, revenues declined
from prior year by $712,854 or 41%. Included in the prior year results were
revenues of $415,000 and $200,000 attributable to the Evercom contract and the
one-time sale to T-Netix respectively.
Cost of Sales:
Cost of Sales increased by $550,576 from $87,403 to $637,979 for the three
months ended September 30, 2005 compared to the corresponding three months ended
September 30, 2004. Accounting for most of the increase, was the Cost of Sales
increase attributable to the SMEI acquisition, which was $517,322.
Cost of Sales for the nine months ended September 30, 2005 increased by
$1,280,303 to $1,612,226 from $331,923. Accounting for most of the increase, was
the Cost of Sales attributable to the SMEI acquisition, which was $1,277,563. As
a percent of revenue, the cost of sales in the software technology division are
substantially lower than that of the software consulting division. The software
consulting division is labor intensive and is dependent on the utilization
levels of billable personnel.
Research and Development:
Research and development expenses consist primarily of salaries and
related personnel costs, and consulting fees associated with product
development.
For the three months ended September 30, 2005, Research and development
expenses increased to $127,097 compared to $27,044 for the three months ended
September 30, 2004.
Research and development expenses increased by $197,596 from $125,467 for
the nine months ended September 30, 2004 to $323,063 for the nine months ended
September 30, 2005. The increase was attributable to the hiring of additional
engineering staff. Management believes that continual enhancements of the
Company's products will be required to enable Science Dynamics to maintain its
competitive position. Science Dynamics will have to focus its principal future
product development and resources on developing new, innovative, technical
products and updating existing products.
Selling, General and Administrative:
Selling, General and administrative expenses consist primarily of expenses
for management, finance and administrative personnel, legal, accounting,
consulting fees, sales commissions and marketing, and facilities costs.
For the three months ended September 30, 2005 SG&A expenses increased to
$647,085 compared to $362,911 for the comparative three months ended September
30, 2004. Included in the overall increase of $284,174 was $431,588 of expenses
attributable to the SMEI acquisition. Excluding the SMEI expenses, SG&A expenses
decreased $147,414. The decrease was primarily attributable to cost cutting
measures implemented in the first quarter of 2005.
11
For the nine months ended September 30, 2005, SG&A increased to $1,930,264
from $964,171 for the comparative nine months ended September 30, 2004. Included
in the overall increase of $966,093 was $1,162,892 attributable to the SMEI
acquisition. Excluding the SMEI expenses, SG&A expenses decreased by $196,799.
As stated above, the decrease was primarily attributable to cost cutting
measures implemented in the first quarter of 2005.
Interest Expense:
Interest expense consists of interest paid and accrued on outstanding
convertible notes, notes payable, interest due on loans from stockholders.
Interest Expense decreased to $88,391 for the three months ended September
30, 2005 compared to $129,326 for the three months ended September 30, 2004.
Interest Expense increased to $227,607 for the nine months ended September
30, 2005 compared to $204,732 for the nine months ended September 30, 2004.
Finance Expense:
There was no finance expense recorded in the nine months ended September
30, 2005 which compared to $66,847 of amortized financing costs for the nine
month's in the prior period ended September 30, 2004
LIQUIDITY AND CAPITAL RESOURCES
For the nine month period ended September 30, 2005, cash and cash
equivalents decreased to $5,854 from $192,681 at December 31, 2004. Net cash
provided by operating activities was $65,385 for the nine months ended September
30, 2005 compared to net cash used for operating activities of $125,732 in the
corresponding nine months ended September 30, 2004. This consisted of a net loss
of $1,093,411 favorably offset by non-cash items amounting to $339,973 a
decrease in our accounts receivable of $416,039, a decrease in inventory of
$48,018 and an increase in the Company's accounts payable and accrued expenses
of $406,537.
Net cash used in investing activities was $1,658,041 for the nine months
ended September 30, 2005. This consisted primarily of the cash component of the
SMEI purchase of $1,655,325. The lack of investing in capital equipment is
consistent with the Company's planned budgetary restraints.
Net cash provided by financing activities was $1,405,829 for the nine
months ended September 30, 2005 compared to $109,979 in the corresponding nine
months ended September 30, 2004. In connection with the acquisition of SMEI, the
Company entered into a Securities Purchase Agreement, dated February 11, 2005,
with Laurus Master Fund, Ltd. for the sale of a $2,000,000 principal amount
secured convertible term note and a common stock purchase warrant to purchase
6,000,000 shares of common stock at a price of $0.11 per share, which provided
net proceeds of $1,870,292. The net increase in cash provided by financing
consisted of the net proceeds of $1,870,292 from the issuance of the $2,000,000
convertible note used to finance the purchase of SMEI and for working capital
requirements. For the period ended September 30, 2005, the Company reduced its
Short Term Notes and the outstanding balance on its Revolving Credit facility by
$100,000 and $334,000 respectively. Additionally, the Company reduced its
officer/shareholder loans and United Bank Term Loan by $4,213 and $26,250
respectively. The revolving credit facility is based on the accounts receivable
of the Company's software consulting division.
On November 7, 2005 The Company closed on a $1,000,000 Revolving Line of
Credit with Presidential Financial Group. The new Line of Credit with
Presidential is for a period of 12 months and is a credit facility up to
$1,000,000 and is secured primarily by the Company's operating subsidiary's
("SMEI's") accounts receivables. The Advance Rate on the Company's government
receivables is 85%. Interest on the line will be charged at the rate of prime
plus 2% on the average daily loan balance with a minimum monthly loan balance
requirement of $200,000. Additionally, a monthly service charge will be charged
at a rate of 1.00% of the average daily loan balance. We have used $449,320 of
the line to refinance our original revolving line of credit with United Bank.
12
The cash requirements for funding our operations continue to exceed cash
flows from operations. To date, we have satisfied our operating cash flow
deficiencies primarily through the reduction of working capital and debt
financing.
We have successfully negotiated payment arrangements with some of our
vendors and are attempting to negotiate payment arrangements with other vendors.
We cannot guarantee that any of these discussions will be successful. If we are
unable to obtain successful negotiations, our business may well be severely
adversely affected.
On November 21, 2005, we entered into an Amendment and Waiver agreement
with Laurus Master Fund, Ltd. whereby Laurus waived each Event of Default for
our failure to pay principal and interest on our outstanding secured convertible
term note through November 1, 2005 and for our failure to timely file a
registration statement with the SEC. As consideration for the waiver, we issued
Laurus a seven-year warrant to purchase 3,000,000 shares of common stock with an
exercise price of $0.075 per share (the "Additional Warrant"). We agreed to file
a registration statement registering the resale of the shares issuable upon
exercise of the Additional Warrant no later than February 16, 2006, subject to
the terms of the Registration Rights Agreement dated as of February 11, 2005
with Laurus. The Amendment and Waiver agreement was effective November 22, 2005
when we paid Laurus $32,236.25 of overdue interest under the secured convertible
term note and issued Laurus the Additional Warrant.
Laurus further agreed that we are not required to pay principal due
December 1, 2005 on the secured convertible term note provided that such
principal payment and all overdue principal payments shall by paid in full on
the maturity date.
For the nine months ended September 30 2005, the Company has incurred a
net loss. The Company's operating cash flows have not been sufficient to pay its
current expenses. The Company believes that with the new $1,000,000 credit
facility with Presidential Financial combined with its expected operating
cashflows, it will have sufficient liquidity to pay its current obligations due
in the next twelve months. However, the Company lacks the sufficient cash flows
from operations and availability on its credit facility to pay some past
obligations and the monthly principal payments due on the Laurus secured
convertible term note starting January 1, 2006 (as per the Amendment and Waiver
dated November 18, 2005 discussed above). If the Company is unable to arrange
suitable payment plans on its past obligations or pay its principal payments due
by converting the payments into the Company's common stock (in accordance with
the repayment provisions of the secured convertible term note) then the Company
will need to obtain additional financing. If the Company is not successful in
obtaining this financing then the Company could be required to reduce or curtail
operations. The Company has not identified additional financing as of the date
of this filing.
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not have any off balance sheet arrangements that are
reasonably likely to have a current or future effect on our financial condition,
revenues, results of operations, liquidity or capital expenditures.
CRITICAL ACCOUNTING POLICIES
Item 3. Controls and Procedures.
As of the end of the period covered by this report, we conducted an
evaluation, under the supervision and with the participation of our chief
executive officer and chief financial officer of our disclosure controls and
procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange
Act). Based upon this evaluation, our chief executive officer and chief
financial officer concluded that our disclosure controls and procedures are
effective to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is: (1) accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, as appropriate to allow timely decisions regarding required
disclosure; and (2) recorded, processed, summarized and reported, within the
time periods specified in the Commission's rules and forms. There was no change
to our internal controls or in other factors that could affect these controls
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
13
PART II
Item 1. Legal Proceedings.
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Not applicable.
Item 3. Defaults Upon Senior Securities.
As part of the Company's acquisition of SMEI, the Company assumed a
revolving line of credit (United Bank) the lesser of $700,000 or 85%-90% of
eligible billed government receivables and 75% of eligible billed commercial
receivables bearing interest at the prime plus 1.0% with a minimum rate of 5.25%
per annum. The line of credit is secured by substantially all of SMEI's assets
and is guaranteed by two former stockholders of SMEI. The agreement expires on
June 30, 2005 but was extended to September 30, 2005 with no change in terms.
The line of credit agreement is subject to Working Capital Current ratio of 1.2
to 1 and Net Worth Covenants (in excess of $300,000) and debt to Worth ratios in
excess of 2.5 to 1.0. The Company is in violation of these financial covenants.
The total outstanding balance on this facility as of November 7, 2005 was
$449,320 which was refinanced by Presidential Financial.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information.
Entry into a Material Definitive Agreement; Creation of a Direct Financial
Obligation or an Obligation under an Off-Balance Sheet Arrangement of a
Registrant
On November 7, 2005 The Company closed on a $1,000,000 Revolving Line of
Credit with Presidential Financial Group. The new Line of Credit with
Presidential is for a period of 12 months and is a credit facility up to
$1,000,000 and is secured primarily by the Company's operating subsidiary's
("SMEI's") accounts receivables. The Advance Rate on the Company's government
receivables is 85%. Interest on the line will be charged at the rate of prime
plus 2% on the average daily loan balance with a minimum monthly loan balance
requirement of $200,000. Additionally, a monthly service charge will be charged
at a rate of 1.00% of the average daily loan balance. We have used $449,320 of
the line to refinance our original revolving line of credit with United Bank.
Item 6. Exhibits.
Exhibit
Number Description
--------------------------------------------------------------------------------
31.1 Certification by Chief Executive Officer, required by Rule 13a-14(a)
or Rule 15d-14(a) of the Exchange Act.
31.2 Certification by Chief Financial Officer, required by Rule 13a-14(a)
or Rule 15d-14(a) of the Exchange Act.
32.1 Certification by Chief Executive Officer, required by Rule 13a-14(b)
or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63
of Title 18 of the United States Code.
32.2 Certification by Chief Financial Officer, required by Rule 13a-14(b)
or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63
of Title 18 of the United States Code.
14
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SCIENCE DYNAMICS CORPORATION
Dated: November 22, 2005 By: /s/ Paul Burgess
--------------------------------
Paul Burgess
Chief Executive Officer
Dated: November 22, 2005 By: /s/ Joe Noto
--------------------------------
Joe Noto
Chief Financial Officer and
Principal Accounting Officer
15