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 MARCH 31, 2006
[_] 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 (IRS Employer Identification No.)
of incorporation or organization)
7150 N. Pennsauken, New Jersey 08109
(Address of principal executive offices)
Issuer's telephone Number: (856) 910-1166
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 [_] 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 May 19, 2006, the issuer
had 112,947,431 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........ 11
Item 3. Controls and Procedures.......................................... 15
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................ 15
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...... 15
Item 3. Defaults Upon Senior Securities.................................. 15
Item 4. Submission of Matters to a Vote of Security Holders.............. 15
Item 5. Other Information................................................ 16
Item 6. Exhibits......................................................... 16
SIGNATURES................................................................ 17
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2006 December 31, 2005
Unaudited Audited
-------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 115,768 $ 53,997
Accounts receivable - trade 1,026,644 706,255
Inventories 1,943 6,049
Other current assets 219,587 190,581
-------------- --------------
Total current assets 1,363,942 956,882
-------------- --------------
Property and equipment, net 14,338 35,279
Goodwill 2,063,833 2,063,833
Other Intangibles, net 1,020,420 1,077,110
Other assets 21,312 19,213
-------------- --------------
Total assets $ 4,483,845 $ 4,152,317
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Customer deposits $ 166,311 $ 150,199
Accounts payable 1,006,127 986,505
Accrued expenses 1,219,813 1,084,555
Current maturities notes payable 2,870,713 2,667,942
Derivative Liability 462,462 462,462
-------------- --------------
Total current liabilities 5,725,426 5,351,663
Minority Interest 85,758 78,316
Shareholders' equity - (Deficit)
Preferred stock - .01 par value
10,000,000 shares authorized -- --
No shares issued
Common stock - .01 par value,
200,000,000 shares authorized,
89,841,498 and 89,841,498 issued
89,715,698 and 89,715,698 outstanding
in 2006 and 2005 respectively 898,415 898,415
Additional paid-in capital 18,800,980 18,800,980
(Deficit) (20,628,901) (20,579,224)
-------------- --------------
(929,506) (879,829)
Common stock held in treasury, at cost (397,833) (397,833)
-------------- --------------
Total shareholders' equity (Deficit) (1,327,339) (1,277,662)
-------------- --------------
Total liabilities and shareholders'
Equity $ 4,483,845 $ 4,152,317
============== ==============
The accompanying notes are an integral part of these
consolidated financial statements.
1
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended March 31,
2006 2005
"as Restated"
------------ ------------
Sales - Technology Products $ 423,890 $ 433,447
Sales - Technology Services 917,917 441,123
------------ ------------
Total Sales 1,341,807 874,570
Cost of Sales - Technology Products 154,120 109,609
Cost of Sales - Technology Services 478,248 235,482
------------ ------------
Total Cost of Sales 632,368 345,091
------------ ------------
Total Gross Margin 709,439 529,479
Operating costs and expenses:
Research and development 109,134 95,147
Selling, general
and administrative 504,606 585,872
------------ ------------
613,740 681,019
------------ ------------
Operating Income (Loss) before other income (expenses) 95,699 (151,540)
Other income (expense):
Derivative -- (532,836)
Interest Expense (129,890) (105,186)
Finance Expense (8,043) --
------------ ------------
Total Other income (expenses) (137,933) (638,022)
Net Income (Loss) before Minority Interest (42,234) (789,562)
Minority Interest (7,442) --
------------ ------------
Net Loss $ (49,676) $ (789,562)
============ ============
Net Loss per Common Share -Basic and Diluted $ (0.00) $ (0.01)
============ ============
Weighted average shares outstanding basic and diluted 89,841,498 70,126,584
------------ ------------
The accompanying notes are an integral part of these
consolidated financial statements.
2
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended March 31,
2006 2005
"As Restated"
------------ ------------
Cash flows from operating activities:
Net (loss) $ (49,676) $ (789,562)
------------ ------------
Adjustments to reconcile net (loss) to net cash
provided by (used for) operating activities:
Depreciation 20,940 25,320
Amortization Intangible assets 56,690
Financing expense non cash 8,043 --
Derivative Expense -- 532,836
Non Cash interest Derivative 36,180 27,912
Minority interest 7,442 --
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable (320,390) 256,137
Inventories 4,106 --
Other current assets (37,049) --
Other assets (2,100) (13,703)
Increase (decrease) in:
Accounts Payable and
accrued expenses 154,883 215,100
Customer Deposits 16,111 19,850
------------ ------------
Total adjustments (55,144) 1,063,453
------------ ------------
Net cash provided by (used for)
operating activities (104,820) 273,890
------------ ------------
Cash flows from investing activities:
Investment in SMEI -- (1,655,325)
Cash acquired in SMEI acquisition -- 5,159
Purchase of property and equipment - net -- (7,875)
------------ ------------
Net cash (used) in investing activities -- (1,658,041)
------------ ------------
Cash flows from financing activities:
Exercise of Stock Options -- --
Loans from Stockholders & Officers -- (49,700)
Payment of Bank Notes -- (3,750)
Issuance of Convertible Debt -- 1,867,500
Short term, net -- (120,000)
Net borrowing (Payment)on Revolving AR credit facility 166,591 (367,000)
------------ ------------
Net cash (used in) provided by financing activities 166,591 1,327,050
------------ ------------
Net increase (decrease) in
cash and cash equivalents 61,771 (57,101)
Cash and cash equivalents -
beginning of period 53,997 192,681
------------ ------------
Cash and cash equivalents -
end of period $ 115,768 $ 135,580
============ ============
Supplemental Information:
Interest Paid $ 54,527
The accompanying notes are an integral part of these
consolidated financial statements.
3
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1- Organization and Summary of Significant Accounting Policies
a) Organization
Science Dynamics Corporation (the "Company", "SciDyn" or "Science Dynamics") was
incorporated in the State of Delaware May 1973 and commenced operations in July
1977. The Company began as a provider of specialized solutions to the telecom
industry. Throughout its history SciDyn has adapted to the changes in this
industry by reinventing itself to be more responsive and open to the dynamic
pace of change experienced in the broader converged communications industry of
today. Currently SciDyn provides advanced solutions for several vertical
markets. The greatest change in operations is in the shift from being a
component manufacturer to a solution provider focused on developing applications
through software on our core platform technology. To further its strategy of
becoming a solutions provider, the Company acquired a majority interest in
"SMEI" in February 2005. With the SMEI acquisition, approximately 70% of the
Company's revenues are derived from solution services.
b) Basis of Financial Statement Presentation
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company has generated
significant losses and is unable to predict profitability for the future. These
factors indicate that the Company's continuation, as a going concern is
dependent upon its ability to obtain adequate financing. The Company plans to
address the going concern by replacing debt with equity and continuing to grow
the company with profitable sales both organically and through acquisitions.
Management believes successfully executing these tasks will lead to the removal
of the going concern comment from our audited financials.
The accompanying financial statements include the operating results of Systems
Management Engineering Systems, Inc. (SMEI), a majority owned (86%) subsidiary
of Science Dynamics acquired February 14, 2005. On February 14, 2005 the Company
recorded on its Balance Sheet a Minority Interest Liability of $171,995
representing the net asset value not acquired by the Company. The carrying value
of the minority interest of $171,995 has since been reduced by $86,237 at March
31, 2006 giving effect to the SMEI's net operating results. The carrying value
increased by $7,442 in the quarter ended March 31, 2006 giving effect to the
portion of SMEI's net operating profit allocable to minority shareholders.
c) Principles of Consolidation:
The consolidated financial statements included the accounts of the Company and
all of its subsidiaries in which a controlling interest is maintained. All
significant inter-company accounts and transactions have been eliminated in
consolidation. For those consolidated subsidiaries where Company ownership is
less than 100%, the outside stockholders' interests are shown as minority
interests.
d) Use of Estimates:
The financial statements have been prepared in accordance with accounting
principles generally accepted in the United States (US GAAP). The preparation of
these financial statements requires management to make estimates and assumptions
that affect the reported amounts in the financial statements and accompanying
notes. These estimates form the basis for judgments made about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Estimates and judgments are based on historical experience and on
various other assumptions that the Company believes are reasonable under the
circumstances. However, future events are subject to change and the best
estimates and judgments routinely require adjustment. US GAAP requires 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 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.
4
Note 2- Segment Reporting
Management views its business as two operating units, Technology Consulting
Services and Technology Products.
Three Months Ended Three Months Ended
March 31, 2006 March 31, 2005
------------------ ------------------
Revenue
Technology Services $ 917,917 441,123 (a)
Technology Products 423,890 433,447
------------------ ------------------
Total Consolidated Revenue $ 1,341,807 $ 874,570 (a)
------------------ ------------------
Gross Profit
Technology Services 439,670 205,641 (a)
Technology Products 269,770 323,838
------------------ ------------------
Total Gross Profit 709,439 529,479 (a)
------------------ ------------------
Assets
Technology Services $ 4,135,170 (b) 4,285,914
Technology Products 348,675 392,722
------------------ ------------------
Total Consolidated Assets $ 4,483,845 (b) $ 4,678,636
------------------ ------------------
(a) - Gross Profit for the three months ended March 31, 2005 reflects SMEI's
operating results for the period from February 14, 2005, the date of the SMEI
acquisition, to March 31, 2005
(b) - Includes $2,063,833 of Goodwill and $1,020,420 Intangibles, net related to
the SMEI acquisition.
Note 3 - Employment Contracts
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. The total
amount of recorded liability to Calabash as of March 31, 2006 was $125,000 as
stipulated in the agreement. The Company is past due on the $125,000 payment.at
March 31, 2006. .
Mr. Paul Burgess CEO & President of the Company has waived his right to the base
salary of $56,250 of his compensation as described in his employment agreement
for the quarter ended March 31, 2006. Mr. Burgess and the board are presently
renegotiating his contract going forward.
5
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 4 - Notes payable
Notes payable consists of the following as of March 31, 2006 and December 31,
2005:
2006 2005
----------------------------------
Face value $2,000,000, variable rate (8.0% at December 31, 2005)
Secured Convertible Term Note, due in monthly payments of $60,606
commencing June 30, 2005 (a) $ 1,478,642 $ 1,442,462
$400,000, 8.0% Secured Convertible Keshet Term Note (b) 400,000 400,000
8% Secured Convertible Laurus Term Note, originally due May 21,
2003 (b) -- --
Revolving credit facility (c) 369,442 202,851
Notes Payable - Stockholders/Officers (d) 388,629 388,629
Short term notes payable (e) 234,000 234,000
----------------------------------
Total notes payable 2,870,713 2,667,942
Less current maturities, associated with notes payable (2,870,713) (2,667,942)
----------------------------------
Long-term debt $ -- $ --
==================================
(a) 2005 Laurus Agreements:
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 received net proceeds of $1,867,500 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%. The interest terms include a monthly reset feature that provides for
decreases in interest rates pro-rata for certain increases in the Company's
common stock above the conversion rate; such feature does not become effective
until the underlying common shares are registered. Otherwise, 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.
6
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 and
Warrants 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. Failure to file
or become effective results in liquidating damages penalties of 2% per month of
the face value of the Note. The Company has been in default on the note by not
becoming effective on the registration statement by the required 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 issued 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. The
Company allocated the fair value of the Additional Warrant to deferred finance
costs ($42,275) and derivative expense ($5,725) on a relative fair value basis.
The additional deferred finance costs is being amortized through periodic
charges to interest expense using the effective interest method which commenced
in the fourth fiscal quarter of 2005.
In accordance with EITF 00-19 "Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company's Own Stock," the basis from
the 2005 Laurus Agreements was allocated to embedded derivative features indexed
to the Company's common stock (consisting of the conversion and interest reset
features) in the amount of $444,920, and the Warrant, in the amount, in the
amount of $270,000. See Derivative Financial Instruments, below. These discounts
resulted in an initial carrying value of the Secured Convertible Term Note of
$1,285,080. The debt is being amortized through charges to interest expense over
the debt term using the effective method. Amortization during the three months
ended March31, 2006 amounted to $36,180.
The Company is currently in default on the note with Laurus in that it didn't
make principal and interest payments when due. As of May 2006, the Company is in
arrears on its monthly principal payments of $60,606 for Jan 2006 , Feb 2006,
Mar 2006 , Apr 2006 and May 2006, and interest for March and April 2006 totaling
$36,055.
Laurus agreed to waive all the events of default upon the Company remitting the
March and April overdue interest. The overdue interst of $36,055 was paid May 4,
2006. As a result, the Company did not accrue any fees or default interest as of
March 31, 2006.
(b) 2001 Laurus and Keshet Financing Agreements
On May 21, 2001, the Company entered into concurrent financing arrangements,
each bearing similar terms and conditions, with Laurus and Keshet Capital for
$1,000,000 and $400,000, respectively. The notes bore interest at 8% and were
due and payable in May 2003. The notes were convertible into the Company's
common stock at 85% of the average trading market price over a period of twenty
days preceding conversion. In addition, the notes were issued with detachable
warrants to purchase 727,273 (relative to the Laurus arrangement) and 290,908
(relative to the Keshet Arrangement) shares of common stock. The warrants had
terms of five years and fixed strike prices of $1.43. The Keshet notes, which
remain outstanding as of March 31, 2006 are in default.
7
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
In accordance with EITF 00-19 "Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company's Own Stock," the basis from
the 2001 Laurus Agreements was allocated to embedded derivative feature indexed
to the Company's common stock (consisting of the conversion feature) in the
amount of $634,501, and the Warrant, in the amount, in the amount of $334,546.
These discounts resulted in an initial carrying value of the Secured Convertible
Term Note of $30,953. The debt discount was amortized through charges to
interest expense over the term using the effective method at effective interest
rate of 99.07%. The basis from the 2001 Keshet Agreements was allocated to
embedded derivative features indexed to the Company's common stock (consisting
of the conversion feature) in the amount of $253,800, and the Warrant, in the
amount, in the amount of $133,818. These discounts resulted in an initial
carrying value of the Secured Convertible Term Note of $12,382. The debt
discount was amortized through charges to interest expense over the term using
the effective method at effective interest rate of 99.07%.
(c) Revolving Line of credit
As part of the "SMEI" acquisition the Company assumed a Revolving Line of Credit
with United Bank. 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. The total outstanding balance on this facility as of
March 31, 2006 was $369,442.
(d) Notes Payable Stockholders/officers
The Company assumed a short term note in the amount of $35,000 as part of the
SMEI acquisition from the CEO. The loan bears interest at 18% per annum. The
Company also borrowed an additional $175,000, these notes bear interest at 10%
per annum. The total amount due at March 31, 2006 is $228,551 including
interest. The notes are unsecured demand notes and may be collected by the
lender at any time. The notes are subordinate to the bank line of credit.
The Company has other short-term loans payable to various stockholders and
officers of the Company amounting to $165,328, these notes bear interest at 8%
per annum. The notes are unsecured demand notes.
(e) Short term notes
At March 31, 2006 the Company had $234,000 in short term notes. These loans are
collateralized by the future sale of the New Jersey Net Operating Loss in 2006.
These notes bear interest at 20% per annum.
Note 5 - Derivative Financial Instruments
The balance sheet caption derivative liabilities consist of (i) embedded
conversion features and (ii) the Warrants, issued in connection with the 2005
Laurus Financing Arrangement and the 2001 Keshet Financing Arrangement. These
derivative financial instruments are indexed to an aggregate of 63,072,421 and
36,509,283 shares of the Company's common stock as of March 31, 2006 and 2005,
respectively, and are carried at fair value. The following tabular presentation
sets forth information about the derivative instruments for the three months
ended March 31, 2006 and 2005:
March 31, 2006:
Conversion
Features Warrants Total
----------------------------------------------------
Net liabilities as of March 31, 2006 $ (255,462) $ (207,000) $ (462,462)
====================================================
Derivative income (loss): $ -- $ -- $ --
====================================================
8
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2005:
Conversion
Features Warrants Total
----------------------------------------------------
====================================================
Derivative income (loss): $ (394,836) $ (138,000) $ (532,836)
====================================================
Freestanding derivative instruments, consisting of warrants and options that
arose from the Laurus financing are valued using the Black-Scholes-Merton
valuation methodology because that model embodies all of the relevant
assumptions that address the features underlying these instruments. Significant
assumptions used in Black Scholes Models included: Conversion or Strike Prices
ranging from $0.10--$1.43; Volatility Factors-35.50% - 41.88 based upon forward
terms of instruments; Terms-remaining term for all instruments; and, Risk Free
rate-4.88%. Fair value for forward-based features (principally the interest
reset feature) is determined using the income approach; generally discounted
cash flows.
Embedded derivative instruments consist of multiple individual features that
were embedded in the convertible debt instruments. The Company evaluated all
significant features of the hybrid instruments and, where required under current
accounting standards, bifurcated features for separate report classification.
These features were, as attributable to each convertible note, aggregated into
one compound derivative financial instrument for financial reporting purposes.
The compound embedded derivative instruments are valued using the Flexible Monte
Carlo methodology because that model embodies certain relevant assumptions
(including, but not limited to, interest rate risk, credit risk, and
Company-controlled redemption privileges) that are necessary to value these
complex derivatives. Significant assumptions included in the Flexible Monte
Carlo included: Conversion or Strike Prices ranging from $0.06--$0.10;
Volatility Factors-40.70% to 41.88% based upon forward terms of instruments;
Terms-remaining term for all instruments; equivalent interest rate risk ranging
from 3.10% to 3.41% and equivalent yield rate ranging from 12.15% to 13.15%
Equivalent amounts reflect the net results of multiple modeling simulations that
the Monte Carlo Simulation methodology applies to underlying assumptions.
Note 6 - Restatements
For the three months
ended
March 31, 2005
----------------
Net Loss Applicable to Stockholders, as previously
reported ($228,815)
----------------
Adjustments:
Derivative expense 560,748
----------------
Net Loss Applicable to Stockholders, as restated (789,563)
----------------
Basic and Diluted Loss per Common Share (as previously
reported) ($0.00)
----------------
Basic and Diluted Loss per Common Share (as Restated) ($0.01)
----------------
9
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The Company corrected its accounting for derivative financial instruments to
conform to the requirements of Statements of Financial Accounting Standards No.
133, as amended. Embedded conversion features that meet the definition of
derivative financial instruments have, where applicable, been bifurcated from
host instruments and, in all instances; derivative financial instruments have
been recorded as liabilities and are carried at fair value. Other instruments,
such as warrants, where physical or net-share settlement is not within the
Company's control are recorded as liabilities and carried at fair value.
Finally, instruments that were initially recorded as equity were reclassified to
liabilities at the time that the Company no longer possessed the ability to
settle the instruments on a physical or net-share basis.
The Fair Value adjustments included in the restated consolidated statement of
operations for the quarter ended March 31, 2005 are as follows:
Interest expense ($27,912)
Less Derivative Expense ($532,836)
---------
Net Adjustment ($560,748)
---------
The interest expense adjustment is included under the caption interest expense
and the derivative expense is reflected as a separate caption on the 2005
restated consolidated statement of operations.
Note 7 - Recent Accounting Pronouncements.
The Company believes that any new accounting pronouncements since December 31,
2005, will not have an affect on the Company's financial statements.
Note 8 - Subsequent Events
Default of Laurus Note
As of May 4, 2006, the Company was in default on the note since it didn't pay
the monthly principal payments of $60,606 due on the 1st of January, February,
March, April and May 2006 and because the required registration statement was
not declared effective. Additionally, the Company was in arrears on the March
2006 and April 2006 interest payments totaling $36,055. As a result, the Company
was potentially liable for fees and interest of 2% per month accruing on all
outstanding obligations and 130% of the outstanding principal if an agreement to
waive the existing events of default was not reached.
Effective May 4, 2006, Laurus agreed to waive each existing Event of Default
under the terms of the Term Note upon receiving payment of the overdue interest
of $36,055. The overdue interest of $36,055 was paid to Laurus on May 4, 2006.
As a result, the Company did not record any liabilities in the quarter ended
March 31, 2006 related to default fees or penalties.
Private Placement - Equity Financing
Between April 14, 2006 and May 11, 2006 the Company raised $1.4 million of
gross proceeds from the sale of common stock and warrants to purchase additional
shares of common stock to various accredited investors in private placement
transactions. The Company sold an aggregate of 23,231,733 shares of common stock
and warrants to purchase 11,615,867 shares of common stock. Each unit is
comprised of 100 shares and 50 warrants to purchase one shares of common stock
with an exercise price of $0.12 per share exercisable for five years. Each 100
shares of common stock and one common stock purchase warrant were sold for a
per-unit price of $6.00, or $0.06 per share.
10
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 Corporation was incorporated in the State of Delaware in
May 1973 and commenced operations in July 1977. We have been developing and
delivering technologically advanced telecommunication solutions for over
twenty-five years and recently expanded our product offering to include IT
solutions with the acquisition of 86% of Systems Management Engineering, Inc.
("SMEI") on February 14, 2005.
We have completely and successfully integrated SMEI with our operations
and as a result we are realizing SG&A synergies that have improved the Company's
bottom line performance. As a result, the Company generated positive EBITDA
(earnings before interest, taxes, depreciation and amortization) of $173,329 in
the first quarter of 2006. Most importantly, the acquisition enabled us to
leverage the capabilities of both companies in product development and customer
reach which we believe, combined with the cost efficiencies, moves us closer to
profitability.
We were encouraged by the improved results in the first quarter
specifically by the $1,341,807 in revenues and the positive EBITDA of $173,329
realized in the first fiscal quarter of 2006. Revenue increased 53.4% from
$874,570 in the quarter ended March 31, 2005 compared to $1,341,807 in the
quarter ended March 31, 2006. The Company generated positive EBITDA of $173,329
for the quarter ended March 31, 2006 compared to an EBITDA loss of $126,220 in
the quarter ended March 31, 2005. Management believes the improvement in our
EBITDA highlights the positive contribution made by SMEI. Our priorities in 2006
are to further increase sales revenue, pursue further strategic acquisitions and
improve the bottom line. Currently our total contract backlog is over $16
million on government contracts ranging up to 5 years, giving the Company a
strong contractual base to grow our existing revenue base.
We intend to expand our sales efforts both within the federal government
software solutions space and commercial accounts. We plan on building upon our
recent success in these markets by expanding our marketing efforts through our
direct sales strategy. Our team is driven to increase shareholder value through
both organic growth and acquisitions throughout the year. With regards to our
acquisition strategy, we will continue to pursue profitable companies with
proprietary products and services we can sell to our existing customers and
which have synergies with our existing business.
Subsequent to the close of the first quarter the company has raised
approximately $1.4M in equity from a group of accredited investors. The company
plans to use the proceeds to expand its acquisition strategy, reduce debt,
reduce the convertible debenture held by Laurus Master Fund, Ltd. ("Laurus") and
for general working capital. The company will continue to identify financing
opportunities that provide the company with the opportunity to expand our
business model and increase shareholder value.
11
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THE THREE
MONTHS ENDED MARCH 31, 2005
Sales:
Sales were $1,341,807 during the three months ended March 31, 2006,
compared to $874,570 for the three months ended March 31 2005, representing an
increase of $467,237 or 53.4%. The overall increase in revenues attributable to
the SMEI acquisition (February 2005) was $400,379 derived primarily from the
Technology Consulting Services segment. Sales for the Technology Consulting
Services segment increased by $476,794, or 108%, from $441,123 in the three
months ended March 31, 2005 to $917,917 in the three months ended March 31,
2006.Sales for the Technology Products segment decreased slightly by $9,557, or
2%, from $433,447 in the three months ended March 31, 2005 to $423,890 in the
three months ended March 31, 2006.
Cost of Sales:
Cost of sales for the Technology Consulting Services segment consist of
employee salaries and outside consulting fees, and other direct costs chargeable
to contract These costs increased by $242,765, or 103%, from $235,483 in the
three months ended March 31, 2005 to $478,248 in the three months ended March
31, 2006 due to the acquisition of SMEI during February 2005. Cost of sales for
the Technology Products segment consist of employee salaries and computer
hardware. These costs increased by $44,511, or 41%, from $109,609 in the three
months ended March 31, 2005 to $154,120 in the three months ended March 31,
2006. Cost of sales increased in the technology products due to an increase in
subcontracting expenses needed for a large order.
Gross Margin:
Gross Margin increased by $179,960 or 34% from $529,479 for the quarter
ended March 31, 2005 to $709,439 for the quarter ended March 31, 2006. Total
Gross Margin, as a percent of revenues, was 52.9% for the quarter ended March 31
2006 versus 60.5% in the quarter ended March 31, 2005 . The decrease was
attributable to the increased revenue from the Technology consulting Services
business, which has lower margins compared to the Technology Products business..
Gross margin is higher in the Technology product segment vs. consulting segment,
since consulting is labor intensive.
Research and Development Expenses:
Research and development expenses consist primarily of salaries and
related personnel costs, and consulting fees associated with product
development.
For the quarter ended March 31, 2006, Research and development expenses
increased to $109,134 compared to $95,147 for the quarter ended March 31, 2005.
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. Our Research and Development focuses on the
development of technologies utilizing IP telephony and IP communications
Selling, General and Administrative Expenses:
Selling, general and administrative ("SG&A") expenses consist primarily of
expenses for management, finance and administrative personnel, legal,
accounting, consulting fees, sales commissions and marketing, and facilities
costs.
For the quarter ended March 31, 2006 SG&A expenses decreased to $504,606
compared to $585,872 for the three months ended March 31, 2005. The decrease was
primarily attributable to a combination of synergy savings from integrating
SMEI, cost reductions and changes in executive compensation. The Company
incurred savings in the reduction of administrative and IT staff.
12
Derivative Expenses:
During the quarter ended March 31, 2005 the Company incurred $532,836 of
expenses related to embedded conversion features and warrants issued in
connection with a financing transaction conducted during the that quarter with
Laurus, the proceeds from which were primarily used to fund the acquisition of
SMEI. The expenses incurred from these derivative instruments are described
further in Note 5 to the accompanying unaudited consolidated financial
statements. There were no similar expenses incurred during the quarter ended
March 31, 2006.
Interest Expense:
Interest expense consists of interest paid and accrued on outstanding
convertible notes, notes payable, interest due on loans from stockholders.
Interest Expense increased to $129,870 for the three months ended March
31, 2006 compared to $105,186 for the three months ended March 31, 2005. The
increase is attributable to carrying the $2,000,000 Laurus convertible note for
the entire quarter and an increase in our revolving line of credit.
Finance Expense:
Finance expense recorded in the three months ended March 31, 2006 was
$8,043. This expense resulted from the amortization of deferred finance costs
related to the $2 million principal amount Secured Convertible Term Note issued
to Laurus.
Net Loss:
As a result of the above-described factors, the Company's net loss for the
three months ended March 31, 2006 decreased significantly to $49,676 compared to
a net loss of $789,562 for the three months ended March 31, 2005.
LIQUIDITY AND CAPITAL RESOURCES
For the three months period ended March 31, 2006, cash and cash
equivalents increased to $115,768 from $53,997 at December 31, 2005. Net cash
used by operating activities was $104,820 for the three months ended March 31,
2006 compared to net cash provided by operating activities of $273,890 in the
corresponding three month period ended March 31, 2005. This consisted of a net
loss of $49,676, an increase in our accounts receivable of $320,390,, an
increase in other assets of $39,149 partially offset by non-cash items amounting
to $129,295,(depreciation, Amortization of intangibles, derivative interest and
financing cost) a decrease in inventory of $4,106, an increase in customer
deposits of $16,111 and an increase in the Company's accounts payable and
accrued expenses of $154,883.
Net cash provided by financing activities was $166,591 for the three
months ended March 31, 2006 compared to $1,327,050 in the corresponding three
months ended March 31, 2005. During the quarter ended March 31, 2005 and in
connection with the acquisition of SMEI, and additional working capital the
Company entered into a Securities Purchase Agreement, dated February 11, 2005,
with Laurus for the sale of a $2,000,000 principal amount secured convertible
term note. For the current quarter ended March 31, 2006, the Company increased
the outstanding balance on its Revolving Credit facility by $166,591. The
revolving credit facility is based on the accounts receivable of the Company's
software consulting division. The outstanding balance on the line as of March
31, 2006 was $369,442.
Subsequent Events
On May 16, 2006, the Company entered into an agreement with Laurus,
pursuant to which, effective May 4, 2006, Laurus waived each Event of Default
pursuant to that certain Secured Convertible Term Note dated February 11, 2005
that has arisen under Section 4.1 of the Note as a result of the failure of the
Company to comply with: (i) Section 1.2 of the Note from January 1, 2006 through
May 1, 2006 (overdue principal), and (ii) Section 1.1(a) of the Note from March
1, 2006 through April 1, 2006 (overdue interest). If Laurus had not waived such
events of default, the Company would have been liable for substantial default
fees and interest of approximately $600,000 and $40,000 per month, respectively.
13
As of March 31, 2006 the Company lacked sufficient liquidity to support
the debt service on its outstanding secured convertible term note and its other
debts coming due in the next twelve months. The Company's management estimates
that as of March 31, 2006, the Company needed at least $2,500,000 of financing
to settle the outstanding secured convertible term note held by Laurus and to
provide an adequate level of working capital to support operations for the
subsequent twelve months. Towards that objective, between April 14, 2006 and May
11, 2006 the Company raised $1.4 million of gross proceeds from the sale of
common stock and warrants to purchase additional shares of common stock to
various accredited investors in private placement transactions. The Company sold
an aggregate of 23,231,733 shares of common stock and warrants to purchase
11,615,867 shares of common stock. Each unit is comprised of 100 shares and 50
warrants to purchase one shares of common stock with an exercise price of $0.12
per share exercisable for five years. Each 100 shares of common stock and one
common stock purchase warrant were sold for a per-unit price of $6.00, or $0.06
per share.
Additionally, The Company is in ongoing discussions with Laurus to
renegotiate the terms of outstanding secured convertible term note. The
Company's management believes that the Company's anticipated cash flows from
operations, the funds available from SMEI's Accounts Receivable Credit Facility
and additional funds from financing activities totaling $1.1 million together
will provide the necessary liquidity to support operations and any payments
coming due in the next twelve months. If the Company is not successful at either
renegotiating or refinancing the secured convertible term note held by Laurus or
raising the additional equity financing needed, Laurus will, among other things,
have the right to declare all sums owing to it under the secured convertible
term note immediately due and payable and it may take immediate possession of
all of our assets and all of the assets of our subsidiaries, including SMEI. If
this were to occur, we most likely would be forced to discontinue operations.
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
The financial statements have been prepared in accordance with accounting
principles generally accepted in the United States (US GAAP). The preparation of
these financial statements requires management to make estimates and assumptions
that affect the reported amounts in the financial statements and accompanying
notes. These estimates form the basis for judgments made about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Estimates and judgments are based on historical experience and on
various other assumptions that the Company believes are reasonable under the
circumstances. However, future events are subject to change and the best
estimates and judgments routinely require adjustment. US GAAP requires 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 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.
Basis of Financial Statement Presentation -The accompanying financial statements
have been prepared on a going concern basis, which contemplates the realization
of assets and the satisfaction of liabilities in the normal course of business.
The Company has generated significant losses and is unable to predict
profitability for the future. These factors indicate that the Company's
continuation, as a going concern is dependent upon its ability to obtain
adequate financing. The Company plans to address the going concern by replacing
debt with equity and continuing to grow the company with profitable sales both
organically and through acquisitions. Management believes successfully executing
these tasks will lead to the removal of the going concern comment from our
audited financials.
Principles of Consolidation- The consolidated financial statements included the
accounts of the Company and all of its subsidiaries in which a controlling
interest is maintained. All significant inter-company accounts and transactions
have been eliminated in consolidation. For those consolidated subsidiaries where
Company ownership is less than 100%, the outside stockholders' interests are
shown as minority interests.
14
ITEM 3. CONTROLS AND PROCEDURES.
As of the end of the period covered by this report, the Company conducted
an evaluation, under the supervision and with the participation of its Chief
Executive Officer and Chief Financial Officer of the Company's disclosure
controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the
Exchange Act). Based upon this evaluation, the Company's Chief Executive Officer
and Chief Financial Officer concluded that the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in the reports that it files or submits under the Exchange Act is:
(1) accumulated and communicated to the Company's management, including its
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 the Company's internal controls or in
other factors that could affect these controls during the Company's last fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, its internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company is not a party to any pending legal proceeding, nor is the
Company's property the subject of a pending legal proceeding, that is not in the
ordinary course of business or otherwise material to the financial condition of
its business. None of the Company's directors, officers or affiliates is
involved in a proceeding adverse to the Company's business or has a material
interest adverse to the Company's business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
On May 21, 2001, the Company entered into concurrent debt financing
arrangements, each bearing similar terms and conditions, with Laurus Master
Fund, Ltd. and Keshet Capital for proceeds of $1,000,000 and $400,000,
respectively. The notes bore interest at 8% and were due and payable in May
2003. The notes were convertible into the Company's common stock at 85% of the
average trading market price over a period of twenty days preceding conversion.
In addition, the notes were issued with detachable warrants to purchase 727,273
(relative to the Laurus arrangement) and 290,908 (relative to the Keshet
arrangement) shares of common stock. The warrants had terms of five years and
fixed strike prices of $1.43. The Keshet notes, which remain outstanding as of
March 31, 2006 are in default.
Until May 4, 2006, the Company was in default on a secured convertible
term note held by Laurus Master Fund, Ltd. due to the failure to make required
monthly principal payments of $60,606 due on the 1st of January, February,
March, April and May 2006 and because the required registration statement was
not declared effective. Additionally, the Company was in arrears on the March
2006 and April 2006 interest payments on the secured convertible term note
totaling $36,055. As a result, the Company was potentially liable for fees and
interest of 2% per month accruing on all outstanding obligations and 130% of the
outstanding principal if an agreement to waive the existing events of default
was not reached.
Effective May 4, 2006, Laurus Master Fund, Ltd. agreed to waive each
existing event of default under the terms of the secured convertible term note
upon receiving payment of the overdue interest of $36,055. The overdue interest
of $36,055 was paid to Laurus Master Fund, Ltd. on May 4, 2006 As a result, the
Company did not record any liabilities in the quarter ended March 31, 2006
related to default fees or penalties.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
15
ITEM 5. OTHER INFORMATION.
Not applicable.
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.
16
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
Date: May 22, 2006 By: /s/ Paul Burgess
------------------------------------
Paul Burgess
Chief Executive Officer
Date: May 22, 2006 By: /s/ Joe Noto
------------------------------------
Joe Noto
Chief Financial Officer
17