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STRIKEFORCE TECHNOLOGIES INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) CAUTION REGARDING FORWARD-LOOKING INFORMATION Included in this Report are "forward-looking" statements, within the meaning of the Private Securities Litigation Reform Act of 1995 ("PSLRA") as well as historical information. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that the expectations reflected in these forward-looking statements will prove to be correct. Our actual results could differ materially from those anticipated in forward-looking statements as a result of certain factors, including matters described in the section titled "Risk Factors." Forward-looking statements include those that use forward-looking terminology, such as the words "anticipate," "believe," "estimate," "expect," "intend," "may," "project," "plan," "will," "shall," "should," and similar expressions, including when used in the negative. Although we believe that the expectations reflected in these forward-looking statements are reasonable and achievable, these statements involve risks and uncertainties and we cannot assure you that actual results will be consistent with these forward-looking statements. We claim the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA. Such risks include, among others, the following: demand for payment of our convertible notes outstanding under which we are currently in default, our inability to obtain adequate financing to repay the convertible notes, our ability to continue financing our operations either through debt or equity offerings, international, national and local general economic and market conditions: our ability to sustain, manage or forecast our growth; material costs and availability; new product development and introduction; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; the loss of significant customers or suppliers; prospective changes to financing options due to the Jobs Act of 2012, fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other factors referenced in this filing. Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements and there can be no assurance that the actual results anticipated by management will be realized or, even if substantially realized, that they will have the expected consequences to or effects on our business operations. We undertake no obligation to update or revise these forward-looking statements, whether to reflect events or circumstances after the date initially filed or published, to reflect the occurrence of unanticipated events or except as required by the federal securities laws. Unless otherwise noted, references in this Form 10-Q to "StrikeForce" "we", "us", "our", "SFT", and the "Company" means StrikeForce Technologies, Inc., a Wyoming corporation. Background StrikeForce Technologies, Inc. is a software development and services company that offers a suite of integrated computer network security products using proprietary technology. StrikeForce Technical Services Corporation was incorporated in August 2001 under the laws of the State of New Jersey. On September 3, 2004, the stockholders approved an amendment to the Certificate of Incorporation to change the name to StrikeForce Technologies, Inc. On November 15, 2010, we redomiciled under the laws of the State of Wyoming. We initially conducted operations as an integrator and reseller of computer hardware and telecommunications equipment and services until December 2002. In December 2002, and formally memorialized in September 2003, we acquired certain intellectual property rights and patent pending technology from NetLabs.com including the rights to further develop and sell their principal technology. In addition, certain officers of NetLabs.com joined our company as officers and directors of our company. We subsequently changed our name to StrikeForce Technologies, Inc., under which we have conducted our business since August 2003. Our strategy is to develop and market our suite of network security products to the corporate, financial, healthcare, government, technology, insurance, e-commerce and consumer sectors. We plan to grow our business primarily through our globally expanding network and internally generated sales, rather than by acquisitions. We have no subsidiaries and we conduct our operations from our corporate office in Edison, New Jersey. We own the exclusive right to license and develop various identification protection software products to protect computer networks from unauthorized access and to protect network owners and users from identity theft. We have developed a suite of products partly based upon this exclusive license that is targeted to the financial, e-commerce, corporate, government, healthcare, insurance,, technology and consumer sectors. 34 -------------------------------------------------------------------------------- We began our operations in 2001 as a reseller and integrator of computer hardware and iris biometric technology. From the time we started our operations through the first half of 2003, we derived the majority of our revenues as an integrator. In December 2002, upon the acquisition of the licensing rights to certain intellectual property and patent pending technology from NetLabs.com, we shifted the focus of our business to developing and marketing our own suite of security products. Based upon the acquired licensing rights and additional research and development, we have developed various identification protection software products to protect computer networks from unauthorized access and to protect network owners and users from identity theft. In November 2010, we received notice that the United States Patent Office ("USTPO") had issued an official Notice of Allowance for the patent application for the technology relating to our ProtectID® product, titled "Multi-Channel Device Utilizing a Centralized Out-of-Band Authentication System". In January 2011, we received notice that the United States Patent Office issued the Company Patent No. 7,870,599. The "Out-of-Band" Patent went through a USTPO Re-Examination process starting on August 16, 2011 and concluded on December 27, 2011, with all of our patent claims remaining intact and seven additional Company patent claims being added. In 2011, we submitted an additional continuation patent on the "Out-of-Band" Patent, with another sixty-six additional Company claims now pending. The technology we developed and use in our GuardedID® product is the subject of a pending patent application. In December 2011, we executed an exclusive agreement with an agent to represent us in enforcing the "Out-of-Band" Patent. We terminated that exclusive agreement in September 2012. We shall be enforcing our patent rights and our management has taken the initial steps concerning such enforcement as recommended by our patent attorneys. We completed the development of our ProtectID® platform at the end of June 2006 and we completed the core development of our keyboard encryption and anti-keylogger product, GuardedID®, in December 2006, with continuous enhancements, which is currently being sold and distributed. We seek to locate customers in a variety of ways. These include contracts primarily with value added resellers and distributors (both inside the United States and internationally), direct sales calls initiated by our internal staff, exhibitions at security and technology trade shows, through the media, through consulting agreements, and through our own and agent relationships. Our sales generate revenue either as an Original Equipment Manufacturer ("OEM") model, through a Hosting/License agreement, bundled with other company's products or through direct purchase by customers. We price our products for cloud consumer transactions based on the number of transactions in which our software products are utilized. We also price our products for business applications based on the number of users. We believe that these pricing models provide our company with one-time, monthly, quarterly and yearly recurring revenues. We are also generating revenues from annual maintenance contracts, renewal fees and expect, but cannot guarantee, an increase in revenues based upon the execution of various agreements that we have recently closed and are being implemented. In October 2010, we executed an agreement to pursue a funding opportunity through a consulting company that, through an executed Memorandum of Understanding, purports to provide funding to us over time, necessary to sustain the Company while current contracts for business revenues develop and increase to a sustainable level. Other multiple alternative funding options had not progressed to viable proposals or did not close because of their expressed high risk level associated with our secured lenders, large debt positions and low revenues. A requirement of this funding source, utilizing an equity funding approach, required us to re-domicile in the State of Wyoming in order for this project to move forward in a necessary timeframe and at a necessary low cost to the Company. In November 2010, we received the corporate registration, amended articles of incorporation and by-laws as a result of our re-domiciling in the State of Wyoming. We generated all of our revenues of $642,596, for the nine months ended September 30, 2012, compared to $286,695 for the nine months ended September 30, 2011, from the sales of our security products. We market our products globally to financial service firms, healthcare related companies, e-commerce companies, government agencies, the enterprise market in general and with virtual private network companies, as well as technology service companies that service all the above markets. We seek such sales through our own direct efforts and primarily through distributors, resellers and third party agents internationally. We are also seeking to license the technology as original equipment with computer hardware and software manufacturers. We are engaged in production installations and pilot projects with various distributors, resellers and direct customers, as well as having reached additional reseller agreements with strategic vendors internationally, including South America, Europe, Asia, Africa and the Pacific Rim. Our GuardedID® product is also being sold directly to consumers, primarily through the Internet as well as distributors, resellers, third party agents and potential OEM agreements by bundling GuardedID® with their products (providing a value-add to their own products and offerings). We have incurred substantial losses since our inception. Our management believes that our products provide a cost-effective, more secure and technologically competitive solution to address the problems of network security and identity theft in general. However, there can be no assurance that our products will continue to gain increased acceptance and continue to grow in the commercial marketplace or that one of our competitors will not introduce technically superior products. Our executive office is located at 1090 King Georges Post Road, Suite 603, Edison, NJ 08837. Our telephone number is (732) 661-9641. We have 7 employees. Our Company's website is www.strikeforcetech.com. We are not including the information contained in our website as part of, or incorporating it by reference into, this Report on Form 10-Q. 35 -------------------------------------------------------------------------------- Business Model We are focusing primarily on developing sales through "channel" relationships in which our products are offered by other manufacturers, distributors, value-added resellers and agents, internationally. In 2010, we added and publicly announced a major channel distributor who provides a presence for us in London, England, representing us in the European Union. We also sell our suite of security products directly from our Edison, NJ office, which also augments our channel partner relationships. It is our strategy that these "channel" relationships will provide the greater percentage of our revenues ongoing, as was the case in 2011. Examples of the channel relationships that we are seeking include already established original equipment manufacturer ("OEM") and bundled relationships with other security technology and software providers that would integrate or bundle the enhanced security capabilities of ProtectID® and or GuardedID® into their own product lines, thereby providing greater value to their clients. These would include providers of networking software and manufacturers of computer and telecommunications hardware and software that provide managed services, as well as all markets interested in increasing the value of their products and packages, such as financial services software, anti-virus, government integrators and identity theft product companies. Our primary target markets include financial services such as banks, insurance companies, e-commerce based services companies, telecommunications and cellular carriers, technology software companies, healthcare related companies, government agencies and consumers. For the near term, we are focusing our concentration on the identity theft and data breach strategic problem areas, such as where compliance with government regulations are key and stolen passwords are used to acquire private information illegally. In the fourth quarter of 2011, we executed a multi-year contract with a major US financial lender who utilizes our ProtectID® solution for its over 12,000,000 employees, administrators and consumers. The contract became revenue producing in the fourth quarter of 2011. In the first quarter of 2012, we executed a multi-year contract with a healthcare facility who utilizes our ProtectID® solution for its employees and administrators. The contract became revenue producing in the first quarter of 2012. In addition, we signed a major contract during the second quarter of 2012 with a branded digital signature service company with clients in financial services and technology services for the government, that is required to include two-factor authentication with a bias on Out-of-Band Authentication. This implementation is planned, but not guaranteed, to be revenue producing in 2012 with increasing recurring revenues. Because we are now experiencing a continual recurring growing market demand, we are developing a sizeable global reseller and distribution channel as a strategy to generate, manage and fulfill demand for our products across market segments, minimizing the requirement for an increase in our staff. We have minimized the concentration on our initial direct sales efforts as our distribution and reseller channels continue to grow internationally and require appropriate levels of support. We seek to generate revenue through fees for ProtectID® based on consumer usage in the financial and healthcare services markets, as well as enterprises in general, through our Cloud Service, plus one-time and annual per person fees in the enterprise markets which often are for local installations of our product, and set-up and recurring transaction fees when the product is accessed in our Cloud Service, along with yearly maintenance fees, and other one-time and recurring fees. We also intend to generate revenues through sales of our GuardedID® product. GuardedID® pricing is for an annual license and we discount for volume purchases. GuardedID® pricing models, especially when bundling through OEM contracts, include monthly and quarterly recurring revenues. As more agreements are reached by our distributors, we are experiencing monthly increasing sales growth, through the execution of GuardedID® bundled OEM agreements. We also provide our clients a choice of operating our ProtectID® software internally by licensing it or through our hosted Cloud Service or a hybrid that some clients have implemented. GuardedID® requires a download on each and every computer it protects, whether for employees or consumers. We have three GuardedID® products, (i) a standard version which protects browser data entry only, (ii) a premium version which protects almost all the applications running under Microsoft Windows on the desktop, including Microsoft Office Suite and (iii) an Enterprise version which provides the Enterprise administrative rights and the use of Microsoft's Enterprise tools for the product's deployment. Our management believes that our products provide a cost-effective and technologically competitive solution to address the problems of network security and identity theft in general. Updated guidance for the Federal Financial Institutions Examination Council ("FFIEC") regulations include the requirement for solutions that have Two-Factor Out-of-Band Authentication and products that stop keylogging malware, real time, which our management believes our proprietary products uniquely and directly address. This new updated guidance went into effect as of January 1, 2012. Based on this new requirement in the latest FFIEC update that was published in June 2011 and now being enforced as of January 2012, we have recently experienced a growing increase in sales orders and inquiries. However, there can be no assurance that our products will continue to gain acceptance and continue to grow in the commercial marketplace or that one of our competitors will not introduce technically superior products. 36 -------------------------------------------------------------------------------- Marketing Our multi-channel marketing strategy includes: 1. Direct sales to enterprise and commercial customers. In this effort, we are purchasing marketing programs, a new strategy for us, and we are looking at other inside sales alternatives in order to respond aggressively to inquiries relating to our products. 2. The global addition of resellers, agents & distributors (our strategic sales channel) who distribute and resell our products and services to enterprise and commercial customers (technology and software product distributors, systems integrators, managed service companies, other security technology and software vendors, telecom companies, identity theft related product companies, etc.). 3. Application Service Provider (ASP) Partners: Our certified SAS 70 third party service provides a hosting platform that facilitates faster implementations at competitive prices for our Cloud Service option. 4. Original Equipment Manufacturers (OEM): SFT products are sold to other security technology vendors that integrate ProtectID® and GuardedID® into their products (bundling) and services providing for monthly increasing recurring revenues. 5. Internet sites that sell GuardedID® to consumers and small enterprises, such as affiliates. Our hosting service provider is Host My Site and we have been under contract with them since December 2007 when we executed an agreement with a nationwide premier data center and co-location services provider who functions as an Application Service Provider for our ProtectID product, which requires a secondary server used for the "Out-of-Band" two-factor authentication technology. We believe that this relationship improves the implementation time, reduces the cost and training requirements, and allows for ease of scalability on an as needed basis. The hosting site is also SAS 70 (Statement on Auditing Standards (SAS) No. 70,) certified, which is critical to providing a secure compliant service that is required by most of our clients. Our agreement with the services provider was for a one-year (1) term, initially ending in December 2008 and renewing automatically for one-year (1) terms, and is still in effect. The relationship can be terminated by either party on sixty days written notice. The hosting service is compensated by our Company based on a flat monthly fee per the terms of the contract that can increase as we require additional services. Intellectual Property In December 2011, we executed an exclusive agreement with an agent to represent us in enforcing the "Out-of-Band" patent. We terminated that exclusive agreement in September 2012. We shall be enforcing our patent rights and our management has taken the initial steps concerning such enforcement as recommended by our patent attorneys. Our firewall product, which was in the research and design phase, is no longer being developed; therefore, the pending provisional patent application was allowed to expire. A fourth patent application relating to our ProtectID® product was combined into the first ProtectID® patent application and the fourth application was allowed to lapse. We have three trademarks that have been approved and registered: ProtectID®, GuardedID® and CryptoColor®. We have two trademarks that are in the application process: ID Genie™ and MobileTrust™. A portion of our software is licensed from third parties and the remainder is developed by our own team of developers while leveraging some limited external consultant expertise as necessitated. We rely upon confidentiality agreements signed by our employees, consultants and third parties to protect the intellectual property rights. We license technology from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. We anticipate that we will continue to license technology from third parties in the future. Although we are not substantially dependent on any individual licensed technology, some of the software that we license from third parties could be difficult for us to replace. The effective implementation of our products depends upon the successful operation of third-party licensed products in conjunction with our suite of products, and therefore any undetected errors in these licensed products could create delays in the implementation of our products, impair the functionality of our products, delay new product introductions, damage our reputation, and/or cause us to provide substitute products. 37 -------------------------------------------------------------------------------- Business Strategy We expect to incur significant additional costs before we become profitable. We anticipate that most of the costs that we incur will be related to salaries, professional fees, marketing, sales and research & design. We anticipate that we will increase our sales force by approximately one full-time employee and our technology staff by approximately two employees during the next twelve months. At the present time, our monthly cash expenditure burn rate is approximately $110,000 per month. We expect that our monthly cash usage for operations will increase in the future due to contracted and anticipated increased volumes and the preceding additions. We anticipate that the area in which we will experience the greatest increase in operating expenses is in marketing, selling, advertising, payroll related to sales and product support, technology and global strategic business consulting subject to cash availability. Our primary strategy over the next 12 months is to focus on the growth and support of our channel partners, including distributors, resellers and original equipment manufacturers (OEMs). Secondly, our internal sales team will target potential direct sales in industries that management believes provides the greatest potential for sales. These include small to medium sized financial institutions, government agencies, e-commerce, healthcare and enterprise businesses. We are also executing agreements with strategic resellers and distributors for marketing, selling and supporting our products internationally. It is our intention to ultimately utilize distributors, resellers and agents to generate the bulk of our sales internationally, realizing that this strategy will take time to nurture. There can be no assurance, however, that we will succeed in implementing our sales strategy. Although management believes that there is an increasingly strong market for our products, we have not generated substantial revenue from the sale of our principal products and there is no assurance we can secure a market sufficient to permit us to achieve profitability in the next twelve months. Competition The software development and services market is characterized by innovation and competition. There are several well-established companies within this market that offer network security systems and newer companies with emerging technologies. We believe that our patented "Out-of-Band" two-factor identity authentication product is an innovative, secure, adaptable, competitively priced, integrated network authentication system. The main features of ProtectID® include: an open architecture "Out-of-Band" platform for user authentication; operating system independence; biometric layering; mobile authentication; secure website logon; Virtual Private Network ("VPN") access; domain authentication and multi-level authentication. Unlike other techniques for increased network security, ProtectID® does not rely on a specific authentication device or method (e.g., phone, tokens, smart cards, digital certificates or biometrics, such as a retinal or fingerprint scan). Rather ProtectID® has been developed as an "open platform" that incorporates many authentication devices and methods. For example, once a user has been identified to a computer network, a system deploying our ProtectID® authentication system permits the "Out-of-Band" authentication of that user by a telephone, iPhone, iPad, Blackberry, PDA, email, hard token, SSL client software, a biometric device such as a fingerprint scan, or others, before that user is permitted to access the network. By using "Out-of-Band" authentication methods, management believes that ProtectID® provides a competitive product for customers with security requirements greater than typical name and password schemes for virtual private networks and computer systems with multiple users at remote locations, as examples. We also believe that our keystroke encryption product, GuardedID®, offers an additional competitive edge for network security and e-commerce applications that should provide greater levels of security and the ability to evolve over time based on newer technologies when made available. Both products have limited competition based on our product's ability to protect individual identities and computers/devices. Although we believe that our suite of products offer competitive advantages, there is no assurance that any of these products will gain acceptance in the marketplace. Our competitors include established software and hardware companies that are likely to be better financed and to have established sales channels. Due to the high level of innovation in the software development industry, it is also possible that a competitor will introduce a product that provides a higher level of security than the ProtectID® products or which can be offered at prices that are more advantageous to the customer. 38 -------------------------------------------------------------------------------- Results of Operations FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2011 Our revenues for the three months ended September 30, 2012 were $289,515 compared to $137,535 for the three months ended September 30, 2011, an increase of $151,980 or 111%. The increase in revenues was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® ("Out-of-Band") technology. Our revenues generated consisted of hardware and software sales, services and maintenance sales, revenues from sign on fees, and recurring transaction revenues. Hardware sales for the three months ended September 30, 2012 were $0 compared to $5,211 for the three months ended September 30, 2011, a decrease of $5,211. The decrease in hardware revenues was primarily due to the decrease in the sales of our one-time-password token key-fobs. Software, services and maintenance sales for the three months ended September 30, 2012 were $289,515 compared to $132,324 for the three months ended September 30, 2011, an increase of $157,191. The increase in software, services and maintenance revenues was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® ("Out-of-Band") technology. Our cost of revenues for the three months ended September 30, 2012 was $1,029 compared to $5,179 for the three months ended September 30, 2011, a decrease of $4,150, or 80.1%. The decrease resulted primarily from the overall increase in our software product revenues which entail a reduced cost of sales as compared with revenues that include hardware purchases and the decrease in the sales of our one-time-password token key-fobs. Cost of revenues as a percentage of total revenues for the three months ended September 30, 2012 was 0.36% compared to 3.8% for the three months ended September 30, 2011. The decrease resulted primarily from the overall increase in our software product revenues which entail a reduced cost of sales as compared with revenues that include hardware purchases. Our gross profit for the three months ended September 30, 2012 was $288,486 compared to $132,356 for the three months ended September 30, 2011, an increase of $155,950, or 118%. The increase in gross profit was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® ("Out-of-Band") technology. Our research and development expenses for the three months ended September 30, 2012 were $78,000 compared to $97,500 for the three months ended September 30, 2011, a decrease of $19,500, or 20.0%. The decrease was primarily attributable to the decrease in time expended by our research and development personnel. The salaries, benefits and overhead costs of personnel conducting research and development of our software products comprise research and development expenses. Our selling, general and administrative ("SGA") expenses for the three months ended September 30, 2012 were $258,578 compared to $1,065,892 for the three months ended September 30, 2011, a decrease of $807,314 or 75.7%. The decrease was due primarily to expenses in stock based compensation through the issuance of employee and non-employee stock options in the third fiscal quarter of 2011 in the amount of $823,875. Selling, general and administrative expenses consist primarily of salaries, benefits and overhead costs for executive and administrative personnel, insurance, fees for professional services, including consulting, legal, and accounting fees, plus travel costs and non-cash stock compensation expense for the issuance of stock to non-employees and other general corporate expenses. Our other expense for the three months ended September 30, 2012 was $214,010 as compared to $100,799 for the three months ended September 30, 2011, representing an increase in other expense of $113,211, or 112%. The increase was primarily due to an increase in interest expense and the change in the fair value of the derivatives relating to a portion of our secured and unsecured convertible debenture balance. Our net loss for the three months ended September 30, 2012 was $262,102 compared to a net loss of $1,131,835 for the three months ended September 30, 2011, a decrease of $869,733, or 76.8%. The decrease in our net loss was due primarily to expenses in stock based compensation through the issuance of employee and non-employee stock options in the third fiscal quarter of 2011, in addition to increased gross profit in the third fiscal quarter of 2012. 39 -------------------------------------------------------------------------------- FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2011 Our revenues for the nine months ended September 30, 2012 were $642,596 compared to $286,695 for the nine months ended September 30, 2011, an increase of $355,901 or 124%. The increase in revenues was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® ("Out-of-Band") technology. Our revenues generated consisted of hardware and software sales, services and maintenance sales, revenues from sign on fees, and recurring transaction revenues. Hardware sales for the nine months ended September 30, 2012 were $6,067 compared to $10,305 for the nine months ended September 30, 2011, a decrease of $4,238. The decrease in hardware revenues was primarily due to the decrease in the sales of our one-time-password token key-fobs. Software, services and maintenance sales for the nine months ended September 30, 2012 were $636,529 compared to $144,066 for the nine months ended September 30, 2011, an increase of $492,463. The increase in software, services and maintenance revenues was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® ("Out-of-Band") technology. Our cost of revenues for the nine months ended September 30, 2012 was $13,050 compared to $19,038 for the nine months ended September 30, 2011, a decrease of $5,988, or 3.2%. The decrease resulted primarily from the overall increase in our software product revenues which entail a reduced cost of sales as compared with revenues that include hardware purchases and the decrease in the sales of our one-time-password token key-fobs. Cost of revenues as a percentage of total revenues for the nine months ended September 30, 2012 was 2.0% compared to 6.6% for the nine months ended September 30, 2011. The decrease resulted primarily from the overall increase in our software product revenues which entail a reduced cost of sales as compared with revenues that include hardware purchases. Our gross profit for the nine months ended September 30, 2012 was $629,546 compared to $267,657 for the nine months ended September 30, 2011, an increase of $361,889, or 135%. The increase in gross profit was primarily due to the increase in the sales of our GuardedID® keyboard encryption (anti-keylogger) technology and our ProtectID® ("Out-of-Band") technology. Our research and development expenses for the nine months ended September 30, 2012 were $253,500 compared to $260,669 for the nine months ended September 30, 2011, a decrease of $7,169, or 2.8%. The decrease was primarily attributable to the decrease in time expended by our research and development personnel. The salaries, benefits and overhead costs of personnel conducting research and development of our software products comprise research and development expenses. Our selling, general and administrative ("SGA") expenses for the nine months ended September 30, 2012 were $855,541 compared to $4,297,635 for the nine months ended September 30, 2011, a decrease of $3,442,094 or 80.1%. The decrease was due primarily to the non-recurrence of one-time expense in stock based compensation through the issuance of preferred stock in the first fiscal quarter of 2011 in the amount of $987,000 and expenses in stock based compensation through the issuance of employee and non-employee stock options in the first, second and third fiscal quarters of 2011 in the amount of $1,960,875. The parties receiving the irrevocably preferred stock waived all conversion rights to such preferred stock. Selling, general and administrative expenses consist primarily of salaries, benefits and overhead costs for executive and administrative personnel, insurance, fees for professional services, including consulting, legal, and accounting fees, plus travel costs and non-cash stock compensation expense for the issuance of stock to non-employees and other general corporate expenses. Our other expense for the nine months ended September 30, 2012 was $415,522 as compared to $396,295 for the nine months ended September 30, 2011, representing an increase in other expense of $19,227, or 4.9%. The increase was primarily due to an increase in interest expense and the change in the fair value of the derivatives relating to a portion of our secured and unsecured convertible debenture balance. Our net loss for the nine months ended September 30, 2012 was $895,017 compared to a net loss of $4,686,942 for the nine months ended September 30, 2011, a decrease of $3,791,925, or 80.9%. The decrease in our net loss was due primarily to the non-recurrence of one-time expense in stock based compensation through the issuance of preferred stock in the first fiscal quarter of 2011 and expenses in stock based compensation through the issuance of employee and non-employee stock options in the first fiscal quarter of 2011, in addition to increased gross profit in fiscal 2012. The parties receiving the irrevocable preferred stock waived all conversion rights to such preferred stock. 40 -------------------------------------------------------------------------------- Liquidity and Capital Resources Our total current assets at September 30, 2012 were $377,100, which included cash of $228,884, as compared with $87,744 in total current assets at December 31, 2011, which included cash of $0. Additionally, we had a stockholders' deficit in the amount of $10,481,556 at September 30, 2012 compared to a stockholders' deficit of $10,262,227 at December 31, 2011. We have historically incurred recurring losses and have financed our operations through loans, principally from affiliated parties such as our directors, and from the proceeds of debt and equity financing. The liabilities include a computed liability for the fair value of derivatives of $568,867, which will only be realized on the conversion of the derivatives, or settlement of the debentures. We financed our operations during the nine months ended September 30, 2012 primarily through the sale and issuance of debt, in the amount of $353,000, through the sale of our common stock, in the amount of $430,000, and through recurring revenues from our ProtectID® hosting platform and license fees, and sales of our GuardedID® keystroke encryption technology, in the amount of $642,596. Management anticipates that we will continue to rely on equity and debt financing, at least in the near future, to finance our operations. While management believes that there will be a substantial percentage of our sales generated from our GuardedID® product and there are an increasing number of customers for our ProtectID® product, we will continue to have customer concentrations. Inherently, as time progresses and corporate exposure in the market continues to grow, with increasing marketing efforts, management believes, but cannot guarantee, we will continue to attain greater numbers of customers and the concentrations could decrease over time. Until this is accomplished, management will continue to attempt to secure additional financing through both the public and private market sectors to meet our continuing commitments of expenditures and until our sales revenue can provide greater liquidity. Our number of common shares outstanding increased from 221,388,354 shares at the year ended December 31, 2011 to 294,253,293 at the nine months ended September 30, 2012, an increase of 32.9%. The increase in the number of common shares outstanding was due to common shares issued related to the issuance, conversion and settlement of debt, equity financing and consulting obligations, which, consequently, reduced our total debt. We have historically incurred losses and we anticipate that we will not generate any significant revenues until the fourth quarter of 2012 or later. Our operations presently require funding of approximately $110,000 per month. Management believes we will be cash flow positive by the end of 2012, or shortly thereafter, based on recently executed and announced contracts and potential contracts that we anticipate closing throughout 2012 in the financial industry, technology, insurance, enterprise, healthcare, government, and consumer sectors in the United States, Latin America, Europe, Africa and the Pacific Rim. There can be no assurance, however, that the sales anticipated will materialize or that we will achieve the profitability we have forecasted. Management also recognizes the consequences of the current world economic developments and the possible volatile effect on currency rates resulting from revenues derived from foreign markets. DRAWDOWN EQUITY FINANCING AGREEMENT On April 13, 2012, we entered into a Drawdown Equity Financing Agreement, together with a Registration Rights Agreement, with Auctus Private Equity Fund, LLC ("Auctus"), the selling stockholder. In October 2012, we elected to withdraw our Form S-1/A registration statement and terminate the Drawdown Equity Financing Agreement with Auctus. SUMMARY OF OUR OUTSTANDING SECURED CONVERTIBLE DEBENTURES At September 30, 2012, $542,588 in aggregate principal amount of the DART Limited ("DART"), custodian for Citco Global Custody NV ("Citco Global") as of July 2012, debentures, as assigned by YA Global and Highgate in April 2009, were issued and outstanding. During the nine months ended September 30, 2012, DART had no conversions. The DART secured convertible debentures are fully matured. We have been in contact with the note holder who has indicated that it has no present intention of exercising its right to convert the debentures into restricted shares of our common stock. The note holder has advised us that it currently is willing to wait until it receives a buyout offer from us. 41 -------------------------------------------------------------------------------- During the nine months ended September 30, 2012, we issued unsecured convertible notes in an aggregate total of $353,000 to two unrelated parties per the terms of a term sheet executed with investor firms in November 2011, April 2012 and July 2012. Additionally, during the nine months ended September 30, 2012, an investor firm converted $40,000 of the convertible note dated December 5, 2011 into 10,243,847 unrestricted shares of our common stock pursuant to an exemption provided under Regulation D of the Securities Act of 1933, as discussed below. The conversion price was $0.005622 per share for 2,668,089 shares and $0.0033 per share for 7,575,758 shares. Since the unsecured convertible note arose greater than six months and, as no additional consideration was paid in the notice of conversion by the investor firm, the conversion was tacked back to the original date of the issuance of the note as the holding period under SEC Rule 144(d)(3)(ii) resulting in the issuance of unrestricted shares. Additionally, during the nine months ended September 30, 2012, we repaid a total of $500 of unsecured convertible notes to one unrelated party. During the nine months ended September 30, 2012, we repaid a total of $10,401 of unsecured notes to one unrelated party and we settled a total of $70,000 of unsecured notes held by one unrelated party in exchange for unrestricted shares of our common stock. Summary of Funded Debt As of September 30, 2012, our Company's open unsecured promissory note balance was $2,374,765, net of discount on promissory notes of $1,598, listed as follows: · $18,750 to an unrelated individual - current portion · $275,000 to an unrelated individual - current portion · $85,113 to an unrelated company - current portion · $210,000 to an unrelated company - current portion · $1,650,000 to twenty unrelated individuals through term sheet with the StrikeForce Investor Group - current portion · $137,500 to an unrelated company - current portion As of September 30, 2012, our Company's open unsecured related party promissory note balances were $722,638, listed as follows: · $722,638 to our CEO - current portion As of September 30, 2012, our Company's open convertible secured note balances were $542,588, listed as follows: · $542,588 to DART (custodian for Citco Global and as assigned in 04/09 by YA Global and Highgate House Funds, Ltd.) As of September 30, 2012 our Company's open convertible note balances were $1,308,942, net of discount on convertible notes of $272,825, listed as follows: · $235,000 to an unrelated company (03/05 unsecured debenture) - current portion · $7,000 to an unrelated company (06/05 unsecured debenture) - current portion · $10,000 to an unrelated individual (06/05 unsecured debenture) - current portion · $40,000 to three unrelated individuals (07/05 unsecured debentures) - current portion · $48,255 to an unrelated individual (01/06 unsecured debenture) - current portion · $200,000 to an unrelated individual (06/06 unsecured debenture) - current portion · $150,000 to an unrelated individual (09/06 unsecured debenture) - current portion · $3,512 to an unrelated individual (02/07 unsecured debenture) - current portion · $100,000 to an unrelated individual (05/07 unsecured debenture) - current portion · $100,000 to an unrelated individual (06/07 unsecured debentures) - current portion · $100,000 to an unrelated individual (07/07 unsecured debenture) - current portion · $120,000 to three unrelated individuals (08/07 unsecured debentures) - current portion · $50,000 to two unrelated individuals (12/09 unsecured debentures) - current portion · $30,000 to an unrelated company (03/10 unsecured debenture) - long term portion · $35,000 to un unrelated company (12/11 unsecured debenture) - current portion · $150,000 to un unrelated company (01/12 unsecured debenture) - current portion · $75,000 to un unrelated company (03/12 unsecured debenture) - current portion · $53,000 to un unrelated company (04/12 unsecured debenture) - current portion · $32,500 to un unrelated company (05/12 unsecured debenture) - current portion · $42,500 to un unrelated company (07/12 unsecured debenture) - current portion 42 -------------------------------------------------------------------------------- As of September 30, 2012 our Company's open convertible note balances - related parties were $360,500, listed as follows: · $268,000 to our CEO - current portion · $57,500 to our VP of Technical Services - current portion · $30,000 to a relative of our CTO & one of our Software Developers - current portion · $5,000 to a relative of our former CFO - current portion Based on present revenues and expenses, we are unable to generate sufficient funds internally to sustain our current operations. We must raise additional capital or determine other borrowing sources to continue our operations. It is management's plan to seek additional funding through the sale of common stock, the sale and settlement of trade payables and debentures, and the issuance of notes and debentures, including notes and debentures convertible into common stock. If we issue additional shares of common stock, the value of shares of existing stockholders is likely to be diluted. However, the terms of the convertible secured debentures issued to certain of the existing stockholders require that we obtain the consent of such stockholders prior to our entering into subsequent financing arrangements. No assurance can be given that we will be able to obtain additional financing, that we will be able to obtain additional financing on terms that are favorable to us or that the holders of the secured debentures will provide their consent to permit us to enter into subsequent financing arrangements. Our future revenues and profits, if any, will primarily depend upon our ability, and that of our distributors and resellers, to secure sales of our suite of network security and anti-malware products. We do not presently generate significant revenue from the sales of our products. Although management believes that our products are competitive for customers seeking a high level of network security, we cannot forecast with any reasonable certainty whether our products will gain acceptance in the marketplace and if so by when. Except for the limitations imposed upon us respective to the convertible secured debentures of DART (custodian for Citco Global and as assigned by YA Global and Highgate House Funds, Ltd.), there are no material or known trends that will restrict either short term or long-term liquidity. Off-Balance Sheet Arrangements We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, result of operations, liquidity or capital expenditures. Going Concern The report of our independent registered public accounting firm on our annual financial statements contains explanatory language that substantial doubt exists about our ability to continue as a going concern The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates continuity of operations, realization of assets, and liquidation of liabilities in the normal course of business. As reflected in the accompanying financial statements, we had a working capital deficiency of $10,477,624 and $10,177,078 and deficits in stockholders' equity of $10,481,556 and $10,262,227 at September 30, 2012 and December 31, 2011, respectively, and net losses of $895,017 and $4,686,942 and net cash used in operating activities of $502,004 and $639,681 for each of the nine-month periods then ended. These factors raise substantial doubt about our ability to continue as a going concern. Currently, management is attempting to increase revenues and improve gross margins by a revised sales strategy. In principle, we are redirecting our sales focus from direct sales to domestic and international channel sales, where we are primarily selling through a channel of Distributors, Value Added Resellers, Strategic Partners and Original Equipment Manufacturers. While we believe in the viability of our strategy to increase revenues and in its ability to raise additional funds, there can be no assurances to that effect. Our ability to continue as a going concern is dependent upon our ability to continually increase our customer base and realize increased revenues from recently signed contracts. The financial statements do not include any adjustments related to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern. 43 -------------------------------------------------------------------------------- Critical Accounting Policies See Notes to the Financial Statements. Recently Issued Accounting Pronouncements Refer to Note 2 in the accompanying interim financial statements. Additional Information You are advised to read this Form 10-Q in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Quarterly Reports on Form 10-Q, Annual Reports on Form 10-K, Registration Statement on Form S-1 and Current Reports on Form 8-K that we file from time to time. You may obtain copies of these reports directly from us or from the SEC at the SEC's Public Reference Room at 100 F. Street, N.E. Washington, D.C. 20549, and you may obtain information about obtaining access to the Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains information for electronic filers at its website http://www.sec.gov. |