Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2009
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-15864
SEDONA Corporation
(Exact name of small business issuer as specified in its charter)
PENNSYLVANIA | 95-4091769 | |
(State or other jurisdiction of | (IRS Employer | |
incorporation or organization) | Identification No.) | |
1003 W. 9th Avenue, Second Floor, King of Prussia, PA | 19406 | |
(Address of principal executive offices) | (Zip Code) |
Issuer’s telephone number, including area code (610) 337-8400.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o Noþ.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o Noþ.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months(or for such shorter period that the registrant was required to submit and post such files. YES o NOo.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filero | Accelerated filero | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting companyþ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) YES o NOþ.
As of November 9, 2009 there were 127,364,064 shares outstanding of the registrant’s common stock, par value $0.001 per share.
SEDONA CORPORATION AND SUBSIDIARIES
INDEX
PAGE | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
7 | ||||||||
8-21 | ||||||||
22-32 | ||||||||
33 | ||||||||
33 | ||||||||
34 | ||||||||
34 | ||||||||
34 | ||||||||
34 | ||||||||
34 | ||||||||
34 | ||||||||
35 | ||||||||
36 | ||||||||
CERTIFICATIONS | 37-40 | |||||||
EX-31.1 | ||||||||
EX-31.2 | ||||||||
EX-32.1 | ||||||||
EX-32.2 |
2
Table of Contents
NOTE ON FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended. Forward-looking statements are statements other than historical information or statements of current condition. Some forward-looking statements may be identified by use of terms such as “may”, “will”, “should”, “could”, “would”, “plan”, “estimates”, “projects”, “predicts”, “potential” “believes”, “anticipates”, “intends”, “expects” or similar expressions. These forward-looking statements relate to the plans, objectives, and expectations of SEDONA® Corporation (the “Company”, “SEDONA Corp.”, “SEDONA”, “we”, “us” or “our”) for future operations. In light of the risks and uncertainties inherent in all forward-looking statements, the inclusion of such statements in this Form 10-Q should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved or that any of the Company’s operating expectations will be realized. The Company’s revenues and results of operations are difficult to forecast and could differ materially from those projected in the forward-looking statements contained herein as a result of certain factors including, but not limited to, dependence on strategic relationships, ability to raise additional capital, ability to attract and retain qualified personnel, customer acquisition and retention and rapid technological change. These factors should not be considered exhaustive; the Company undertakes no obligation to release publicly the results of any future revisions it may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
3
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENT
SEDONA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 101 | $ | 34 | ||||
Accounts receivable | 802 | 410 | ||||||
Prepaid expenses and other current assets | 13 | 62 | ||||||
Total current assets | 916 | 506 | ||||||
Accounts receivable, non-current | 718 | 474 | ||||||
Property and equipment, net | 16 | 13 | ||||||
Other non-current assets | 3 | 3 | ||||||
Total non-current assets | 737 | 490 | ||||||
Total assets | $ | 1,653 | $ | 996 | ||||
Liabilities and stockholders’ deficit | ||||||||
Current liabilities: | ||||||||
Current maturities of long-term debt, net of discount | $ | 7,308 | $ | 2,000 | ||||
Accounts payable | 624 | 663 | ||||||
Accrued litigation expenses | 634 | 622 | ||||||
Accrued expenses and other current liabilities | 1,404 | 2,061 | ||||||
Deferred and unearned revenue | 1,119 | 882 | ||||||
Total current liabilities | 11,089 | 6,228 | ||||||
Long-term debt, less current maturities | — | 2,280 | ||||||
Deferred and unearned revenue | 718 | 474 | ||||||
Total long-term liabilities | 718 | 2,754 | ||||||
Total liabilities | 11,807 | 8,982 | ||||||
Stockholders’ (deficit): | ||||||||
Class A convertible preferred stock (liquidation preference $1,000) | ||||||||
Authorized shares — 1,000,000 | ||||||||
Series A, par value $2.00, Issued and outstanding shares — 500,000 | 1,000 | 1,000 | ||||||
Common stock, par value $0.001 | ||||||||
Authorized shares —175,000,000, Issued and outstanding shares — 127,364,064 and 101,004,818 in 2009 and 2008, respectively | 127 | 101 | ||||||
Additional paid-in-capital | 73,155 | 71,274 | ||||||
Accumulated deficit | (84,436 | ) | (80,361 | ) | ||||
Total stockholders’ deficit | (10,154 | ) | (7,986 | ) | ||||
Total liabilities and stockholders’ deficit | $ | 1,653 | $ | 996 | ||||
See accompanying notes to condensed consolidated financial statements
4
Table of Contents
SEDONA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
Three Months Ended | ||||||||
September 30, | ||||||||
2009 | 2008 | |||||||
Revenues: | ||||||||
Product licenses | $ | 106 | $ | 94 | ||||
Services | 228 | 213 | ||||||
Total revenues | 334 | 307 | ||||||
Cost of revenues: | ||||||||
Services | 84 | 67 | ||||||
Total cost of revenues | 84 | 67 | ||||||
Gross profit | 250 | 240 | ||||||
Expenses: | ||||||||
General and administrative | 281 | 453 | ||||||
Litigation expenses | 10 | 232 | ||||||
Sales, marketing and customer services | 214 | 100 | ||||||
Research and development | 95 | 115 | ||||||
Total operating expenses | 600 | 900 | ||||||
Loss from operations | (350 | ) | (660 | ) | ||||
Other expense: | ||||||||
Interest expense | (1,123 | ) | (167 | ) | ||||
Total other expense | (1,123 | ) | (167 | ) | ||||
Net loss | (1,473 | ) | (827 | ) | ||||
Deemed dividends applicable to preferred stockholders | (30 | ) | (30 | ) | ||||
Loss applicable to Common Stockholders | $ | (1,503 | ) | $ | (857 | ) | ||
Basic and diluted net loss per share applicable to common shares | $ | (0.01 | ) | $ | (0.01 | ) | ||
Basic and diluted weighted average common shares outstanding | 127,335,691 | 100,441,516 | ||||||
See accompanying notes to condensed consolidated financial statements
5
Table of Contents
SEDONA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
Nine Months Ended | ||||||||
September 30, | ||||||||
2009 | 2008 | |||||||
Revenues: | ||||||||
Product licenses | $ | 304 | $ | 442 | ||||
Services | 643 | 639 | ||||||
Total revenues | 947 | 1,081 | ||||||
Cost of revenues: | ||||||||
Services | 295 | 154 | ||||||
Total cost of revenues | 295 | 154 | ||||||
Gross profit | 652 | 927 | ||||||
Expenses: | ||||||||
General and administrative | 889 | 1,063 | ||||||
Litigation expenses | 25 | 696 | ||||||
Sales, marketing and customer services | 668 | 404 | ||||||
Research and development | 240 | 414 | ||||||
Total operating expenses | 1,822 | 2,577 | ||||||
Loss from operations | (1,170 | ) | (1,650 | ) | ||||
Other expense: | ||||||||
Interest expense | (2,905 | ) | (493 | ) | ||||
Loss on extinguishment of debt | — | (247 | ) | |||||
Total other expense | (2,905 | ) | (740 | ) | ||||
Net loss | (4,075 | ) | (2,390 | ) | ||||
Deemed dividends applicable to preferred stockholders | (90 | ) | (90 | ) | ||||
Loss applicable to Common Stockholders | $ | (4,165 | ) | $ | (2,480 | ) | ||
Basic and diluted net loss per share applicable to common shares | $ | (0.04 | ) | $ | (0.02 | ) | ||
Basic and diluted weighted average common shares outstanding | 116,079,891 | 99,691,479 | ||||||
See accompanying notes to condensed consolidated financial statements
6
Table of Contents
SEDONA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands, except share and per share data)
(Unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands, except share and per share data)
(Unaudited)
Nine Months Ended | ||||||||
September 30, | ||||||||
2009 | 2008 | |||||||
Net cash used in operating activities | (1,554 | ) | $ | (815 | ) | |||
Investing activities: | ||||||||
Purchase of equipment | (7 | ) | (6 | ) | ||||
Net cash used in investing activities | (7 | ) | (6 | ) | ||||
Financing activities: | ||||||||
Proceeds from other non-current liabilities | — | 535 | ||||||
Proceeds from the line of credit | — | 160 | ||||||
Proceeds from sale of common stock, net | 3 | 108 | ||||||
Proceeds from the exercise of stock options | — | 9 | ||||||
Proceeds from issuance of short-term note | 1,625 | — | ||||||
Net cash provided by financing activities | 1,628 | 812 | ||||||
Net increase/(decrease) in cash and cash equivalents | 67 | (9 | ) | |||||
Cash and cash equivalents, beginning of period | 34 | 49 | ||||||
Cash and cash equivalents, end of period | $ | 101 | $ | 40 | ||||
See accompanying notes to condensed consolidated financial statements | ||||||||
Supplemental Disclosures of Cash Flow Information | ||||||||
Cash paid during period for interest | $ | 1 | $ | 18 | ||||
Supplemental Disclosures of Non-Cash Financing Activities | ||||||||
Beneficial conversion on debt issuance | $ | 975 | $ | — | ||||
Forgiveness of OSI litigation liability | $ | 846 | $ | — | ||||
7
Table of Contents
SEDONA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note #1:General
The accompanying condensed consolidated balance sheet as of September 30, 2009, the condensed consolidated statements of income for the three and nine months ended September 30, 2009 and September 30, 2008, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2009 and September 30, 2008 are unaudited and include the accounts of SEDONA Corporation and subsidiaries (“SEDONA” or the “Company”). All significant intercompany transactions and balances have been eliminated.
The condensed consolidated financial statements included herein for the nine months ended September 30, 2009 and 2008 are unaudited. In the opinion of Management, all adjustments (consisting of normal recurring accruals) have been made which are necessary to present fairly the financial position of the Company in accordance with accounting principles generally accepted in the United States. The results of operations experienced for the nine month period ended September 30, 2009 are not necessarily indicative of the results to be experienced for the year ending December 31, 2009.
The financial statements of the Company have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Accordingly, the financial statements do not include any adjustment that might be necessary should the Company be unable to continue in existence. In addition to the loss of $4,075,000, which includes non-cash charges of $2,377,000 related to the restructuring of debt obligations realized during the nine months ended September 30, 2009, the Company incurred substantial losses from operations for the year ended December 31, 2008 of approximately $5,313,000 which includes non-cash charges of $2,455,000 related to the restructuring of debt obligations and $1,010,000 for litigation expenses related to a contract dispute with Open Solutions, Inc. The Company also has negative working capital of $10,173,000 and stockholders’ deficit of $10,154,000 as of September 30, 2009. These factors raise substantial doubt about the Company’s ability to continue as a going concern.
The Company will require additional working capital during the next twelve months and beyond as we continue (i) our research and development efforts; (ii) expand our marketing and sales activities; and (iii) hire additional personnel across all disciplines to support our revenue growth and continued market acceptance of our services. For the Company to meet its business objectives, highly qualified personnel of the requisite caliber must be recruited and retained. The addition of this experienced staff will require substantial increases to the employee stock purchase plan.
The Company’s plans include: (i) continuing to develop a direct sales staff to increase our market penetration and increase our average price per sale; (ii) expanding our sales distribution agreements with service organizations for the financial services market; (iii) fostering the existing OEM partnerships with leading core system providers by promoting corporate-wide adoption of our technologies; and (iv) introducing new product and services for improving financial performance at each stage of the customer and institutional lifecycle.
The Company plans to pursue additional fundraising activities with existing and potential new investors. Our plans include raising additional capital through public or private sale of equity or debt securities, debt financing, short-term loans, or a combination of the foregoing. In addition, the Company is currently evaluating the options to best restructure its existing debt obligations in order to attract additional investment in combination with assessing other synergistic opportunities with the goal of improving the Company’s balance sheet and liquidity position. There can be no assurances that the Company will succeed in its plan to obtain any such financing or that additional financing will be available when needed or that, if available, financing will be obtained on terms acceptable to the
8
Table of Contents
Company and our stockholders. In addition, if we raise additional funds through the issuance of equity securities, dilution to our existing shareholders would likely result.
The statements and related notes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted pursuant to such rules and regulations. The accompanying notes should therefore be read in conjunction with the Company’s December 31, 2008 annual financial statements included in the Company’s Annual Report on Form 10-K filed on April 16, 2009.
Certain amounts from the prior year financial statements have been reclassified to conform to the current year presentation. Current maturities of long-term debt in the amount of $8,000 were reclassified to accrued expenses for the period ended December 31, 2008. This reclassification had no effect on the Company’s consolidated net loss or stockholders’ deficit.
We have evaluated subsequent events through November 16, 2009, which is the date these financial statements were issued.
Note #2:Property and Equipment
Property and equipment consists of:
Nine Months Ending | Year Ending | |||||||
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Machinery and equipment | $ | 86 | $ | 78 | ||||
Leasehold improvements | 15 | 15 | ||||||
Purchased software for internal use | 35 | 35 | ||||||
136 | 128 | |||||||
Less accumulated depreciation and amortization | 120 | 115 | ||||||
$ | 16 | $ | 13 | |||||
Note #3:Stockholders’ Equity and Other Financing Activities
Issuance of Stock for Professional Services:
During the nine months ended September 30, 2009, the Company issued 629,419 shares of its common stock to a consultant in lieu of approximately $47,000 cash compensation for professional services rendered during 2009 and 2008.
In addition, the Company issued 450,000 shares of its common stock to Marco A. Emrich, the Company’s former President and CEO, who resigned his positions at the Company effective September 17, 2008. Under the terms of the separation agreement dated January 31, 2009, Mr. Emrich was entitled to receive, in addition to certain cash compensation, 450,000 shares of unrestricted common stock at a fair market value of $0.07 per share or $31,500.
The Company also issued 25,254,781 shares of its common stock to David R. Vey. On December 31, 2008, Mr. Vey elected to convert $495,216 of principal due on a convertible note and $767,523 of related accrued interest into shares of common stock at a rate of $0.05 per share.
9
Table of Contents
Issuance of Stock Pursuant to Employee Stock Purchase Plan
In April 2009, the Company issued 25,046 shares of its common stock to employees under the Employee Stock Purchase Plan. The contribution was valued at approximately $2,700.
Note #4:Major Customer Transactions and Geographic Information
Since a portion of the Company’s sales are derived from our relationships with our strategic business partners, the Company’s accounts receivable and revenues are derived from a limited number of customers or OEM partners. Consequently, the Company’s trade accounts receivables and revenues are generally concentrated and any customer/partner may account for more than 10% of the total accounts receivable or revenue derived during any given quarter.
For the nine months ended September 30, 2009 and 2008, the Company had obtained net revenues from significant customers/OEM distribution partners as follows:
September 30, 2009 | September 30, 2008 | |||||||
OEM distribution partner A | 27 | % | 35 | % | ||||
OEM distribution partner B | 13 | % | — |
As of September 30, 2009 and December 31, 2008, the Company had accounts receivable from significant customers/OEM accounts as follows:
September 30, 2009 | December 31, 2008 | |||||||
OEM distribution partner A | 24 | % | 28 | % | ||||
OEM distribution partner B | 47 | % | 45 | % |
Substantially, all of the Company’s revenues are from customers in the United States and all long-lived assets are located in the United States.
Note # 5:Earnings Per Share
Earnings Per Share requires a dual presentation of basic and diluted earnings/loss per common share. Basic earnings/loss per common share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the year. Diluted loss per common share is computed assuming the conversion of common stock equivalents when dilutive. For the quarter ended September 30, 2009, the Company’s common stock equivalents, consisting of warrants to purchase 22,408,940 shares of common stock, preferred stock and debt convertible into 132,254,928 common shares, and options to purchase 2,982,598 shares of common stock issued under the 2000 Incentive Stock Option Plan, were not included in computing diluted loss per share because their effects were anti-dilutive. For the quarter ended September 30, 2008, the Company’s common stock equivalents, consisting of warrants to purchase 12,516,600 shares of common stock, preferred stock and debt convertible into 33,284,834 common shares, and options to purchase 3,755,450 shares of common stock issued under the 2000 Incentive Stock Option Plan, were not included in computing diluted loss per share because their effects were anti-dilutive.
Note # 6:Litigation
On May 5, 2003, SEDONA filed a civil action lawsuit against numerous defendants in the United States District Court for the Southern District of New York. The Company sought damages from the defendants named, and other defendants yet to be named, in the complaint for allegedly participating in the manipulation of its common stock, fraud, misrepresentation, failure to exercise fiduciary responsibility, and/or failure to adhere to SEC trading rules and regulations, tortuous interference, conspiracy and other actions set forth in the complaint.
On March 27, 2009, the Honorable Judge Laura Swain, a federal judge in the United States District Court for the Southern District of New York, issued an opinion dismissing several of the defendants from the
10
Table of Contents
civil action lawsuit filed by SEDONA on May 5, 2003. SEDONA was granted the right and has filed a third amended petition against the remaining defendants and is aggressively pursuing these claims. On May 1, 2009, Amro International, S.A., Rhino Advisors, Inc., Roseworth Group., LTD., and Cambois Finance, Inc., all defendants in the May 5, 2003 action, filed suit against SEDONA and several of its former directors in Federal Court in the Southern District of New York alleging breach of a settlement agreement seeking unspecified damages and attorney’s fees and expenses. The suit is being vigorously defended by SEDONA and its former directors. The outcome of litigation proceedings is inherently uncertain and there is no assurance that the Company will prevail in either of these matters.
On September 28, 2006, SEDONA filed a civil action lawsuit against Open Solutions Inc. (OSI), in Montgomery County Court in Pennsylvania for breach of a software license agreement entered into between the parties in May, 2002. In the lawsuit, the Company alleges that since September 2004, OSI has failed to pay royalty payments required under the parties’ master software license and services agreement for licensed products and services sold by OSI to its customers. OSI removed the case to federal court and successfully moved for a change in venue from the United States District Court for the District of Pennsylvania to the United States District Court for the District of Connecticut. SEDONA filed an amended complaint after the case was transferred to the District of Connecticut, case no. 3:07-cv-171. In its amended complaint, SEDONA seeks a declaration and damages relating to OSI’s failure to pay royalties under the agreement for its sales of the cView product operating on the .NET platform and for breach of the agreement’s confidentiality provision. OSI served an amended answer with counterclaims asserted against SEDONA for declaratory relief and breach of contract. Discovery was completed and each party has moved for summary judgment. The parties participated in oral argument before the Court concerning the summary judgment motions on September 19, 2009.
In a ruling filed August 19, 2009, the court denied SEDONA’s motion for summary judgment on claims that OSI was required to pay royalties on the sale of the cView product and that failure to pay such royalties and disclosure of confidential information to the offshore development company constituted a breach of contract. Further, the court denied OSI’s motion for summary judgment on claims that SEDONA was in breach of contract for demanding royalty payments, while accepting OSI’s claim that cView was a license enhancement not subject to royalties (see Note 8).
No actions other than the matters set forth above or matters involved in the ordinary course of business are currently known by Management and such other matters are believed by Management not to have material significance.
Note #7:Debt Obligations
Long-term debt consists of the following (in thousands):
September 30, 2009 | December 31, 2008 | |||||||
Oak Harbor note | $ | 1,040 | $ | 1,040 | ||||
$4,100 consolidated convertible note with David Vey, dated December 31, 2008, net of discount of $640 and $2,460, respectively | 3,460 | 1,640 | ||||||
$1,625 convertible note with David Vey, dated December 31, 2008, net of discount of $417 | 1,208 | — | ||||||
Convertible note with William Rucks | 1,000 | 1,000 | ||||||
Convertibles notes with Rucks & Mitchell | 600 | 600 | ||||||
Total debt obligations | 7,308 | 4,280 | ||||||
Less current maturities | 7,308 | 2,000 | ||||||
Long-term debt | $ | — | $ | 2,280 | ||||
11
Table of Contents
The Company has entered into the following financing agreements to provide working capital with Mr. David R. Vey, Chairman of the Board of Directors.
David Vey and Oak Harbor
Oak Harbor Note
As part of a refinancing of certain obligations to Oak Harbor Investment Properties, LLC (“Oak Harbor”), the Company issued a promissory note to Oak Harbor dated August 17, 2006 in the principal amount of $1,040,402 (the “Oak Harbor Note”). Oak Harbor is a limited liability corporation in which David Vey and Richard T. Hartley are managing members. The Oak Harbor Note had a maturity date of May 1, 2009, at which time all outstanding principal and interest were due. The Oak Harbor Note bears interest at a rate of eight percent (8%) per year. Effective March 11, 2009, the Oak Harbor Note was amended and the note is payable as follows: $400,000 of principal due on November 15, 2009; $640,402 of principal plus accrued interest will be due on May 15, 2010.
Convertible Note with David Vey
The Company refinanced its existing debt obligations with David Vey on December 31, 2008. As part of the refinancing, the Company issued to Mr. Vey a consolidated secured convertible promissory note, dated December 31, 2008, in the principal amount $4,100,000 (the “New Convertible Note”). The New Convertible Note has a maturity date of January 4, 2010, unless theretofore converted, and bears interest at the rate of eight percent (8%) per year, which interest will be due upon maturity. Mr. Vey has the option to convert, at any time, all or part of the unpaid principal and accrued but unpaid interest of the New Convertible Note into shares of Company common stock at a conversion price of $0.05 per share. The number of shares which would be issuable upon the conversion of the $4,100,000 principal balance of the New Convertible Note is presently 82,000,000. The New Convertible Note is secured by substantially all of the assets of the Company, pursuant to the terms of a Security Agreement between Mr. Vey and the Company, dated October 23, 2006.
Since the fair value of the Company’s common stock was $0.08 per share on December 31, 2008, the intrinsic value of the beneficial conversion feature for the difference between the fair value per share and the conversion price was $2,460,000. The Company began accreting this debt discount to interest expense over the one year term of the New Convertible Note, commencing January 1, 2009. For the three and nine months ended September 30, 2009, the Company recorded accretion of the debt discount of approximately $620,000 and $1,820,000 respectively.
The New Convertible Note contains certain mandatory prepayment provisions. In the event that the Company receives total net proceeds from (i) sales of the Company’s securities (other than to Mr. Vey and his affiliates) and (ii) litigation awards exceeding $1,000,000; or in the event that the Company maintains current cash on hand in excess of $2,000,000 for a period exceeding thirty (30) days, an amount equal to fifty percent of such proceeds or cash shall be paid by the Company to Mr. Vey as a mandatory prepayment.
12
Table of Contents
Convertible Note with Vey Associates
On December 31, 2008, the Independent Committee recommended to the Board of Directors that the Company enter into a new agreement to borrow up to $2,250,000 from Vey Associates (the “New Loan”). Vey Associates has agreed to fund the New Loan in five (5) installments as follows:
(i) | the first installment in the amount of $100,000 on or before December 31, 2008; | ||
(ii) | the second installment on or before January 15, 2009, in the amount of $300,000; | ||
(iii) | the third installment on or before March 18, 2009, in the amount of $600,000; | ||
(iv) | the fourth installment on or before May 1, 2009 in the amount of $750,000; and | ||
(v) | the fifth installment on or before September 30, 2009 in the amount of $500,000. |
Payment of the fifth installment is subject to the Company achieving a certain profitability level, referred to as “EBITDA Break Even”, at the end of the third quarter of Fiscal year 2009.
The Company received $1,625,000 under the New Loan during the nine months ended September 30, 2009.
The New Loan is evidenced by a secured convertible promissory note having a principal amount of up to $2,250,000 (the “Vey Associates Convertible Note”). The Vey Associates Convertible Note has a maturity date of January 4, 2010, unless theretofore converted, and bears interest at the rate of eight percent (8%) per year, which interest will be due upon maturity. Once $1,750,000 of the New Loan has been paid to the Company, Vey Associates has the option to convert all or part of the unpaid principal and accrued but unpaid interest of the Vey Associates Convertible Note into shares at a conversion price of $0.05 per share. The number of shares which would be issuable upon the conversion of the $2,250,000 principal balance is presently 45,000,000.
The fair value of the Company’s common stock was $0.08 per share on December 31, 2008, the commitment date. The intrinsic value of the beneficial conversion feature which is the difference between the fair value per share and the conversion price aggregated for the $1,625,000 of funding received under the note was $975,000. The Company will accrete this debt discount to interest expense over the term of the note depending on when the funding was received. For the three and nine months ended September 30, 2009, the Company recorded accretion of the debt discount in the amount of approximately $321,000 and $558,000, respectively.
The Vey Associates Convertible Note contains certain mandatory prepayment provisions. In the event that total net proceeds received by the Company from (i) sales of Company securities (other than to Mr. Vey and his affiliates) and (ii) litigation awards exceed $1,000,000; or the Company maintains current cash on hand in excess of $2,000,000 for a period exceeding thirty (30) days, an amount equal to fifty percent of such proceeds or cash shall be paid by the Company to Vey Associates as a mandatory prepayment.
The Vey Associates Convertible Note is secured by substantially all of the assets of the Company pursuant to a Security Agreement dated December 31, 2008 between the Company and Vey Associates (the “Vey Associates Security Agreement”).
13
Table of Contents
Amended and Restated Intercreditor Agreement
Mr. Vey, Vey Associates, the Company and Oak Harbor Investment Properties, LLC (“Oak Harbor”), a company in which Mr. Vey is a managing member and 35% owner, entered into an Amended and Restated Intercreditor Agreement, dated December 31, 2008 (the “Intercreditor Agreement”). The Intercreditor Agreement provides (i) that Oak Harbor shall have a first priority interest in substantially all of the assets of the Company with regard to the obligations of SEDONA to Oak Harbor under an existing promissory note and related security agreement, and (ii) that the security interests of Vey Associates under the Vey Associates Convertible Note shall be junior to those of Oak Harbor but senior to those of Mr. Vey.
Security Agreement
The Oak Harbor Note is secured by substantially all of the assets of the Company pursuant to an Amended and Restated Security Agreement dated August 17, 2006 between the Company and Oak Harbor (the “Amended Security Agreement”). The Amended Security Agreement amends and restates the Security Agreement between Oak Harbor and the Company effective January 13, 2003 which granted to Oak Harbor a lien and security interest in the assets of the Company (the “Oak Harbor Security Agreement”). The changes to the Security Agreement were effected by the Amended and Restated Security Agreement which include: (i) the modification of the term “Obligations” to mean all of the obligations, indebtedness, and liabilities of the Company to Oak Harbor and Vey; (ii) the acknowledgement and consent of Oak Harbor to the grant of a subordinate security interest in the assets of the Company set forth in the Amended Security Agreement (the “Collateral”) to Vey; and (iii) the modification of Appendix A to the Security Agreement to reflect the current outstanding permitted liens in the Collateral and references the subordinate security interest to the Collateral granted to Vey pursuant to the Security Agreement between the Company and Vey dated October 23, 2006 (the “Vey Security Agreement”).
Cross Default Provisions of the Notes
The New Consolidated Notes contain cross default provisions. Consequently an event of default under any of the Notes would constitute an event of default under each of the Notes. An event of default under the Notes will also have occurred if a default occurs under any other loan, extension of credit, security right, instrument, document, agreement or obligation from the Company to Vey or Oak Harbor.
Approval for Additional Shares
The Articles of Incorporation of the Company provides for 175,000,000 of which 127,364,064 were issued and outstanding as of September 30, 2009. At the present time, the Company does not have sufficient authorized shares to issue all of the shares to Mr. Vey required upon full conversion of notes and exercise of options and warrants. The Company intends to seek approval of its shareholders for an amendment to its Articles of Incorporation to increase its authorized shares by at least an amount necessary to cover its share issuance obligations at its next annual shareholders’ meeting. Mr. Vey and Vey Associates have agreed to refrain from converting any notes or exercising any options or warrants which they respectively hold until the Company has a sufficient number of authorized shares in exchange for an agreement by the Company to allow Vey Associates to pledge the Vey Associates Convertible Note or Mr. Vey to pledge the New Convertible Note in the future.
14
Table of Contents
Rucks and Mitchell
Charles F. Mitchell (“Mitchell”) extended a loan to the Company, which was evidenced by a convertible promissory note dated May 31, 2006, in the principal amount of $300,000, with a conversion price of $0.20 per share (the “Mitchell Convertible Note”). William Rucks (“Rucks”) extended several loans to the Company which were evidenced by the following convertible promissory notes: (i) note dated July 1, 2005 in the principal sum of $250,000; (ii) note dated August 2, 2005 in the principal sum of $250,000; and (iii) $500,000 note dated September 29, 2005 and (iv) a note in the amount of $300,000 dated May 31, 2006 (collectively the “Rucks Notes”). The Notes designated as (i), (ii), and (iii) each had a conversion price of $0.18 per share, while the note designated as (iv) had a conversion price of $0.20 per share. The Notes designated as (i), (ii), and (iii), in the total sum of $1,000,000 shall mature and are payable on January 1, 2009, unless theretofore converted. The two $300,000 convertible notes shall mature and are payable on October 23, 2009, unless theretofore converted. The convertible notes bear interest on the principal outstanding at a rate of 8% per year, annually in arrears, from the date of the convertible notes until the earlier of maturity or the date upon which the unpaid balance is paid in full or is converted into shares of common stock. The investors may, at their option, at any time after each loan, elect in writing to convert all or a designated part of the unpaid principal balance, together with the accrued and unpaid interest, of each convertible note into shares. The conversion price for principal is protected by full-ratchet anti-dilution, with the exception of stock and stock options issued to the Company’s employees and directors only. As additional consideration, the investors shall be granted one (1) four-year warrant for every two (2) shares able to be converted. The exercise prices of the warrants range from $0.30 to $0.35 per share.
Pursuant to the Rucks Convertible Note and the Mitchell Convertible Note, Rucks and Mitchell were granted the option to convert the unpaid principal balance and accrued unpaid interest on their notes into Shares of the Company. The respective conversion prices are subject to adjustment under certain circumstances. The issuance of the Vey Convertible Note triggered such an adjustment. At the request of the Company, Rucks and Mitchell have agreed to waive their rights to have the conversion price set forth in their respective convertible notes adjusted. Evidence of such waiver is contained in certain Waivers dated as of October 23, 2006 from Rucks to the Company and from Mitchell to the Company.
The Company is currently in negotiations with Mr. Rucks to modify the agreement to extend the maturity date of the $1,000,000 in notes payable and related accrued interest which was due January 1, 2009. The Company is currently in default of its obligations. There are no specific penalty provisions related to a default event included in the convertible notes.
Interest Expense
Interest expense consists of the following (in thousands):
Three months ending | Three months ending | |||||||
September 30, 2009 | September 30, 2008 | |||||||
Interest expense on principal | $ | 182 | $ | 162 | ||||
Non-cash amortization of debt discount, convertible notes | 941 | 5 | ||||||
Total | $ | 1,123 | $ | 167 | ||||
Nine months ending | Nine months ending | |||||||
September 30, 2009 | September 30, 2008 | |||||||
Interest expense on principal | $ | 528 | $ | 461 | ||||
Non-cash amortization of debt discount, convertible notes | 2,377 | 32 | ||||||
Total | $ | 2,905 | $ | 493 | ||||
15
Table of Contents
Note #8:Related Party Transaction
David Vey and OSI Litigation
On September 4, 2007, SEDONA entered into an agreement with Vey Associates, Inc. in which Vey Associates agreed to provide funding to assist SEDONA in the payment of certain fees and expenses related to the lawsuit captioned Sedona Corp. v. Open Solutions, Inc., (“OSI”)Action No. 3:07-CV-00171-VLB (the “litigation”), in the United States District Court for the District of Connecticut. David Vey, the Chairman and a shareholder of SEDONA, is an officer, director and majority shareholder of Vey Associates, Inc.
Under the agreement, Vey Associates will advance up to $750,000 to SEDONA to pay fees and expenses in connection with the litigation. Any proceeds received from the settlement, verdict or other conclusion of the litigation will be first applied to repay Vey Associates and SEDONA for expenses incurred. Thereafter, SEDONA will receive twenty-five (25%) percent of any proceeds and Vey Associates will receive seventy-five (75%) percent of the proceeds. In the event that SEDONA is unsuccessful in the litigation and does not receive any litigation proceeds, it will have no obligation to repay any sums to Vey Associates. All amounts advanced by Vey Associates to SEDONA shall accrue interest at a rate of ten (10%) percent per year.
In a ruling filed August 19, 2009, as more fully described in Note 6, the court denied SEDONA’s motion for summary judgment. In accordance with the terms of the litigation support agreement, the Company had no obligation to repay any sums to Vey Associates and reclassified approximately $846,000 of principal and accrued interest to additional paid in capital.
David Vey and Oak Harbor
In addition, as more fully described in Note 7, the Company completed transactions with David R. Vey, the Company’s Chairman of its Board of Directors and Oak Harbor related to the consolidation and refinancing of certain indebtedness to David R. Vey.
Note # 9:Stock Options & Warrants
The Company recorded total compensation expense of $3,447 and $6,363 respectively, for share-based payments for the nine months ended September 30, 2009 and 2008. As of September 30, 2009, the total expense impact of the non-vested awards is approximately $5,000 and will be recognized over a weighted-average period of 1.10 years.
Stock Option Plan
During 2000, the stockholders of the Company approved the 2000 Incentive Stock Option Plan (the “2000 Plan”). The 2000 Plan has replaced the 1992 Long-Term Incentive Plan (the “1992 Plan”) under which no further options will be issued. Significant provisions of the 2000 Plan include: reserving 20% of the outstanding shares for awards that may be outstanding at any one time, rather authorizing restricted stock, deferred stock, stock appreciation rights, performance awards settleable in cash or stock, and other types of awards based on stock or factors influencing the value of stock; adding provisions so that options and other performance-based awards will qualify for tax deductions; and, specifying obligations relating to non-competition and proprietary information that may be imposed on optionees. The term of each Award under the 2000 Plan shall be for such period as may be determined by the Compensation Committee of the Board of Directors which administers such plan, but generally, in no event shall the term exceed a period of ten (10) years from the date of grant. Options issued under the 2000 Plan are considered outstanding until they are exercised and any other award is outstanding in the calendar year in which it is granted and for so long thereafter as it remains such to any vesting condition required by continuing employment. The Compensation Committee shall determine the term of each option, the
16
Table of Contents
circumstances under which an award may be exercised in whole or in part (including based on achievement of performance goals and/or future service requirements), the methods by which such exercise price may be paid or deemed to be paid, the form of such payment, including without limitation, cash, stock, other awards or awards granted under other plans of the Company and any subsidiary, or other property and the methods by or forms in which stock will be delivered or deemed to be delivered to participants.
Options
Options outstanding under the 1992 Plan and the 2000 Plan have been granted to Officers, Directors, employees and others, and expire between November 2009 and August 2016. All options were granted at or above the fair market value of the underlying common stock on the grant date. Transactions under these Plans were as follows:
Weighted | ||||||||||||||
Average Value of | ||||||||||||||
Weighted | remaining | Aggregate intrinsic | ||||||||||||
Average | contractual terms | value of in-the- | ||||||||||||
Shares | Exercise Price | (years) | money options | |||||||||||
Stock Options: | ||||||||||||||
Outstanding at December 31, 2008 | 3,260,452 | $ | 0.46 | 3.11 | — | |||||||||
Canceled or expired | (277,854 | ) | 0.96 | — | — | |||||||||
Granted | — | — | — | — | ||||||||||
Exercised | — | — | — | — | ||||||||||
Outstanding at September 30, 2009 | 2,982,598 | 0.41 | 2.87 | — | ||||||||||
Exercisable at September 30, 2009 | 2,922,598 | 0.41 | 2.85 | — |
The following table summarizes information about stock options outstanding at September 30, 2009:
Ranges | Total | |||||||||||||||
Range of exercise prices | $ | 0.15 to $1.03 | $ | 1.35 to $1.72 | $ | 3.16 to $5.13 | $ | 0.15 to $5.13 | ||||||||
Options outstanding | 2,784,598 | 145,000 | 53,000 | 2,982,598 | ||||||||||||
Weighted average remaining contractual life (years) | 4.08 | 0.32 | 0.52 | 2.87 | ||||||||||||
Weighted average exercise price | $ | 0.29 | $ | 1.56 | $ | 3.33 | $ | 0.41 | ||||||||
Exercisable | 2,724,598 | 145,000 | 53,000 | 2,922,598 | ||||||||||||
Weighted average exercise price | $ | 0.30 | $ | 1.56 | $ | 3.33 | $ | 0.41 |
17
Table of Contents
Warrants
Warrants outstanding have been granted to Officers, Directors, Stockholders and others to purchase common stock at prices ranging from $0.07 to $1.53 per share and expiring between November 2009 and December 2012. All warrants were granted at or above the fair market value of the underlying common stock on the grant date. Transactions under the plan were as follows:
Weighted | ||||||||||||||||
Average Value of | ||||||||||||||||
Weighted | remaining | Aggregate intrinsic | ||||||||||||||
Average | contractual terms | value of in-the- | ||||||||||||||
Shares | Exercise Price | (years) | money warrants | |||||||||||||
Warrants: | ||||||||||||||||
Outstanding at December 31, 2008 | 22,679,690 | $ | 0.19 | 2.25 | $ | 126,274 | ||||||||||
Canceled or expired | (270,750 | ) | 1.75 | — | — | |||||||||||
Granted | — | — | — | — | ||||||||||||
Outstanding at September 30, 2009 | 22,408,940 | 0.18 | 1.70 | $ | 126,274 | |||||||||||
Exercisable at September 30, 2009 | 22,408,940 | 0.18 | 1.70 | $ | 126,274 |
The following table summarizes information about common stock warrants outstanding at September 30, 2009
Ranges | Total | |||||||||||||||
Range of exercise prices | $ | 0.07 to $0.35 | $ | 0.51 to $0.91 | $ | 1.03 to $1.53 | $ | 0.07 to $1.53 | ||||||||
Outstanding | 21,966,720 | 214,570 | 227,650 | 22,408,940 | ||||||||||||
Weighted average remaining contractual life (years) | 1.73 | 2.31 | 0.94 | 1.70 | ||||||||||||
Weighted average exercise price | $ | 0.16 | $ | 0.72 | $ | 1.18 | $ | 0.18 | ||||||||
Exercisable | 21,966,720 | 214,570 | 227,650 | 22,408,940 | ||||||||||||
Weighted average exercise price | $ | 0.16 | $ | 0.72 | $ | 1.18 | $ | 0.18 |
The Company estimates the fair value of each common stock option and warrant to purchase common stock at the grant date by using the Black-Scholes option-pricing model. No assumptions are listed for 2009, as no options or warrants have been issued during the nine months ended September 30, 2009.
All warrants issued and outstanding are classified in equity.
Note #10:Recent Accounting Pronouncements
In September 2009, the Company adopted ASC Topic 105-10-05 (“ASC 105-10-05”), which provides for the FASB Accounting Standards Codification™ (the “Codification”) to become the single official source of authoritative, nongovernmental U.S. generally accepted accounting principles (“GAAP”) to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. The Codification does not change GAAP, but combines all authoritative standards into a comprehensive, topically organized online database. ASC 105-10-05 explicitly recognizes rules and interpretative releases of the Securities and Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. Subsequent revisions to GAAP will be incorporated into the ASC through Accounting Standards Updates (“ASU”). ASC 105-10-05 is effective for interim and annual periods ending after September 15, 2009, and was effective for the Company in the third quarter of 2009. The adoption of ASC 105-10-05 impacted the Company’s financial statement disclosures, as all references to authoritative accounting literature were updated to and in accordance with the Codification. The adoption of ASC 105-10-05 did not have a material impact on the Company’s consolidated results of operations and financial condition.
18
Table of Contents
In September 2006, the FASB issued an accounting standard codified within ASC Topic 820, “Fair Value Measurements and Disclosures.” This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. This standard was effective for fiscal years beginning after November 15, 2007, and all interim periods within those fiscal years. In February 2008, the FASB delayed the effective date of this standard for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. The implementation of this standard for financial assets and liabilities, effective January 1, 2008, and for non-financial assets and non-financial liabilities, effective January 1, 2009, did not have a material impact on the Company’s consolidated financial position and results of operations.
In December 2007, the FASB issued an accounting standard codified within ASC Topic 805, “Business combinations,” which changed the accounting for business acquisitions. This standard establishes principles and requirements for how the acquirer recognizes and measures assets acquired and liabilities assumed in a business combination, as well as, goodwill acquired and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of a business combination. In April 2009, the FASB issued an accounting standard codified within ASC Topic 805 which amends the provisions related to the initial recognition and measurement, subsequent measurement, and disclosure of assets and liabilities from contingencies in a business combination. The standard requires that contingent assets acquired and liabilities assumed be recognized at fair value on the acquisition date if the fair value can be reasonably estimated. If the fair value cannot be reasonably estimated, the contingent asset or liability would be measured in accordance with ASC Topic 450 “Contingencies.” Both standards were effective for the Company as of January 1, 2009 and did not have an impact on the Company’s condensed consolidated financial statements since the Company did not consummate any acquisitions in the nine months ended September 30, 2009.
In December 2007, the FASB issued an accounting standard codified with ASC Topic 810, “Consolidation.” This standard requires that a non-controlling interest in a subsidiary be reported as equity and that the amount of consolidated net income attributable to the parent and to the non-controlling interest should be separately identified in the consolidated financial statements. The Company has applied the provisions of this standard prospectively, as of January 1, 2009, except for the presentation and disclosure requirements, which were applied retrospectively for all periods presented. The adoption of this standard did not have an impact on the Company’s consolidated financial statements.
In March 2008, the FASB issued an accounting standard related to disclosures about derivative instruments and hedging activities, codified within ASC Topic 815, Derivatives and Hedging.” This new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of this standard, effective January 1, 2009, did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued an accounting standard codified within ASC Topic 820, “Fair Values Measurements and Disclosures,” which provides additional guidance in determining whether a market is active or inactive and whether a transaction is distressed. It is applicable to all assets and liabilities that are measured at fair value and requires enhanced disclosures. This standard is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. The adoption of this standard in the second quarter of 2009 did not have a material impact on the Company’s consolidated financial statements.
19
Table of Contents
In April 2009, the FASB issued an accounting standard codified within ASC Topic 825, “Financial Instruments,” that requires disclosures of the fair value of financial instruments that are not reflected in the consolidated balance sheet at fair value whenever summarized information for interim reporting periods are presented. This standard requires disclosure of the methods and significant assumptions used to estimate the fair value of financial instruments and describe the changes in methods and significant assumptions, if any, during the period. This standard is effective for interim reporting periods ending after June 15, 2009. Because this standard applies only to financial statement disclosure, the adoption did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued an accounting standard codified within ASC Topic 320, “Investments – Debt and Equity Securities.” This standard provides a framework to perform another-than-temporary impairment analysis, in compliance with GAAP, which determines whether the holder of an investment in a debt or equity security, for which changes in fair value are not regularly recognized in earnings, should recognize a loss in earnings when the investment is impaired. Additionally, this standard amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The standard is effective for interim reporting periods ending after June 15, 2009. The Company adopted the standard during the quarter ended June 30, 2009. The adoption did not have a material impact on the Company’s consolidated financial statements.
In May 2009, the FASB issued an accounting standard codified within ASC Topic 855, “Subsequent Events,” which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this standard provides guidance on the period after the balance sheet date and the circumstances under which management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements. The standard also requires certain disclosures about events or transactions occurring after the balance sheet date. This standard is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted the provisions of this standard in the quarter ended June 30, 2009. The adoption did not have a material impact on the Company’s consolidated financial statements.
Standards Issued But Not Yet Adopted
In June 2009, the FASB issued Statement No. 166, “Accounting for Transfers of Financial Assets - - an amendment of FASB Statement No. 140” (“SFAS 166”), which has yet to be codified in the ASC. Once codified the standard would amend ASC 860, “Transfers and Servicing.” SFAS 166 amends the existing guidance on transfers of financial assets. The amendments include: (1) eliminating the qualifying special-purpose entity concept, (2) a new unit of account definition that must be met for transfers of portions of financial assets to be eligible for sale accounting, (3) clarifications and changes to the derecognition criteria for a transfer to be accounted for as a sale, (4) a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor, and (5) extensive new disclosures. SFAS 166 is effective for new transfers of financial assets occurring on or after January 1, 2010. The adoption of SFAS 166 is not expected to have a material impact on the Company’s consolidated financial statements; however, it could impact future transactions entered into by the Company.
In June 2009, the FASB issued Statement No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”), which has yet to be codified in the ASC. Once codified, the standard would amend ASC 810, “Consolidation.” SFAS 167 amends the consolidation guidance for variable-interest entities under FIN 46(R), “Consolidation of Variable Interest Entities — an interpretation of ARB No. 51.” The amendments include: (1) the elimination of the exemption for qualifying special purpose entities, (2) a new approach for determining who should consolidate a variable-interest entity, and (3) changes to when it is necessary to reassess who should consolidate a variable-interest entity. SFAS 167 is effective January 1, 2010. The Company is currently evaluating the impact of this standard on its consolidated financial statements.
20
Table of Contents
In August 2009, the FASB issued Accounting Standards Update 2009-05, “Fair Value Measurements and Disclosures (Topic 820)—Measuring Liabilities at Fair Value” (“ASU 2009-05”). ASU 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value of such liability using one or more of the techniques prescribed by the update. ASU 2009-05 is effective for reporting periods (including interim periods) beginning after August 26, 2009, which would be the fourth quarter of 2009 for the Company. The Company is currently evaluating the impact of the pending adoption this ASU on its consolidated financial statements.
In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements, (amendments to ASC Topic 605, Revenue Recognition)” (“ASU 2009-13”) and ASU 2009-14, “Certain Arrangements That Include Software Elements, (amendments to ASC Topic 985, Software)” (“ASU 2009-14”). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company is currently evaluating the impact of the adoption of these ASUs on its consolidated financial statements.
Note #11: Lease Commitments
Effective February 27, 2009, the Company modified its lease for its Minnesota facility. Beginning May 1, 2009, the Company leased an 894 square foot facility in Plymouth, Minnesota. The lease commenced on May 1, 2009 and expires April 30, 2011. The initial base annual rent is $7,020 per year or $7.85 per sq. ft. plus an escalation charge of 3.4%. The Company has the option to renew its lease for two (2) years by providing nine (9) months written notice to the Landlord, prior to the lease expiration. Annual base rent for the Minnesota office is projected to be approximately $6,400 in 2009.
21
Table of Contents
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
See Condensed Consolidated Financial Statements beginning on page 5.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Overview
SEDONA is a software application and services provider that seeks to improve financial institution performance by providing SAAS-based advanced business intelligence and analytics, sentiment-based computing and relationship mining. The Company has strategically targeted small to mid-sized financial services organizations (SMBs) to introduce its leading CRM/MRM application solution including, but not limited to, community and regional banks, credit unions, savings and loans, and brokerage firms. SEDONA defines the SMB market as any financial services institution with total asset values below $10 billion; however, SEDONA’s technology has and may be sold to institutions whose total asset values exceed $10 billion. The Company offers various flexible delivery solutions that fulfill any budgetary requirements. The Company’s application solutions enable financial services organizations to improve key performance metrics to strengthen their position in the market and obtain greater share of the customer’s wallet.
Beginning in December 2008, SEDONA added sales and marketing staff to the organization to enhance the direct distribution of SEDONA CRM to the financial services industry. In addition, SEDONA also retained its indirect distribution channel strategy. The Company licenses its CRM/MRM technology to software and services providers, who market, sell, distribute and support SEDONA’s technology either as a component of their total solution or as stand-alone offering. The Company is not an application service provider (ASP) or software as a service provider (SAAS); however, SEDONA CRM/MRM can be deployed in an ASP/SAAS environment through the Company’s distribution partners or as an installed service inside a customer’s data center.
SEDONA has signed Original Equipment Manufacturer (OEM) and reseller agreements with several leading software and services providers for the financial services market, including, but not limited to: Fiserv; Connecticut Online Computer Center, Inc.; Profit Technologies; Bradford-Scott; CU ink and Share One.
Recent Business Developments
The Company is continuing to re-architect its product suite to enable rapid deployment and partnering of new capabilities. This includes the ability to integrate third-party solutions for contact management, demographic and psychographic information services, performance assessment and profitability management, and digital publishing through both licensed installations and SAAS subscriptions. This new product platform fully exploits the Company’s unique capabilities in data warehousing, data mining, business intelligence and predictive analytics.
The Company’s new vision is to provide advanced technology solutions throughout the entire lifecycle of the financial institution. The new architecture facilitates financial institution performance by supporting the transition from processing agent to trusted advisor. Through 2010, the Company will be releasing a series of new products and services that will expand the Company’s market presence from the smallest community bank and credit union to the largest global financial institution—improving risk management, customer retention, growth and profitability from teller to bank president to banking conglomerate CEO.
22
Table of Contents
Revenues
The Company’s revenues currently consist of product license revenue and service license revenue.
Product license revenue includes:
• | license fees from direct sales by either the Company or its distribution partners | ||
• | monthly subscription fees from ASP/SAAS sales through direct sales and by our distribution partners |
Service license revenue includes:
• | professional services fees including set-up and installation fees, training and mapping fees | ||
• | annual maintenance fees |
The following is a discussion and analysis of the Company’s results of operations and financial condition for the nine months ended September 30, 2009 and September 30, 2008 and should be read in conjunction with the Company’s audited financial statements as of December 31, 2008 along with the notes to those financial statements.
Critical Accounting Policies
Principles of Consolidation
The Company’s condensed consolidated financial statements include the accounts of its wholly owned subsidiary, SEDONAâGeoServices, Inc. All significant inter-company accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States and requires management to make estimates and assumptions that affect the amounts reported and disclosures in the condensed consolidated financial statements and accompanying notes. We evaluate, on an on-going basis, our estimates and judgments, including those related to bad debts, income taxes, contingencies and litigation. Our estimates are based on historical experience and assumptions that we believe to be reasonable under the circumstances; the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Cash and Cash Equivalents
The Company considers all unencumbered highly liquid investments with original maturities of three (3) months or less when purchased to be cash equivalents. Cash and cash equivalents, which primarily consist of cash on deposit and money market funds, are stated at cost, and approximate fair value.
Accounts Receivable
Trade receivables are generated primarily from the Company’s customers and distribution partners. Receivables are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. A valuation allowance is provided for known and anticipated credit losses, as determined by Management in the course of regularly evaluating individual customer receivables. Receivables are written off when deemed uncollectible. Recoveries of receivables previously written off are recorded when received.
23
Table of Contents
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the respective assets, which range from three (3) to seven (7) years.
Impairment of Long-Lived Assets
The Company evaluates the recoverability of its long-lived assets whenever circumstances or events indicate that the carrying amount of such assets may not be recoverable. If such review indicates that the carrying amount of the asset is not recoverable, the carrying amount of such asset will be reduced to fair value.
Revenue Recognition
The Company’s revenues from software arrangements currently consist of license fees, fees for installation services and maintenance. The Company has established vendor specific objective evidence of fair value for its maintenance contracts based on the price of renewals of existing maintenance contracts. The remaining value of the software arrangement is allocated to license fees and professional services based on contractual terms agreed upon by the customer and based on Company-maintained list prices.
Product License Revenue
The Company utilizes both a direct sales model and an indirect sales model whereby it distributes its product through its distribution partners, for which the Company receives royalty payments based on percentages of the license fees charged by the distribution partners. Under the direct sales model, revenue is not recognized until the software is delivered. The Company either receives written acceptance from its clients that the software has been installed/delivered or provides receipts for the electronic delivery of the software. Under the indirect sales model, royalty fees are recognized by SEDONA when the Company receives written acknowledgement from the distribution partners that a contract has been signed with an end-user and monies are owed to SEDONA from the distribution partner.
Recently, there has been a strategic shift in direction by our clients toward SAAS subscription agreements in lieu of license sales. The Company believes this trend will continue in future periods. The SAAS model provides financial institutions with an immediately available, fully integrated system, including all of the software, hardware and services required for the deployment of a comprehensive, web-based enterprise business application, for a fixed monthly subscription fee. The SAAS model shortens the sales cycle by greatly reducing the financial barriers — software, hardware and “people-ware” costs — and the resource requirements on a customer’s existing IT organization. The model also builds a recurring revenue stream and generates new revenue opportunities through the upgrade of new integration and training services as well as software upgrades. In addition, in a SAAS deployment, the immediate availability of the application enables organizations to achieve a positive return on investment more rapidly than traditional software licensing.
As of September 30, 2009, the Company had recorded a total of approximately $1,013,000 in current and non-current accounts receivable and associated deferred revenue for monthly subscription fees from its distribution partners’ ASP/SAAS contracts that will be recognized ratably over the contract terms. This represents a 45% annual increase over the approximately $697,000 reported as of September 30, 2008.
24
Table of Contents
Revenues from the sale of product licenses are recognized as follows:
• | Persuasive evidence of an arrangement exists, generally by receipt of a signed contract | ||
• | Delivery and acceptance of the software has been received | ||
• | The fee to be paid by the customer is fixed or determinable | ||
• | Collection of the fee is reasonably assured (Our contracts do not contain general rights of return) |
Since SEDONA CRM/MRM can be implemented on the Company’s customers’ systems without significant alterations to the features and the functionality of the software, or without significant interfacing, the Company’s license agreements are written so that formal written acceptance of the product is received when installation is complete. Therefore, the timing of license fee revenue recognition coincides with the completion of the installation and acceptance of the software by the customer.
Services Revenue
Services revenue includes revenue from professional services (primarily installation and training services) and maintenance revenue. Installation service revenue is earned from implementation planning, hardware and software set-up, data integration including data aggregation, conversion, cleansing and analysis, and testing and quality assurance, which are accounted for as a separate element of a software arrangement.
The Company recognizes service revenue as follows:
• | Installation revenue is recognized upon completed installation and customer acceptance and is based on a contractual hourly rate. Training revenue is not a material element of a contract and revenue is recognized as training services are provided. | ||
• | Annual maintenance revenue is recognized ratably over the life of the related contract. The Company establishes the value of maintenance revenue based on the price quoted and received for renewals of existing maintenance contracts. |
Recent Accounting Pronouncements
In September 2009, the Company adopted ASC Topic 105-10-05 (“ASC 105-10-05”), which provides for the FASB Accounting Standards Codification™ (the “Codification”) to become the single official source of authoritative, nongovernmental U.S. generally accepted accounting principles (“GAAP”) to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. The Codification does not change GAAP, but combines all authoritative standards into a comprehensive, topically organized online database. ASC 105-10-05 explicitly recognizes rules and interpretative releases of the Securities and Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. Subsequent revisions to GAAP will be incorporated into the ASC through Accounting Standards Updates (“ASU”). ASC 105-10-05 is effective for interim and annual periods ending after September 15, 2009, and was effective for the Company in the third quarter of 2009. The adoption of ASC 105-10-05 impacted the Company’s financial statement disclosures, as all references to authoritative accounting literature were updated to and in accordance with the Codification. The adoption of ASC 105-10-05 did not have a material impact on the Company’s consolidated results of operations and financial condition.
In September 2006, the FASB issued an accounting standard codified within ASC Topic 820, “Fair Value Measurements and Disclosures.” This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. This standard was effective for fiscal years beginning after November 15, 2007,
25
Table of Contents
and all interim periods within those fiscal years. In February 2008, the FASB delayed the effective date of this standard for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. The implementation of this standard for financial assets and liabilities, effective January 1, 2008, and for non-financial assets and non-financial liabilities, effective January 1, 2009, did not have a material impact on the Company’s consolidated financial position and results of operations.
In December 2007, the FASB issued an accounting standard codified within ASC Topic 805, “Business combinations,” which changed the accounting for business acquisitions. This standard establishes principles and requirements for how the acquirer recognizes and measures assets acquired and liabilities assumed in a business combination, as well as, goodwill acquired and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of a business combination. In April 2009, the FASB issued an accounting standard codified within ASC Topic 805 which amends the provisions related to the initial recognition and measurement, subsequent measurement, and disclosure of assets and liabilities from contingencies in a business combination. The standard requires that contingent assets acquired and liabilities assumed be recognized at fair value on the acquisition date if the fair value can be reasonably estimated. If the fair value cannot be reasonably estimated, the contingent asset or liability would be measured in accordance with ASC Topic 450 “Contingencies.” Both standards were effective for the Company as of January 1, 2009 and did not have an impact on the Company’s condensed consolidated financial statements since the Company did not consummate any acquisitions in the nine months ended September 30, 2009.
In December 2007, the FASB issued an accounting standard codified with ASC Topic 810, “Consolidation.” This standard requires that a non-controlling interest in a subsidiary be reported as equity and that the amount of consolidated net income attributable to the parent and to the non-controlling interest should be separately identified in the consolidated financial statements. The Company has applied the provisions of this standard prospectively, as of January 1, 2009, except for the presentation and disclosure requirements, which were applied retrospectively for all periods presented. The adoption of this standard did not have an impact on the Company’s consolidated financial statements.
In March 2008, the FASB issued an accounting standard related to disclosures about derivative instruments and hedging activities, codified within ASC Topic 815, Derivatives and Hedging.” This new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of this standard, effective January 1, 2009, did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued an accounting standard codified within ASC Topic 820, “Fair Values Measurements and Disclosures,” which provides additional guidance in determining whether a market is active or inactive and whether a transaction is distressed. It is applicable to all assets and liabilities that are measured at fair value and requires enhanced disclosures. This standard is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. The adoption of this standard in the second quarter of 2009 did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued an accounting standard codified within ASC Topic 825, “Financial Instruments,” that requires disclosures of the fair value of financial instruments that are not reflected in the consolidated balance sheet at fair value whenever summarized information for interim reporting periods are presented. This standard requires disclosure of the methods and significant assumptions used to estimate the fair value of financial instruments and describe the changes in methods and significant assumptions, if any, during the period. This standard is effective for interim reporting
26
Table of Contents
periods ending after June 15, 2009. Because this standard applies only to financial statement disclosure, the adoption did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued an accounting standard codified within ASC Topic 320, “Investments – Debt and Equity Securities.” This standard provides a framework to perform another-than-temporary impairment analysis, in compliance with GAAP, which determines whether the holder of an investment in a debt or equity security, for which changes in fair value are not regularly recognized in earnings, should recognize a loss in earnings when the investment is impaired. Additionally, this standard amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The standard is effective for interim reporting periods ending after June 15, 2009. The Company adopted the standard during the quarter ended June 30, 2009. The adoption did not have a material impact on the Company’s consolidated financial statements.
In May 2009, the FASB issued an accounting standard codified within ASC Topic 855, “Subsequent Events,” which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this standard provides guidance on the period after the balance sheet date and the circumstances under which management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements. The standard also requires certain disclosures about events or transactions occurring after the balance sheet date. This standard is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted the provisions of this standard in the quarter ended June 30, 2009. The adoption did not have a material impact on the Company’s consolidated financial statements.
Standards Issued But Not Yet Adopted
In June 2009, the FASB issued Statement No. 166, “Accounting for Transfers of Financial Assets - - an amendment of FASB Statement No. 140” (“SFAS 166”), which has yet to be codified in the ASC. Once codified the standard would amend ASC 860, “Transfers and Servicing.” SFAS 166 amends the existing guidance on transfers of financial assets. The amendments include: (1) eliminating the qualifying special-purpose entity concept, (2) a new unit of account definition that must be met for transfers of portions of financial assets to be eligible for sale accounting, (3) clarifications and changes to the derecognition criteria for a transfer to be accounted for as a sale, (4) a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor, and (5) extensive new disclosures. SFAS 166 is effective for new transfers of financial assets occurring on or after January 1, 2010. The adoption of SFAS 166 is not expected to have a material impact on the Company’s consolidated financial statements; however, it could impact future transactions entered into by the Company.
In June 2009, the FASB issued Statement No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”), which has yet to be codified in the ASC. Once codified, the standard would amend ASC 810, “Consolidation.” SFAS 167 amends the consolidation guidance for variable-interest entities under FIN 46(R), “Consolidation of Variable Interest Entities — an interpretation of ARB No. 51.” The amendments include: (1) the elimination of the exemption for qualifying special purpose entities, (2) a new approach for determining who should consolidate a variable-interest entity, and (3) changes to when it is necessary to reassess who should consolidate a variable-interest entity. SFAS 167 is effective January 1, 2010. The Company is currently evaluating the impact of this standard on its consolidated financial statements.
In August 2009, the FASB issued Accounting Standards Update 2009-05, “Fair Value Measurements and Disclosures (Topic 820)—Measuring Liabilities at Fair Value” (“ASU 2009-05”). ASU 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value of such liability
27
Table of Contents
using one or more of the techniques prescribed by the update. ASU 2009-05 is effective for reporting periods (including interim periods) beginning after August 26, 2009, which would be the fourth quarter of 2009 for the Company. The Company is currently evaluating the impact of the pending adoption this ASU on its consolidated financial statements.
In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements, (amendments to ASC Topic 605, Revenue Recognition)” (“ASU 2009-13”) and ASU 2009-14, “Certain Arrangements That Include Software Elements, (amendments to ASC Topic 985, Software)” (“ASU 2009-14”). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company is currently evaluating the impact of the adoption of these ASUs on its consolidated financial statements.
Results of Operations
The following is a discussion and analysis of the Company’s results of operations and financial condition for the nine months ended September 30, 2009 and September 30, 2008 and should be read in conjunction with the Company’s Condensed consolidated Financial Statements and the notes related thereto for the nine months ended September 30, 2009 and 2008.
Total Revenues
Total revenues for the three months ended September 30, 2009 and 2008 were $334,000 and $307,000, respectively. Revenue from license fees and royalties totaled $106,000 and $94,000 for the three months ended September 30, 2009 and 2008, respectively. Revenues from license fees and royalties increased $12,000 or 13% mainly due to an increase in SAAS license revenues. During the three months ended September 30, 2009, the Company recognized $228,000 in services revenue compared to $213,000 during the same three months in 2008. Services revenues increased $15,000 or 7% during the three months ended September 30, 2009 due to the addition of SEDONA’s on-boarding process, a service exclusive to SEDONA’s CRM and MRM clients. On-boarding allows banks and credit unions to automate their new customer/member processes. The Company’s banking and credit union customers have reported increases up to 6% in customer retention after implementing such services.
For the nine months ended September 30, 2009 and 2008, total revenues were $947,000 and $1,081,000, respectively. Revenue from license fees declined 31% to $304,000 compared to $442,000 for the nine months ended September 30, 2009 and 2008, respectively. The $138,000 decrease in license fee revenue is attributable to a shift in strategic directions toward SAAS subscription agreements in lieu of license sales. The Company anticipates in future periods, customers will favor the SAAS sales model compared to direct license sales model. If this trend continues, the Company believes that its deferred revenue and accounts receivable will increase because license fees under the SAAS sales model are recognized ratably over the contract term as opposed to one-time direct license sales.
During the nine months ended September 30, 2009, the Company recognized $643,000 in services revenues compared to $639,000 during the same nine months in 2008. Services revenues increased $4,000 due to the variety of new services programs currently under development which we are beginning to offer to our customers.
28
Table of Contents
Cost of Revenues; Gross Profit
Cost of revenues includes the direct expenses and third party cost associated with providing professional services, training, customer support, and installation services. These services are typically billed on a time and materials basis.
As a percentage of services revenue, cost of sales related to services was 37% of service revenue or $84,000 for the three months ended September 30, 2009. In comparison, cost of sales equaled 31% of service revenue or $67,000, for the three months ended September 30, 2008. The increase in cost of sales is a result of upgrading the client base to a new version of our CRM/MRM application during the three months ended September 30, 2009.
For the nine months ended September 30, 2009, cost of sales related to services was 46% of service revenue or $295,000. In comparison, cost of sales equaled 24% of service revenue or $154,000 for the nine months ended September 30, 2008. The increase in cost of sales is a result of the service and support costs attributable to releasing a new version of our CRM/MRM application.
Operations
Total operating expenses decreased 33% or $300,000 to $600,000 in the three months ended September 30, 2009, compared to $900,000 reported in the three months ended September 30, 2008. The decrease in expenses was generally attributable to a decrease in litigation expenses related to the civil action lawsuit filed against OSI (Open Solutions Inc.) on September 28, 2006, alleging a violation of a software license agreement entered into between the parties (See Note #6 Litigation). Litigation expenses totaled $10,000 for the three months ended September 30, 2009, compared to $232,000 for the three months ended September 30, 2008. Litigation expenses decreased because the discovery phase of the litigation was completed and the case was awaiting a decision on summary judgment. Litigation fees and expenses incurred by the Company have been funded through an agreement with Vey Associates (See Note #8, David Vey and OSI).
General and administrative expenses were $172,000 or 38% lower in three months ended September 30, 2009 compared to three months ended September 30, 2008 due primarily to an accrual of approximately $143,000 for compensation and benefits expenses related to the resignation of the Company’s former President and CEO in September 2008. In addition, the Company’s legal expenses decreased by $45,000 primarily due to lower fees associated with financial and capitalization matters and employment- related issues for the three months ended September 30, 2009, as compared to the three months ended September 30, 2008. The Company has also decreased its investor relations expenses by approximately $25,000 due to the termination of outside investor relation services in early 2009.
Operating expenses decreases were also offset by $114,000 or 114% increase in sales and marketing expenses related to the hiring of additional staff in these departments to support the Company’s direct sales and marketing efforts.
For the nine months ended September 30, 2009, total operating expenses decreased 29% or $755,000 to $1,822,000 compared to $2,577,000 reported in the nine months ended September 30, 2008. The decrease in expenses was primarily attributable to a $671,000 or 96% decrease in litigation expenses related to the civil action lawsuit filed against OSI (Open Solutions Inc.) on September 28, 2006, as reported above.
The Company’s general and administrative expenses decreased by $174,000 in the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 primarily due to the recognition of compensation and benefits expenses related to the resignation of a former executive officer as discussed above. In addition, the Company’s legal expenses decreased primarily due to lower fees associated with financial and capitalization matters for the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2009. The Company has also decreased its investor
29
Table of Contents
relations expenses for the nine months ended September 30, 2009 compared to the same period in 2008 as discussed above.
The Company’s sales, marketing and customer services expenses increased 65% or $264,000 to $668,000 for the nine months ended September 30, 2009, due to the addition of new sales and support staff and the launch of the new corporate website in early 2009. We anticipate that our expenditures in sales, marketing and customer services will grow in future periods as we increase our marketing penetration with new direct sales opportunities and expand the opportunities within our direct channel and through the addition of new alliance partners.
The Company’s research and development expenses decreased 42% or $174,000 to $240,000 for the nine months ended September 30, 2009, as compared to $414,000 for the nine months ended September 30, 2008. Overall, research and development expenses generally did not decrease but were shifted to cost of revenues to reflect the time spent upgrading and supporting the roll-out of a new version of the Company’s CRM/MRM application.
As of September 30, 2009, the Company had fourteen full-time employees and one-part time employee. In addition, the Company hires consultants, where applicable, to augment its staffing needs. As of September 30, 2009, the Company had three consultants engaged in various duties throughout the organization.
Other Expenses
Total interest expense for the three months ended September 30, 2009 increased to $1,123,000 compared to $167,000 reported in the three months ended September 30, 2008. The increase in interest expense reflects $941,000 of non-cash interest charges related to the accretion of debt discount on convertible notes for the three months ended September 30, 2009, as fully explained in Note 7.
Total interest expense for the nine months ended September 30, 2009 increased to $2,905,000 compared to $493,000 reported in nine months ended September 30, 2008. The increase in interest expense reflects $2,377,000 of non-cash interest charges related to the accretion of debt discount on convertible notes for the nine months ended September 30, 2009, as fully explained in Note 7. In addition, for the nine months ended September 30, 2008, the Company recorded $247,000 loss on extinguishment of debt.
Liquidity and Capital Resources
At September 30, 2009, cash and cash equivalents increased to $101,000 compared to the December 31, 2008 amount of $34,000. For the nine months ended September 30, 2009, the cash flows from operating activities resulted in a net use of cash of $1,554,000 compared to $815,000 for the nine months ended September 30, 2008. The increase in net cash used in operations for the nine months ended September 30, 2009, was primarily related to the increase in staffing cost for the expansion of the Company’s sales and marketing efforts. In addition, accounts payable and accrued liabilities decreased in the nine months ended September 30 2009, as compared to same period in 2008.
For the nine months ended September 30, 2009, cash flows from investing activities resulted in a net use of cash of $7,000 related to the purchase of equipment. For the nine months ended September 30, 2008, cash flows from investing activities resulted in a net use of cash of $6,000 related to the purchase of office equipment and software.
For the nine months ended September 30, 2009, the cash flows from financing activities resulted in net cash provided by financing activities of $1,628,000. The Company received $1,625,000 in proceeds from Vey Associates under the convertible note agreement. The $1,625,000 represents installment payments on the December 31, 2008 agreement to provide up to $2,250,000 in financing to the Company.
30
Table of Contents
For the nine months ended September 30, 2008, the cash flows from financing activities resulted in net cash provided by financing activities of $812,000. The Company received $535,000 in advance payments from David Vey to fund the OSI litigation expenses. See Note 8 for additional information. The Company also received $160,000 in proceeds from its line of credit. Additionally, the Company received $108,000 in proceeds from the sale of the Company’s common stock in private placement transactions and $9,000 from the exercise of stock options.
Previously, the Company had issued a promissory note to Oak Harbor dated as of August 17, 2006 in the principal amount of $1,040,402 (the “Oak Harbor Note”). Effective March 11, 2009, the Oak Harbor Note was extended and has a maturity date of May 15, 2010. The Company will be required to make a principal payment in the amount of $400,000 on November 15, 2009, and the remaining principal of $640,402 and all accrued but unpaid interest will be due on maturity, at May 15, 2010. The Oak Harbor Note bears interest at a rate of eight percent (8%) per year. The Company is currently negotiating with the lender and anticipates an agreement will be reached to extend the maturity date of this obligation.
Charles F. Mitchell (“Mitchell”) extended a loan to the Company, which was evidenced by a convertible promissory note dated May 31, 2006, in the principal amount of $300,000, with a conversion price of $0.20 per share (the “Mitchell Convertible Note”). William Rucks (“Rucks”) extended several loans to the Company which were evidenced by the following convertible promissory notes: (i) note dated July 1, 2005 in the principal sum of $250,000; (ii) note dated August 2, 2005 in the principal sum of $250,000; and (iii) $500,000 note dated September 29, 2005 and (iv) a note in the amount of $300,000 dated May 31, 2006 (collectively the “Rucks Notes”). The Notes designated as (i), (ii), and (iii) each had a conversion price of $0.18 per share, while the note designated as (iv) had a conversion price of $0.20 per share. The Notes designated as (i), (ii), and (iii), in the total sum of $1,000,000 have matured and were payable on January 1, 2009, unless theretofore converted. The two $300,000 convertible notes shall mature and are payable on October 23, 2009, unless theretofore converted. The convertible notes bear interest on the principal outstanding at a rate of 8% per year, annually in arrears, from the date of the convertible notes until the earlier of maturity or the date upon which the unpaid balance is paid in full or is converted into shares of common stock. The Company is currently in negotiations with Mr. Rucks and Mr. Mitchell to modify the agreement to extend the maturity date of the $1,600,000 in notes payable which was due. The Company is currently in default of this agreement, however, there are no specific penalty provisions related to a default event under this agreement.
The Company refinanced its existing debt obligations with David Vey on December 31, 2008. As part of the refinancing, the Company issued Mr. Vey a consolidated secured convertible promissory note, dated as of December 31, 2008, in the principal amount $4,100,000. The New Convertible Note has a maturity date of January 4, 2010, unless theretofore converted, and bears interest at the rate of eight percent (8%) per year, which interest will be due upon maturity. Mr. Vey has the option to convert, at any time, all or part of the unpaid principal and accrued but unpaid interest of the New Convertible Note into shares of Company common stock at a conversion price of $0.05 per share. The number of shares which would be issuable upon the conversion of the $4,100,000 principal balance of the New Convertible Note is presently 82,000,000.
The Company required additional financing in 2009 and has entered into a financing agreement with Vey Associates to borrow up to $2,250,000. The loan is evidenced by a secured convertible promissory note having a principal amount of up to $2,250,000 (the “Vey Associates Convertible Note”). The Vey Associates Convertible Note has a maturity date of January 4, 2010, unless theretofore converted, and bears interest at the rate of eight percent (8%) per year, which interest will be due upon maturity. Once $1,750,000 of the loan has been paid to the Company, Vey Associates has the option to convert all or part of the unpaid principal and accrued but unpaid interest of the Vey Associates Convertible Note into shares at a conversion price of $0.05 per share. The number of shares which would be issuable upon the conversion of the $2,250,000 principal balance is presently 45,000,000.
31
Table of Contents
Vey Associates had agreed, as previously amended on March 18, 2009, to fund the loan in five (5) installments as follows:
(i) | the first installment on or before December 31, 2008, in the amount of $100,000; | ||
(ii) | the second installment on or before January 15, 2009, in the amount of $300,000; | ||
(iii) | the third installment on or before March 18, 2009, in the amount of $600,000; | ||
(iv) | the fourth installment on or before May 1, 2009 in the amount of $750,000; and | ||
(v) | the fifth installment on or before September 30, 2009 in the amount of $500,000. |
Payment of the fifth installment is subject to the Company achieving a certain profitability level, referred to as “EBITDA Break Even”, at the end of the third quarter of Fiscal year 2009.
The Company received $1,625,000 under the New Loan during the nine months ended September 30, 2009.
The financial statements of the Company have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Accordingly, the financial statements do not include any adjustment that might be necessary should the Company be unable to continue in existence. In addition to the loss of $4,075,000, which includes non-cash charges of $2,377,000 related to the restructuring of debt obligations realized during the nine months ended September 30, 2009, the Company incurred substantial losses from operations for the year ended December 31, 2008 of approximately $5,313,000 which includes non-cash charges of $2,455,000 related to the restructuring of debt obligations and $1,010,000 for litigation expenses related to a contract dispute with Open Solutions, Inc. The Company also has negative working capital of $10,173,000 and stockholders’ deficit of $10,154,000 as of September 30, 2009. These factors raise substantial doubt about the Company’s ability to continue as a going concern.
The Company will require additional working capital during the next twelve months and beyond as we continue (i) our research and development efforts; (ii) expand our marketing and sales activities; and (iii) hire additional personnel across all disciplines to support our revenue growth and continued market acceptance of our services. For the Company to meet its business objectives, highly qualified personnel of the requisite caliber must be recruited and retained. The addition of this experienced staff will require substantial increases to the employee stock purchase plan.
The Company’s plans include: (i) continuing to develop a direct sales staff to increase our market penetration and increase our average price per sale; (ii) expanding our sales distribution agreements with service organizations for the financial services market; (iii) fostering the existing OEM partnerships with leading core system providers by promoting corporate-wide adoption of our technologies; and (iv) introducing new product and services for improving financial performance at each stage of the customer and institutional lifecycle.
The Company plans to pursue additional fundraising activities with existing and potential new investors. Our plans include raising additional capital through public or private sale of equity or debt securities, debt financing, short-term loans, or a combination of the foregoing. In addition, the Company is currently evaluating the options to best restructure its existing debt obligations in order to attract additional investment in combination with assessing other synergistic opportunities with the goal of improving the Company’s balance sheet and liquidity position. There can be no assurances that the Company will succeed in its plan to obtain any such financing or that additional financing will be available when needed or that, if available, financing will be obtained on terms acceptable to the Company and our stockholders. In addition, if we raise additional funds through the issuance of equity securities, dilution to our existing shareholders would likely result.
32
Table of Contents
Item 3. Quantitative and Qualitative Disclosures About Market Risks
As a smaller reporting company, the Company is not required to provide Part I, Item 3 disclosure in this quarterly filing.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures and Changes in Internal Control Over Financial Reporting
The Company maintains a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed by the Company in its Form 10-Q, and in other reports required to be filed under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported within the time periods specified in the rules and forms for such filings.
The Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, based on their evaluation of such controls and procedures as of the end of the period covered by this report, are effective to ensure that information required to be disclosed by the Company in the reports it files under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is 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.
During the nine months ended September 30, 2009, there were no significant changes in the Company’s internal controls or other factors that occurred which had significantly affected or could significantly affect these controls.
33
Table of Contents
PART II — OTHER INFORMATION
Item 1 — | Legal Proceedings — None not previously reported. |
Item 2 — | Unregistered Sale of Equity Securities and Use of Proceeds — None not previously reported. |
Item 3 — | Default Upon Senior Securities — None |
Item 4 — | Submission of Matters to a Vote of Security Holders |
At the Company’s Annual Meeting of Stockholders held on September 28, 2009, the Shareholders of the Company elected the following directors to the Board to serve for the ensuing year until their successors are duly elected and qualified.
The voting results for the election of directors were as follows:
Name | For | Withheld | ||||||
David R. Vey | 103,739,985 | 2,269,163 | ||||||
Jack A. Pellicci | 103,633,185 | 2,375,963 | ||||||
Roger W. Scearce | 103,661,827 | 2,347,321 | ||||||
David C. Bluestone | 103,661,194 | 2,347,954 |
Item 5 — | Other Information |
Item 6 — | Exhibits |
Exhibit 31.1* — | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 31.2* — | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 32.1* — | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 32.2* — | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
* | Filed herewith |
34
Table of Contents
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.
Thereunto duly authorized.
SEDONA CORPORATION | ||||
DATE: November 16, 2009 | /s/ David R. Vey | |||
Chief Executive Officer | ||||
DATE: November 16, 2009 | /s/ Anita M. Primo | |||
Vice President and Chief Financial Officer |
35
Table of Contents
EXHIBIT INDEX
Exhibit No. | Description | |
Exhibit 31.1* | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 31.2* | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 32.1* | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 32.2* | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
* | Filed herewith |
36