Business Context and Reporting Period
This Form 10-Q covers the three and nine months ended September 30, 2012. The filing identifies the registrant as Information Systems Associates, Inc., although the request metadata identifies Duos Technologies Group, Inc.; this discrepancy should be verified. The company provides mobile data-center management systems and turnkey data-center management solutions using its proprietary OSPI technology.
The company is shifting its growth strategy toward software sales supported by professional services, bringing software development in-house after terminating a UK-based support and development provider. The financial statements are unaudited.
Key Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Revenue | $259,617 vs. $160,003 | $493,321 vs. $361,878 |
| Gross profit | $226,938 vs. $142,441 | $427,702 vs. $317,402 |
| Gross margin | 87.4% vs. 89.0% | 86.7% vs. 87.7% |
| Operating loss | $(119,017) vs. $(217,903) | $(481,591) vs. $(738,962) |
| Net loss | $(405,815) vs. $(231,746) | $(815,048) vs. $(756,873) |
| Basic and diluted loss per share | $(0.01) vs. $(0.01) | $(0.03) vs. $(0.03) |
Reported values are in dollars unless otherwise indicated. Operating expenses were $345,955 for the quarter and $909,293 for the nine-month period. Interest expense was $287,018 for the quarter and $333,420 year to date, substantially reflecting amortization of original issue discounts, beneficial conversion features and warrant-related amounts.
At September 30, 2012, cash and cash equivalents were $10,150, total assets were $218,118, current liabilities were $796,869 and stockholders’ equity was a deficit of $578,751. Accounts payable were $197,058, and deferred revenue was $100,907.
Cash used in operating activities was $342,145 for the nine months ended September 30, 2012, compared with $490,750 in the prior-year period. Investing cash outflow was $257, compared with $52,152. Financing cash inflow was $351,564, compared with $557,743. Ending cash increased from $988 to $10,150.
Debt and debt-like obligations included $110,755 of notes payable, $23,774 of factoring debt, $4,622 under a bank line of credit, $4,485 of insurance financing, $190,401 owed to shareholders, $122,495 owed to related parties and $22,372 of convertible notes, net of unamortized discount.
Material Changes Versus Prior Comparable Period
- Quarterly revenue increased approximately 62% and nine-month revenue increased approximately 36%, driven primarily by higher consulting services revenue.
- Quarterly operating loss improved by $98,886, while the nine-month operating loss improved by $257,371, due to higher revenue and lower operating expenses.
- Operating expenses declined 4.0% for the quarter and 13.9% for the nine-month period. Year-to-date salaries and employee benefits declined by $70,786 and professional fees declined by $70,516.
- Net loss worsened for the quarter because interest expense increased by approximately $272,917. Year-to-date net loss increased by $58,175 despite the improvement in operating results.
- Accounts payable increased from $139,609 at December 31, 2011 to $197,058, while total current liabilities increased from $594,378 to $796,869.
- Cash improved from $988 at year-end but remained very limited. Property and equipment, net, declined from $52,500 to $18,845, primarily reflecting depreciation and amortization.
- Common shares outstanding increased to 30,599,417 from 28,666,084. A convertible note with a $137,500 principal amount was converted into 1,833,333 common shares in March 2012.
Outlook, Risks, Contingencies and Unusual Items
Management stated that current operations require additional capital to sustain the company through the second quarter of 2013. It identified financing needs of up to $360,000 for software enhancements and product rollout and was evaluating debt and equity alternatives. A private offering targeting up to $250,000 had raised $135,000 as of the filing.
The company expects approximately $25,000 of capital expenditures over the following 12 months for computer equipment, software-development infrastructure and professional-services support. As of December 10, 2012, management reported cash on hand of $15,282.
The financial statements contain a going-concern disclosure. Management stated that the accumulated deficit was $4,326,248 and that continuation depends on implementing the business plan and raising additional capital. The filing states that these conditions raise substantial doubt about the company’s ability to continue as a going concern.
During 2012, the company incurred additional short-term and related-party financing, including a secured $165,000 note backed by the OSPI patent. The transaction replaced a convertible note and resulted in cancellation of related conversion rights and warrants. Officers deferred $89,154 of net payroll, recorded as related-party loans, to be paid as funds become available.
The company disclosed material weaknesses in disclosure controls and procedures related to insufficient financial and management resources and concluded that its controls were not effective. Remediation included appointing a new president and CFO, hiring a controller, changing accounting personnel and appointing a new audit committee chair.
Management identified failure to generate sufficient revenue, failure to raise capital and adverse capital-market conditions as principal risks to its forward-looking statements. No material changes to legal proceedings, defaults upon senior securities or unregistered equity sales were reported.
Investor Verification Items
- Confirm the registrant’s legal identity and whether the filing corresponds to Duos Technologies Group, Inc. or Information Systems Associates, Inc.
- Assess the going-concern disclosure, near-term cash requirements and the feasibility of raising the identified $360,000 of additional capital.
- Review the terms, maturity dates, interest rates, collateral and related-party status of the company’s substantial short-term debt obligations.
- Determine how much of the reported interest expense is recurring cash interest versus non-cash amortization of discounts, conversion features and warrants.
- Evaluate the conversion, warrant and option overhang, including 4,825,000 outstanding warrants and 350,000 options at September 30, 2012.
- Review remediation of the disclosed material weaknesses and whether subsequent filings demonstrate effective disclosure controls.
- Validate revenue recognition, deferred revenue of $100,907 and the expected timing of software sales and product rollout.