- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2010

 

¨ 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 333-134658

 

DEFENTECT GROUP, INC. (Exact Name of Registrant as Specified in Its Charter)
Delaware		22-393-8509
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)
535 Connecticut Avenue, 2 nd floor, Norwalk, CT 06854  (Address of Principal Executive Offices)
Registrant’s Telephone Number, Including Area Code: ( 203) 354-9164
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.

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.

Yes    x    No   ¨

 

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    ¨      No    ¨

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 definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨      No   x

 

As of November 22, 2010, there were 78,775,040 outstanding shares of Common Stock, $.001 par value.

 

 

 

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DEFENTECT GROUP, INC. AND SUBSIDIARIES

Formally Known as Splinternet Holdings, Inc.

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements.		3
Item 2.	Management’s Discussion and Analysis of Financial Condition
	and Results of Operations.		12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.		22
Item 4T.	Controls and Procedures.		22
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings.		23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.		24
Item 3.	Default upon Senior Securities.		24
Item 4.	[Removed and Reserved].		24
Item 5.	Other Information.		24
Item 6.	Exhibits.		26
SIGNATURES			27

 

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PART I – FINANCIAL INFORMATION

 

Item 1.

Financial Statements.

 

Condensed Consolidated Balance Sheets at September 30, 2010 (Unaudited) and December 31, 2009	4
Condensed Consolidated Statements of Operations (Unaudited) for the three  and nine months ended September 30, 2010 and 2009	5
Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2010 and 2009	6
Notes to the Condensed Consolidated Financial Statements (Unaudited)	7

 

EXPLANATORY NOTE:  The financial statements included in this Report have not been reviewed by an independent public accountant as required by Regulation S-X.  As a result, this Report is deficient.  We undertake the responsibility to file an amended Form 10-Q for this period when the review is completed. Our failure to obtain the review of our interim unaudited financial statements required by Regulation S-X may result in changes to the financial statements when reviewed by an independent public accountant.

 

 

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Defentect Group, Inc. and Subsidiaries

Formerly Known as Splinternet Holdings, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

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		September 30,				December 31,
		2010				2009
		(unaudited and
		not reviewed)
ASSETS
Assets:
Current assets
Cash and cash equivalents		$	2,993			$	24,334
Accounts receivable			33,803				104,290
Prepaid expenses			23,838				86,021
Inventory			6,717				20,152
Note receivable			79,087				77,947
Other Current Assets			22,995				22,995
Due from employees			-				21,337
Total current assets			169,433				357,076
Property and equipment, net			22,738				27,911
Deposit			14,394				14,394
Total Assets		$	206,565			$	399,381
LIABILITIES AND STOCKHOLDERS’ DEFICIENCY
Liabilities:
Current liabilities
Accounts payable		$	243,049			$	183,566
Accrued expenses			109,039				98,778
Deferred Revenue			80,000				80,000
Loans from officers			988,160				874,067
Total current liabilities			1,420,248				1,236,411
Deferred rent			4,858				10,000
Total Liabilities			1,425,106				1,246,411
Commitments and Contingencies			-				-
Stockholders’ Deficiency:
Preferred Stock, 10,000,000 shares authorized and none outstanding			-				-
Common stock, $.001 par value, 250,000,000 shares authorized; 78,775,040 and 68,360,040 issued and outstanding			78,778				68,363
Additional paid-in capital			9,313,818				7,004,366
Accumulated deficit			(10,611,137	)			(7,919,759	)
Total Stockholders’ Deficiency			(1,218,541	)			(847,030	)
Total Liabilities and Stockholders’ Deficiency		$	206,565			$	399,381

See notes to condensed consolidated financial statements

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DEFENTECT GROUP, INC.  AND SUBSIDIARIES

Formerly Known as Splinternet Holdings, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED AND NOT REVIEWED)

		Three Months Ended								Nine Months ended
		September 30,								September 30,
		2010				2009				2010				2009
Service revenue		$	52,719			$	294,285			$	233,945			$	681,684
Cost of revenue			44,916				331,995				214,228				656,796
Gross profit (loss)			7,803				(37,710	)			19,717				24,888
Selling, general and administrative expenses			522,676				187,445				2,593,082				747,834
Research and development costs			20,826				33,233				67,528				124,336
Loss from operations			(535,699	)			(258,386	)			(2,640,893	)			(847,282	)
Interest income			1,070				1,350				3,679				4,053
Interest expense			17,506				16,269				54,164				31,836
Net loss		$	(552,135	)		$	(273,035	)		$	(2,691,378	)		$	(875,065	)
Net loss per share:
Basic and Diluted		$	(0.01	)		$	(0.00	)		$	(0.04	)		$	(0.01	)
Weighted average common stock outstanding:
Basic and Diluted			78,651,414				65,689,073				74,790,573				63,820,820

 

See notes to condensed consolidated financial statements.

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Defentect Group, Inc. and Subsidiaries

Formerly Known as Splinternet Holdings, Inc.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED AND NOT REVIEWED)

		Nine Months Ended September 30,
		2010				2009
Cash flow from operating activities:
Net loss		$	(2,691,378	)		$	(875,065	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation			5,173				5,171
Issuance of stock, warrants and options to employees and consultants			2,153,210				711,179
Non-cash interest expense			51,343				-
Change in assets and liabilities:
Decrease (increase) in accounts receivable			70,487				(17,408	)
Decrease (increase) in prepaid expenses			3,840				(96,388	)
Decrease in inventory			13,435				-
Decrease (increase) in advances to employee			21,337				(22,913	)
(Increase) in notes receivable			(1,140	)			(3	)
Increase (decrease) in accounts payable and accrued expenses			69,744				(227,694	)
(Decrease) in deferred rent			(5,142	)			-
Net cash used in operating activities			(309,091	)			(523,121	)
Cash flows from financing activities:
Loans from officer			86,250				479,615
Repayment of loan from officer			(23,500	)			-
Net proceeds from sale of common stock and warrants			225,000				90,000
Net cash provided by financing activities			287,750				569,615
Net (decrease) increase in cash and cash equivalents			(21,341	)			46,496
Cash and cash equivalents, beginning of period			24,334				6,407
Cash and cash equivalents, end of period		$	2,993			$	52,903
Non-cash investing and financing activity
Issuance of stock for settlement of accrued compensation		$	-			$	255,947

See notes to condensed consolidated financial statements.

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DEFENTECT GROUP, INC.   AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.    PRINCIPAL BUSINESS ACTIVITY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Defentect Group, Inc., formerly known as Splinternet Holdings, Inc. (the “Company”) is the parent company of Splinternet Communications, Inc., originally a provider of Internet Telephony services, which entered the security market in 2007, and Vidiation, Inc., a security sales and marketing company which was acquired on April 30, 2008.

The Company develops and markets technologies for the security and risk management industry.  Our products react to the detection of chemical, biological, radiological or nuclear threats and notify responders and key administrators immediately. The Company’s unique response technology can be easily integrated with other manufacturers’ sensors, and serve many different markets. The Company has more recently entered the market for personal security solutions, tied to our DefenCall Smartphone application; this service leverages our unique response technology. DefenCall enables our customers to communicate location and personal information required to facilitate a timely and informed response to any event of consequence. The Company receives all its current revenues from its telephony service and is pursuing new customers and partners in the security market.

The Company was incorporated in the State of Delaware on March 22, 2006 under the name Splinternet Holdings, Inc. On April 3, 2006, the Company conducted a share for share exchange of securities with Splinternet Communications, Inc., as a result of which Splinternet Communications, Inc. became a wholly owned subsidiary of the Company.

Splinternet Communications, Inc. was incorporated in the State of Connecticut on January 12, 2000. Since inception, we have been a developer of products, services, and marketing strategies centered around opportunities in Internet communications.  From 2000 through 2007 our approach was to develop products and services that would capitalize on the shift in telecommunications technologies from traditional telephony to Internet telephony. During this period the Company experienced disappointing revenue growth in this market. Because of this, during 2007 we shifted our focus into the development of a new radiation detection device which launched us into the security market. In 2008 our research and development was focused on developing an Internet Protocol (IP) based management, monitoring and messaging system which interfaced with our radiation detection devices and other third-party sensors. In 2009 we successfully completed several pilot programs which utilized our management, monitoring and messaging system and sensors.

Vidiation, Inc. was a security sales and marketing company incorporated in the State of Delaware on December 10, 2007, which acquired certain assets from Vidiation LLC.  Vidiation LLC was a radiation detection technology development company which had extensive sales and marketing experience in the surveillance and security market space and was actively engaged in that space.  The progress Vidiation, Inc. had been making in that business was desired by the Company and precipitated the above-referenced transaction.

The Company does not conduct any business or own any assets other than all of the issued and outstanding shares of Splinternet Communications, Inc. and Vidiation, Inc.  

 

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2.    BASIS OF PREPARATION

 

Pursuant to the rules and regulations of the Securities and Exchange Commission for Form 10-Q, the financial statements, footnote disclosures and other information normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed. The financial statements contained in this report are unaudited and have not been reviewed by an independent public accountant as required by Regulation S-X but, in the opinion of the Company, reflect all adjustments, consisting of only normal recurring adjustments necessary as of September 30, 2010 and the results of operations and cash flows for the interim periods ended September 30, 2010 and 2009, to fairly represent the financial position presented herein. The results of operations for any interim period are not necessarily indicative of results for the full year. The balance sheet at December 31, 2009 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Basic loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted loss per share is computed by dividing net loss by the weighted average number of shares of common stock, potential common stock and potentially dilutive securities outstanding during each period. Options and warrants to purchase 9,864,583 shares of the Company's common stock, as of September 30, 2010, were not included in the calculation, due to the fact that these options and warrants were anti-dilutive for the three and nine months ended September 30, 2010.  Warrants to purchase 1,032,500 shares of the Company's common stock, as of September 30, 2009, were not included in the calculation, due to the fact that these options and warrants were anti-dilutive for the three and nine months ended September 30, 2009.

All current assets are carried at their cost and current liabilities are recorded at their contract amount, which approximates fair value because of their short term nature. The carrying value of short-term financing arrangements and notes receivable approximates fair value because interest rates over the relative term of these instruments approximate current market interest rates.

As of September 30, 2010, the Company had approximately $3,000 in cash and liabilities of approximately $1,430,000. The Company’s net cash used in operating activities for the nine months ended September 30, 2010 was approximately $309,000; hence, the Company will require additional funding in order to be adequately funded for the foreseeable future.

The Company has a history of substantial operating losses and an accumulated deficit of $10,611,138 as of September 30, 2010. For the nine months ended September 30, 2010, our net loss was $2,691,378 . The Company has historically experienced cash flow difficulties primarily because expenses have exceeded revenues. The Company expects to incur additional operating losses for the immediate near future. These factors, among others, raise significant doubt about the Company’s ability to continue as a going concern. For the nine months ended September 30, 2010 James C. Ackerly, the Chief Executive Officer and director to the Company made loans of $86,250, $23,500 of which was repaid to Mr. Ackerly in April 2010. Additionally, during the nine months ended September 30, 2010 the Company sold 2,625,000 shares of its common stock and 2,250,000 warrants to accredited investors for total proceeds of $225,000 in a private placement offering.  If the Company is unable to generate sufficient revenue from operations to pay expenses or is unable to obtain additional financing on commercially reasonable terms, our business, financial condition and results of operations will be materially and adversely affected.

 

3.   MAJOR CUSTOMER

During the three months ended September 30, 2010 and 2009, one customer (BuenaVox LLC) accounted for 78% and 98% of all revenues, respectively. For the nine months ended September 30, 2010 and 2009, the same customer accounted for 93% and 97% of all revenues, respectively. This customer accounted for 67% and 76% of the Company’s accounts receivable at September 30, 2010 and 2009.

 

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4.   TAXES

 

Effective January 1, 2007, the Company adopted the accounting standard on accounting for uncertainty in income taxes. This standard provides detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in the financial statements. Tax positions must meet a “more-likely-than-not” recognition threshold at the effective date to be recognized upon the adoption and in subsequent periods. Upon the adoption, the Company had no unrecognized tax benefits. During the nine months ended September 30, 2010 and 2009, the Company recognized no adjustments for uncertain tax benefits.

 

The Company recognizes interest and penalties, if any, related to uncertain tax positions in selling, general and administrative expenses.  No interest and penalties related to uncertain tax positions were accrued at September 30, 2010.

 

As of September 30, 2010 the Company has net operating loss carryforwards of approximately $10,500,000 available to offset taxable income through the year 2030 and may be limited to Internal Revenue Service (IRS) change in control provisions.

 

The Company recorded a deferred income tax asset for the tax effect of net operating loss carryforwards and temporary differences, aggregating approximately $4,181,250 as of September 30, 2010. In recognition of the uncertainty regarding the ultimate amount of income tax benefits to be derived, the Company has recorded a valuation allowance of $4,181,250 at September 30, 2010.

5. STOCKHOLDERS EQUITY

During the nine months ended September 30, 2010 the Company issued an aggregate of 1,000,000 shares of common stock to a consultant with a value of $80,000 for future services to be rendered. The Company recorded a non-cash stock compensation expense of approximately $60,000 for the period ended September 30, 2010. The remaining non-cash stock compensation expense will be recorded over the term of the agreement. Pursuant to this consulting agreement the Company issued 500,000 shares during the first quarter of 2010 and 500,000 shares on June 1, 2010.

The Company also issued, during the nine months ended September 30, 2010, 6,000,000 shares of common stock to the same consultant in accordance with a consulting agreement with the Company dated January 14, 2009 and a subsequent exchange agreement, in which the parties agreed to exchange options to purchase 300,000 shares for the subject issuance in recognition of service provided. Half the shares were issued on April 16, 2010 and the other half were issued on May 20, 2010. The Company recorded a non-cash stock compensation expense of approximately $1,189,000 for the nine months ended September 30, 2010.

The Company issued 100,000 shares of common stock to a second consultant with a value of $20,000 for future services to be rendered. In connection therewith, the consultant was also issued a total of 100,000 two-year warrants exercisable for one share of common stock at $0.10 per share. The Company recorded a non-cash stock compensation expense of approximately $4,800 for the period ended September 30, 2010. The remaining non-cash stock compensation expense will be recorded over the term of the agreement.

The Company has an agreement with another consultant to issue 60,000 shares per quarter through June 30, 2014 unless the agreement is terminated by either party. This agreement was revised in April 2010, at the request of the consultant, whereby the non-cash stock compensation in shares were changed to 60,000 options per quarter through June 30, 2014. The prior transactions associated with the non-cash stock compensation expenses were reversed in the second quarter. The consultant terminated this agreement on August 1, 2010 at which time the consultant become a commission only Sales Representative for the Company. For the nine months ended September 30, 2010 the Company recorded a non-cash stock compensation expense of approximately $12,000.  No additional non-cash stock compensation expense will be records by the Company because of the termination.

In addition, during the nine months ended September 30, 2010, the Company issued 375,000 shares of stock to its chairman of the board and recorded non-cash stock compensation expense of approximately $60,000. Furthermore, the Company issued 315,000 shares of common stock to an employee as payment for accrued compensation as of December 31, 2009 in the amount of approximately $57,000.

 

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During the nine months ended September 30, 2010, the Company sold 2,625,000 shares of its common stock at $0.05 per share to accredited investors for total proceeds of $225,000 in a private placement offering. In connection therewith, the investors was also issued a total of 2,250,000 two-year warrants exercisable for one share of common stock at $0.10 per share.

6.   STOCK OPTION PLAN

On April 22, 2008, the Board of Directors of the Company adopted the Company’s 2008 Stock Incentive Plan (the “2008 Stock Plan”). Under the 2008 Stock Plan, officers, other employees and directors of, and consultants to, the Company or its subsidiaries may be awarded stock options, stock appreciation rights and other stock awards. As amended subsequent to the quarter ended September 30, 2010, the number of shares subject to the 2008 Stock Plan may not exceed 15,000,000 shares in total. The 2008 Stock Plan provides for the grant of (i) options that are intended to qualify as incentive stock options ("Incentive Stock Options") within the meaning of Section 422 or 424 of the Internal Revenue Code to key employees and (ii) options not so intended to qualify ("Nonqualified Stock Options") to officers, employees of or consultants to the Company or any non employee director. On April 22 and 30, 2008, the Board of Directors granted 1,265,000 nonqualified stock options to employees and consultants. The Stock Option Plan is administered by a committee of the Board of Directors (or if there is no committee, the Board of Directors itself). The committee shall determine the terms of the options granted, including the exercise price, the number of shares subject to the option and the terms and conditions of exercise.

 

During the nine months ending September 30, 2010, 750,000 stock options were forfeited when individuals stopped working for the Company.

The exercise price of Incentive Stock Options granted under the plan must be at least equal to the fair market value of the shares on the date of the grant. The maximum term for each Incentive Stock Option granted is five years. Options shall be exercisable at such times and in such installments as the committee shall provide in the terms of each individual option. The maximum number of shares for which options may be granted to any individual in any fiscal year is 2,000,000. The Stock Option Plan also provides for the granting of stock appreciation rights, restricted stock awards, restricted stock unit awards, performance awards, qualified performance awards and stock awards. The Board of Directors has not granted any of these other types of awards.

 

During the nine months ended September 30, 2010 the Company granted 6,650,000 options.

For the three months ended September 30, 2010 and 2009 the share-based compensation expense, related to the Company’s stock option plan, was approximately $330,000 and $34,000, respectively. For the nine months ended September 30, 2010 and 2009 the share-based compensation expense was approximately $684,000 and $102,000, respectively.

 

The Company recognizes stock-based compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term.

 

As of September 30, 2010, there were approximately $80,000 of unrecognized compensation cost related to non-vested stock option awards, which is expected to be recognized over a remaining weighted-average vesting period of 3.33 years.

 

7.   SEGMENT INFORMATION

 

Effective January 1, 2010 management determined that it would cease the separate reporting of two separate businesses and focus the entire organization on the development and sale of software and services.  All of the company's products are based on the same basic software system.  In support of the Company’s new focus, the Company changed its name to Defentect Group, Inc.  

 

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8.   LOANS FROM OFFICERS

  

Mr. James C. Ackerly, the Chief Executive Officer and director, made loans of $86,250 to the Company during the nine months ended September 30, 2010 while $23,500 of which was repaid to Mr. Ackerly in April 2010.  The loans are demand loans that are secured by all the assets of the Company and accrue interest at the rate of 8%.  The Company accrued $17,444 in interest charges due to loans payable to Mr. Ackerly for the three months ended September 30, 2010.

9.   CONTINGENCY

On April 28, 2009, The Idler Company, Inc. (“Idler”) commenced an action against the Company, Vidiation, Inc., Vidiation, LLC, Frank O’Connor and James C. Ackerly in the United States District Court, District of Connecticut pertaining to the purchase by Idler of shares of Vidiation, LLC for $100,000 in 2007.  Such action alleges various securities law violations, breach of contract, rescission, fraud and unjust enrichment.  We intend to vigorously defend this matter. However, we cannot predict or estimate the timing or ultimate outcome of this matter. Management is of the opinion that the ultimate outcome of this matter would not have a material adverse impact on the financial position of the Company or the results of its operations and the Company intends to vigorously defend itself against this claim.

 

10.   SUBSEQUENT EVENTS

On October 26, 2010 James C. Ackerly, the Company’s Chief Executive Officer, loaned the Company $10,329.

On October 26, 2010 Edmund Resor, the Company’s Director, loaned the Company $6,500.

Additionally, on November 12, 2010 the Company received an unsecured loan of $5,000 from an investor.

 

 

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Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Financial Statements included in this report and is qualified in its entirety by the foregoing.

Forward-Looking Statements

This report contains “forward-looking statements”, which involve known and unknown risks, uncertainties and other factors which could cause actual financial or operating results, performances or achievements expressed or implied by such forward-looking statements not to occur or be realized.  These forward-looking statements generally are based on our best estimates of future results, performances or achievements, based upon current conditions and assumptions. Forward-looking statements may be identified by the use of forward-looking terminology such as “may,” “can,” “could,” “project,” “expect,” “believe,” “plan,” “predict,” “estimate,” “anticipate,” “intend,” “continue,” “potential,” “would,” “should,” “aim,” “opportunity” or similar terms, variations of those terms or the negative of those terms or other variations of those terms or comparable words or expressions. These risks and uncertainties include, but are not limited to:

 

·

general economic conditions in both foreign and domestic markets,

 

·

Cyclical factors affecting our industry,

 

·

lack of growth in our industry,

 

·

our ability to comply with government regulations,

 

·

a failure to manage our business effectively and profitably,

 

·

our ability to sell both new and existing products and services at profitable yet competitive prices, and

 

·

other risks and uncertainties set forth from time to time in our filings with the Securities and Exchange Commission.

 

You should carefully consider these risks, uncertainties and other information, disclosures and discussions which contain cautionary statements identifying important factors that could cause actual results to differ materially from those provided in the forward-looking statements.  Defentect Group, Inc. undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

Defentect Group, Inc., formerly known as Splinternet Holdings, Inc. (the “Company”) is the parent company of Splinternet Communications, Inc., originally a provider of Internet Telephony services, which entered the radiation detection market in 2007, and Vidiation, Inc., a security sales and marketing company which was acquired on April 30, 2008.

The Company develops and markets technologies for the security and threat management industry.  Our products react to the detection of chemical, biological, radiological or nuclear threats and notify responders and key administrators immediately. The Company’s unique response technology can be easily integrated with other manufacturers’ sensors, and serve many different markets. The Company has more recently entered the market for personal security solutions, tied to our DefenCall Smartphone application, the service leverages our unique response technology and enables our customers to communicate location and personal information required to facilitate timely and informed response to any event of consequence. The Company receives all its current revenues from its telephony service and is pursuing new customers and partners in the security market.

 

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The Company was incorporated in the State of Delaware on March 22, 2006 under the name Splinternet Holdings, Inc. On April 3, 2006, the Company conducted a share for share exchange of securities with Splinternet Communications, Inc. whereby 214,002 shares of the common stock, par value $0.001 per share of Splinternet Communications, Inc. were exchanged for 53,500,500 shares of the common stock, par value $0.001 per share (the “Common Stock”) of the Company (the “Share Exchange”), as a result of which Splinternet Communications, Inc. became a wholly owned subsidiary of the Company.

On April 30, 2008, the Company consummated the transaction contemplated by an Agreement and Plan of Merger (the “Vidiation Merger Agreement”) dated February 7, 2008 among the Company, Vidiation, Inc., a Delaware corporation and Splinternet Merger Sub I, Inc. (a wholly owned subsidiary of the Company formed for the purpose of such transaction) (the “Merger Sub”) pursuant to which the Merger Sub merged into Vidiation, Inc. resulting in Vidiation, Inc. becoming a wholly-owned subsidiary of the Company.   Upon closing, the Company issued an aggregate of 4,788,179 shares of common stock to the shareholders of Vidiation, Inc. in exchange for the cancellation of the then outstanding shares of common stock of Vidiation, Inc.

Splinternet Communications, Inc. was incorporated in the State of Connecticut on January 12, 2000. Since inception, we have been a developer of products, services, and marketing strategies centered around opportunities in Internet communications.  From 2000 through 2007 our approach was to develop products and services that would capitalize on the shift in telecommunications technologies from traditional telephony to Internet telephony. During this period the Company experienced disappointing revenue growth in this market. Because of this, during 2007 we shifted our focus into the development of a new radiation detection device which launched us into the radiation detection market. In 2008 our research and development was focused on developing an Internet Protocol (IP) based management, monitoring and messaging system which interfaced with our radiation detection devices and other third-party sensors. In 2009 we successfully completed several pilot programs, which utilized our management, monitoring and messaging system and sensors.

Vidiation, Inc. was a security sales and marketing company incorporated in the State of Delaware on December 10, 2007, which acquired certain assets from Vidiation LLC.  Vidiation LLC was a radiation detection technology development company, which had extensive sales and marketing experience in the surveillance and security market space and was actively engaged in that space.  The progress Vidiation, Inc. had been making in that business was desired by the Company and precipitated the above-referenced transaction.

The Company does not conduct any business or own any assets other than all of the issued and outstanding shares of Splinternet Communications, Inc. and Vidiation, Inc.  

References herein to “we”, “us” or “our” refer to the Company and its wholly owned subsidiaries, unless explicitly stated to the contrary.

Recent Events

On October 26, 2010 James C. Ackerly, the Company’s Chief Executive Officer, loaned the Company $10,329.

On October 26, 2010 Edmund Resor, the Company board member, loaned the Company $6,500.

Additionally, on November 12, 2010 the Company received an unsecured loan of $5,000 from an investor.

 

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Results of Operations

 

SERVICE REVENUE

Service revenue for the three months ended September 30, 2010 were $52,719, which is a decrease from $294,285 for the same period in 2009. Service revenue for the nine months ended September 30, 2010 were $233,945, which is a decrease from $681,684 for the same period in 2009. The decreases are due to the decline in the Company’s long distance termination usage by its customer.

COST OF REVENUE

The Company continues to purchase long distance minutes at wholesale prices from phone companies and then resells them at a markup to its customer. For the three months ended September 30, 2010, the costs of the wholesale minutes were $44,916, which is a decrease from $331,995 for the same period in 2009. For the nine months ended September 30, 2010, the costs of wholesale minutes were $214,228, which is a decrease from $656,796 for the same period in 2009. The decreases are due to the decline in usage for this service by the Company’s customer.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

In the three months ended September 30, 2010, selling, general and administrative costs were $522,676, which is an increase from $187,445 in the comparable period in 2009.  The increase is due to (1) higher consulting expenses due to marketing of the Company’s new product DefenCall and (2) the Company expanding the use of stock based compensation to employees and consultants during the second quarter 2010 as compared to the same period in 2009. For the nine months ended September 30, 2010 selling, general and administrative costs were $2,593,082, which is an increase from $747,834 for the same period in 2009. The increase is primarily due to the Company expanding the use of stock based compensation to employees and consultants . Stock based compensation increased to $346,317 in the three months ended September 30, 2010 from $61,722 for the comparable periods in 2009. For the nine months ended September 30, 2010 stock based compensation was $2,149,866, which is an increase from $342,633 during the comparable period in 2010.

RESEARCH AND DEVELOPMENT

Research and development decreased to $20,826 and $67,528 in the three and nine months ended September 30, 2010 from $33,233 and $124,336 for the comparable periods in 2009. The decrease is the result of the completion of the Company’s radiation detection sensors. The Company continues development of its IP based management, monitoring and messaging system software, which is also utilitized by the Company’s new smart phone application

INTEREST INCOME

Interest earned in the three and nine months ended September 30, 2010 was $1,070 and $3,679 compared to $1,350 and $4,053 for the comparable period in 2009. The slight decrease is primarily due to a lower average balance invested in 2010 due to the Company using cash to fund operations.

INTEREST EXPENSE

Interest expense in the three and nine months ended September 30, 2010 was $17,506 and $54,164 compared to $16,269 and $31,836 for the comparable period in 2009. The increase is due to the accrual of higher interest expense, which is the result of the additional loans made by the Chief Executive Officer to the Company during 2009.

NET LOSS

We incurred a net loss of $552,135 and $2,691,378, during the three and nine months ended September 30, 2010 compared to a net loss of $273,035 and $875,065 during the same period in the prior year for an overall increase in net loss of $279,100 and $1,816,313 for the respective periods. The increase in the net loss was primarily the result of the Company’s increase in non-cash stock compensation expenses.

 

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Financial Condition, Liquidity and Capital Resources

 

As of September 30, 2010, we had approximately $3,000 in cash and current liabilities of approximately $1,430,000; hence, we require additional funding in order to be adequately funded for the foreseeable future. The Company has primarily supplied its cash needs through loans from Mr. Ackerly (the Company’s Chief Executive Officer) and stock offerings. The Company’s need to obtain capital from outside investors is expected to continue until we are able to achieve profitable operations, if ever.

The Company has a history of substantial operating losses and an accumulated deficit of $10,611,138 as of September 30, 2010. The Company has historically experienced cash flow difficulties primarily because expenses have exceeded revenues. The Company expects to incur additional operating losses for the immediate near future. These factors, among others, raise significant doubt about ability to continue as a going concern.

Net cash used by operating activities for the nine months ended September 30, 2010 was $309,091, which was primarily the result of the net loss of $2,691,378.  No net cash was used in investing activities for the nine months ended September 30, 2010 and for the same period in the prior year.  This is due to the Company eliminating the purchase of property and equipment to conserve cash.   For the nine months ended September 30, 2010, net cash provided by financing activities was $287,750 compared to $569,615 for the nine months ended September 30, 2009. The change is due to the Chief Executive Officer of the Company making fewer loans to the Company during the nine months ended September 30, 2010 as compared to the same period in 2009.  If the Company is unable to generate sufficient revenue from operations to pay expenses or is unable to obtain additional financing on commercially reasonable terms, our business, financial condition and results of operations will be materially and adversely affected which may force us to cease operations.

Risk Factors

There are numerous and varied risks, known and unknown, that may prevent us from achieving our goals, including those described below. The risks described below are not the only ones we will face. Additional risks not presently known to us or that the Company currently deems immaterial may also impair our financial performance and business operations. If any of these risks actually occurs, our business, financial condition or results of operations may be materially adversely affected. In such case, the trading price of our Common Stock could decline, and you may lose all or part of your investment. Before making any investment decision, you should also review and consider the other information set forth in this report.

BUSINESS AND FINANCIAL RISKS

THE ONGOING ECONOMIC SLOWDOWN MAY HAVE A MATERIAL ADVERSE IMPACT ON OUR BUSINESS AND FINANCIAL CONDITION THAT WE CURRENTLY CANNOT PREDICT.

The ongoing global economic slowdown has caused turmoil and upheaval characterized by extreme volatility and declines in prices of securities, diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse or sale of financial institutions and an unprecedented level of intervention from the United States federal government and other governments. Unemployment has risen while businesses and consumer confidence have declined and there are fears of a prolonged recession.  While the ultimate outcome of these events cannot be predicted, they could materially adversely affect our business and financial condition, including our ability to raise any equity or debt financing in the future.

 

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OUR INDEPENDEENT REGISTERED PUBLIC ACCOUNTING FIRM HAVE ISSUED A GOING CONCERN OPINION.

Our auditors have included an explanatory paragraph in their opinion that accompanies our audited financial statements as of and for the year ended December 31, 2009, indicating that our recurring losses from operations, stockholders’ deficiency, and working capital deficiency raise substantial doubt about our ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

WE WILL NEED ADDITIONAL FINANCING IN ORDER TO CONTINUE OUR OPERATIONS WHICH WE MAY NOT BE ABLE TO RAISE.

We will require additional capital to finance our future operations.  We can provide no assurance that we will obtain additional financing sufficient to meet our future needs on commercially reasonable terms or otherwise.  If we are unable to obtain the necessary financing, our business, operating results and financial condition will be materially and adversely affected.

OUR PERFORMANCE DEPENDS ON MARKET ACCEPTANCE OF OUR PRODUCTS AND WE CANNOT BE SURE THAT OUR PRODUCTS ARE COMMERCIALLY VIABLE.

We expect to derive a substantial portion of our future revenues from the sales of radiation detection equipment and services that is only now entering the initial marketing phase. Although we believe our products and technologies will be commercially viable, these are new products.  If markets for our products fail to develop further, develop more slowly than expected or are subject to substantial competition, our business, financial condition and results of operations will be materially and adversely affected.

RAPIDLY CHANGING TECHNOLOGY AND SUBSTANTIAL COMPETITION MAY ADVERSELY AFFECT OUR BUSINESS.

Our business is subject to rapid changes in technology.  We can provide no assurances that research and development by competitors will not render our technology obsolete or uncompetitive.  We compete with a number of companies that have technologies and products similar to those offered by us and have greater resources, including more extensive research and development, marketing and capital than we do.  If our technology is rendered obsolete or we are unable to compete effectively, our business, operating results and financial condition will be materially and adversely affected.

DEFECTS IN OUR PRODUCTS MAY ADVERSELY AFFECT OUR BUSINESS.

Complex technologies such as the technologies developed by us may contain defects when introduced and also when updates and new products are released. Our introduction of technology with defects or quality problems may result in adverse publicity, product returns, reduced orders, uncollectible or delayed accounts receivable, product redevelopment costs, loss of or delay in market acceptance of our products or claims by customers or others against us. Such problems or claims may have a material and adverse effect on our business, financial condition and results of operations.

WE HAVE HAD LIMITED REVENUES THUS FAR.

To date, we have had limited revenues. Because we are subject to all risks inherent in a business venture, it is not possible to predict whether we will ever be profitable.  Even if we succeed with our current business plan, we may never become profitable, as we will continue to incur operating and capital expenditures for items such as salary, inventory, data processing equipment, shipping and other ongoing business activities.

Accordingly, it is not possible to predict whether or not our current and proposed activities will be sufficiently profitable. Purchasers of our shares should bear in mind that, in light of the risks and contingencies involved, no assurance can be given that we will ever generate enough revenue to offset expenses or to generate a return on invested capital. There is no guarantee of our successful, profitable operation. Our failure to achieve or maintain profitability can be expected to have a material adverse effect on our business, financial condition, results of operations and future business prospects.

 

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WE MAY EXPERIENCE SIGNIFICANT FLUCTUATIONS IN OUR OPERATING RESULTS AND RATE OF GROWTH AND MAY NOT BE PROFITABLE IN THE FUTURE.

 

Our results of operations may fluctuate significantly due to a variety of factors, many of which are outside of our control and difficult to predict. The following are some of the factors that may affect us from period to period and may affect our long-term financial performance:

·

our ability to retain and increase revenues associated with customers and satisfy customers’ demands;

·

our ability to be profitable in the future;

·

our investments in longer-term growth opportunities;

·

our ability to expand our marketing network, and to enter into, maintain, renew and amend strategic alliance arrangements on favorable terms;

·

changes to service offerings and pricing by us or our competitors;

·

fluctuations caused by marketing efforts and competitors’ marketing and pricing strategies;

·

changes in the terms, including pricing, of our agreements with our telecommunications providers;

·

the effects of commercial agreements and strategic alliances and our ability to successfully integrate them into our business;

·

technical difficulties, system downtime or interruptions;

·

the effects of litigation and the timing of resolutions of disputes;

·

the amount and timing of operating costs and capital expenditures;

·

changes in governmental regulation and taxation policies; and

·

changes in, or the effect of, accounting rules, on our operating results.

OUR HISTORICAL FINANCIAL STATEMENTS MAKE EVALUATION OF OUR BUSINESS BY POTENTIAL INVESTORS AND OTHERS DIFFICULT.  

     

We commenced our business operations in January 2000 and began generating revenue in 2001. However, since we recently refocused our business strategy to include security and threat management software, our historical financial statements, which primarily reflect our Internet telephony retail sales, are of limited usefulness in evaluating our potential future financial position.

WE MAY NOT SUCCESSFULLY ENHANCE EXISTING OR DEVELOP NEW PRODUCTS AND SERVICES IN A COST-EFFECTIVE MANNER TO MEET CUSTOMER DEMAND IN THE RAPIDLY EVOLVING MARKETS IN WHICH WE ARE ENGAGED.

The markets in which we are engaged are characterized by rapidly changing technology, evolving industry standards, changes in customer needs and frequent new service and product introductions. Our future success will depend, in part, on our ability to use leading technologies effectively, to continue to develop our technical expertise, to enhance our existing services and to develop new services that meet changing customer needs on a timely and cost-effective basis. We may not be able to adapt quickly enough to changing technology, customer requirements and industry standards. If we fail to use new technologies effectively, to develop our technical expertise and new services, or to enhance existing services on a timely basis, either internally or through arrangements with third parties, our product and service offerings may fail to meet customer needs, which would adversely affect our revenues and prospects for growth.

 

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We have spent and will continue to spend signification resources enhancing, developing, implementing and launching our security and threat management products and services. We believe threat detection products and services represent a significant growth opportunity. However, losses are expected to result in the early stages until a sufficient number of customers are added whose recurring revenues, net of recurring costs, more than offset sales, marketing and other expenses incurred to add additional customers.

To the extent we pursue commercial agreements, acquisitions and/or strategic alliances to facilitate new product or service activities, the agreements, acquisitions and/or alliances may not be successful. If any of this were to occur, it could damage our reputation, limit our growth, negatively affect our operating results and harm our business.

RELIANCE UPON THIRD-PARTY SUPPLIERS FOR COMPONENTS MAY PLACE US AT RISK OF INTERRUPTION OF SUPPLY OR INCREASE IN COSTS.

We rely on third-party suppliers for the hardware and software necessary for our services and we do not have any long-term supply agreements. Although we believe we can secure other suppliers, we expect that the deterioration or cessation of any relationship would have a material adverse effect, at least temporarily, until the new relationships are satisfactorily in place.

We also run the risk of supplier price increases and component shortages. Competition for materials in short supply can be intense, and we may not be able to compete effectively against other purchasers who have higher volume requirements or more established relationships. Even if suppliers have adequate supplies of components, they may be unreliable in meeting delivery schedules, experience their own financial difficulties, provide components of inadequate quality or provide them at prices which reduce our profit. Any problems with our third-party suppliers can be expected to have a material adverse effect on our financial condition, business, results of operations and continued growth prospects.

 

WE FACE SIGNIFICANT COMPETITION.

 

We compete on the basis of advanced technologies, competent execution of these technologies, the quality, reliability and price of our services and our prompt and responsive performance.  For example, in much of the world, radiation detection activities are conducted by a combination of private entities and governmental agencies.  In the United States, most of our competitors are larger, have substantial resources, and have been particularly active in recent years in soliciting business.  We will also face substantial competitive pressures from a number of smaller competitors.

 

THE RADIATION DETECTION INDUSTRY IS SUBJECT TO EXTENSIVE DOMESTIC AND FOREIGN GOVERNMENT REGULATIONS, WHICH COULD INCREASE OUR COSTS, CAUSE US TO INCUR LIABILITIES AND ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.

 

The radiation detection industry is subject to federal, state, and international governmental regulation. Unknown matters, new laws and regulations, or stricter interpretations of existing laws or regulations may materially affect our proposed entry into this business or operations in the future and/or could increase the cost of compliance.  Our products will have to comply with various domestic and international standards that are used by regulatory and accreditation bodies for approving such services and products.  The failure of the Company to obtain accreditation for its products and services may adversely affect us and the market perception of the effectiveness of our proposed products.  In the future, changes in these standards and accreditation requirements may also result in the Company having to incur substantial costs to adapt its offerings and procedures.  Additionally, changes affecting radiation detection practices, including new understandings of the hazards of radiation exposure and amended regulations, may impact how the Company’s services are used by its customers and may, in some circumstances, cause the Company to alter its products and delivery of its services.

 

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OUR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY IN THE RADIATION DETECTION INDUSTRY COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.

 

With regard to our radiation detection device, patents will be material to our operations.  We have initiated the process of patenting our detection and reporting process.  No assurance can be given that such patent application will be granted.  Our success will depend in part on our ability to develop patentable products and obtain and enforce patent protection for our products both in the United States and in other countries.   Patents may not be issued for any pending or future patent applications owned by or licensed to us, and the claims allowed under any issued patents may not be sufficiently broad to protect our technology.  Any issued patents owned by or licensed to us may be challenged, invalidated or circumvented, and the rights under these patents may not provide us with competitive advantages.  In addition, competitors may design around our technology or develop competing technologies.  Intellectual property rights may also be unavailable or limited in some foreign countries, which could make it easier for competitors to capture increased market position.  We could incur substantial costs to defend ourselves in suits brought against us or in suits in which we may assert our patent rights against others. An unfavorable outcome of any such litigation could materially adversely affect our business and results of operations.

 

THERE IS NO ASSURANCE THAT WE CAN SUCCESSFULLY IMPLEMENT JOINT VENTURES OR FIND PARTNERS FOR OUR BUSINESS.

 

With regard to our radiation detection business, we intend to acquire or joint venture with security companies that sell or install security systems to various markets. These markets include and are not limited to hospitals and waste management. The success of out business plan is predicated on us finding appropriate partners and introducing the Company’s radiation detection products to their operations.

 

There is no assurance that we will be able to access such companies or to complete their acquisition or negotiate joint ventures.

 

ONGOING SUCCESS AND OUR ABILITY TO COMPETE DEPEND UPON HIRING AND RETENTION OF KEY PERSONNEL.

Success will   be dependent to a significant degree upon the involvement of current management. These individuals have critical industry experience and relationships upon which we rely. The loss of services of any of our key personnel could divert time and resources, delay the development of our business and negatively affect our ability to sell our services or execute our business. In addition, we will need to attract and retain additional talented individuals in order to carry out our business objectives. The competition for such persons is intense and there are no assurances that these individuals will be available. Such problems might be expected to have a material adverse impact on our financial condition, results of current operations and future business prospects.

DIRECTOR AND OFFICER LIABILITY IS LIMITED.

As permitted by Delaware law, the certificate of incorporation of the Company limits the personal liability of directors to the fullest extent permitted by the provisions of the Delaware General Corporation Law. As a result of our charter provision and Delaware law, stockholders may have limited rights to recover against directors for breach of fiduciary duty. In addition, the certificate of incorporation of the Company provides that it shall indemnify its directors and officers to the fullest extent permitted by law.

 

RISKS RELATING TO THE OUR COMMON STOCK

 

WE HAVE HAD IMPAIRMENT OF GOODWILL.

The Company had significant intangible assets related to goodwill and other acquired intangibles. In determining the recoverability of goodwill and other intangibles, assumptions are made regarding estimated future cash flows and other factors to determine the fair value of the assets. After completing the impairment testing of goodwill and other intangible assets, the Company concluded an impairment charge of $2,831,790 should be taken at December 31, 2009 in connection with the recorded goodwill arising from its acquisition made in 2008, This impairment charge was the result of projected revenue related to the acquisition not being achieved and future sales contracts not being closed.

 

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THE PRICE OF OUR COMMON STOCK IS HIGHLY VOLATILE.

The price of our common stock is highly volatile. Fluctuations in the market price of our common stock may be a result of any number of factors or a combination of factors including, but not limited to:

·

the number of shares in the market and the number of shares we may be required to issue in the future compared to market demand for our shares;

·

our performance and meeting expectations of performance, including the development and commercialization of our current and proposed products and services;

·

market conditions for Internet and media companies in the small capitalization sector; and

·

general economic and market conditions.

PENNY STOCK REGULATIONS MAY IMPOSE CERTAIN RESTRICTIONS ON MARKETABILITY OF THE COMPANY’S SECURITIES.  

Our common stock relies on the OTC Bulletin Board for the quotations and is subject to rules pertaining to “penny stocks”. The SEC has adopted regulations which generally define a “penny stock” to be any equity security that has a market price (as defined) of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our shares currently have a market price of less than $5.00 per share. As a result, the Company’s Common Stock is subject to rules that impose additional sales practice requirements on broker/dealers who sell such securities to persons other than established clients and “accredited investors”. For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of such securities and have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer must also disclose the commission payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the “penny stock” rules may restrict the ability of broker/dealers to sell shares of the Company’s Common Stock and may affect the ability of investors to sell such shares of Common Stock in the secondary market and the price at which such investors can sell any of such shares.

Investors should be aware that, according to the SEC, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include :

·

control of the market for the security by one or a few broker/dealers that are often related to the promoter or issuer;

·

manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases;

·

“boiler room” practices involving high pressure sales tactics and unrealistic price projections by inexperienced sales persons;

·

excessive and undisclosed bid-ask differentials and markups by selling broker/dealers; and

·

the wholesale dumping of the same securities by promoters and broker/dealers after prices have been manipulated to a desired level, along with the inevitable collapse of those prices with consequent investor losses.

 

 

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Section 15(g) of the Exchange Act and Rule 15g-2 of the Securities and Exchange Commission require broker/dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document before making any transaction in a penny stock for the investor’s account. You are urged to obtain and read this disclosure carefully before purchasing any of our shares.

 

Rule 15g-9 of the Securities and Exchange Commission requires broker/dealers in penny stocks to approve the account of any investor for transactions in these stocks before selling any penny stock to that investor. This procedure requires the broker/dealer to:

 

·

get information about the investor’s financial situation, investment experience and investment goals;

·

reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor can evaluate the risks of penny stock transactions;

·

provide the investor with a written statement setting forth the basis on which the broker/dealer made his or her determination; and

·

receive a signed and dated copy of the statement from the investor, confirming that it accurately reflects the investors’ financial situation, investment experience and investment goals.

 

Compliance with these requirements may make it harder for our stockholders to resell their shares.

IF WE RAISE ADDITIONAL FUNDS THROUGH THE ISSUANCE OF EQUITY SECURITIES, OR DETERMINE IN THE FUTURE TO REGISTER ADDITIONAL COMMON STOCK, YOUR PERCENTAGE OWNERSHIP WILL BE REDUCED, YOU WILL EXPERIENCE DILUTION WHICH COULD SUBSTANTIALLY DIMINISH THE VALUE OF YOUR STOCK AND SUCH ISSUANCE MAY CONVEY RIGHTS, PREFERENCES OR PRIVILEGES SENIOR TO YOUR RIGHTS WHICH COULD SUBSTANTIALLY DIMINISH YOUR RIGHTS AND THE VALUE OF YOUR STOCK.

 

The Company may issue additional shares of Common Stock for various reasons and may grant stock options to employees, officers, directors and third parties. If the Company determines to register for sale to the public additional shares of Common Stock or other debt or equity securities in any future financing or business combination, a material amount of dilution can be expected to cause the market price of the Common Stock to decline. One of the factors which generally affects the market price of publicly traded equity securities is the number of shares outstanding in relationship to assets, net worth, earnings or anticipated earnings. Furthermore, the public perception of future dilution can have the same effect even if actual dilution does not occur.

 

SINCE WE DO NOT INTEND TO DECLARE DIVIDENDS IN THE FORESEEABLE FUTURE, THE RETURN ON YOUR INVESTMENT WILL DEPEND UPON APPRECIATION OF THE MARKET PRICE OF YOUR SHARES.

 

We have never paid any dividends on our common stock. Our board of directors does not intend to declare any dividends in the foreseeable future, but intends to retain all earnings, if any, for use in our business operations. As a result, the return on your investment in us will depend upon any appreciation in the market price of our common stock. The holders of common stock are entitled to receive dividends when, as and if declared by the board of directors, out of funds legally available for dividend payments. The payment of dividends, if any, in the future is within the discretion of our board of directors and will depend upon our earnings, capital requirements and financial condition, and other relevant factors.

 

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Critical Accounting Policies

 

The following is a discussion of the accounting policies that the Company believes are critical to its operations :

 

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Revenue recognition

The Company records revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured. 

 

We recognize revenue when products have been shipped or services have been performed. The Company does not offer prepays for termination services. For the Company’s radiation detection products which require an acceptance period during which the customer may cancel their contract or purchase order without penalty, the Company defers the revenue recognition until the end of that acceptance period. The Company offers a one-year warranty on its radiation detection products and provides for estimated future warranty costs at the time revenue is recognized. As of this filing date, no warranty obligation has been recorded.

 

Stock based Compensation

 

The Company records stock based compensation when (1) a consultant or vendor providers services and is compensated by the Company issuing restricted shares and (2) an employee or consultant is awarded stock options under the Company’s 2008 Stock Plan. The non-cash stock compensation expense is recorded for the period. When a stock based compensation expense occurs for future services the Company records the non-cash stock compensation expense for the period and the remaining non-cash stock compensation expense is recorded over the term of the agreement.

 

Off-Balance Sheet Arrangements

We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, and results of operations, liquidity or capital expenditures.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

 

Item 4T.

Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure (1) that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms, and (2) that this information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.  In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.

 

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Prior to the filing date of this report, under the supervision and review of our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded, as of September 30, 2010, that our disclosure controls and procedures were not effective in alerting them in a timely manner to material information regarding us that is required to be included in our periodic reports to the SEC due to the material weakness noted below.

A material weakness is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

At the end of fiscal year 2009, we decided to change the focus of our business activities as described elsewhere in this document.  As a result, the goodwill associated with the acquisition of Vidiation, Inc. in 2008 was impaired. Due to an oversight in our policies and procedures for the review of the testing of goodwill impairment, we temporarily overlooked important issues related to the testing of goodwill impairment. Although this oversight was discovered before filing of any reports, it did create a reasonable possibility that a material misstatement of our annual or interim financial statements might not be prevented or detected on a timely basis in the future. Accordingly, we determined that this control deficiency constituted a material weakness.

 

During the preparation of our annual report on Form 10-K, the underlying circumstances of this material weakness were fully communicated to and considered by our independent registered public accounting firm to ensure that the appropriate accounting treatment was recorded in the financial statements included in the Form 10-K.

 

We have developed the following remediation plan to address this material weakness and we are proceeding expeditiously with measures to enhance our internal control over financial reporting:

·

Our Board of Directors will monitor the accounting policies adopted by the Company and will direct additional measures as deemed appropriate.

 

Accordingly, our management believes that the accounting included in this Form 10-Q fairly presents in all material respects our financial position, results of operations and cash flows for the periods presented.

In addition, there have been no other significant changes in our internal controls or in other factors that could significantly affect those controls that occurred during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  We can provide no assurance, however, that our system of disclosure controls and procedures will always achieve its stated goals under all future conditions, no matter how remote.

PART II  - OTHER INFORMATION

Item 1.

Legal Proceedings

Except as set forth below, we are not a party to any pending legal proceeding, nor is our property the subject of a pending legal proceeding, that is not in the ordinary course of business or otherwise material to the financial condition of our business. None of our directors, officers or affiliates is involved in a proceeding adverse to our business or has a material interest adverse to our business.

 

On April 28, 2009, The Idler Company, Inc. (“Idler”) commenced an action against the Company, Vidiation, Inc., Vidiation, LLC, Frank O’Connor and James C. Ackerly in the United States District Court, District of Connecticut pertaining to the purchase by Idler of shares of Vidiation, LLC for $100,000 in 2007.  Such action alleges various securities law violations, breach of contract, rescission, fraud and unjust enrichment.  We intend to defend this matter vigorously. However, we cannot predict or estimate the timing or ultimate outcome of this matter.

 

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Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

In connection with the appointment of Ambassador L. Paul Bremer, III to serve as a member of the Company’s Board of Directors, effective October 10, 2008, the Board has agreed to issue to Ambassador Bremer, or his designee, 1,000,000 shares of our common stock which will vest quarterly over two years with acceleration of vesting when authorized by the Board of Directors in acknowledgement of extraordinary circumstances or success.  As a result, unless accelerated, 125,000 shares will be issued to Ambassador Bremer quarterly and the Company will record non-cash compensation expense for the fair value of shares issued.  Through September 30, 2010, a total of 1,000,000 shares have been issued.  Of such amount, 375,000 were issued in the nine months ended September 30, 2010.  The issuance of these shares of common stock are exempt from registration requirements pursuant to Section 4(2) of the Securities Act of 1933, as amended.  

During the nine months ended September 30, 2010, the Company issued 315,000 shares of common stock to an employee as payment for accrued compensation as of December 31, 2009.  The issuance of these shares of common stock are exempt from registration requirements pursuant to Section 4(2) of the Securities Act of 1933, as amended.  

During the nine months ended September 30, 2010 the Company issued an aggregate of 7,100,000 shares of common stock to two consultants for services rendered and 315,000 shares of common stock to an employee as payment for accrued compensation as of December 31, 2009.  The issuance of these shares of common stock are exempt from registration requirements pursuant to Section 4(2) of the Securities Act of 1933, as amended.  

In addition, during the nine months ended September 30, 2010, the Company sold 2,625,000 shares of its common stock at $0.05 per share to accredited investors for total proceeds of $225,000 in a private placement offering. In connection therewith, the investor was also issued a total of 2,250,000 two-year warrants exercisable for share of common stock at $0.10 per share.  The securities were issued in reliance upon the exemption from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended, and/or Rule 506 thereunder.

Item 3.

Defaults Upon Senior Securities

Not applicable.

Item 4.

[Removed and Reserved]

 

Item 5.

Other Information

Effective June 15, 2010, the Board of Directors of the Company elected Jeffrey W. Knapp President and Chief Operating Officer of the Company.  Concurrent with this appointment, Mr. Knapp has been granted an option to purchase 3,000,000 shares of the Company’s Common Stock under our Stock Incentive Plan.  Through September 30, 2010, a total of 500,000 options have vested.  In addition, Mr. Knapp will be entitled to receive certain cash and equity based compensation upon the Company achieving funding and business successes in the future as determined by the board.

Mr. Knapp, age 53, has served in executive management positions for companies in all stages of business growth.  From February 2007 to June 2010, he served as the Vice President of Marketing for On-Net Surveillance Systems, Inc. (OnSSI), a market leader in open-architecture, intelligent IP-based video surveillance software. While at OnSSI, he successfully developed strategies for branding, launch and positioning of new products, implemented consultant marketing and partner development programs, and was responsible for overseeing all product marketing, industry event, website management, partner marketing, sales and distribution channel support, and marketing communications.  Prior to joining OnSSI Mr. Knapp was President of Management Strategy, Inc., a firm that provided strategic consulting and business development services to early stage high technology organizations.  Prior thereto, and from 2001 to 2005, he was Executive Vice President of eSocrates, and from 1996 to 2000, he was Executive Vice President of Stores Automated Systems, Inc.  Mr. Knapp holds degrees from Yale University (B.A. Psychology) and the Stern School of Business at New York University (M.B.A. Management).

 

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Mr. Knapp does not have any family relationships with any of the Company’s directors or executive officers, or any person nominated or chosen by the Company to become a director or executive officer.

 

Other than as disclosed herein, there are no arrangements or understandings between Mr. Knapp and any other person pursuant to which he was selected as an officer, and there have not been any past transactions, nor are there any currently proposed transactions, between the Company or any of its subsidiaries, on the one hand, and Mr. Knapp, on the other hand, that would require disclosure pursuant to Item 404(a) of Regulation S-K.

 

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Item 6.

Exhibits

 

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   (Rules 13a-14 and 15d-14 of the Exchange Act)
31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act)
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)
32.2	Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	DEFENTECT GROUP, INC.
	(Registrant)
Dated:  November 22, 2010	By:	/s/ James C. Ackerly
	James C. Ackerly, Chief Executive Officer
	(Principal Executive Officer)
Dated:  November 22, 2010	By:	/s/ John T. Grippo
	John T. Grippo, Chief Financial Officer
	(Principal Financial Officer)

 

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