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| MSGI.OB > SEC Filings for MSGI.OB > Form 10-K on 13-Oct-2009 | All Recent SEC Filings |
13-Oct-2009
Annual Report
Critical Accounting Policies
Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. This should be read in conjunction with the financial statements, and notes thereto, included in this Form 10-K. The following is a brief description of the more significant accounting policies and methods used by the Company.
The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America 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. The Company believes that the estimates, judgments and assumptions upon which the Company relies are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The significant accounting policies that the Company believes are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
· Revenue Recognition and
· Costs of Product Shipped to Customers for which Revenue has not been Recognized
· Accounts Receivable and Allowance for Doubtful Accounts
· Accounting for Income Taxes
· Equity based compensation
· Debt instruments and the features / instruments contained therein
· Investments in non-consolidated entities
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed the Company's critical accounting policies and related disclosures with our Audit Committee. See Notes to Consolidated Financial Statements, which contain additional information regarding our accounting policies and other disclosures required by GAAP.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates and assumptions made in the preparation of the consolidated financial statements relate to the carrying amount and amortization of long lived assets, deferred tax valuation allowance, valuation of stock options, warrants and debt features and the allowance for doubtful accounts. Actual results could differ from those estimates
Revenue Recognition:
The Company accounts for revenue recognition in accordance with Staff Accounting
Bulletin No. 104, (SAB 104), which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements. Revenues are
reported upon the completion of a transaction that meets the following criteria:
(1) persuasive evidence of an arrangement exists; (2) delivery of our services
has occurred; (3) our price to our customer is fixed or determinable; and (4)
collectability of the sales price is reasonably assured. Since the Company has a
limited number of revenue transactions, that are each unique to each customer,
the Company reviews each transaction to determine that all revenue criteria are
met.
Our revenues for the year ended June 30, 2009 were derived from consulting services provided to third parties.
The Company had certain shipments to various customers associated with our Apro relationships during fiscal 2008 in the aggregate of approximately $6.4 million that were not recognized as revenue in fiscal 2008 due to certain revenue recognition criteria not being met as of June 30, 2008, related to the assurance of collectability among other factors. These transactions will be recognized as revenue in the period in which all the revenue recognition criteria, as noted above, has been fully met. Therefore, there is no revenue or related accounts receivable recorded for these transactions in 2008 or 2009. Inventory costs related to these transactions for which revenue has not been recognized had been reported on the consolidated balance sheet in Costs of product shipped to customers for which revenue has not been recognized. As of June 30, 2009, the value of all such inventory has been fully reserved and written off, as the revenue transactions has not yet been recognized and there is litigation to attempt to recover some of the damages that we suffered as a result of such transactions.
Costs of product shipped to customers for which revenue has not been recognized
As of June 30, 2008, the Company had capitalized the expense recognition of approximately $5.4 million in product costs for goods that were shipped to customers associated with our Apro relationships as of June 30, 2008 but for which revenue has not yet been recognized. The Company had also recorded a reserve against these product costs in the amount of approximately $1.4 million. During the fiscal year ended June 30, 2009, the Company recorded an additional reserve of approximately $4.0 million, thus fully reserving the entire capitalized balance of approximately $5.4 million. We have instituted a law suit to recover soe of the damages that we suffered as a result of such transactions.
The Company extends credit to its customers in the ordinary course of business. Accounts are reported net of an allowance for uncollectible accounts. Bad debts are provided on the allowance method based on historical experience and management's evaluation of outstanding accounts receivable. In assessing collectability the Company considers factors such as historical collections, a customer's credit worthiness, and age of the receivable balance both individually and in the aggregate, and general economic conditions that may affect a customer's ability to pay. The Company does not require collateral from customers nor are customers required to make up-front payments for goods and services.
Accounting for Income Taxes:
The Company recognizes deferred taxes for differences between the financial statement and tax bases of assets and liabilities at currently enacted statutory tax rates and laws for the years in which the differences are expected to reverse. The Company uses the asset and liability method of accounting for income taxes, as set forth in SFAS No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities and net operating loss carry-forwards, all calculated using presently enacted tax rates. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
The Company follows the provisions of Financial Standards Accounting Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an interpretation of SFAS 109" (FIN 48). FIN 48 provides recognition criteria and a related measurement model for uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 requires that a position taken or expected to be taken in a tax return be recognized in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. Tax positions that meet the more likely than not threshold are then measured using a probability weighted approach recognizing the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement. The adoption did not have an effect on the consolidated financial statements and there is no liability related to unrecognized tax benefits at June 30, 2009.
Equity Based Compensation:
We follow Statement of Financial Accounting Standards No. 123 Revised 2004 (SFAS 123R), "Share-Based Payment". This Statement requires that the cost resulting from all share-based payment transactions are recognized in the financial statements of the Company. That cost will be measured based on the fair market value of the equity or liability instruments issued.
Debt instruments, and the features/instruments contained therein:
Deferred financing costs are amortized over the term of its associated debt instrument. The Company evaluates the terms of the debt instruments to determine if any embedded derivatives or beneficial conversion features exist. The Company allocates the aggregate proceeds of the notes payable between the warrants and the notes based on their relative fair values in accordance with Accounting Principles Board No. 14 ("APB 14"), "Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants". The fair value of the warrants is calculated utilizing the Black-Scholes option-pricing model. The Company is amortizing the resultant discount or other features over the term of the notes through its earliest maturity date using the effective interest method. Under this method, the interest expense recognized each period will increase significantly as the instrument approaches its maturity date. If the maturity of the debt is accelerated because of defaults or conversions, then the amortization is accelerated. The Company's debt instruments do not contain any embedded derivatives at June 30, 2009.
Investments in Non-Consolidated Entities:
The Company accounts for its investments under the cost basis method of accounting if the investment is less than 20% of the voting stock of the investee, or under the equity method of accounting if the investment is greater than 20% of the voting stock of the investee. Investments accounted for under the cost method are recorded at their initial cost, and any dividends or distributions received are recorded in income. For equity method investments, the Company records its share of earnings or losses of the investee during the period. Recognition of losses will be discontinued when the Company's share of losses equals or exceeds its carrying amount of the investee plus any advances made or commitments to provide additional financial support.
An investment in non-consolidated companies is considered impaired if the fair value of the investment is less than its cost on an other-than-temporary basis. Generally, an impairment is considered other-than-temporary unless (i) the Company has the ability and intent to hold an investment for a reasonable period of time sufficient for an anticipated recovery of fair value up to (or beyond) the cost of the investment; and (ii) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. If impairment is determined to be other-than-temporary, then an impairment loss is recognized equal to the difference between the investment's cost and its fair value.
Overview
To facilitate an analysis of MSGI operating results, certain significant events should be considered.
Hyundai
In September and October of 2006, the Company entered into various agreements
with Hyundai Syscomm Corp, a California Corporation, ("Hyundai"). Under the
License Agreement and the Subscription agreement, the Company provided for the
sale of 900,000 shares of the Company's common stock upon receipt of a $500,000
fee under the License Agreement. The three-year Sub-Contracting Agreement with
Hyundai allows for MSGI and its affiliates to participate in contracts that
Hyundai and/or its affiliates now have or may obtain hereafter, where the
Company's products and/or services for encrypted wired or wireless surveillance
systems or perimeter security would enhance the value of the contract(s) to
Hyundai or its affiliates. There have been no business transactions under the
Sub-Contract or License agreements to date. The Company has subsequently named
Hyundai as a defendant in a legal action taken in the State of California and
currently views any and all contracts and agreements with Hyundai in breach.
Apro Media
On May 10, 2007, the Company entered into an exclusive sub-contract and
distribution agreement with Apro Media Corp. for at least $105 million of
expected sub-contracting business over seven years to provide commercial
security services to a Fortune 100 defense contractor and/or other
customers. Under the terms of the contract, MSGI will acquire components from
Korea and deliver fully integrated security solutions at an average expected
level of $15 million per year for the length of the seven-year engagement. The
contract calls for gross profit margins estimated to be between 26% and 35%
including a profit sharing arrangement with Apro Media, which will initially
take the form of unregistered MSGI common stock, followed by a combination of
stock and cash and eventually just cash. The Company has subsequently named Apro
as a defendant in a legal action taken in the State of California and currently
views any and all contracts and agreements with Apro in breach.
CODA
On April 1, 2007 the Company entered into a non-exclusive license agreement with
CODA Octopus, Inc. (CODA) whereby the Company will receive a royalty on sales of
products using the Innalogic proprietary technology. In connection with such
transaction, CODA assumed certain development and operations responsibilities of
the Innalogic entity.
Major recent financing transactions
On December 13, 2007, the Company entered into four short-term notes with
private institutional lenders. These promissory notes provided proceeds totaling
$2.86 million to the Company. The proceeds of these notes were used to purchase
inventory to fulfill various purchase orders referred to us by Apro. These notes
have been amended at various times and now bear interest at 18% per annum. As of
June 30, 2009, these short-term notes remain outstanding to the four lenders,
and all are due on demand and are classified as current liabilities on the
consolidated balance sheet.
On January 10, 2008, the Company issued (i) 5,000,000 shares of the Company's Series H Convertible Preferred Stock (ii) a Put Option agreement and (iii) warrants exercisable for 5,000,000 shares of Common Stock at an exercise price of $2.50 per share. The Buyers paid a total of $5,000,000 for securities issued in the Preferred Stock Transaction. From the Total Purchase Price, $2,000,000 was used to purchase the securities of Current Technology and $1,800,000 was placed in a restricted cash account to be used as collateral for the Company's obligations under the Put Option Agreement. See below for a description of the Securities Exchange Transaction.
On January 10, 2008, the Company entered into a Subscription Investment Agreement with Current Technology Corporation, a corporation formed under the laws of the Canada Business Corporation Act. Under this agreement, at March 31, 2009, the Company has invested a total of $2 million and owns 20 million shares of the common stock of Current Technology, which represents approximately 13% ownership of their outstanding common stock. In addition, the Company held warrants to purchase 20 million additional shares of common stock. As of June 30, 2009, the Company has an option to invest an additional $500,000 under the original agreement terms. In August 2008, the 20 million warrants were assigned to a third party as part of a Securities Exchange Agreement involving the Company's Preferred Stock. During the year ended June 30, 2009, the Company was forced to surrender 5,000,000 shares of common stock in Current Technology as part of an amendment to a loan agreement associated with an advance from an officer (see Note 5).
On August 22, 2008, the Company entered into a Securities Exchange Agreement with Enable Growth Partners, LP (Enable), an existing institutional investor of MSGI and as of that date, holder of 100% of MSGI's Series H Convertible Preferred Stock pursuant to which MSGI retired all outstanding shares of the Series H Preferred Stock, 5,000,000 warrants issued in connection with the preferred stock, exercisable for shares of common stock of MSGI and put options exercisable for 5,000,000 shares of Common Stock. Enable recently acquired the Series H Preferred Stock, Warrants and Put Options pursuant to a private transaction with third parties.
On March 16, 2009, the Company entered into three convertible promissory notes with Enable which provided the Company with gross proceeds of $250,000. The notes bear interest at a rate of 10% annually and are convertible into shares of common stock of the Company at a conversion rate of $0.25 per share. As an incentive for Enable to issue these convertible promissory notes, the Company and Enable entered into a certain warrant exchange agreement whereby Enable has been granted the right to exchange all warrants held from previous transactions into 10,000,000 shares of common stock of the Company. The original warrants carry exercise prices ranging from $0.50 to $2.50 and represent a total of 14,642,852 shares available to purchase.
During 2009 and 2008, the Company received net proceeds of approximately $167,000 and $0 of advances from officers and others, which have no stated interest rate or maturity date.
Results of Operations Fiscal 2009 Compared to Fiscal 2008
For the year ended June 30, 2009 (the Current Period), the Company realized revenues in the amount of $282,000 from consulting service provided to third parties.
For the year ended June 30, 2008 (the Prior Period), the Company realized revenues in the amount of approximately $3.8 million from the sales of products through our relationship with Apro Media Corp., a $100,000 royalty fee / referral fee income generated from the CODA Octopus Group, Inc., and $128,000 for consulting services. The Company had additional shipments and corresponding billings to various customers in the aggregate of approximately $6.5 million, which have not been recognized as revenues in fiscal 2008 or fiscal 2009 to date as a result of issues surrounding collectibility. In addition, the $6.5 million of billings have been reversed and are not reflected as of June 30, 2008 or 2009. Of these shipments, approximately $1.6 million were from shipments of products through our relationship with Apro and approximately $4.9 million were from shipments to other customers referred to us by Apro.
Costs of goods sold of approximately $4.1 million in the Current Period were the result of the Company recording a reserve for potential loss in recognition of potential recovery issues surrounding costs associated with product shipped to customers during the Prior Period for which revenue has not yet been recognized due to recognition criteria on the transactions having not been met. These costs are not associated with the revenue realized during the Current Period.
Costs of goods sold of approximately $4.2 million in the Prior Period consisted primarily of the expenses related to acquiring the components required to provide the specific technology applications ordered by individual customers. The Company classified as an asset approximately $5.4 million in costs associated with the product shipped during the Prior Period due to the revenue recognition criteria on these transactions have not been met. The Company recorded a reserve for potential loss of approximately $1.4 million in recognition of potential recovery issues for certain of such transactions, which is included in costs of goods sold for the Prior Period. The gross profit realized on individual commercial sales averaged 26% for transactions for product shipments, with the revenue for the referral and consulting fee raising the overall gross profit to the 30%. This was offset with the reserve against the product costs, which created the negative gross margin since there was no revenue recognized in fiscal 2008 against these transactions. The Company has commenced litigation against the parties to such transaction for breach of contract.
Research and development expenses were approximately $88,000 in the Prior Period and related to the development of RFID technologies. There were no such costs realized in the Current Period. The Company ceased much of its operations as it re-focused its business relationships from Apro/Hyundai to NASA related technologies.
Salaries and benefits of approximately $1.1 million in the Current Period decreased by approximately $1.2 million from salaries and benefits of approximately $2.3 million in the Prior Period. Salaries and benefits decreased primarily due to accruals of additional payroll taxes, penalties and interest booked in the Prior Period by the Company, which were not realized during the Current Period.
Selling, general and administrative expenses of approximately $1.4 million in the Current Period decreased by approximately $3.1 million or 69% from comparable expenses of $4.5 million in the Prior Period. The decrease is due primarily to the cost of shares issued to Apro in connection with the Company's sub-contract agreement, which resulted in an expense of approximately $1.1 million in the Prior Period versus a credit of approximately $62,000 in the Current Period, as well as reductions in investor relations of approximately $1.0 million, professional fees such as legal and accounting of approximately $0.6 million, office expenses of approximately $0.1 million and travel and entertainment expenses of approximately $0.2 million. The Company ceased much of its operations as it re-focused its business relationships from Apro/Hyundai to NASA related technologies.
During the Current Period, the Company recorded depreciation and amortization expense of approximately $15,000, which represented a decrease of approximately $12,000 from comparable expenses of approximately $27,000 in the Prior Period. This variance is the result of certain intangible assets being fully amortized during the Prior Period.
Interest income of approximately $13,000 in the Current Period increased over interest income of approximately $6,000 in the Prior Period due primarily to the Company holding larger average cash balances during the course of the Current Period than that of the Prior Period.
Interest expense of approximately $2.7 million in the Current Period decreased by approximately $8.9 million from interest expense of approximately $11.6 million in the Prior Period. The expenses in the Prior Period were due primarily to the effect of certain repricing transactions during the year affecting certain debt instruments and the adjustments to the values of certain equity instruments granted to note holders. The non-cash component of interest expense was approximately $1.5 million in the Current Period as compared to $9.8 million in the Prior Period.
Non-cash expenses for the revaluation of the fair value of the put option in the amount of approximately $1.6 million were realized in the Prior Period. These expenses related to recognition by the Company of the fair value of the put options issued with the Convertible Series H Preferred Stock, above the amount of gross proceeds of the issuance of the stock. An additional non-cash expense or approximately $150,000 was realized in the Current Period, such that an aggregate loss of $1.7 million has been recognized since inception. This aggregate loss was offset by a gain of approximately $1.7 million in the Current Period upon cancellation and redemption of the Series H Preferred Stock. There is no outstanding Series H Preferred Stock as of June 30, 2009.
The non-cash loss on debt guarantee realized during the Current Period was the result of the forfeiture of a portion of the Company's investment in Current Technology Corporation under the guarantee of a certain bridge loan agreement, which was entered into by Mr. J. Jeremy Barbera, Chief Executive Officer and Chairman of MSGI (see Note 16) ), and for which a portion of the proceeds were used to advance funds to the Company. The Company surrendered 5,000,000 shares of common stock of Current Technology Corporation at a carrying value of $500,000. The Company has no further guarantee obligations under the bridge loan agreement.
Our provision for income taxes is minimal and primarily due to state and local taxes incurred on taxable income or equity at the operating subsidiary level, which cannot be offset by losses incurred at the parent company level or other operating subsidiaries. The Company has recognized a full valuation allowance against the deferred tax assets because it is more likely than not that sufficient taxable income will not be generated during the carry forward period to utilize the deferred tax assets.
As a result of the above, net loss attributable to common stockholders of approximately $8.0 million in the Current Period decreased by approximately $12.2 million from comparable net loss of $20.2 million in the Prior Period.
Off-Balance Sheet Arrangements
Financial Reporting Release No. 61, which was released by the SEC, requires all companies to include a discussion to address, among other things, liquidity, off-balance sheet arrangements, contractual obligations and commercial commitments. The Company currently does not maintain any off-balance sheet arrangements.
Liquidity and Capital Resources
Historically, the Company has funded its operations, capital expenditures and acquisitions primarily through private placements of equity and debt transactions. The Company currently has limited capital resources, has incurred significant historical losses and negative cash flows from operations and has limited current revenues. At June 30, 2009, the Company had approximately $700 in cash and no accounts receivable. The Company believes that funds on hand combined with funds that will be available from its various operations will not be adequate to finance its operations and enable the Company to meet its financial obligations and payments under its convertible notes and promissory notes for the next twelve months. A significant portion of our promissory notes and and other notes payable are past due or due within the next 12 months. Further, there is uncertainty as to timing, volume and profitability of transactions that may arise from our relationship with NASA and others. There can be no assurance as to the timing of when we will receive amounts due to us for products shipped to customers prior to June 30, 2009, and we have commenced litigation to attempt to recover damages. There are no assurances that any further capital raising transactions will be consummated. Although certain transactions have been successfully closed in the past, failure of our operations to generate sufficient future cash flow and failure to consummate our strategic transactions or raise additional financing could have a material adverse effect on the Company's ability to continue as a going concern and to achieve its business objectives. These conditions raise substantial doubt about . . .
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