LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2004, we had a working capital deficit of $1,939,067, as compared to $6,311,497 at December 31, 2003. We had cash and cash equivalents of $1,980,511 at September 30, 2004 as compared to cash and cash equivalents of $58,881 at December 31, 2003. The decrease in the working capital deficit and the increase in cash and cash equivalents is principally due to the restructuring of related party debt and the issuance of a $2,000,000 convertible promissory note to an unrelated third party. Our current cash on hand plus cash expected to be generated from operations will not be sufficient to sustain our current operations and service our outstanding debt for the next twelve months. We will need to issue debt or equity securities in order to service existing debt requirements and to sustain operations until such time that we can generate positive cash flow from our operations.
During the nine months ended September 30, 2004, our financing activities provided cash of $4,435,695, while our operating and investing activities used cash of $2,454,006 and $60,059, respectively. The cash used in operating activities was principally a result of the net loss we incurred. Our negative cash flow from operations was principally funded by borrowing additional amounts from a related party and the issuance of a $2,000,000 convertible promissory note to an unrelated third party.
During the nine months ended September 30, 2004, we obtained $2,442,825 from advances from a related party and $2,000,000 from the issuance of a convertible promissory note to an unrelated third party.
We recently restructured all of our related party debt as follows:
o On July 21, 2004, we issued a convertible promissory note to Mr. John Woodward, our former President, in the amount of $1,824,000, which represents principal due on a previously issued note payable in the amount of $1,343,722 plus accrued interest in the amount of $480,279. This note bears interest at 10% per annum and calls for monthly interest payments from August 1, 2004 to December 1, 2004. Beginning on January 1, 2005, this note requires monthly principal payments of $50,405 plus accrued interest with any unpaid principal and interest due on July 1, 2007. The monthly principal and interest payments can be paid with shares of our common stock at the option of the holder. The conversion price is the lesser of the average closing price of our common stock five business days immediately prior to the conversion notice or $0.08. We have agreed to register the shares issuable upon conversion of this note. We have determined that there is a beneficial feature associated with this convertible promissory note in the amount of $615,600. This amount will be amortized as financing costs over the term of the note.
o On July 21, 2004, we issued a convertible promissory note to Mr. Kevin Ryan, our Chief Executive Officer, in the amount of $5,396,764, which represents (a) principal due on two previously issued notes payable in the amounts of $852,680 and $1,010,000, (b) principal due
under a revolving credit agreement in the amount of $1,766,500, (c) principal due under an additional note payable in the amount of $1,500,000 and (d) accrued interest on the above mention obligations in the amount of $267,584. This note bears interest at 10% per annum and calls for monthly principal payments from August 1, 2004 to December 1, 2004 of $45,000. On the last day of the month beginning on August 31, 2004 through November 30, 2004, the accrued interest will be added to the principal amount. Beginning on January 1, 2005, this note requires monthly principal payments of $174,584 with any unpaid principal and interest due on July 1, 2007. The monthly principal and interest payments can be paid with shares of our common stock at the option of the holder. The conversion price is the lesser of the average closing price of our common stock five business days immediately prior to the conversion notice or $0.08. In addition, we granted to Mr. Ryan a warrant to purchase 1,875,000 shares of our common stock. The exercise price is lesser of the average closing price of our common stock five business days immediately prior to the notice of exercise or $0.08. We have agreed to register the shares issuable upon conversion of this note and exercise of the warrant. In accordance with EITF 00-27, we first determined the value of the note and the fair value of the detachable warrants issued in connection with this note. The estimated value of the warrants of $200,625 was determined using the Black-Scholes option pricing model and the following assumptions: term of 7 years, a risk free interest rate of 3.5%, a dividend yield of 0% and volatility of 371%. The face amount of the note payable of $5,396,764 was proportionately allocated to the note and the warrants in the amounts of $5,203,330 and $193,434, respectively. The value of the note was then allocated between the note and the preferential conversion feature, which amounted to $3,188,488 and $2,014,842, respectively. The combined total discount is $2,208,276, and is being amortized over the term of the note.
o On July 21, 2004, we issued a promissory note to Ryan Capital Management, Inc. (this company is controlled by Kevin Ryan) in the amount of $452,137, which represents principal due on a previously issued note payable in the amount of $400,000 plus accrued interest in the amount of $52,137. This note bears interest at 10% per annum and calls for monthly interest payments from August 1, 2004 to December 1, 2004. Beginning on January 1, 2005, this note requires monthly principal payments of $37,902 plus accrued interest with any unpaid principal and interest due on December 1, 2005.
o On August 1, 2004, we issued a promissory note to McCary & Rood (this company is controlled by Kevin Ryan) in the amount of $280,000, which represents past due consulting fees under a consulting agreement dated May 28, 2003. This note calls for monthly payments beginning August 1, 2004 of $30,000 with any unpaid principal due on May 1, 2005.
o On August 1, 2004, we issued a promissory note to McCary & Rood in the amount of $214,037, which represents past due reimbursable expenses under a consulting agreement dated May 28, 2003. This note calls for monthly payments beginning August 1, 2004 of $30,000 with any unpaid principal due on March 1, 2005.
On September 23, 204, we issued a convertible promissory note to CMKXTREME.COM in the amount of $2,000,000. This note bears interest at 10% per annum and calls for monthly principal payments of $55,556 plus accrued interest beginning November 1, 2004 with any unpaid principal and interest due on October 1, 2007. The monthly principal and interest payments can be paid with shares of our common stock at the option of the holder. The conversion price is the lesser of the average closing price of our common stock five business days immediately prior to the conversion notice or $0.08. In addition, we granted to CMKXTREME.COM a warrant to purchase 2,500,000 shares of our common stock. The exercise price is lesser of the average closing price of our common stock five business days immediately prior to the notice of exercise or $0.08. We have agreed to register the shares issuable upon
conversion of this note and exercise of the warrant. In accordance with EITF 00-27, we first determined the value of the note and the fair value of the detachable warrants issued in connection with this note. The estimated value of the warrants of $200,000 was determined using the Black-Scholes option pricing model and the following assumptions: term of 7 years, a risk free interest rate of 3.5%, a dividend yield of 0% and volatility of 371%. The face amount of the convertible promissory note of $2,000,000 was proportionately allocated to the note and the warrants in the amounts of $1,818,182 and $181,818, respectively. The value of the note was then allocated between the note and the preferential conversion feature, which amounted to $1,636,364 and $181,818, respectively. The combined total discount is $363,636, and is being amortized over the term of the note.
In addition, on July 21, 2004, we issued 3,019,000 shares of our common stock to Kevin Ryan as additional consideration for the financing provided to us. Also, certain holders of our Series A preferred stock reallocated 2,647,900 of their shares to certain investors and senior members of our management team. We will take a charge to financing costs and compensation expense of $2,747,011 and $409,275, respectively, related to the issuance and reallocation of these common and preferred shares.
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