UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____
COMMISSION FILE NUMBER 0-25675
PATRON SYSTEMS, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
DELAWARE 74-3055158
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
311 BELLE FORET DRIVE, SUITE 150 60044
LAKE BLUFF, IL
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(847) 295-7338
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(TITLE OF CLASS)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 |_|
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. |_|
State issuer's revenues for its most recent fiscal year ......... $0.00
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity,
as of a specified date within the past 60 days. (See definition of affiliate in
Rule 12b-2 of the Exchange Act). $16,181,760, based upon the closing price of
the Registrant's common stock on March 27, 2003 of $3.44 per share.
(ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS) Check
whether the issuer has filed all documents and reports required to be filed by
Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities
under a plan confirmed by a court. Yes |_| No |_|
(APPLICABLE ONLY TO CORPORATE REGISTRANTS) State the number of shares
outstanding of each of the issuer's classes of common equity, as of the latest
practicable date. 33,513,888 shares of common stock outstanding as of March 27,
2003.
DOCUMENTS INCORPORATED BY REFERENCE. Portions of Registrant's definitive proxy
statement to be delivered to stockholders in connection with the Registrant's
2003 Annual Meeting of Stockholders, which is required to be filed within 120
days of Registrant's fiscal year end, are incorporated by reference into Part II
and Part III of this Form 10-KSB.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE) Yes |_| No |X|
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements and information relating to the
Registrant, its industry and planned business operations as well as other
information security businesses that involve risks and uncertainties. The
statements contained in this report that are not historical statements of fact
are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 (Securities Act) and Section 21E of the Securities
Exchange Act of 1934, as amended (Exchange Act). Forward-looking-statements
include, among other things, statements regarding our expectations, beliefs,
intentions or strategies regarding the future. All forward-looking statements
included in this report are based on information available to us up to and
including the date of this document, and we expressly disclaim any obligation to
update or alter our forward-looking statements, whether as a result of new
information, future events or otherwise. Our actual results could differ
significantly from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth below, under "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors" and elsewhere in this report.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
CORPORATE BACKGROUND
Patron Systems, Inc. is currently a developmental stage company that is
a successor entity to Combined Professional Services, Inc., a Nevada corporation
originally formed in October 1995 (CPS), which later changed its name to Patron
Holdings, Inc. (Holdings). Holdings (as CPS) was originally formed to provide
corporate services to other business entities, but abandoned that business plan
shortly after formation. Holdings, therefore, has never had business operations
or revenue. Holdings (as CPS) began filing reports under the Exchange Act on
March 31, 1999, at which time it stated its intention to seek out, merge with or
acquire a business entity.
Patron Systems, Inc., a Delaware corporation (Systems) was formed in
April 2002 by a group of business leaders to provide comprehensive, end-to-end
information security solutions to global corporations and government
institutions. Systems' initial business plan contemplated that Systems would
grow in part through acquisitions and, in furtherance of such plan, Systems
entered into letters of intent for the acquisitions of TrustWave Corporation and
Entelagent, Inc., as further described below. In order to raise the necessary
financing to complete these acquisitions, Systems' founders intended initially
to raise capital on a private equity basis and thereafter to pursue an initial
public offering of the surviving company's common stock. Due to a difficult
market environment for initial public offerings of developmental stage
companies, Systems determined that there was a need for it to pursue a
transaction with an existing public company, which would have publicly-traded
shares that Systems could use in acquisition transactions, and to induce and
attract a qualified management team. Systems identified CPS during this process
and determined that CPS was well-suited for such transaction with Systems
because its public company status and lack of operational history afforded
Systems an open platform from which to grow, without the risk of depending on a
successful initial public offering in the future or the necessity of divesting
existing operations or incurring liabilities as a result of existing operations.
On October 11, 2002, Holdings (as CPS), Systems and the stockholders of
Systems consummated a share exchange (Share Exchange) pursuant to an Amended and
Restated Share Exchange Agreement, whereby Holdings (as CPS) issued to each
Systems stockholder, on a one-for-one basis and in exchange for all of the
outstanding shares of Systems capital stock, an aggregate of 25,400,000 shares
of Holdings (as CPS) common stock. Upon the closing of the Share Exchange, the
Systems stockholders held approximately 85% of the outstanding capital stock of
Holdings (as CPS), and Systems became a wholly owned subsidiary of Holdings (as
CPS). On November 22, 2002, CPS announced that it changed its name to Patron
Holdings, Inc. and that it would trade on the OTC Bulletin Board under the
symbol "PAHG".
On March 27, 2003, Holdings merged with and into Systems, for the
purpose of changing its state of incorporation from Nevada to Delaware
(Redomestication Merger). Systems was the surviving corporation of the
Redomestication Merger, and its Second Amended and Restated Certificate of
Incorporation, Amended and Restated Bylaws and Board of Directors became the
governing documents and governing body, respectively, of the surviving
corporation. The surviving corporation is referred to herein as "we", "us", the
"Company" or "Patron". In connection with the Redomestication Merger, Patron
filed with the SEC a successor entity report on Form 8K-12g-3, whereby Patron
succeeded to the reporting obligations of Holdings under the Exchange Act.
Patron Systems has no material assets or business operations. Systems'
principal activities since its formation in April 2002 consisted of the
development of its business plan, capital raising and evaluation and negotiation
of potential acquisitions. Patron, post-Redomestication Merger, intends to
implement Systems' plans, through acquisitions and internal growth, to offer
trusted security services and next generation integrated security products.
Patron intends to work with organizations to ensure that global enterprises
implement information security policies, procedures and products that result in
"trusted" information environments. Patron expects to offer information security
and vulnerability assessments, certification programs, remediation,
implementation, training, monitoring and management services.
Patron is currently a development stage company that only has five
employees and exists essentially as a publicly held shell company. Patron has
developed a business plan, has been engaged in various capital raising
activities, has signed two definitive acquisition agreements with TrustWave
Corp. and Entelagent Software Corp. and has employed a senior management team.
Even if Patron can complete one or more financing transactions, there can be no
assurance that the Company will be successful in carrying out its business plan
and become profitable. Patron's ability to complete these acquisitions is
dependent upon Patron's success in raising capital in amounts adequate to fund
the required payments at closing under the acquisition agreements and to fund
certain working
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capital requirements. Current market conditions have made it increasingly
difficult for development stage companies, such as Patron, to raise capital. To
date, Patron has engaged in discussions with various potential investors and is
in active negotiations with certain of these potential investors. Unless such
negotiations result in the timely completion of financing transactions, Patron
is unlikely to be able to complete its planned acquisitions. The failure to
complete these transactions will materially adversely affect Patron's ability to
carry out its business plan and could jeopardize Patron's ability to continue
its corporate existence.
OUR BUSINESS OPPORTUNITY
The following information describes the key elements of our business
plan and proposed business activities. Our ability to pursue this plan and carry
out such activities is dependent on our acquisitions and financing strategies.
We believe that recent world events like September 11th have produced a marked
shift in what is "secure" on both a physical and virtual level. Key principles
of security in the information technology industry related to certification,
regulation compliance, ubiquitous protection against various digital attacks,
and business assurance are beginning to impact and inform Board-level
discussions. We believe that historical practice in the industry falls short of
today's information security business imperative. Enterprise-level solutions
require more than a firewall, intrusion detection and first generation malicious
code detection technologies, such as anti-virus scanners. We believe that
companies require sound broad-based security services, spanning a more
traditional consultative, project management approach, and a partner to identify
optimal technology product solutions that will meet the future needs of the
enterprise, while acknowledging current capabilities.
"INFORMATION"
"Information" can exist in many forms. It can be printed or written on
paper, stored electronically, transmitted by post or using electronic means,
shown on films, or spoken in conversation. Whatever form the information may
take, or means by which it is shared or stored, it should always be
appropriately protected. Information security includes the preservation of:
o CONFIDENTIALITY - ENSURING THAT INFORMATION IS ACCESSIBLE ONLY TO
THOSE WITH AUTHORIZED ACCESS.
o INTEGRITY - SAFEGUARDING THE ACCURACY AND COMPLETENESS OF INFORMATION
AND PROCESSING METHODS.
o AVAILABILITY - ENSURING THAT AUTHORIZED USERS HAVE ACCESS TO
INFORMATION AND ASSOCIATED ASSETS WHEN REQUIRED.
At a government level, information protection is a matter of national
security. At a corporate level, the risks include non-compliance with
information privacy and protection as well as unauthorized access by persons
both within and outside an organization. Risks also include the theft of
corporate information and assets, business interruption and associated impacts
on operations and market value.
SECURITY CONCEPTS
We believe that the global economy depends, in significant part, upon
the ability to trust and protect information systems and processes. The current
fragmented information security marketplace devotes substantial time to
"patching" new security gaps and little attention to strategic solutions to
create a measurable, reliable and certifiable security environment. The rampant
service disruptions and business continuity failures of September 11th
demonstrated to us that reliance on specific security solutions without a
general trusted environment framework is not an effective means of protection.
We believe that the development and incorporation of the Internet into
the information infrastructure has changed the trustworthiness of the business
environment, but is not being used for trusted business operations equal to its
potential. While many of the largest banks, brokerage firms and credit card
companies have shifted traditional services to Internet enhanced versions,
adoption rates among users have not kept pace. The obstacle is that technology
has not yet overcome two fundamental principals of the Internet that make it
very different from more traditional and trusted, voice and data communication:
o The Internet does not possess a point-to-point design over a
controlled network. The confidence that comes from the personal touch
- recognizing your banker's voice - is not present. Over the Internet,
the exchange is focused on the content of the exchange without the
personal touch. This sense of detachment results in greater rates of
fraud and abuse. Furthermore, the interaction, whether credit card,
email, or an instant message, is less susceptible to confirmation.
o The Internet, by its very design, is intended to be "open" and
available to all. Because this open architecture is incorporated into
most organizations' information infrastructures, these infrastructures
tend to be porous and under-defended.
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In the past, information security has often been solely the
responsibility of chief information officers or chief technology officers. We
believe that trust in information security is now a fiduciary responsibility
shared by each participant within an organization and has the focus of the Board
of Directors as well as senior management. The organization must ensure that the
business remains available and sustainable in the face of natural disasters such
as hurricanes and fires, as well as acts of dishonesty and malicious threats. We
believe that a trusted information infrastructure for conducting business
transactions requires six types of assurance:
o AUTHENTICATION - ARE THE ORIGINATOR AND THE RECIPIENT PROPERLY
IDENTIFIED?
o PRIVILEGE - ARE THE ORIGINATOR AND THE RECIPIENT AUTHORIZED TO SEND
AND/OR RECEIVE THIS INFORMATION?
o CONFIDENTIALITY - DO WE HAVE PRIVACY TO THE LEVEL DESIRED OR
REQUESTED?
o DATA INTEGRITY - DID WE RECEIVE WHAT WAS SENT WITHOUT CHANGE?
o SECURITY MANAGEMENT INFRASTRUCTURE - CAN WE CONTINUE A TRANSACTIONAL
RELATIONSHIP IN A STABLE ENVIRONMENT THAT IS AVAILABLE WHEN WE WANT
IT?
o NON-REPUDIATION - IS THERE PROOF THAT THE TRANSACTION TOOK PLACE FROM
BOTH SIDES?
MARKET POTENTIAL
We believe that, in addition to showing significant financial
opportunity, the current information security market is largely underserved by
the existing service providers, which provide mature point solutions,
non-certifiable assessment methodologies, and non-comprehensive services.
Currently, several types of firms directly or indirectly offer security
services and products. We believe that many large professional services
organizations do not have the capabilities to fully address current security
concerns. Other firms with the skills to address information security are small
and do not appear to have the access to capital that would allow them the scale
to manage an enterprise-wide implementation. Existing security product providers
are largely first generation software and hardware developers with single
product offerings that do not interoperate on an enterprise-wide basis.
SOCIOPOLITICAL DRIVERS
We believe that government institutions and global corporations
understand the information security threat and are beginning to implement
appropriate solutions. Further, legislation is being enacted which will require
that government institutions and global corporations protect the accuracy and
privacy of certain types of information. We believe that these developments will
continue to drive the growth of the information security market. For example:
o The Office of Homeland Security recently appointed a Special Advisor to
President Bush on Cyber Security and Terrorism, formally recognizing
that the United States now depends on a complex, interdependent network
of critical infrastructure information systems essential to our
national and economic security. National security is a function of both
government and corporate information security.
o A number of leading corporations have created a corporate function
focused on information security that provides guidance to customers and
business units on government regulations and security.
o In October of 2001, President Bush issued Presidential Decision
Directive I, entitled "Organization and Operation of Homeland
Security." This directive encourages certification under the National
Information Assurance Partnership, with sponsorship by the National
Security Agency, of federal government agencies and major banks,
brokers, retailers and transport companies operating in the United
States. Although Presidential Directive I is voluntary, we believe that
certification of communications and information flow accountability
will become standard practice.
o The Healthcare Insurance Portability and Accountability Act ("HIPAA")
requires the standardization of patient electronic data, unique
identifiers and security standards to protect the confidentiality and
integrity of health information past, present and future. HIPAA calls
for severe civil and criminal penalties for failure to comply. As a
result of HIPAA regulation, sweeping changes will be required for
systems and security for all organizations in the health care chain
including doctors, hospitals, insurers, billing agencies, information
technology service providers and universities.
o The Gramm Leach-Bliley Act requires that financial institutions protect
the security, integrity and confidentiality of customer information
against unauthorized access. We believe that this legislation impacts
all financial institutions and will require significant changes to
systems and security.
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We believe the threat to government institutions and global
corporations, including disruption and loss of assets due to insecure operating
environments and the inherent insecurity of the Internet is real. The threat is
evidenced by:
o 60% of all corporate date assets reside unprotected on PCs.
Source: Search Security Newsletter, April 4, 2002
o 90% of corporations and government agencies detected computer security
breaches within the last twelve months; 80% acknowledged financial
losses due to these breaches.
Source: 2002 Computer Security Institute/FBI Computer Crime & Security
Survey
o The average financial loss from computer security breaches in 2001 was
over two million dollars per company. The most serious financial
losses occurred through theft of proprietary information.
Source: 2002 Computer Security Institute/FBI Computer Crime & Security
Survey
o Thirty-four percent of organizations who have a security breach report
the intrusions to law enforcement. (In 1996, only 16% of acknowledged
reporting intrusions to law enforcement). Source: 2002 Computer
Security Institute/FBI Computer Crime & Security Survey
o The average security breach costs companies an estimated US $22,790.
Source: The Register, March 18, 2002
DIFFERENTIATION
We intend to provide a thoughtful and comprehensive response to the
concerns and challenges of establishing a trusted information management system
based upon both innovative methodologies and next-generation technologies. We
are focused on developing a unique, proprietary and comprehensive approach to
examining, certifying, and auditing an organization's information security
standing. We intend that this multi-stage methodology will introduce the concept
of "trusted operating environments" to an organization, which assures
compliance, while maintaining technological currency.
PROPOSED SECURITY SERVICES GROUP
On November 23, 2002, Patron Systems, TWC Acquisition, Inc., a Maryland
corporation and wholly owned subsidiary of Patron Systems (TrustWave Mergerco),
and TrustWave Corp., a Maryland corporation (TrustWave), entered into an
Agreement and Plan of Merger, as subsequently amended (the TrustWave Merger
Agreement), whereby TrustWave would merge with and into TrustWave Mergerco with
TrustWave Mergerco surviving as a wholly owned subsidiary of Patron (the
TrustWave Merger). In connection with the TrustWave Merger, shareholders of
TrustWave would be entitled to, in the aggregate: (1) $20,000,000 in cash, 50
percent of which was paid at the closing of the TrustWave Merger and 50 percent
of which will be paid not later than six months after the closing of the
TrustWave Merger; and (2) approximately 8,850,000 shares of Patron's common
stock, subject to a one-time increase of up to 100 percent in the event that the
shares of the Patron System's common stock fail to trade at or above $12 per
share, on average, over the 21 days prior to an including the first anniversary
of the closing date. In addition, Patron would be required to issue
approximately 2,150,000 stock options to current TrustWave option holders.
In connection with the TrustWave merger, an unaffiliated investor has
placed in a trust $2,000,000 to be applied towards the cash consideration due
under the related agreements. Patron is negotiating the terms by which this
amount will become an investment in Patron at the closing of the TrustWave
Merger.
The TrustWave Merger has been approved by the Boards of Directors of
Patron Systems, TrustWave Mergerco and TrustWave. The TrustWave Merger was also
approved by the shareholders on TrustWave on March 28, 2003. The TrustWave
Merger is intended to be a tax-free reorganization under the Internal Revenue
Code. In connection with the consummation of the TrustWave Merger, certain
executive officers of TrustWave would execute employment agreements with Patron.
In order to consummate the TrustWave Merger, Patron will need to raise
approximately $12 million in funds for use as of the closing of the TrustWave
Merger and an additional $10 million of funds within 90 days of closing of the
TrustWave Merger. Patron has held discussions with numerous potential investors
to date, but these discussions have yet to result in the receipt by Patron of
available funds sufficient to proceed with the TrustWave closing. Patron is in
active negotiations with certain potential investors and as discussed below, has
received
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commitments from certain investors to provide certain financing to Patron.
Certain of these commitments have been in existence for several months, but have
yet to be finalized to the extent necessary to permit Patron to have access to
the funds contemplated by the commitments. Although Patron remains confident
that such commitments will result in funds becoming available to Patron, the
timing of the receipt of such funds is currently uncertain. The acquisition
agreement relating to the TrustWave Merger currently provides for an expiration
date of April 1, 2003. Patron is engaged in discussions with TrustWave to extend
the expiration date, but there can no assurance that it will be successful in
achieving an extension. In the event that Patron was unsuccessful in obtaining
funds adequate to consummate the TrustWave Merger or the receipt of funds did
not occur prior to the expiration of the acquisition agreement for the TrustWave
Merger, it is unlikely that Patron would be successful in completing the
TrustWave merger. Because Patron's current business plan is premised on the
successful acquisition by Patron of TrustWave, Patron would unlikely be able to
pursue its business plan and achieve its growth objectives. Without adequate
funding, Patron will also have difficulty in maintaining its corporate existence
and employing its current staff of employees.
In connection with the TrustWave transaction, Patron was required to
provide pre-closing working capital financing to TrustWave. Advances under such
notes bear interest at 10 percent per annum and are repayable on demand. Total
outstanding advances under such notes at December 31, 2002, were $840,000. In
January 2003, an additional $400,000 was advanced to TrustWave.
If we are successful in acquiring TrustWave, the TrustWave business
will form the core of our Security Services Group, and the professional services
staff of TrustWave will comprise our initial security specialist resource for
client projects. TrustWave, a security consulting company offering forensic
security services and managed security services, resells and implements security
products and offers a range of proprietary security scanning services, including
TrustKeeper(TM). TrustWave client projects are initiated with an assessment of
the client organization and information infrastructure, followed by the
development of effective information assurance policies and architecture.
TrustWave identifies and deploys technical solutions for the enterprise,
actively securing the client network by monitoring events from threats, both
internal and external, in a globally networked communications environment.
If we are successful in acquiring TrustWave, we will acquire
TrustKeeper(TM), a proprietary scanning engine that ensures compliance with
security parameters. TrustKeeper(TM) is currently used in financial markets, and
has applications that can be used over multiple enterprise level computer
systems. TrustKeeper(TM) is a second generation product that can be set to scan
an enterprise computer system for security parameters throughout the world. This
product, bundled with others that we are evaluating for acquisition, is intended
to be a platform product that will insure security compliance for any
international or enterprise computer system. Our strategy is to seek other
security applications and consulting practices that will be complementary to the
products and services that TrustWave has developed.
FDC CONTRACT
TrustWave has a contract with a seven-year term with First Data
Corporation (NYSE: FDC), a $6.5 billion provider of credit card processing,
electronic payment and money transfer services. Under this contract, TrustWave
has developed and plans to implement a mandatory security-testing program to
validate FDC's Internet merchants' and affiliated clearing banks' compliance
with Interest security requirements.
PROPOSED PRODUCT AND TECHNOLOGY GROUP
We also intend to develop a Product and Technology Group that through
proprietary and carefully evaluated third-party products will deploy and support
the following products and components:
o AUTHENTICATION AND ACCESS--Enabling secure and valid "right to use" of
internally and externally based network resources.
o CRYPTOGRAPHY--Encrypting business-critical data and intellectual
capital.
o CONTENT CONTROL AND MANAGEMENT--Delivery of content-interpretation and
management technologies to administer filtering, access and storage of
sensitive or proprietary materials.
o POLICY AND USER MANAGEMENT--Technologies to enforce procedures around
user account creation, deletion, maintenance and strong passkey
synchronization
o MALICIOUS CODE PROTECTION--Behavior-based virus and other malicious
code protection beyond reactive, perimeter-based software
o REAL-TIME ENTERPRISE THREAT ANALYSIS--Next-generation security device
event aggregation, correlation and false-positive filtering.
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o MANAGED SERVICES - Contract services deploying highly trained and
certified professionals and hosted solutions to administer the
customer's information security environment.
The management team of Patron anticipates marketing products to target
underserved, business critical information security functionality. Real-Time
Enterprise Threat Analysis, for example, is of particular concern to
establishing a trusted operating environment. Each security appliance or
software agent produces event logs throughout the course of normal operations.
Each device may produce logs in different formats, with separate viewing
mechanisms or reporting processes. In some cases, viewing or reporting is
non-existent. Management estimates that 100 security devices will produce
upwards of 50 petabytes of data per month.
To meet the needs of this underserved information security
functionality, we believe a centralized security information management console
will enable better management of appliances across the enterprise. In addition,
this can help to reduce the administrative burden for IT resources. To be
effective, this console will aggregate and normalize information security logs,
correlate the data to provide meaningful output for the reporting process and
manage policy across a variety of security tools.
Patron Systems Product and Technology Group is committed to providing
the most complete offering of advanced electronic information security products
and services needed for enterprise-level corporations and government
organizations to meet industry and global standards and establish operating
environments of trust.
PROPOSED ENTELAGENT ACQUISITION
On November 24, 2002, we entered into an Agreement and Plan of Merger
to acquire Entelagent Software Corp., a California corporation (Entelagent) by
merger of Entelagent with and into a wholly owned subsidiary of Patron
(Entelagent Merger). Upon consummation of this acquisition, we are obligated to
issue to shareholders of Entelagent, in the aggregate, 1,800,000 shares of our
common stock and to assume certain debts and obligations of Entelagent.
Subsequent to the closing, we will be obligated to grant options to purchase
440,000 shares of common stock to certain employees and non-employee consultants
of Entelagent. In connection with this transaction, we agreed to provide working
capital financing to Entelagent. Our working capital advances bear interest at
10 percent per annum and are repayable upon demand. Total outstanding advances
at December 31, 2002, were $320,000. Additional advances prior to closing will
total approximately $350,000. This acquisition is subject to certain closing
conditions, including consummation of the Redomestication Merger, closing of the
TrustWave Merger, approval by Entelagent shareholders and receipt of funding for
the working capital advances. If we are unsuccessful in completing the TrustWave
Merger, it is unlikely that we would complete the Entelagent Merger.
The professional sales staff of Entelagent is intended to comprise the
core of our product sales and marketing organization. Entelagent's product
provides a flexible and scalable real-time monitoring and post-event review of
email messages and their attachments, as well as infrastructure for knowledge
management of archived email messages and attachments in all media.
Entelagent offers a full range of services tailored to customer
requirements. For example, it helps banking and financial services clients
comply with the SEC rules regarding email communications between securities
firms and the investing public.
Entelagent's email content monitoring technology addresses the need for
comprehensive internal security measures to safeguard company intellectual
capital. Given recent studies on the high level of internal security breaches
versus external threats, in addition to the risk from employee social and
corporate transgressions, we believe that the Entelagent platform adds
significant value to its portfolio of offerings.
ACQUISITION STRATEGY
Our business plan contemplates the acquisition of second and third
generation software and hardware products from companies that wish to join a
larger industry platform. Acquisitions may include hardware, software,
intellectual property, plant and equipment and human resources of the acquired
companies.
We are in the process of assembling key assets that will deliver
enterprise-level information security solutions. From vulnerability assessments
to compliance, remediation, ongoing certification reviews, and managed services
we plan to work with future clients to ensure the security of digital assets.
Our intended product offerings are directed outside the mature,
perimeter-focused products such as firewalls and intrusion detection systems.
Our intended product offerings will center on the aggregation and correlation of
security device events and access to/control of content entering and exiting the
enterprise.
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We intend to provide services to identify how government and corporate
customers can ensure, to an auditable NSA certified standard, the
trustworthiness of their proprietary information management systems. Services
are contemplated to include:
o VULNERABILITY ASSESSMENTS - including customer application penetration
testing and software code review
o ELECTRONIC FORENSICS AND INVESTIGATIONS - combining technical,
investigative, and legal experience
o BENCHMARKING
o STRATEGY, POLICY, SOLUTION, AND PROCESS DEVELOPMENT
o SECURITY ARCHITECTURE DEVELOPMENT
o SECURITY INTEGRATION PLANNING, DESIGN, AND IMPLEMENTATION
o APPLICATION SECURITY DESIGN AND IMPLEMENTATION
o SECURITY SOFTWARE PRODUCT EVALUATION AND SELECTION
o BEST PRACTICES, TECHNOLOGY, AND PROJECT TRAINING
o MANAGED SERVICES AND OUTSOURCING
o REMEDIATION
o COMPLIANCE MONITORING AND CERTIFICATION
o MAINTENANCE
COMPETITION
The market for network security products is highly competitive, and we
expect competition to intensify in the future. Competitors may gain market share
and introduce new competitive products. We currently plan to compete principally
on the basis of product and project scalability, performance, reliability,
manageability, cost-effectiveness, and value to the client.
The number of competitors has risen in the past few years. We expect
the intensity of competition in the market segments we intend to serve to
continue to increase in the future as existing competitors enhance and expand
their product offerings and as new participants enter these market segments.
Increased competition may result in price reductions, reduced revenues and loss
of market share. We cannot assure you that we will be able to compete
successfully against existing or future competitors. Some of our customers and
companies with which we are developing strategic relationships also are, or may
be in the future, competitors of ours.
The size and number of our potential competitors varies across our
product areas, as do the resources we have allocated to the segments we target.
Therefore, many of our competitors have greater financial, personnel, capacity
and other resources than we have in a particular market segment or overall.
Competitors with greater financial resources may be able to offer lower prices,
additional products or services or other incentives that we cannot match or
offer. These competitors may be in a stronger position to respond quickly to new
technologies and may be able to undertake more extensive marketing campaigns.
They also may adopt more aggressive pricing policies and make more attractive
offers to potential customers, employees and strategic partners. These
competitors may make strategic acquisitions or establish cooperative
relationships among themselves or with third parties to increase their ability
to gain market share.
Assuming that Patron is able to pursue the activities contemplated in
our business plan, our primary competitors within our various intended product
and service categories areas will include the companies that are listed in the
table below:
9
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APPLICATIONS AND ASPS
----------------------------------------------------------------------------------------------------------------------
ACCESS CONTROL USAGE MANAGEMENT AND NETWORK SECURITY ENTERPRISE SYSTEMS REAL-TIME THREAT
MONITORING MANAGEMENT ANALYSIS AND
PREVENTION
----------------------------------------------------------------------------------------------------------------------
KaVaDo Blockade Systems Internet Security Computer Associates Internet Security
Corp. Systems Intl., Inc. Systems
----------------------------------------------------------------------------------------------------------------------
Secure Computing Corp. BindView Corporation Sophos, Inc. Citrix Systems, Inc. NetScreen
----------------------------------------------------------------------------------------------------------------------
RSA Security Network Associates, SonicWall, Inc. Baan Intrusion, Inc.
Inc.
----------------------------------------------------------------------------------------------------------------------
Trend Micro, Inc. Internet Security Stonesoft, Inc. Borland Software Check Point Software
Systems Corporation Corp.
----------------------------------------------------------------------------------------------------------------------
Digi-Sign Computer Associates F-Secure Corporation Avaya
Intl., Inc.
----------------------------------------------------------------------------------------------------------------------
SonicWALL, Inc. RSA Security BindView Corporation Symantec
----------------------------------------------------------------------------------------------------------------------
F-Secure Corp. NetIQ Corporation Secure Computing Corp. SonicWALL, Inc.
----------------------------------------------------------------------------------------------------------------------
Blockade Systems Corp. Trend Micro, Inc. Check Point Software WatchGuard
Corp. Technologies, Inc.
----------------------------------------------------------------------------------------------------------------------
Computer Associates Check Point Software SafeNet, Inc. Enterasys, Inc.
Intl., Inc. Corp.
----------------------------------------------------------------------------------------------------------------------
Novell Secure Computing RSA Security
Corp.
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Symantec KVS, Inc.
----------------------------------------------------------------------------------------------------------------------
Check Point Software Archive-it, Inc.
Corp.
----------------------------------------------------------------------------------------------------------------------
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INFORMATION SECURITY SERVICES
----------------------------------------------------------------------------------------------------------------------
SECURITY STRATEGY SECURITY COMPLIANCE ELECTRONIC FORENSICS INTEGRATION AND MANAGED SECURITY
(Policies, Procedures, ASSESSMENTS AND INVESTIGATIONS IMPLEMENTATION SERVICES
and Benchmarking)
----------------------------------------------------------------------------------------------------------------------
BearingPoint NetIQ Corporation Computer Forensics, IBM Business Services TruSecure
Inc.
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SANS Institute StillSecure Guidance Software, Cisco Systems, Inc. Guardent
Inc.
----------------------------------------------------------------------------------------------------------------------
NetIQ Corporation
(PentaSafe Security Network Associates, ESS Computer Lucent Technologies, Verisign
Technologies, Inc.) Inc. (McAfee) Forensics, Inc. Inc.
----------------------------------------------------------------------------------------------------------------------
IT GlobalSecure, Inc. SRA International, Ontrack Computer Nokia Corporation, Symantec
Inc. Systems, Inc. Inc.
----------------------------------------------------------------------------------------------------------------------
META Security Group Veridian Nortel Network, Inc. Vigilar, Inc.
----------------------------------------------------------------------------------------------------------------------
SecurInfo Entrust
----------------------------------------------------------------------------------------------------------------------
IT GlobalSecure, Inc. Ubizen
----------------------------------------------------------------------------------------------------------------------
Conxion
----------------------------------------------------------------------------------------------------------------------
NETSEC
----------------------------------------------------------------------------------------------------------------------
ITEM 2. DESCRIPTION OF PROPERTY
Our corporate office is currently located at 311 Belle Foret, Suite
150, Lake Bluff, IL 60044. This space, which consists of approximately 1,000
square feet, is currently being provided to us pursuant to an oral understanding
at a cost of $500 per month. We also have another oral understanding in place to
reimburse Robert E. Yaw II, one of our directors, for certain costs incurred in
connection with his use of an office in Osprey, Florida. We are planning to move
our corporate office to new leased office space on or about August 15, 2003.
This base will be for approximately 5,000 square feet in the northern Chicago
suburbs. We have no, and do not intend to make any, investments in real estate.
10
ITEM 3. LEGAL PROCEEDINGS -
As of March 27, 2003, we were not a party to any material legal
proceedings, litigation or arbitrations. We insure some, but not all, of our
exposure with respect to such proceedings and business risk.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 23, 2002, our stockholders acted by written consent to
approve the Redomestication Merger, the appointment of Patrick J. Allin, Brett
Newbold and Robert E. Yaw II as directors, the adoption of a Long-Term Incentive
Plan ("LTIP") and the reservation of 8,000,000 shares pursuant to such plan, and
the appointment of Grant Thornton, LLP as auditors. The adoption of the LTIP and
appointment of auditors will be submitted for ratification by the stockholders
as part of our annual meeting of stockholders, currently expected to be held on
May 22, 2003.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock trades on the NASDAQ Over-the-Counter Bulletin Board
(the "OTC") under the symbol "PAHG", which will be changing to a new symbol on
or about March 31, 2003 to "PTRS". The following table lists the high and low
per share sales prices for the common stock as reported by the OTC for the
periods indicated:
2002: HIGH LOW
----- ---- ---
First Quarter............ $6.28 $3.50
Second Quarter........... $6.80 $3.51
Third Quarter............ $7.50 $0.90
Fourth Quarter........... $5.95 $1.28
2001:
-----
First Quarter............ $4.19 $2.49
Second Quarter........... $5.44 $3.66
Third Quarter............ $5.30 $3.53
Fourth Quarter........... $9.00 $4.23
These quotations reflect inter-dealer prices, without retail markups, markdowns
or commissions and do not necessarily represent actual transactions. The
quotations were derived from the National Quotations Bureau OTC Market Report.
As of March 27, 2003 there were approximately 38 holders of record of
the common stock. However, we believe that the number of beneficial owners is in
excess of 720, because a large portion of the common stock is held of record
through brokerage firms in "street name."
DIVIDEND POLICY
Holders of our common stock are entitled to dividends when and if
declared by the board of directors out of funds legally available therefore. We
have not declared or paid any dividends on our common stock since inception and
do not anticipate the declaration or payment of cash dividends in the
foreseeable future. We intend to retain earnings, if any, to finance the
development and expansion of our business. Future dividend policy will be
subject to the discretion of the board of directors and will be contingent upon
future earnings, if any, our financial condition, capital requirements, general
business conditions and other factors. Therefore, there can be no assurance that
dividends of any kind will ever be paid.
11
UNREGISTERED SECURITIES
The following unregistered securities have been issued by the Company
during the last three fiscal years:
Name of Name or Class of
Title and Amount of Securities Principal Persons who Received Consideration
Date of Grant Granted/Exercise Price if Applicable Underwriter Securities Received
------------- ------------------------------------ ----------- -------------------- -------------
February 2001 2,300,000/Common Stock None Marc Baker $0.001
June 2001 150,000/Common Stock None PBJ Holdings, Inc. 49 shares of
PBJ Holdings2
July 2002 4,000,000/Common Stock None Jeff Spanier $0.003
October 2002 25,400,000/Common Stock None Shareholders of Patron $0.004
Systems, Inc.
October 2002 1,801,688/Common Stock None Shareholders of Holdings $0.005
November 2002 300,000/Common Stock None Stronghold & Associates $0.006
December 2002 8,823,529/Common Stock None Mercatus & Partners Ltd. $3,000,0007
The above unregistered securities were issued pursuant to an exemption
from the registration requirements of the Securities Act under Section 4(2) of
the Securities Act and/or Regulation D promulgated under the Securities Act.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis present the factors that had a
material effect on our results of operations during the year ended December 31,
2002. You should read this discussion in conjunction with our historical
financial statements and notes to those statements included elsewhere in this
report on Form 10-KSB.
---------------------------
(1) Mr. Baker did not tender any consideration for the shares but rather the
board of directors of Holdings believed that such issuance was necessary to
entice him to join the company based on his extensive experience with mergers
and acquisitions. Mr. Baker was issued an additional 2,200,000 shares during his
tenure with the company. On July 18, 2002, Mr. Baker resigned from his positions
with Holdings and returned all 4,500,000 shares that he had received.
(2) On June 7, 2001, Holdings exchanged 150,000 shares of its common stock for
49 shares of PBJ Holdings, Inc., which at the time were valued at $3,320.
(3) Mr. Spanier did not tender any consideration for his shares but rather the
board of directors of Holdings believed such issuance was necessary to entice
him to join the company as its president and sole director. Upon his resignation
from Holdings, Mr. Spanier returned the 4,000,000 shares that he was issued.
(4) On October 11, 2002, Holdings issued 25,400,000 shares of its common stock
to the stockholders of Systems in conjunction with the Share Exchange.
(5) On October 11, 2002, Holdings issued 1,801,688 shares of its common stock to
its stockholders in conjunction with the Share Exchange.
(6) On November 7, 2002, Holdings issued 300,000 shares of its common stock in
consideration for services provided to the Company by Stronghold & Associates.
(7) On December 12, 2002, we entered into a loan agreement with Mercatus &
Partners Ltd., a financing group ("Mercatus"), for a collateralized loan for
$3,000,000. As collateral for this loan, we placed in escrow 8,823,529 shares of
common stock. On January 3, 2003, we entered into another loan agreement with
Mercatus for a collateralized loan of $1,500,000. As collateral for this loan,
we placed in escrow 5,769,231 shares of common stock. As of March 27, 2003,
Mercatus has yet to provide funding pursuant to the terms of the collateral loan
agreement and promissory note and is in breach of contract. We have sent
notification to Mercatus terminating the agreement and requesting Mercatus to
return all shares placed in escrow. Upon receipt of the shares, we will cancel
such shares.
12
OVERVIEW
Our company was formed in connection with the Redomestication Merger
and the Share Exchange. We are a development stage information security company
that will provide security services and technology products to global
enterprises. We are headquartered in Illinois. During fiscal 2002, our
predecessor entity, Holdings, was a "public shell" company with no operations,
and Systems, its wholly owned subsidiary, was engaged primarily in the
development of a business plan, capital raising and negotiation of potential
acquisitions. The Company has been redomesticated in the state of Delaware under
the name of Patron Systems, Inc. as of March 27, 2003. THE COMPANY CONTINUES AS
A DEVELOPMENT STAGE COMPANY WITH NO CURRENT BUSINESS OPERATIONS AND HAS BEEN
GIVEN A QUALIFIED OPINION BY ITS INDEPENDENT AUDITOR AS A "GOING CONCERN".
Systems' founders intended to raise capital on a private equity basis,
but determined that there was a need for a public company currency to achieve
their growth plan. Systems then began to evaluate opportunities to merge with
and become part of an existing public company. Systems identified CPS during
this process and determined that CPS was well-suited to provide Systems with its
public currency because of its lack of operational history, affording Systems an
open platform from which to grow, without the necessity of divesting existing
operations or incurring liabilities as a result of existing operations. Since
Systems' inception in April 2002, we have reported a net loss of approximately
$16,328,338, principally associated with expenses related to forming Systems,
assembling our management team, retaining consulting services, raising capital
and seeking out and negotiating acquisitions consistent with our business plan.
The expenses charged against Patron's income statement were largely non-cash and
include:
o Charge (non-cash) of fair value of shares issued to consultants as
part of the CPS transaction
o Charge (non-cash) of fair value of common stock and options issued in
lieu of cash for services
o Loss due to unconsummated financing arrangement in which 950,000
shares were pledged
Critical Accounting Policies
SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not
require, companies to record compensation cost for stock-based employee
compensation plans based on the fair value of options granted. The Company has
elected to account for stock-based compensation using the intrinsic value method
provided under Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. The Company uses the
fair value method in accounting for options issued to third party consultants.
All expenses incurred in connection with the formation of the Company and
related start up activities have been expensed as incurred and are included in
general and administrative expenses in the accompanying financial statements.
Results of Operations from inception (April 30, 2002) to December 31, 2002
For the period from inception (April 30, 2002) to December 31, 2002, the Company
generated a net loss of $16,328,338. As previously indicated the Company has yet
to generate revenues and as such is a development stage company. The Company
generated a loss of operations of $15,249,536 for the period. Included in this
loss are general and administrative expenses totaling $2,439,060. The most
significant components of general and administrative expense are accrued
salaries of $660,000, professional fees for legal and accounting services of
$557,000 and travel and lodging costs of $294,000. The Company also incurred
charges associated with its merger with Combined Professional Services, Inc. of
$3,965,726 representing a fee valued at $720,000 paid to a consultant in cash
and shares of common stock and the value of 1,801,688 shares issued on the
closing date to prior officers and other third parties for past services
rendered. In addition, the Company incurred non-cash consulting expense paid for
with the issuance of common stock and stock options of $8,844,000.
Other income and expense for the period ended December 31, 2002 include interest
expense on notes payable of $31,074 and a charge associated with a financing
transaction of $1,047,728 that arose from a series of accommodation agreements
with five stockholders who pledged shares of stock as collateral for a financing
arrangement with a third party. The Company is obligated to return the pledged
shares or provide replacement shares in the event of foreclosure by the lender,
and one additional share of common stock as compensation. The Company has
accounted for this obligation as an in-substance foreclosure on the loan
collateral by the lender. In doing so, the Company has recorded an obligation of
$1,497,600 to the shareholders who pledged their shares representing the value
of the shares that are required to be returned in November 2003, resulting in a
loss of $1,047,728, equal to the difference between the loan proceeds and the
value of the obligation. The amount of the Company's obligation and the related
loss on this arrangement will fluctuate throughout 2003 until the date the
pledged shares are replaced with existing shares based on the fair value of the
shares.
LIQUIDITY AND CAPITAL RESOURCES
The company has cash of $362 on hand at December 31, 2002 and negative working
capital of $1,354,143 at December 31, 2002. Included in the Company's assets are
amounts due from TrustWave Corporation and Entelagent Software Corp. totaling
$1,188,654. Management believes these receivable and $600,000 advanced to these
entities in the aggregate since December 31, 2002 are collectible.
During the period ended December 31, 2002, the Company used cash of $156,875 in
its initial, development stage operation. Cash used in investing activities
totaled $1,401,163 and consisted of loans to TrustWave and Entelagent and
professional fees capitalized in connection with pending acquisitions. The
Company received cash flows from investing activities of $1,558,400.
STOCKHOLDER ADVANCES
We have been financed to date by a group of stockholders and private
investors with "seed" capital. At December 31, 2002, the face amount of notes
with stockholders was $628,500 with related accrued interest of $26,201. Each of
these advances bears interest at rates ranging from 8 percent to 10 percent per
annum and is due on demand. In addition, certain of our stockholders and
officers have incurred operating expenses totaling $453,127. In addition, in
2002, we borrowed an aggregate amount of $230,000 from six unrelated third
parties. Four of the notes representing this debt bear interest at a rate of 8
percent per annum and are convertible into shares of our common stock, with the
conversion price based on the fair market value of such shares on the date on
which the notes are converted. Two of the notes representing this debt are
demand notes accruing interest at a rate of 10 percent per annum.
ACCOMMODATION ARRANGEMENTS
In November 2002, we entered into a financing arrangement with a third
party (subsequently amended), which called for the Company to borrow $950,000
pursuant to a note secured by a pledge by five of our stockholders of 950,000
shares of our common stock. In connection with this arrangement, we executed a
series of Accommodation Agreements with the pledging stockholders, whereby each
pledgor pledged shares in return for the right to receive, on or before March
31, 2003, the return of the pledged shares plus additional shares, for a total
of 1,200,000 shares of common stock. In December 2002, we received $450,000 of
proceeds under the note, and provided the lender with all of the pledged shares.
To date, we have not received the remaining $500,000 commitment. To the extent
our financial resources permit, we intend to take all necessary action to either
enforce the loan or secure the return of the pledged shares. We have issued and
plan to register 1,200,000 shares of common stock to the pledging stockholders
to replace the pledged shares. We have accounted for these events as an
in-substance foreclosure on the loan collateral by the lender.
SECURED PROMISSORY NOTES
In December 2002, we entered into a collateral loan agreement and
promissory note with Mercatus & Partners, Ltd. (Mercatus), a financing group, in
the amount of $3 million. On January 2, 2003, the Company entered into a second
promissory note with Mercatus in the amount of $1.5 million. The Company has not
borrowed any amounts under these arrangements. Borrowings on the $3 million note
are collateralized by 8,823,529 shares of
13
common stock, and borrowings on the $1.5 million note are collateralized by
5,769,231 shares of common stock, all of which have been placed in a custodial
account with UBS Bank in Switzerland for the benefit of the lender as security
for the loan. Interest on amounts borrowed accrues at 5.5 percent per annum. We
have agreed to pay fees of 3% to the lender and two months principal and
interest in advance. The term of the loan is five years. Interest only payments
will be due in the first year after funding of the loan. Aggregate monthly
principal payments of $93,750 will be due beginning February 2004. There is an
early termination charge for prepayment. Mercatus also requires a "key man" life
insurance policy naming it as beneficiary and matching the principal balance of
the loan on a decreasing basis. We are also required within 90 days of a loan
drawdown to enter into good faith negotiations to establish a warrant or option
position.
As of March 27, 2003, Mercatus has yet to provide funding pursuant
to the terms of the collateral loan agreement and promissory note. We have sent
notification to Mercatus terminating the agreement and requesting Mercatus to
return all shares placed in escrow. Upon receipt of the shares, we will cancel
such shares.
PRIVATE PLACEMENTS
The Company is currently negotiating a private placement of 3 to 4
million shares of common stock with a group of investors, for a per share price
of $5.00, for an aggregate investment of $15,000,000 to $20,000,000. This
funding is conditioned on, among other things, the closing of the TrustWave
transaction. There can be no assurance that such negotiations will result in a
transaction.
On January 13, 2003, we entered into a term sheet with a private
international investor, pursuant to which the investor has agreed to provide to
the Company an investment facility of up to $40 million for use by the Company
in the information security services and products markets.
The investment facility is to be comprised of: (1) a $15 million
equity investment in privately placed common stock at a price per share of
$5.00; and (2) $25 million in subordinated debt available in increments of not
less than $5 million at the discretion of the Company. The $15 million equity
investment is to be used by the Company to fulfill its obligations as part of
the acquisition of TrustWave. A portion of the proceeds of the investment
facility are intended to be used to consummate the acquisition by the Company of
Entelagent. Remaining proceeds may be used for start-up costs, world-wide
business development opportunities and for general working capital purposes.
Each tranche of subordinated debt has a seven-year maturity date and
accrues interest at the prime rate quoted in The Wall Street Journal. During the
first year, we are obligated to make interest payments only, and thereafter we
are obligated to pay principal and interest until maturity. The subordinated
debt facility may be drawn down for up to a period of one year. We have agreed
to pay the investors: (1) a semi-annual fee of 25 basis points on all
uncommitted funds; and (2) a commitment fee of 3 percent, payable in equity or
cash at the election of the Company, on the first anniversary of the execution
of the Term Sheet.
The investors are currently finalizing documentation with regard to
the investment facility. There have been numerous delays to date with respect to
this financing and there can be no assurance that this financing will be
completed particularly on a basis which is timely enough to permit the closing
of the TrustWave Merger.
We have agreed with this investor to jointly pursue business
development opportunities in Europe and Asia related to wireless information
security initiatives.
In March 2003, the Company received proceeds of $1,000,000 from the
sale of 500,000 shares to unaffiliated investors in a private placement
transaction.
PENDING ACQUISITIONS
TRUSTWAVE ACQUISITION
The TrustWave acquisition will be consummated on or about April 1,
2003. Upon the consummation of the TrustWave Merger, shareholders of TrustWave
received, in the aggregate: [(1) $10 million in cash paid at the closing and the
right to receive an additional $10 million, to be paid three months after the
closing; and (2) approximately 8,850,000 shares of common stock, subject to a
one-time increase of up to 100 percent in the event that the shares of the our
common stock fails to trade at or above $12 per share, on average, over the 21
days prior to and including the first anniversary of the closing date. In
addition, we issued approximately 2,100,000 stock options to existing TrustWave
option holders. In connection with closing of the transaction, we provided
working capital financing to TrustWave totaling $1.24 million.
14
The TrustWave Merger has been approved by the Boards of Directors of
Patron Systems, TrustWave Mergerco and TrustWave. The TrustWave Merger was also
approved by the shareholders on TrustWave on March 28, 2003. The TrustWave
Merger is intended to be a tax-free reorganization under the Internal Revenue
Code. In connection with the consummation of the TrustWave Merger, certain
executive officers of TrustWave would execute employment agreements with Patron.
In order to consummate the TrustWave Merger, Patron will need to raise
approximately $12 million in funds for use as of the closing of the TrustWave
Merger and an additional $10 million of funds within 90 days of closing of the
TrustWave Merger. Patron has held discussions with numerous potential investors
to date, but these discussions have yet to result in the receipt by Patron of
available funds sufficient to proceed with the TrustWave closing. Patron is in
active negotiations with certain potential investors and as discussed above, has
received commitments from certain investors to provide certain financing to
Patron. Certain of these commitments have been in existence for several months,
but have yet to be finalized to the extent necessary to permit Patron to have
access to the funds contemplated by the commitments. Although Patron remains
confident that such commitments will result in funds becoming available to
Patron, the timing of the receipt of such funds is currently uncertain. The
acquisition agreement relating to the TrustWave Merger currently provides for an
expiration date of April 1, 2003. Patron is engaged in discussions with
TrustWave to extend the expiration date, but there can no assurance that it will
be successful in achieving an extension. In the event that Patron was
unsuccessful in obtaining funds adequate to consummate the TrustWave Merger or
the receipt of funds did not occur prior to the expiration of the acquisition
agreement for the TrustWave Merger, it is unlikely that Patron would be
successful in completing the TrustWave merger.
ENTELAGENT ACQUISITION
On November 24, 2002, Systems entered into an Agreement and Plan of
Merger to acquire Entelagent. Upon the consummation of the Entelagent Merger,
shareholders of Entelagent will receive, in the aggregate, 1,800,000 shares of
our common stock and we will assume certain debts and obligations of Entelagent.
Subsequent to the closing of this transaction, the Company will be obligated to
grant 440,000 common stock options to certain employees and non-employee
consultants of Entelagent. In connection with this transaction, we agreed to
provide working capital financing to Entelagent. Advances under such notes bear
interest at 10 percent per annum and are repayable upon demand. Total
outstanding advances under such notes at December 31, 2002, were $320,000.
Entelagent's working capital advances prior to closing will increase by
approximately $350,000.
The closing of the Entelagent acquisition is subject to several closing
conditions, including approval of the transaction by Entelagent's shareholders,
the closing of the TrustWave Merger and obtaining funding for the additional
working capital needs of Entelagent. If we are unsuccessful in completing the
TrustWave merger, it is unlikely that we would complete the Entelagent Merger.
15
The risks noted below and elsewhere in this report and in other
documents we file with the SEC are risks and uncertainties that could cause our
actual results to differ materially from the results contemplated by the
forward-looking statements contained in this report and other public statements
we make.
FACTORS THAT MAY AFFECT OUR BUSINESS AND FUTURE RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
LACK OF PROFITABILITY.
We have never been profitable, and there can be no guarantee of
profitability in the future.
LACK OF BUSINESS OPERATIONS.
Patron continues to seek financing for the acquisition of TrustWave and
Entelagent. We continue to believe that we will have financing secured shortly
but there can no assurance of our success.
OUR LIMITED HISTORY MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS.
Holdings (as CPS) was incorporated in Nevada in 1995 and Systems was
incorporated in Delaware in 2002. We have not had any business operations since
inception. As a result of our limited history, it may be difficult to plan
operating expenses or forecast our revenues accurately. Our assumptions about
customer or network requirements may be wrong. The revenue and income potential
of these products is unproven, and the markets addressed by these products are
volatile. If such products are not successful, our actual operating results
could be below our expectations and the expectations of investors and market
analysts, which would likely cause the price of our common stock to decline.
LACK OF MARKET FOR PRODUCTS.
Prior to our proposed acquisition of TrustWave, we do not have any
current products or revenues. We intend to acquire products through the
acquisition of existing businesses. There is no guarantee, however, that a
market will develop for Internet security solutions of the type we intend to
offer. We cannot predict the size of the market for Internet security solutions,
the rate at which the market will grow, or whether our target customers will
accept our acquired products.
THE PRICE OF OUR COMMON STOCK IS LIKELY TO BE VOLATILE.
The market prices of the securities of technology-related companies
have historically been volatile and may continue to be volatile. Thus, the
market price of our common stock is likely to be subject to wide fluctuations.
If our revenues do not grow or grow more slowly than we anticipate, if operating
or capital expenditures exceed our expectations and cannot be reduced
appropriately, or if some other event adversely affects us, the market price of
our common stock could decline. Only a small public market currently exists for
our common stock and the number of shares eligible for sale in the public market
is currently very limited, but is expected to increase. Sales of substantial
shares in the future would depress the price of our common stock. In addition,
we currently do not receive any stock market research coverage by any recognized
stock market research or trading firm and our shares are not traded on any
national securities exchange. A larger and more active market for our common
stock may not develop.
Because of our limited operations history and lack of assets and
revenues to date, our common stock is believed to be currently trading on
speculation that we will be successful in implementing our acquisition and
growth strategies. There can be no assurance that such success will be achieved.
The failure to implement our acquisitions and growth strategies would likely
adversely affect the market price of our common stock. In addition, if the
market for technology-related stocks or the stock market in general experiences
a continued or greater loss in investor confidence or otherwise fails, the
market price of our common stock could decline for reasons unrelated to our
business, results of operations and financial condition. The market price of our
common stock also might decline in reaction to events that affect other
companies in our industry even if these events do not directly affect us.
General political or economic conditions, such as an outbreak of war, a
recession or interest rate or currency rate fluctuations, could also cause the
market price of our common stock to decline. Our common stock has experienced,
and is likely to continue to experience, these fluctuations in price, regardless
of our performance.
16
THE CONCENTRATION OF OUR CAPITAL STOCK OWNERSHIP WITH INSIDERS IS LIKELY TO
LIMIT THE ABILITY OF OTHER STOCKHOLDERS TO INFLUENCE CORPORATE MATTERS.
The executive officers, directors and entities affiliated with any of
them together beneficially own approximately 85.96% of our outstanding common
stock. As a result, these stockholders may be able to exercise control over
matters requiring approval by our stockholders, including the election of
directors and approval of significant corporate transactions. This concentration
of ownership might also have the effect of delaying or preventing a change in
our control that might be viewed as beneficial by other stockholders.
FUTURE SALES OF SHARES BY EXISTING STOCKHOLDERS COULD CAUSE OUR STOCK PRICE TO
DECLINE.
If our existing or future stockholders sell, or are perceived to sell,
substantial amounts of our common stock in the public market, the market price
of our common stock could decline. As of March 27, 2003, there are approximately
33,513,888 shares of common stock outstanding (which number does not include the
14,592,760 shares of common stock pledged to Mercatus that have been requested
to be returned and cancelled, as more fully described in the description of our
Liquidity and Capital Resources), of which all but 4,704,000 shares will be held
by directors, executive officers and other affiliates, the sale of which are
subject to volume limitations under Rule 144, various vesting agreements and our
quarterly and other "blackout" periods. Furthermore, shares subject to
outstanding options and warrants and shares reserved for future issuance under
our stock option plan will become eligible for sale in the public market to the
extent permitted by the provisions of various vesting agreements, the lock-up
agreements and Rule 144 under the Securities Act.
WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE.
Our business plan is dependent upon the acquisition and integration of
companies that have previously operated independently. The process of
integrating could cause an interruption of, or loss of momentum in, the
activities of our business and the loss of key personnel. The diversion of
management's attention and any delays or difficulties encountered in connection
with our integration of acquired operations could have an adverse effect on our
business, results of operations, financial condition or prospects.
AVAILABILITY OF FUTURE CAPITAL.
To achieve our intended growth, we will require substantial additional
capital. We have encountered difficulty and delays in raising capital to date
and the market environment for development stage companies, like Patron, remains
particularly challenging. There can be no assurance that funds will be available
when needed or on acceptable terms. Technology companies in general have
experienced difficulty in recent years in accessing capital. Inability to obtain
additional financing may require us to delay, scale back or eliminate certain of
our growth plans which could have a material and adverse effect on our business,
financial condition or results of operations or to cease operations. Even if we
are able to obtain additional financing, such financing could be structured as
equity financing that would dilute the ownership percentage of any investor in
our securities.
DOWNTURNS IN THE INTERNET INFRASTRUCTURE, NETWORK SECURITY AND RELATED MARKETS
MAY DECREASE OUR REVENUES AND MARGINS.
The market for products and other products we intend to offer depends
on economic conditions affecting the broader Internet infrastructure, network
security and related markets. Downturns in these markets may cause enterprises
and carriers to delay or cancel security projects, reduce their overall or
security-specific information technology budgets or reduce or cancel orders for
products and other products we intend to offer. In this environment, customers
such as distributors, value-added resellers and carriers may experience
financial difficulty, cease operations and fail to budget or reduce budgets for
the purchase of TrustWave's products or other products we intend to offer. This,
in turn, may lead to longer sales cycles, delays in purchase decisions, payment
and collection, and may also result in price pressures, causing us to realize
lower revenues, gross margins and operating margins. In addition, general
economic uncertainty caused by potential hostilities involving the United
States, terrorist activities, the decline in specific markets such as the
service provider market in the United States, and the general decline in the
capital spending in the information technology sector make it difficult to
predict changes in the purchase and network requirements of our potential
customers and the markets we intend to serve. We believe that, in light of these
events, some businesses may curtail or eliminate capital spending on information
technology. A decline in capital spending in the markets we intend to serve may
adversely affect our future revenues, gross margins and operating margins and
make it necessary for us to gain significant market share from our future
competitors in order to achieve our financial goals and achieve profitability.
17
COMPETITION MAY DECREASE OUR PROJECTED REVENUES, MARKET SHARE AND MARGINS.
The market for network security products is highly competitive, and we
expect competition to intensify in the future. Competitors may gain market share
and introduce new competitive products for the same markets and customers we
intend to serve with our products. These products may have better performance,
lower prices and broader acceptance than the products we intend to offer.
Many of our potential competitors have longer operating histories,
greater name recognition, large customer bases and significantly greater
financial, technical, sales, marketing and other resources than we will have
even if we are successful in consummating the TrustWave merger. In addition,
some of our potential competitors currently combine their products with other
companies' networking and security products. These potential competitors also
often combine their sales and marketing efforts. Such activities may result in
reduced prices, lower gross and operating margins and longer sales cycles for
the products we intend to offer. If any of our larger potential competitors were
to commit greater technical, sales, marketing and other resources to the markets
we intend to serve, or reduce prices for their products over a sustained period
of time, our ability to successfully sell the products we intend to offer,
increase revenue or meet our or market analysts expectations could be adversely
affected.
FAILURE TO ADDRESS EVOLVING STANDARDS IN THE NETWORK SECURITY INDUSTRY AND
SUCCESSFULLY DEVELOP AND INTRODUCE NEW PRODUCTS OR PRODUCT ENHANCEMENTS WOULD
CAUSE OUR REVENUES TO DECLINE.
The market for network security products is characterized by rapid
technological change, frequent new product introductions, changes in customer
requirements and evolving industry standards. We expect to introduce our
products and enhancements to existing products to address current and evolving
customer requirements and broader networking trends and vulnerabilities. We also
expect to develop products with strategic partners and incorporate third-party
advanced security capabilities into our intended product offerings. Some of
these products and enhancements may require us to develop new hardware
architectures and ASICs that involve complex and time consuming processes. In
developing and introducing our intended product offerings, we have made, and
will continue to make, assumptions with respect to which features, security
standards and performance criteria will be required by our potential customers.
If we implement features, security standards and performance criteria that are
different from those required by our potential customers, market acceptance of
our intended product offerings may be significantly reduced or delayed, which
would harm our ability to penetrate existing or new markets.
Furthermore, we may not be able to develop new products or product
enhancements in a timely manner, or at all. Any failure to develop or introduce
these new products and product enhancements might cause TrustWave's existing
products to be less competitive, may adversely affect our ability to sell
solutions to address large customer deployments and, as a consequence, our
revenues may be adversely affected. In addition, the introduction of products
embodying new technologies could render existing products we intend to offer
obsolete, which would have a direct, adverse effect on our market share and
revenues. Any failure of our future products or product enhancements to achieve
market acceptance could cause our revenues to decline and our operating results
to be below our expectations and the expectations of investors and market
analysts, which would likely cause the price of our common stock to decline.
THE UNPREDICTABILITY OF AN ACQUIRED COMPANY'S QUARTERLY RESULTS MAY CAUSE THE
TRADING PRICE OF OUR COMMON STOCK TO DECLINE.
An acquired company's quarterly revenues and operating results have
varied in the past and will likely continue to vary in the future due to a
number of factors, many of which are outside of our control. Any of these
factors could cause the price of our common stock to decline. The primary
factors that may affect future revenues and future operating results include the
following:
o the demand for intended current product offerings and our future
products;
o the length of sales cycles;
o the timing of recognizing revenues;
o new product introductions by us or our competitors;
o changes in our pricing policies or the pricing policies of our
competitors;
o variations in sales channels, product costs or mix of products sold;
o our ability to develop, introduce and ship in a timely manner new
products and product enhancements that meet customer requirements;
o our ability to obtain sufficient supplies of sole or limited source
components, including ASICs, and power supplies, for our products;
o variations in the prices of the components we purchase;
18
o our ability to attain and maintain production volumes and quality
levels for our products at reasonable prices at our third-party
manufacturers;
o our ability to manage our customer base and credit risk and to collect
our accounts receivable; and
o the financial strength of our value-added resellers and distributors.
Our operating expenses are largely based on anticipated revenues and a
high percentage of our expenses are, and will continue to be, fixed in the short
term. As a result, lower than anticipated revenues for any reason could cause
significant variations in our operating results from quarter to quarter and,
because of our rapidly growing operating expenses, could result in substantial
operating losses. In this event, the price of our common stock would likely
decline.
WE MAY EXPERIENCE ISSUES WITH OUR FINANCIAL SYSTEMS, CONTROLS AND OPERATIONS
THAT COULD HARM OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Our ability to sell our intended product offerings and implement our
business plan successfully in a volatile and growing market requires effective
management and financial systems and a system of financial processes and
controls. We have limited management resources today and are still establishing
our management and financial systems. Growth, to the extent it occurs, is likely
to place a considerable strain on our management resources, systems, processes
and controls. To address these issues, we will need to continue to improve our
financial and managerial controls, reporting systems and procedures, and will
need to continue to expand, train and manage our work force worldwide. If we are
unable to maintain an adequate level of financial processes and controls, we may
not be able to accurately report our financial performance on a timely basis and
our business and stock price would be harmed.
IF OUR FUTURE PRODUCTS DO NOT INTEROPERATE WITH OUR END CUSTOMERS' NETWORKS,
INSTALLATIONS WOULD BE DELAYED OR CANCELLED, WHICH COULD SIGNIFICANTLY REDUCE
OUR ANTICIPATED REVENUES.
Future products will be designed to interface with its end customers'
existing networks, each of which have different specifications and utilize
multiple protocol standards. Many end customers' networks contain multiple
generations of products that have been added over time as these networks have
grown and evolved. Or future products must interoperate with all of the products
within these networks as well as with future products that might be added to
these networks in order to meet end customers' requirements. If we find errors
in the existing software used in our end customers' networks, we may elect to
modify our software to fix or overcome these errors so that our products will
interoperate and scale with their existing software and hardware. If our future
products do not interoperate with those within our end customers' networks,
installations could be delayed or orders for our products could be cancelled,
which could significantly reduce our anticipated revenues.
WE WILL DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A
RAPIDLY CHANGING MARKET, AND IF WE ARE UNABLE TO HIRE ADDITIONAL PERSONNEL OR
RETAIN EXISTING PERSONNEL, OUR ABILITY TO EXECUTE OUR BUSINESS STRATEGY WOULD BE
IMPAIRED.
We currently have only five employees. Our future success depends upon
the continued services of our executive officers, including in particular
Patrick J. Allin, Richard L. Linting, Brett Newbold and Marie Meisenbach Graul.
The loss of the services of any of our key employees, the inability to attract
or retain qualified personnel in the future, or delays in hiring required
personnel, could delay the development and introduction of, and negatively
impact our ability to sell, our intended product offerings.
WE MIGHT HAVE TO DEFEND LAWSUITS OR PAY DAMAGES IN CONNECTION WITH ANY ALLEGED
OR ACTUAL FAILURE OF OUR PRODUCTS AND SERVICES.
Because our intended product offerings and services provide and monitor
network security and may protect valuable information, we could face claims for
product liability, tort or breach of warranty. Anyone who circumvents our
security measures could misappropriate the confidential information or other
property of end customers using our products, or interrupt their operations. If
that happens, affected end customers or others may sue us. Defending a lawsuit,
regardless of its merit, could be costly and could divert management attention.
Our business liability insurance coverage may be inadequate or future coverage
may be unavailable on acceptable terms or at all.
WE COULD BECOME SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS
THAT COULD BE COSTLY AND RESULT IN THE LOSS OF SIGNIFICANT RIGHTS.
19
In recent years, there has been significant litigation in the United
States involving patents and other intellectual property rights. We may become a
party to litigation in the future to protect our intellectual property or as a
result of an alleged infringement of another party's intellectual property.
Claims for alleged infringement and any resulting lawsuit, if successful, could
subject us to significant liability for damages and invalidation of our
proprietary rights. These lawsuits, regardless of their success, would likely be
time-consuming and expensive to resolve and would divert management time and
attention. Any potential intellectual property litigation could also force us to
do one or more of the following:
o stop or delay selling, incorporating or using products that use the
challenged intellectual property;
o obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which license might
not be available on reasonable terms or at all; or
o redesign the products that use that technology.
If we are forced to take any of these actions, our business might be
seriously harmed. Our insurance may not cover potential claims of this type or
may not be adequate to indemnify us for all liability that could be imposed.
THE INABILITY TO OBTAIN ANY THIRD-PARTY LICENSE REQUIRED TO DEVELOP NEW PRODUCTS
AND PRODUCT ENHANCEMENTS COULD REQUIRE US TO OBTAIN SUBSTITUTE TECHNOLOGY OF
LOWER QUALITY OR PERFORMANCE STANDARDS OR AT GREATER COST, WHICH COULD SERIOUSLY
HARM OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
From time to time, we may be required to license technology from third
parties to develop new products or product enhancements. Third-party licenses
may not be available to us on commercially reasonable terms or at all. The
inability to obtain any third-party license required to develop new products or
product enhancements could require us to obtain substitute technology of lower
quality or performance standards or at greater cost, which could seriously harm
our business, financial condition and results of operations.
GOVERNMENTAL REGULATIONS AFFECTING THE IMPORT OR EXPORT OF PRODUCTS COULD
NEGATIVELY AFFECT OUR REVENUES.
Governmental regulation of imports or exports or failure to obtain
required export approval of our encryption technologies could harm our
international and domestic sales. The United States and various foreign
governments have imposed controls, export license requirements and restrictions
on the import or export of some technologies, especially encryption technology.
In addition, from time to time, governmental agencies have proposed additional
regulation of encryption technology, such as requiring the escrow and
governmental recovery of private encryption keys.
In particular, in light of recent terrorist activity, governments could
enact additional regulation or restrictions on the use, import or export of
encryption technology. Additional regulation of encryption technology could
delay or prevent the acceptance and use of encryption products and public
networks for secure communications. This might decrease demand for our intended
product offerings and services. In addition, some foreign competitors are
subject to less stringent controls on exporting their encryption technologies.
As a result, they may be able to compete more effectively than we can in the
domestic and international network security market.
MANAGEMENT COULD INVEST OR SPEND OUR CASH OR CASH EQUIVALENTS AND INVESTMENTS IN
WAYS THAT MIGHT NOT ENHANCE OUR RESULTS OF OPERATIONS OR MARKET SHARE.
We have made no specific allocations of our cash or cash equivalents
and investments. Consequently, management will retain a significant amount of
discretion over the application of our cash or cash equivalents and investments
and could spend the proceeds in ways that do not improve our operating results
or increase our market share. In addition, these proceeds may not be invested to
yield a favorable rate of return.
20
ITEM 7. FINANCIAL STATEMENTS
Financial Statements and Report of
Independent Certified Public Accountants
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
December 31, 2002
21
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Contents
================================================================================
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 3
FINANCIAL STATEMENTS
Balance Sheet 4
Statement of Operations 5
Statement of Stockholders' Equity (Deficit) 6
Statement of Cash Flows 7
Notes to Financial Statements 8-19
22
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Patron Systems, Inc.
We have audited the accompanying balance sheet of Patron Systems, Inc. (a
Delaware corporation) (a development stage enterprise) (the Company), as of
December 31, 2002, and the related statements of operations, stockholders'
equity (deficit), and cash flows for the period from inception (April 30, 2002)
through December 31, 2002. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Patron Systems, Inc., as of
December 31, 2002, and the results of its operations and its cash flows for the
period from inception (April 30, 2002) through December 31, 2002, in conformity
with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A, the Company is
in the development stage, has incurred losses since inception, and requires
capital to finance its operations and commitments associated with certain
pending acquisitions. These factors, among others, as discussed in Note A to the
financial statements, raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note A. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ GRANT THORNTON LLP
March 29, 2002
Vienna, Virginia
23
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Balance Sheet
================================================================================
December 31, 2002
---------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 362
Loans to TrustWave Corp., and Entelagent Software Corp. 1,188,654
------------
TOTAL CURRENT ASSETS 1,189,016
------------
DEFERRED COSTS ASSOCIATED WITH PENDING ACQUISITIONS 212,509
------------
TOTAL ASSETS $ 1,401,525
---------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Note Payable $ 229,900
Accounts payable 1,200,274
Expense reimbursement due to officers and shareholders 453,127
Accrued payroll and payroll related expenses 659,858
------------
TOTAL CURRENT LIABILITIES 2,543,159
ADVANCES FROM SHAREHOLDERS 628,500
OBLIGATION UNDER FINANCING ARRANGEMENT 1,497,728
COMMITMENTS AND CONTINGENCIES --
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, par value $.001 per share, 50,000,000 shares authorized,
41,137,417 shares issued and outstanding
as of December 31, 2002 41,137
Additional paid in capital 26,254,632
Shares issued and held in escrow (13,235,293)
Deficit accumulated during the development stage (16,328,338)
------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) (3,267,862)
------------
$ 1,401,525
---------------------------------------------------------------------------------------
The accompanying notes are an integral part of this statement.
24
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Statement of Operations
================================================================================
PERIOD FROM INCEPTION
(APRIL 30, 2002) TO
DECEMBER 31, 2002
--------------------
REVENUE $ --
------------
GENERAL AND ADMINISTRATIVE EXPENSES 2,439,060
CHARGE ASSOCIATED WITH ISSUANCE OF STOCK IN
REVERSE MERGER TRANSACTION 3,965,726
COMMON STOCK ISSUED FOR BUSINESS DEVELOPMENT CONSULTING SERVICES 4,168,750
STOCK OPTIONS GRANTED FOR SERVICES 4,676,000
------------
LOSS FROM OPERATIONS (15,249,536)
OTHER INCOME (EXPENSE)
Loss on financing arrangement (1,047,728)
Interest expense (31,074)
------------
LOSS BEFORE INCOME TAXES (16,328,338)
INCOME TAX BENEFIT --
------------
NET LOSS $(16,328,338)
------------
NET LOSS PER SHARE-BASIC AND DILUTED $ (0.62)
------------
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING-BASIC AND DILUTED 26,307,419
------------
The accompanying notes are an integral part of this statement.
25
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Statement of Stockholders' Equity (Deficit)
===============================================================================
For the period from inception (April 30, 2002) to December 31, 2002
-------------------------------------------------------------------------------
DEFICIT ACCUMULATED
SHARES OF PAR VALUE ADDITIONAL SHARES HELD DURING THE
COMMON STOCK COMMON STOCK PAID IN CAPITAL IN ESCROW DEVELOPMENT STAGE TOTAL
----------------------------------------------------------------------------------------
BALANCE AT INCEPTION (APRIL 30, 2002) -- $ -- $ -- -- $ -- $ --
Issuance of founders shares 25,000,000 25,000 225,000 -- -- 250,000
Predecessor shares retained in exchange
transaction 2,687,200 2,687 -- -- -- 2,687
Issuance of common stock in share exchange
transaction 2,201,688 2,202 3,960,837 -- -- 3,963,039
Common stock issued in lieu of cash for
services 2,425,000 2,425 4,166,325 -- -- 4,168,750
Stock options issued in lieu for cash for
services -- -- 4,676,000 -- -- 4,676,000
Issuance of common stock as collateral to
anticipated financing 8,823,529 8,823 13,226,470 (13,235,293) -- --
Net loss -- -- -- -- (16,328,338) (16,328,338)
----------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 41,137,417 41,137 $ 26,254,632 (13,235,293) $(16,328,338) $ (3,267,862)
------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of this statement.
26
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Statement of Cash Flows
===============================================================================
PERIOD FROM INCEPTION
(APRIL 30, 2002) TO
DECEMBER 31, 2002
------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(16,328,338)
Adjustments to reconcile net loss to net cash provided in
operating activities:
Non-cash charge associated with share exchange transaction 3,965,726
Common stock issued in lieu of cash for services 4,168,750
Stock options issued in lieu of cash for services 4,676,000
Non-cash loss on financing arrangement 1,047,728
Changes in assets and liabilities:
Accounts payable 1,200,274
Expense reimbursement due to officers and shareholders 453,127
Accrued payroll and payroll related expenses 659,858
------------
Total adjustments 16,171,463
------------
NET CASH USED IN OPERATING ACTIVITIES (156,875)
------------
CASH FLOWS USED IN INVESTING ACTIVITIES
Loans to TrustWave Corp. and Entelagent Software Corp. (1,188,654)
Deferred costs associated with pending acquisitions (212,509)
------------
NET CASH USED IN INVESTING ACTIVITIES (1,401,163)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of note payable 229,900
Proceeds from issuance of common stock 250,000
Advances from shareholders 628,500
Proceeds received under financing arrangement 450,000
------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,558,400
NET INCREASE IN CASH 362
-------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, beginning of year --
------------
CASH AND CASH EQUIVALENTS, end of year $ 362
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Interest paid $ --
Income taxes paid $ --
The accompanying notes are an integral part of this statement.
27
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE A--ORGANIZATION AND BUSINESS
Patron Systems, Inc. (herein referred to as Systems or the Company) is a
successor entity to Combined Professional Services, Inc., a Nevada
corporation originally formed in October 1995 (CPS), which later changed
its name to Patron Holdings, Inc. (Holdings). Holdings (as CPS) was
originally formed to provide corporate services to other business entities,
but abandoned that business plan shortly after formation. Holdings,
therefore, has never had business operations or revenue.
Patron Systems, Inc., a Delaware corporation (Systems) was formed in April
2002 to provide comprehensive, end-to-end information security solutions to
global corporations and government institutions. Systems' founders intended
to raise capital on a private equity basis, but determined that there was a
need for a public company currency to achieve their growth plan. Systems
then began to evaluate opportunities to merge with and become part of an
existing public company. Systems identified CPS during this process and
determined that CPS was well-suited to provide Systems with its public
currency because of its lack of operational history, affording Systems an
open platform from which to grow, without the necessity of divesting
existing operations or incurring liabilities as a result of existing
operations.
On October 11, 2002, Holdings (as CPS), Systems and the stockholders of
Systems consummated a share exchange (Share Exchange) pursuant to an
Amended and Restated Share Exchange Agreement, whereby Holdings (as CPS)
issued to each Systems stockholder, on a one-for-one basis and in exchange
for all of the outstanding shares of Systems capital stock, an aggregate of
25,400,000 shares of Holdings (as CPS) common stock. Upon the closing of
the Share Exchange, Systems stockholders held approximately 85 percent of
the outstanding capital stock of Holdings (as CPS), and Systems became a
wholly owned subsidiary of Holdings (as CPS). The share exchange was
accounted for as a reverse merger whereby Systems, as the surviving
company, was treated as the acquirer for financial statement purposes.
On March 26, 2003, Holdings merged with and into Systems, for the purpose
of changing its state of incorporation from Nevada to Delaware
(Redomestication Merger). Systems was the surviving corporation of the
Redomestication Merger, and its Second Amended and Restated Certificate of
Incorporation, Amended and Restated Bylaws and Board of Directors are the
governing documents and governing body of the surviving corporation.
Prior to the date of the Redomestication Merger, Systems had no material
assets or business operations. Systems' principal activities since its
formation in April 2002 consisted of the development of its business plan,
capital raising and evaluation and negotiation of potential acquisitions.
Patron, post-Redomestication Merger, intends to implement Systems' plans,
through acquisitions and internal growth, to offer trusted security
services and next generation integrated security products. Patron intends
to work with organizations to ensure that global enterprises implement
information security policies, procedures and products that result in
"trusted" information environments. Patron expects to offer information
security and vulnerability assessments, certification programs,
remediation, implementation, training, monitoring and management services.
28
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE A--ORGANIZATION AND BUSINESS--CONTINUED
The Company has yet to begin revenue-generating operations and as such is a
development stage company. Since its inception, the Company has reported a
net loss of approximately $16,300,000, principally associated with expenses
related to the formation of the Company, assembling its management team,
and capital formation and acquisition activities consistent with its
business plan.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. Critical to the Company's future
success are its ability to close on the acquisitions described in Note D,
together with raising capital sufficient to fund both its obligations
arising from these transactions as well as the Company's ongoing working
capital requirements. Working capital to date has been provided by loans
and advances received from certain shareholders and officers of the
Company. While no assurances can be given that the Company will be
successful in closing its pending acquisitions or raising sufficient
capital, management believes it will be successful in doing so.
================================================================================
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACQUISITION COSTS
The Company has incurred certain expenses, principally legal fees, in
connection with the closed or pending acquisitions described in Note D,
which have been capitalized and deferred pending the completion of each
acquisition. Upon closing, such costs will be included in the purchase
price of each respective target company and allocated to the assets
received and obligations assumed. In the event a pending acquisition does
not occur, such costs will be expensed at that time.
START UP COSTS
All expenses incurred in connection with formation of the Company and
related start up activities have been expensed as incurred and are included
in general and administrative expenses in the accompanying financial
statements.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid securities purchased with original
maturities of three months or less to be cash equivalents.
29
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
INCOME TAXES
The Company accounts for income taxes pursuant to Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Deferred
taxes arise from temporary differences, primarily attributable to the use
of the cash method for tax purposes and accrual method for book purposes
and net operating loss carryforwards.
STOCK OPTION PLANS
SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does
not require, companies to record compensation cost for stock-based employee
compensation plans based on the fair value of options granted. The Company
has elected to account for stock-based compensation using the intrinsic
value method provided under Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations
and to provide additional disclosures with respect to the proforma effects
of adoption had the Company recorded compensation expense under SFAS No.
123.
The following sets forth proforma information as if the Company were using
the fair value method under SFAS No. 123 for the period from inception to
December 31, 2002:
Net loss as reported $ (16,328,338)
Stock-based employee compensation cost included in
the net loss as reported --
Stock-based employee compensation cost under the fair
value method of SFAS No. 123 13,000
Proforma net loss (16,786,338)
Proforma net loss per share-basic and diluted $ (.64)
NET LOSS PER SHARE
Basic net loss per common share is computed by dividing net loss by the
weighted-average number of common shares outstanding during the period.
Diluted net loss per common share also includes common stock equivalents
outstanding during the period if dilutive. Diluted net loss per common
share has been computed by dividing net loss by the weighted-average number
of common shares outstanding without an assumed increase in common shares
outstanding for common stock equivalents; as such common stock equivalents
are antidilutive. Common stock equivalents at December 31, 2002, consist
primarily of 4,400,000 stock options and approximately 113,000 shares
issuable upon conversion of debt to common stock.
30
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
USE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required
to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and revenue and
expenses during the reporting period. Actual results could differ from
those estimates.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2002, Financial Accounting Standards Board (FASB) issued SFAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities,
which addresses accounting and processing for costs associated with exit or
disposal activities. SFAS No. 146 requires the recognition of a liability
for a cost associated with an exit or disposal activity when the liability
is incurred versus the date the Company commits to an exit plan. In
addition, SFAS No. 146 states the liability should be initially measured at
fair value. The requirements of SFAS No. 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. This
pronouncement is not expected to have a material impact on the Company's
financial position or results of operations.
In December 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure. SFAS No. 148 amends the disclosure
and certain transition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation. Its disclosure provisions, which apply to all
entities with employee stock-based compensation, are effective for fiscal
years ending after December 15, 2002. New interim period disclosures are
required in financial statements for interim periods beginning after
December 15, 2002. Other than the additional disclosure requirements, this
pronouncement is not expected to have a material impact on the Company's
financial position or results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. FIN 45 addresses
the disclosure requirements of a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that it
has issued. FIN 45 also requires a guarantor to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken
in issuing the guarantee. The disclosure requirements of FIN 45 are
effective for the Company effective December 31, 2002. The liability
recognition requirements will be applicable prospectively to all guarantees
issued or modified after December 31, 2002. This pronouncement is not
expected to have a material impact on the Company's financial position or
results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 clarifies existing
accounting for whether interest entities should be consolidated in
financial statements based upon the investee's ability to finance
activities without additional financial support and whether investors
possess characteristics of a controlling financial interest. FIN 46 applies
to years or interim periods beginning after June 15, 2003, with certain
disclosure provisions required for financial statements issued after
January 31, 2003. This pronouncement is not expected to have a material
impact on the Company's financial position or results of operations
31
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE C--SHARE EXCHANGE WITH COMBINED PROFESSIONAL SERVICES, INC.
On October 11, 2002, the Company consummated transactions called for in an
Amended and Restated Share Exchange Agreement (the "Exchange Agreement")
wherein the Company issued to each stockholder of Patron Systems, Inc., a
Delaware corporation (Patron Systems), on a one for one basis and in
exchange for all the outstanding shares of Patron Systems, an aggregate of
25,400,000 shares of the Company's common stock (representing 85 percent of
the outstanding capital of the Company). The share exchange was accounted
for as a reverse merger whereby even though the Company was the surviving
entity in the exchange, Patron Systems was treated as the acquirer for
accounting purposes. Prior to the share exchange, the Company was a "public
shell" company with no operations and focused solely on seeking
acquisitions of or merging with other companies to enhance shareholder
value.
Based on guidance provided by the Securities and Exchange Commission,
because the shareholders of the Patron Systems received stock representing
majority control of the Company, Patron Systems was treated as the
accounting acquirer for financial reporting purposes whereby historical
amounts in the accompanying financial statements prior the exchange are
those of Patron Systems. In addition, the share exchange was recorded as a
capital transaction in the accompanying financial statements as opposed to
a business combination. The exchange transaction was therefore reflecting
by recording the 2,687,200 shares of stock retained by the Company's
previous shareholders and the nominal assets received. In connection with
the share exchange, the Company paid a fee of $250,000 in cash and issued
400,000 shares of Company common stock to a consultant, which shares were
valued at $720,000, and expensed in the accompanying financial statements
(value based upon the closing price on October 11, 2002). Such shares were
issued on October 11, 2002, by Patron Systems, and immediately exchanged
for shares of the Company's common stock. Prior to the transaction, the
Company had no operations, no permanent employees and its sole purpose was
to provide a vehicle for mergers and acquisitions.
In addition, on the closing date, the Company issued 1,801,688 shares of
common stock to a prior officer and other third parties for services
rendered. The value associated with this share issuance of approximately
$3.2 million was expensed in the accompanying financial statements.
32
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE D--PENDING ACQUISITIONS SUBJECT TO CLOSING
TRUSTWAVE CORP.
On November 23, 2002, Patron Systems, TWC Acquisition, Inc., a Maryland
corporation and wholly owned subsidiary of Patron Systems (TrustWave
Mergerco), and TrustWave Corp., a Maryland corporation (TrustWave), entered
into an Agreement and Plan of Merger, as subsequently amended (the
TrustWave Merger Agreement), whereby TrustWave will merge with and into
TrustWave Mergerco with TrustWave Mergerco surviving as a wholly owned
subsidiary of the Company (the TrustWave Merger). In connection with the
TrustWave Merger, shareholders of TrustWave will receive, in the aggregate:
(1) $20,000,000 in cash, 50 percent of which will be paid at the closing of
the TrustWave Merger and 50 percent of which will be paid not later than
three months after the closing of the TrustWave Merger; and (2)
approximately 8,850,000 shares of Patron System's common stock, subject to
a one-time increase of up to 100 percent in the event that the shares of
the Patron System's common stock fail to trade at or above $12 per share,
on average, over the 21 days prior to and including the first anniversary
of the closing date. In addition, Patron Systems will issue approximately
2,150,000 stock options to current TrustWave option holders. See Note J for
description of financing which will be used to fund this transaction.
In connection with the TrustWave merger, an unaffiliated investor had
placed in a trust $2,000,000 to be applied towards the cash consideration
due under the related agreements. The Company is negotiating the terms by
which this amount will become an investment in the Company at the closing
of the TrustWave Merger.
The TrustWave Merger had been approved by the Boards of Directors of Patron
Systems, TrustWave Mergerco and TrustWave. The TrustWave Merger is intended
to be a tax-free reorganization under the Internal Revenue Code. In
connection with the consummation of the TrustWave Merger, certain executive
officers of TrustWave will execute employment agreements with Patron
Systems.
In connection with this transaction, Patron Systems is required to provide
pre-closing working capital financing to TrustWave. Advances under such
notes bear interest at 10 percent per annum and are repayable on demand.
Total outstanding advances under such notes at December 31, 2002, were
$840,000. In January 2003, an additional $400,000 was advanced to
TrustWave.
TrustWave provides enterprise information assurance and security services
and solutions company founded in 1995 to corporate, educational and
government customers. In early 2002, TrustWave began work on a contract
with a Fortune 100 financial services company to conduct security
compliance audits and ongoing remote intrusion testing using TrustWave's
proprietary technology and products.
33
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE D--PENDING ACQUISITIONS SUBJECT TO CLOSING--CONTINUED
ENTELAGENT SOFTWARE CORP.
On November 24, 2002, Patron Systems, ESC Acquisition, Inc., a California
corporation and wholly owned subsidiary of Patron Systems (Entelagent
Mergerco), and Entelagent Software Corp., a California corporation
(Entelagent), entered into an Agreement and Plan of Merger, as amended (the
Entelagent Merger Agreement) whereby Entelagent Mergerco will be merged
with and into Entelagent with Entelagent surviving as a wholly owned
subsidiary of Patron Systems (the Entelagent Merger). Patron Systems,
Entelagent Mergerco and Entelagent also concurrently entered into a
Supplemental Agreement, as amended (the Entelagent Supplemental Agreement).
Upon the consummation of the Entelagent Merger, shareholders of Entelagent
will receive, in the aggregate, 1,800,000 shares of Patron Systems and
Patron Systems will assume certain debts and obligations of Entelagent.
The Entelagent Merger has been approved by the Boards of Directors of
Patron Systems, Entelagent Mergerco and Entelagent. The Entelagent Merger
is intended to be a tax-free reorganization under the Internal Revenue
Code. In connection with the consummation of the Entelagent Merger, certain
executive officers of Entelagent will execute employment agreements with
Patron Systems. The closing of the acquisition is subject to several
closing conditions, including approval of the transaction by Entelagent's
shareholders, the consummation of a reincorporation merger pursuant to
which the Company will merge with and into Patron Systems with the Company
continuing as the surviving entity, the consummation of Patron System's
acquisition of TrustWave and obtaining funding for the additional working
capital needs of Entelagent.
Subsequent to the closing of this transaction, the Company will be
obligated to grant 440,000 common stock options to certain employees and
non-employee consultants of Entelagent.
In connection with this transaction Patron Systems agreed to provide
working capital financing to Entelagent. Advances under such notes bear
interest at 10 percent per annum and are repayable upon demand. Total
outstanding advances under such notes at December 31, 2002, were $320,000.
In March 2003, an additional $200,000 was advanced to Entelagent.
Entelagent is an information technology products and services company
founded in 1996. Entelagent's products and services are focused on e-mail
management solutions, including monitoring and data mining with a
particular focus on ensuring compliance with laws and regulations in the
financial services and brokerage industries.
================================================================================
NOTE E--RELATED PARTY TRANSACTIONS
SHAREHOLDERS LOANS
Since its inception, the Company has obtained financing from certain
shareholders for working capital needs. At December 31, 2002, the face
amount of notes with these shareholders was $628,500 and related accrued
interest of $26,201 has been included in accrued expenses. These advances
bear interest at rates ranging from 8 percent to 10 percent per annum and
are due on demand.
34
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE E--RELATED PARTY TRANSACTIONS--CONTINUED
REIMBURSEMENTS OF EXPENSES INCURRED BY OFFICERS AND SHAREHOLDERS
Certain shareholders and officers of the Company have incurred operating
expenses totaling $453,127 on the Company's behalf. Such expenses have been
recorded in the accompanying financial statements with a corresponding
obligation to reimburse the shareholder/officer. Included in such expenses
is approximately $60,000 of expenses incurred by a founder prior to
incorporation of the Company for which the Company has agreed to reimburse
the founder. As of December 31, 2002, no reimbursements have been paid to
the officer/shareholders.
================================================================================
NOTE F--NOTES PAYABLE
CONVERTIBLE NOTES PAYABLE
In 2002, the Company borrowed an aggregate amount of $145,000 from four
unrelated third parties. The notes, bear interest at 8 percent and are
convertible into shares of the Company's common stock with the conversion
price based on the underlying fair market value at the dates that the notes
are settled (approximately 113,000 shares at December 31, 2002, based on
the fair market value of the common stock at that date.)
DEMAND NOTES PAYABLE
In 2002, the Company borrowed an aggregate amount of $85,000 from two
unrelated third parties under demand notes payable, which bears interest at
10 percent.
FINANCING ARRANGEMENT
In November 2002, the Company entered into a financing arrangement with a
third party financial institution (the Lender), which called for the
Company to borrow $950,000 under a note to be collateralized by the pledge
of 950,000 shares of the Company's common stock from five different
stockholders. In connection with this arrangement, the Company executed a
series of Accommodation Agreements with the five stockholders wherein each
stockholder pledged shares in return for the right to receive on a best
efforts basis on or before March 31, 2003, the return of the pledged
shares, or replacement shares in the event of foreclosure, and one
additional share of common stock as compensation.
In December 2002, the Company received $450,000 of proceeds under the note
and provided the Lender the pledged shares. Since that date, no additional
proceeds have been provided by the Lender. The Company plans to take
whatever action is necessary to either enforce the loan or secure the
return of the pledged shares.
35
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE F--NOTES PAYABLE--CONTINUED
In the accompanying financial statements as of December 31, 2002, the
Company has effectively accounted for these events as an in-substance
foreclosure on the loan collateral by the Lender. In doing so, the Company
has recorded an obligation of $1,497,600 to the shareholders who pledged
their shares representing the value of the shares that are required to be
returned in November 2003. Accordingly, a loss on the financing arrangement
of $1,047,600 has been recorded in the Statement of Operations for the
difference between the obligation recorded and the proceeds received under
the loan. Pending the outcome of any efforts the Company has taken or may
take to recover additional proceeds under the loan or the pledged shares
from the Lender, the obligation recorded will fluctuate throughout 2003
until the date the pledged shares are replaced with existing shares based
upon the fair value of the shares.
SECURED PROMISSORY NOTE
In December 2002, the Company entered into a collateral loan agreement and
promissory note with an unrelated third party in the amount of $3 million.
On January 3, 2002, the Company entered into a second promissory note in
the amount of $1.5 million. As of February 28, 2003, the Company has not
borrowed any amounts under these arrangements. Interest on amounts borrowed
accrues at 5.5 percent per annum. Borrowings on the $3 million note are
collateralized by 8,823,529 shares of common stock, which have been placed
in a custodial account for the benefit of the Lender as security for the
loan. Borrowings on the $1.5 million note are collateralized by 5,769,231
shares of common stock, which have also been placed in a custodial account
for the benefit of the Lender as security to the loan. Shares associated
with the $3 million note have been reflected as shares held in escrow in
the accompanying statement of stockholders' equity (deficit). Interest only
payments will be due in the first year after funding of the loan. Aggregate
monthly principal payments of $93,750 will be due beginning February 2004.
On March 27, 2003, the Company cancelled the loan as no proceeds were ever
received under the terms of the loan agreements. The Company requested that
their restricted stock held in escrow be returned immediately to the
transfer agent and cancelled.
================================================================================
NOTE G--STOCK OPTIONS
STOCK OPTION GRANTS
In May and July 2002, options to purchase 1,200,000 shares of the Company's
common stock were granted to employees at an exercise price of $.01 per
share with vesting periods of three years. Under the provisions of APB
Opinion No. 25 and related interpretations, no compensation expense is
required to be recorded by the Company on these options since the exercise
price of such options was equal to the fair market value at the date of
grant. In addition, the fair value of these options granted is not
material.
36
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE G--STOCK OPTIONS--CONTINUED
STOCK OPTION GRANTS--CONTINUED
In October 2002, options to purchase 2,800,000 shares of the Company's
common stock were granted to certain outside consultants. In accordance
with SFAS No. 123, the Company recognized as an expense approximately
$4,676,000 representing the fair value relating to such options. The fair
value of the options at the date of grant was estimated using the
Black-Scholes method using the following assumptions: risk-free interest
rate of 3.68 percent; expected dividend yield zero percent; expected option
life of 10 years; and expected volatility of 87 percent.
In December 2002, an officer of the Company, in conjunction with the
officer's employment agreement, was granted an option to purchase 400,000
shares of common stock at an exercise price of $2.05 per share, the trading
price of the underlying stock on the date of grant. The option vests
quarterly over three years subject to the officer's continued employments
and the options have a ten-year life. The fair value of the options at the
date of grant was $468,000. This value was estimated using the
Black-Scholes method using the following assumptions: risk-free interest
rate of 3.24 percent; expected dividend yield zero percent; expected option
life of three years; and expected volatility of 87 percent.
LOK TECHNOLOGY, INC.
Certain of the Company's founders were directors of Lok Technology, Inc.
(Lok), a technology start up company, which has developed wireless
encryption technology. During the period while such founders served as
directors of Lok, Warren K. K. Luke loaned $500,000 to Lok evidenced by
convertible notes, of which $350,000 was loaned by Lok to Entelagent
Software Corp. Subsequent thereto, certain of the founders chose to vacate
their board positions at Lok to become directors and/or officers of Patron
Systems upon its formation. Mr. Luke joined the Board of Directors of the
Company in January 2003.
In November 2002, Patron Systems entered into a purchase agreement with
such unaffiliated third party, whereby Patron Systems agreed to purchase
such unaffiliated third party's rights and interests related to the
$500,000 loan for 400,000 shares of Patron Systems' common stock. The
consummation of the transactions contemplated by such purchase agreement
are contingent upon, among other things, the consummation of merger of the
Company with and into Patron Systems (see Note C) and Subsidiary's.
As a result, upon the consummation of Patron Systems' acquisition of
Entelagent and the Company's acquisition of the rights and interests
related to the $500,000 loan as described above, Entelagent, as a
subsidiary of Patron Systems, will owe Lok $350,000 and Lok will owe
$500,000 plus accrued interest to Patron Systems. Thereafter, the Company
and Lok intend to cancel these obligations in exchange for a license
agreement and a mutual release and covenant not to sue. Such license
agreement will provide Patron Systems with a non-exclusive right to exploit
Lok's technology for a license fee, the amount of which is dependent on
sales association with such licensed technology.
37
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE G--STOCK OPTIONS--CONTINUED
CONSULTING AGREEMENTS
On December 20, 2002, the Company entered into consulting agreements with
three consultants providing services to the Company related to prospective
mergers, identifying strategic investors, and identifying potential
customers and business partners. The term of each agreement is for two
years. For and as consideration for the services provided pursuant to the
consulting agreements, the Company issued 2,425,000 shares of common stock
of the Company. The Company recorded a charge of approximately $4,200,000
in its 2002 financial statements based upon the value of the shares issued.
================================================================================
NOTE H--INCOME TAXES
Deferred taxes are comprised of the following at December 31, 2002:
TAX EFFECT
---------------------------------------------------------------------------
Deferred tax asset (all related to start up expenses) $ (2,813,178)
Valuation Allowance 2,813,178
------------
Net deferred taxes $ --
------------
Following is a reconciliation of the Company's tax provision to that expected
based upon applying current statutory tax rates to the Company's net loss before
income taxes:
Net loss before income taxes $(16,328,338)
------------
Tax benefit at statutory rates (5,551,635)
Non-deductible expenses associated with reverse merger
(see Note C) 3,377,150
Valuation allowance against deferred tax asset 2,813,178
State income tax benefit (653,133)
Other 14,440
------------
Provision for income taxes $ --
------------
Since its inception, the Company's business activities have been conducted
to develop its business plan, raising capital, and pursuing mergers and
acquisitions consistent with its business plan. The Company has deferred
recognition of expenses associated with these activities as start up costs
for income tax reporting purposes and will amortize them over five years
commencing upon closing of either the TrustWave or Entelagent acquisitions
when revenue generating operations will commence. All costs and charges
associated with the reverse merger described in Note C have not been
deducted for income tax reporting purposes. As a result, the Company has no
net operating loss carryforward to report on its 2002 tax return.
38
PATRON SYSTEMS, INC. (A DEVELOPMENT STAGE ENTERPRISE)
Notes to Financial Statements
================================================================================
December 31, 2002
--------------------------------------------------------------------------------
NOTE I--EMPLOYMENT AGREEMENTS
Effective October 1, 2002, the Company entered into employment agreements
with three officers, each with a three year term. The minimum base
compensation due in the aggregate under such agreements is $960,000 in year
one, $1,140,000 in year two, and $1,320,000 in year three. On December 6,
2002, the Company entered into an employment agreement with a fourth
officer that has a three-year term and provides for annual compensation of
$250,000. In addition, the agreements provide for terms by which each
officer may earn bonuses, severance payments, and other incentive
compensation.
================================================================================
NOTE J--SUBSEQUENT EVENTS
FINANCING TERM SHEET
On January 13, 2003, Patron Systems, entered into a term sheet (the Term
Sheet) with a private group of international investors (the Investors),
pursuant to which the Investors have agreed to provide an investment
facility to Patron Systems in an aggregate amount of up to $40 million.
The investment facility is to be comprised of: (1) a $15 million equity
investment in privately placed common stock of Patron Systems at a price
per share of $5.00; and (2) $25 million in subordinated debt available in
increments of not less than $5 million at the discretion of Patron Systems.
The $15 million equity investment is to be used by Patron Systems to
consummate the acquisition of TrustWave Corp., (see Note D) and is payable
in connection with the closing of such acquisition. A portion of the
proceeds of the investment facility will also be used to consummate the
acquisition by Patron Systems of Entelagent Software Corp. (see Note D).
Each tranche of subordinated debt will have a seven-year maturity and will
accrue interest at the prime rate quoted in The Wall Street Journal. During
the first year, Patron Systems will only be obligated to make interest
payments and will be obligated to pay principal and interest thereafter
until maturity. The subordinated debt facility may be drawn down for up to
a period of one year.
The investment facility provides that the proceeds of the investment
facility are to be used by Patron Systems to finance certain acquisitions,
including the acquisition of TrustWave Corp. and Entelagent Software Corp.,
start-up costs, world-wide business development opportunities and for
general working capital purposes. Patron Systems has agreed to pay the
Investors: (1) a semi-annual fee of 25 basis points on all uncommitted
funds; and (2) a commitment fee of 3 percent, payable in equity or cash at
the election of Patron Systems, on the first anniversary of the execution
of the Term Sheet.
PRIVATE PLACEMENT
In March 2003, the Company received proceeds of $1,000,000 from the sale of
500,000 shares to unaffiliated investors in a private placement
transaction.
39
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Our board of directors has selected Grant Thornton LLP, an independent
accounting firm, to serve as independent certified public accountants for our
fiscal year ended December 31, 2002. Our previous accountant from July 8, 2002
until the retention of Grant Thornton, LLP was Grassano Accounting, P.A. On
December 13, 2002, Patron Holdings received the resignation of Grassano
Accounting, P.A. On July 8, 2002, we dismissed our prior accountant Kurt D.
Saliger, CPA. No report submitted by either Mr. Saliger or by Grassano
Accounting for the past two years contained an adverse opinion or a disclaimer
of an opinion, or was qualified as to uncertainty, audit scope, or accounting
principles. The decision to change accountants was approved by our Board. During
our most recent two fiscal years and for the period of January 1, 2002 through
the date hereof, we have had no disagreements with either of our former
accountants on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of the former accountants, would have caused
them to make reference to the subject matter of the disagreements in connection
with their reports. These matters are more fully disclosed in our Current Report
on Form 8-K filed with the SEC on December 16, 2002.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
DIRECTORS AND EXECUTIVE OFFICERS OF PATRON AS OF MARCH 31, 2003
PATRICK J. ALLIN - CLASS III DIRECTOR, CHIEF EXECUTIVE OFFICER, AGE 51
Until December of 2001, Mr. Allin was Co-Chairman and CEO of Encore
Development, a high end technology consultancy. From 1996 to 2000, Mr. Allin was
a Senior Consulting Partner at Price Waterhouse (subsequently
PricewaterhouseCoopers), where he was responsible for several large practice
areas, including the North American strategy practice. Post merger with Coopers
& Lybrand, Mr. Allin had COO and P&L responsibility for the merged $6 billion
global consulting practice. Throughout his tenure at PW/PWC Mr. Allin built and
managed their largest client relationship. Mr. Allin received a bachelor of
commerce degree from the University of Toronto, and is a Chartered Accountant.
RICHARD G. BEGGS - CLASS II DIRECTOR, AGE 58
Mr. Beggs serves as Executive Vice President and Chief Administrative
Officer for Daiwa Securities America. Prior to joining Daiwa in 1995, Mr. Beggs
was the Managing Director and Chief Operating Officer of Kemper Clearing
Corporation. He has held several positions at Security Pacific Bank/Bank of
America, including President and CEO of the Treasury Management Corporation,
President and COO of Security Pacific Securities Inc. and Managing Director of
the Global Securities Services Group. He has also held senior management
positions at Donaldson, Lufkin and Jenrette and at Salomon Brothers. Mr. Beggs
graduated from Columbia University with a BA in Economics and received an MBA in
Finance from Fairleigh Dickinson University.
ANTHONY J. CARBONE - CLASS III DIRECTOR, AGE 61
Mr. Carbone has been Vice Chairman of Dow Chemicals Board of Directors
since February 2000 and a Senior Consultant since November 2000. He has been a
Director at Dow Chemical since 1995, and employed by Dow Chemical since 1962. He
has had multiple assignments with Dow Chemical, including; Dow Latin America
Marketing Director for Plastics 1974-76, Dow Business Manager for STYROFOAM(TM)
1976-80, Director of Marketing for Functional Products and Systems 1980-83, Dow
U.S.A. General Manager of the Coatings and Resins Department 1983-86, General
Manager of Separation Systems 1986-87, Vice President Dow Plastics 1987-91, Dow
North America Group Vice President for Plastics 1991-93, Group Vice President,
Global Plastics 1993-95, Group Vice President - Global Plastics, Hydrocarbons
and Energy 1995-96, and Executive Vice President, 1996-2000. Mr. Carbone also
serves as Director of Rockwell Collins Inc. and Chairman of Board Compensation
and Governance Committee.
40
WARREN K. K. LUKE - CLASS II DIRECTOR, AGE 58
Mr. Luke serves as Chairman and Chief Executive Officer of Hawaii
National Bank and its parent, Hawaii National Bancshares, Inc. Mr. Luke, has
also been an active member of a number of regional and national institutions.
Mr. Luke served three, three-year terms as a director of the Federal Reserve
Bank of San Francisco, including a term as chair of its audit committee. He has
served as a member of the Board of Governors of the American Red Cross and the
United Way of America and currently serves as a member of the Asia Pacific
Advisory Committee for the Harvard Business School. A graduate of Babson College
and the Harvard Graduate School of Business, Mr. Luke's banking career spans
over thirty years. His numerous leadership positions in business and community
affairs include: various assignments with the American Bankers Association,
chairman of the Pacific and Asian Affairs Council, and directorships for the
following organizations: the Hawaii Chapter of the American Red Cross, the
Chinese Chamber of Commerce of Hawaii, the Hawaii Community Reinvestment
Corporation, the Honolulu Academy of Arts, the Land Use Research Foundation of
Hawaii, Aloha Airlines, and membership on the advisory council for the Korea
Economic Institute of America in Washington D.C.
ROBERT E. YAW II - CLASS I DIRECTOR, AGE 56
Mr. Yaw has been a founding principal shareholder of Patron Systems,
Inc. and a director of other private companies, including principal equity
partnerships with Prudential Insurance Company and New York Life Insurance
Company. Prior thereto, Mr. Yaw founded Salomon Brothers' Global
Telecommunications Group. Mr. Yaw led Salomon Brothers' creation of mortgage
securitization. He was Chairman of that firm's New Products Group and Director
of Private Placements. Prior to founding the Telecommunication Group, Mr. Yaw
served on the staffs of Citigroup, the United States Senate Republican Policy
Committee, the United States Senate Foreign Relations Committee, and the
Presidential Commission on the Causes and Prevention of Violent Crime. Mr. Yaw
received his undergraduate education at Bowdoin College and Clare College
(Cambridge University), and his graduate legal education at Georgetown
University and the University of London.
MARIE MEISENBACH GRAUL - CHIEF FINANCIAL OFFICER, SECRETARY AND TREASURER,
AGE 47
Prior to her employment with Patron, Ms. Graul was Senior Vice
President and Chief Financial Officer of NTE, Inc., a supply chain software
company. From 1997 to 1999, Ms. Graul was the Vice President of Finance and CFO
of Bernard Technologies, Inc. From 1989 through 1997, she served as CFO and
Treasurer for Schwak, Inc., an international imaging technology company. Ms.
Graul also worked as a Vice President for J&W Seligman & Co., a Wall Street
money management firm from 1987 through 1989. Ms. Graul has an MBA from the
University of Oklahoma and a BA from Michigan State University.
BRETT NEWBOLD - CHIEF TECHNOLOGY OFFICER, PRESIDENT, TECHNOLOGY PRODUCTS GROUP,
AGE 50
Since 1999, Mr. Newbold has served as an executive consultant to
Kleiner Perkins Caufield & Byers; a California based private equity firm, and
various software companies. Until 1999, Mr. Newbold was President and Chief
Operating Officer of OpenText Corporation (NASDAQ:OTEX). Prior thereto, Mr.
Newbold served for eight years as Vice President of Research and Development for
Oracle Corporation where he had senior responsibility for the selection and
development of new technologies, reporting directly to its Chairman, Mr.
Ellison. Mr. Newbold received his undergraduate degree from the University of
Washington.
RICHARD L. LINTING - PRESIDENT, SECURITY SERVICES GROUP, AGE 57
Mr. Linting has an extensive track record building consultancies,
including being the Lead Technology Partner and an Executive Committee Member at
Accenture, and building the consulting practices at Computer Sciences
Corporation and Digital Equipment Corporation. From 1996 until 1999, he served
as President of Carreker Corporation (NASDAQ:CANI), a financial services-focused
professional services and products company. Mr. Linting received his
undergraduate degree from the University of Notre Dame and holds a MBA from the
University of Chicago.
The Board of Directors has created a Compensation Committee, an Audit
Committee and a Corporate Governance Committee. Mr. Beggs serves as Chairman of
the Compensation Committee and Mr. Luke serves as Chairman of the Corporate
Governance Committee.
41
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based upon its review of Forms 3, 4 and 5 submitted to it, the
Corporation is aware that (i) Warren K. K. Luke, a Director of the Corporation,
filed a Form 3 on February 24, 2003 with respect to his election as Director on
January 15, 2003, (ii) Richard G. Beggs, a Director of the Corporation, filed a
Form 3 on February 25, 2003 with respect to his election as Director on January
15, 2003, (iii) Marie Meisenbach Graul, an officer of the Corporation, filed a
Form 3 on March 4, 2003 with respect to her election as an officer on December
6, 2002, (iv) Robert E. Yaw II, a Director and officer of the Corporation, has
not timely filed a Form 3, (v) Jeff Spanier, former Director and President of
the Corporation, has not timely filed a Form 3 with respect to shares of common
stock acquired by him in July 2002 or a Form 4 with respect to the change in his
beneficial ownership as a result of the Share Exchange, and (vi) Marc Baker,
former Director and President of the Corporation, has not timely filed a Form 4
with respect to the change in his beneficial ownership as a result of his
resignation as an officer and director of the Corporation and related share
forfeiture.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth a summary, for the years ended December 31,
2001 and 2002, of the compensation of Holdings' President for 2001 and through
July 2002, and its President from July 2002 through October 2002 and its Chief
Executive Officer since October 2002. The table also summarizes compensation for
three other executive officers of Holdings serving as executive officers
beginning on October 11, 2002 and one beginning on December 6, 2002. The six
individuals identified in the Summary Compensation Table are referred to as the
"named executive officers" throughout this report on Form 10-KSB.
SUMMARY COMPENSATION TABLE
------------------------------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------------------------------------------------------
AWARDS PAYOUTS
------------------------------------
Securities
Salary Bonus Other annual Restricted underlying All other
Name and Principal ($) ($) compensation Stock options / LTIP compensation
Position Year (1) (1) ($) Award(s)($) SARs (#) Payouts ($)
------------------------------------------------------------------------------------------------------------------------------
Marc Baker................ 2002 0 0 0 0 0 0 0
Sole Director and 2001 0 0 0 0 0 0 0
President (2)
------------------------------------------------------------------------------------------------------------------------------
Jeffrey Spanier........... 2002 0 0 0 0 0 0 0
Sole Director and
President (3)
------------------------------------------------------------------------------------------------------------------------------
Patrick J. Allin.......... 2002 270,000 0 0 0 0 0 0
Chief Executive
Officer (4)
------------------------------------------------------------------------------------------------------------------------------
Marie Graul............... 2002 20,833 0 0 0 400,000(6) 0 0
Chief Financial
Officer(5)
------------------------------------------------------------------------------------------------------------------------------
Brett Newbold............. 2002 187,000 0 0 0 0 0 0
CTO, President -
Technology Products
(7)
------------------------------------------------------------------------------------------------------------------------------
Richard L. Linting........ 2002 187,000 0 0 0 1,000,000(9) 0 0
President - Security
Services (8)
------------------------------------------------------------------------------------------------------------------------------
(1) Amounts shown include cash compensation earned or to be earned by the named
executive officers for the nine-month period from April 2002 through December
2002, including amounts deferred at the election of those officers. Bonuses are
paid in April of the year following the year during which they are earned.
(2) On February 27, 2001, Holdings (then called Combined Professional Services,
Inc.) issued Mr. Baker 2,300,000 shares of the Holdings' common stock. Mr. Baker
tendered no consideration for the shares, but rather the Board existing at that
time felt that such issuance was necessary to entice him to join Holdings based
on his extensive experience with mergers and acquisitions. Mr. Baker became
Holdings' sole director and officer. During his tenure with Holdings, Mr. Baker
was issued an additional 2,200,000 shares of Holdings' common stock. On July 18,
2002,
42
Mr. Baker resigned from his positions with Holdings and returned all 4,500,000
shares of the Holdings' common stock that he had received.
(3) On July 18, 2002, Mr. Spanier was elected as a director and as President of
Holdings (then called Combined Professional Services, Inc.). Mr. Spanier was
issued 4,000,000 shares of Holdings' common stock at this time. Pursuant to the
Exchange Agreement, and Mr. Spanier's employment agreement with Holdings, Mr.
Spanier returned the 4,000,000 shares to Holdings in conjunction with his
resignation as President of Holdings. These shares were subsequently cancelled.
(4) Mr. Allin became Holdings' Chief Executive Officer on October 11, 2002.
(5) Ms.Graul became Patron Holdings' Chief Financial Officer and Treasurer on
December 6, 2002.
(6) Ms.Graul received, as of December 6, 2002, an option to purchase 400,000
shares of the common stock of Patron Holdings at a per share exercise price of
$2.05. Such grant terminates on December 6, 2012.
(7) Mr. Newbold became Holdings' Chief Technology Officer and President,
Technology Products Group on October 11, 2002.
(8) Mr. Linting became Holdings' President, Security Services Group on October
11, 2002.
(9) Mr. Linting received, on May 1, 2002, an option to purchase 1,000,000 shares
of the common stock of Systems at a per share exercise price of $0.01. Such
option grant terminates on May 1, 2012. As part of the Redomestication Merger,
Mr. Linting's options became exercisable for the shares of the surviving
corporation.
DIRECTOR COMPENSATION
Holdings' Directors did not receive compensation for their services
during the 2001 and 2002 fiscal years. Upon their appointment to the Board of
Directors of Holdings, Richard G. Beggs, Anthony J. Carbone and Warren K. K.
Luke each received an option to purchase 200,000 shares of the common stock of
Holdings. After the Redomestication Merger, the non-employee members of our
Board of Directors in 2003 will receive:
o for new members, an initial option to purchase 200,000 shares of our
common stock;
o subsequent annual grants currently estimated to be 30,000 shares of the
common stock;
o an annual fee of either $30,000 or a grant of restricted stock in an
amount equal to $45,000;
o and reasonable fees and expenses associated with participation on the
board of directors.
o
OPTION GRANTS IN FISCAL 2002
NUMBER OF
SECURITIES % OF TOTAL
UNDERLYING OPTIONS GRANT DATE
OPTIONS GRANTED TO EXERCISE EXPIRATION PRESENT
NAME GRANTED EMPLOYEES PRICE DATE VALUE (2)
---- ------- --------- ----- ---- ---------
Marc Baker.................. 0 - - - -
Jeffrey Spanier............. 0 - - - -
Patrick J. Allin............ 0 - - - -
Marie Graul................. 400,000 25% $2.05 12/6/12 $468,000
(1)
Brett Newbold............... 0 - - - -
Richard L. Linting.......... 1,000,000 (1) 62.5% $0.01 5/1/12 $0 (3)
(1) The stock options granted to Mr. Linting are options to
purchase 1,000,000 shares of the common stock of Patron Systems, while the stock
options granted to Ms. Graul are options to purchase 400,000 shares of the
common stock of Patron Holdings, now known as Patron Systems, Inc.
(2) The Black-Scholes option pricing model was chosen to estimate
the Grant Date Present Value of the options set forth in this table. Patron
Holdings' use of this model should not be construed as an endorsement of
43
its accuracy of valuing options. All stock option valuation models, including
the Black-Scholes model, require a prediction about the future movement of the
stock price. The real value of the options in this table depends upon the actual
performance of Patron Holdings' common stock during the applicable period.
(3) The exercise price of such options was equal to fair market
value at the date of grant.
EXECUTIVE EMPLOYMENT AGREEMENTS
PATRICK J. ALLIN
As of October 2, 2002, Patrick J. Allin and Systems entered into an
employment agreement in connection with Mr. Allin's employment for a three year
term commencing on October 1, 2002, as the Chairman of the Board of Directors
and Chief Executive Officer of Systems. As a result of the Redomestication
Merger, this employment agreement has been assumed by the surviving corporation.
Mr. Allin will receive a minimum annual base salary of $360,000 for the first
year of the employment term, $420,000 for the second year of the employment term
and $480,000 for the third year of the employment term. Mr. Allin is eligible to
receive (i) an annual bonus of 50-100% of his annual base salary if certain
financial performance measures are attained and (ii) such discretionary bonuses
as may be authorized by the Compensation Committee from time to time for
executive employees. Mr. Allin also is eligible to participate in stock option
and other employee benefit plans of Systems that may be in effect from time to
time.
If Mr. Allin's employment is terminated as a result of his death, we
will pay to Mr. Allin's estate his accrued but unpaid base salary, his accrued
but unused vacation and a pro rata annual bonus. If Mr. Allin's employment is
terminated because of his incapacity, we will pay to Mr. Allin for not fewer
than three years an annual disability benefit equal to 60% of the sum of his
base salary and annual bonus, reduced by amounts payable to Mr. Allin under our
disability insurance policy. If Mr. Allin's employment is terminated by us for
Cause (as defined in the employment agreement) or by Mr. Allin without Good
Reason (as defined in the employment agreement), we will pay to Mr. Allin his
accrued but unpaid base salary. If Mr. Allin's employment is terminated by us
without Cause or by Mr. Allin for Good Reason, we will pay to Mr. Allin his
accrued but unpaid base salary, a pro rata annual bonus and all other accrued
but unpaid amounts to which Mr. Allin is entitled (including any pro rata
performance incentive bonus and all accrued but unused vacation). In addition,
if in connection with such a termination Mr. Allin signs a release of all claims
against us, we will (i) pay to Mr. Allin the maximum bonus that could have been
paid to Mr. Allin under any performance incentive bonus plan then in effect;
(ii) for three years pay to Mr. Allin his base salary plus an additional 10%,
and an amount equal to the annual bonus Mr. Allin received for the year prior to
the year of the termination and (iii) continue to provide Mr. Allin with health
insurance coverage for the remainder of the three year employment term and
continue in effect for Mr. Allin's benefit any directors' and officers'
liability insurance covering his period of employment. In the event that the
three year employment term expires without renewal, we will pay to Mr. Allin his
accrued but unpaid base salary, a pro rata annual bonus and all other accrued
but unpaid amounts to which Mr. Allin is entitled (including any pro rata
performance incentive bonus and all accrued but unused vacation). In addition,
if in connection with such expiration Mr. Allin signs a release of all claims
against us, we will (i) pay to Mr. Allin the maximum bonus that could have been
paid to Mr. Allin under any performance incentive bonus plan then in effect;
(ii) for two years pay to Mr. Allin his base salary plus an additional 10%, and
an amount equal to the annual bonus Mr. Allin received for the year prior to the
year in which the agreement expires and (iii) continue in effect for Mr. Allin's
benefit any directors' and officers' liability insurance covering his period of
employment.
Mr. Allin agrees not to compete with us or solicit certain of our
employees or clients for a period of two years after the termination of his
employment (three years in the event that Mr. Allin is receiving payments and
benefits due to the termination of his employment without Cause or for Good
Reason). If any termination payments under the agreement or other amounts
payable to Mr. Allin are subject to the "golden parachute" excise tax imposed
under Section 4999 of the Internal Revenue Code of 1986, as amended, we will
provide Mr. Allin with a gross-up payment in an amount sufficient to offset the
effects of such excise tax.
BRETT NEWBOLD
As of October 2, 2002, Systems entered into an employment agreement
with Brett Newbold in connection with Mr. Newbold's employment for a three year
term commencing on October 1, 2002, as the President of the Technology Products
Group of Patron Systems. The terms of Mr. Newbold's employment agreement are
substantially similar to those described above for Mr. Allin except that Mr.
Newbold will receive a minimum annual base salary of $300,000 for the first year
of the employment term, $350,000 for the second year of the employment term and
$400,000 for the third year of the employment term.
44
RICHARD L. LINTING
As of October 2, 2002, Richard L. Linting and Systems entered into an
employment agreement in connection with Mr. Linting's employment for a three
year term commencing on October 1, 2002, as the President of the Securities
Services Group of Patron Systems. The terms of Mr. Linting's employment
agreement are substantially similar to those described above for Mr. Allin
except that Mr. Linting will receive a minimum annual base salary of $300,000
for the first year of the employment term, $350,000 for the second year of the
employment term and $400,000 for the third year of the employment term. As of
May 1, 2002, Systems granted to Mr. Linting a non-qualified option to purchase
1,000,000 shares of its common stock, $.01 par value, with an exercise price
equal to $.01 per share. The option vests quarterly over three years, commencing
on the date of grant, in approximately equal installments, subject generally to
Mr. Linting's continued employment by Systems. The option expires on May 1,
2012. If Mr. Linting's employment is terminated because of his death or
incapacity, by us without Cause (as defined in the employment agreement) or by
Mr. Linting for Good Reason (as defined in the employment agreement), the option
will become fully vested and thereafter may be exercised until the earlier of
the third annual anniversary of the date Mr. Linting's employment terminates and
the option's expiration date. If Mr. Linting's employment is terminated by us
for Cause, the option automatically will terminate. If Mr. Linting's employment
is terminated by Mr. Linting without Good Reason, the option will be exercisable
only to the extent then vested and thereafter may be exercised until the earlier
of the three month anniversary of the date Mr. Linting's employment terminates
and the option's expiration date. In the event that Mr. Linting's three year
employment term expires without renewal, the option will be exercisable only to
the extent then vested and thereafter may be exercised until the earlier of the
third annual anniversary of the date the term expires and the option's
expiration date.
MARIE MEISENBACH GRAUL
As of December 6, 2002, Marie Meisenbach Graul and Systems entered into
an employment agreement in connection with Ms. Graul's employment for a three
year term commencing on December 6, 2002, as the Senior Vice President, Chief
Financial Officer and Treasurer of Systems. The terms of Ms. Graul's employment
agreement are substantially similar to those described above for Mr. Allin
except that (i) Ms. Graul will receive a minimum annual base salary of $250,000
during the employment term and (ii) Ms.Graul is eligible to receive an annual
bonus of up to 50% of her annual base salary if certain financial performance
measures are attained. As of December 6, 2002, Systems granted to Ms. Graul a
non-qualified option to purchase 400,000 shares of its common stock, $.01 par
value, with an exercise price equal to $2.05 per share. The option vests
quarterly over three years, commencing on the date of grant, in approximately
equal installments, subject generally to Ms. Graul's continued employment by
Systems. The option expires on December 6, 2012. If Ms. Graul's employment is
terminated because of her death or incapacity, by us without Cause (as defined
in the employment agreement) or by Ms. Graul for Good Reason (as defined in the
employment agreement), the option will become fully vested and thereafter may be
exercised until the earlier of the third annual anniversary of the date Ms.
Graul's employment terminates and the option's expiration date. If Ms. Graul's
employment is terminated by us for Cause, the option automatically will
terminate. If Ms. Graul's employment is terminated by Ms. Graul without Good
Reason, the option will be exercisable only to the extent then vested and
thereafter may be exercised until the earlier of the three month anniversary of
the date Ms. Graul's employment terminates and the option's expiration date. In
the event that Ms. Graul's three year employment term expires without renewal,
the option will be exercisable only to the extent then vested and thereafter may
be exercised until the earlier of the third annual anniversary of the date the
term expires and the option's expiration date.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth certain information regarding beneficial
ownership of our common stock as of December 31, 2002, by (i) each person (or
group of affiliated persons) who is known by us to beneficially own more than 5%
of the outstanding shares of our common stock, (ii) each of our directors and
executive officers, and (iii) all of our executive officers and directors as a
group. As of December 31, 2002, there were 32,313,888 shares of common stock
outstanding (which does not include 8,823,529 shares of common stock pledged to
Mercatus as more fully described in Item 6. Except as otherwise indicated, the
beneficial owners listed in the table have sole voting and investment power with
respect to the shares.
45
AMOUNT AND NATURE
OF BENEFICIAL PERCENT OF
CERTAIN BENEFICIAL OWNERS OWNERSHIP CLASS
---------------------------------------------------------------------------------------------------------
DIRECTORS AND EXECUTIVE OFFICERS
Patrick J. Allin, Chief Executive Officer 7,500,000 23.2%(8)
311 Belle Foret Drive, Suite 150
Lake Bluff, Illinois 60044
Marie Meisenbach Graul, Chief Financial Officer,
Secretary and Treasurer 0 0.00%
311 Belle Foret Drive, Suite 150
Lake Bluff, IL 60044
Robert E. Yaw II, Director 7,750,000 24.0%(9)
311 Belle Foret Drive, Suite 150
Lake Bluff, IL 60044
Brett Newbold, Chief Technology Officer, 5,000,000 15.5%(10)
President, Technology Products Group
311 Belle Foret Drive, Suite 150
Lake Bluff, IL 60044
Richard L. Linting, President 1,500,000 5.8%(11)
Security Services Group
311 Belle Foret Drive, Suite 150
Lake Bluff, IL 60044
Warren K. K. Luke, Director 0 0.00%
311 Belle Foret Drive, Suite 150
Lake Bluff, IL 60044
Richard G. Beggs, Director 0 0.00%
311 Belle Foret Drive, Suite 150
Lake Bluff, IL 60044
Anthony J. Carbone, Director 0 0.00%
311 Belle Foret Drive, Suite 150
Lake Bluff, IL 60044
All directors and executive officers
as a group 21,750,000 67.3%
-------------------------
(8) Based on information contained in a Schedule 13D, dated October 18, 2002,
6,250,000 shares are directly owned by Mr. Allin, with 1,250,000 shares
indirectly beneficially owned by him.
(9) Based on information contained in a Schedule 13D, dated October 19, 2002,
1,000,000 shares are directly owned by Mr. Yaw, with 6,750,000 shares indirectly
beneficially owned by him.
(10) Based on information contained in a Schedule 13D, dated October 18, 2002,
2,400,000 shares are directly owned by Mr. Newbold, with 2,600,000 indirectly
beneficially owned by him.
(11) Based on information contained in a Schedule 13D, dated October 18, 2002,
1,350,000 shares are owned by the Richard L. Linting Trust and 150,000 shares
are owned by the Richard L. Linting GST Trust, with all such shares indirectly
beneficially owned by Mr. Linting. Includes 384,815 shares of common stock
issuable pursuant to presently exercisable stock options which will become
exercisable within 60 days of the date of this report on Form 10-KSB.
46
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
LOK TECHNOLOGY AND WARREN K. K. LUKE
Certain of Systems' founders were directors of Lok Technology, Inc.
("Lok"), a technology start up company, which has developed wireless encryption
technology. During the period while such founders served as directors of Lok,
the Warren K. K. Luke Trust and K.J.L. Associates (together, the "Luke Trust"),
affiliates of Warren K. K. Luke, loaned $500,000 to Lok evidenced by convertible
notes, of which $350,000 was loaned by Lok to Entelagent Software Corp.
Subsequent thereto, certain of the founders chose to resign from their board
positions at Lok to become directors and/or officers of Systems and Holdings.
Mr. Luke currently serves on our board of directors.
In November 2002, Systems entered into a purchase agreement with the
Luke Trust, whereby Systems agreed to purchase the Luke Trust's rights and
interests related to the $500,000 loan for 400,000 shares of Systems' common
stock. The consummation of the transactions contemplated by such purchase
agreement is contingent upon, among other things, the consummation of the
Redomestication Merger and the acquisition of Entelagent. As a result, upon the
consummation of the acquisition of Entelagent and Systems' acquisition of the
rights and interests related to the $500,000 loan as described above,
Entelagent, as our subsidiary, will owe Lok $350,000 and Lok will owe $500,000
plus accrued interest to us. Thereafter, we and Lok intend to cancel these
obligations in exchange for a license agreement and a mutual release and
covenant not to sue. Such license agreement will provide us with a non-exclusive
right to exploit Lok's technology for a license fee, the amount of which is
dependent on sales associated with such licensed technology.
We intend to enter into purchase agreements with five Lok shareholders,
pursuant to which we will issue shares of common stock in exchange for all
interests in Lok held by such shareholders. In connection with those agreements,
we intend to enter into termination, waiver and release agreements with Lok and
the shareholders providing for termination of all existing agreements and a
mutual release.
TRANSACTIONS WITH EXECUTIVE OFFICERS AND STOCKHOLDERS
Since Systems' inception, it has obtained financing from certain
shareholders for working capital needs. At December 31, 2002, the total amount
owed to these shareholders was $628,500. These advances currently bear interest
at a range of 8 to 10 percent per annum and are repayable on demand.
Certain shareholders and officers of the Company have incurred
operating expenses totaling $453,127 on the Company's behalf. Such expenses have
been recorded in the accompanying financial statements with a corresponding
obligation to reimburse the shareholder/officer. Included in such expenses is
approximately $60,000 of expenses incurred by Robert E. Yaw II prior to
incorporation of the Company for which the Company has agreed to reimburse Mr.
Yaw. Mr. Yaw is a member of our board of directors.
As of December 31, 2002, no reimbursements have been paid to the
officer/shareholders.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Annual Report on form
10KSB: Exhibits:
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
2.1 Amended and Restated Share Exchange Agreement dated as of October 10,
2002, among Combined Professional Services, Inc., Patron Systems, Inc.
and the holders of the issued and outstanding capital stock of Patron
Systems, Inc. (incorporated by reference to Exhibit 2.1 to Patron
Holdings' Current Report on Form 8-K/A filed October 11, 2002).
2.2 Agreement and Plan of Merger dated as of November 23, 2002, by and
among Patron Systems, Inc., TWC Acquisition, Inc. and TrustWave Corp.
(incorporated by reference to Exhibit 2.1 to Patron Holdings' Current
Report on Form 8-K filed November 27, 2002).
47
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
2.3 Supplemental Agreement dated as of November 23, 2002, and each
amendment thereto by and among Patron Systems, Inc., TWC Acquisition,
Inc., TrustWave Corp. and certain shareholders of TrustWave Corp.
(incorporated by reference to Exhibit 2.2 to Patron Holdings' Current
Report on Form 8-K filed November 27, 2002).
2.4 Agreement and Plan of Merger dated as of November 24, 2002, by and
among Patron Systems, Inc., ESC Acquisition, Inc. and Entelagent
Software Corp. (incorporated by reference to Exhibit 2.3 to Patron
Holdings' Current Report on Form 8-K filed November 27, 2002).
2.5 Supplemental Agreement dated as of November 24, 2002, by and among
Patron Systems, Inc., ESC Acquisition, Inc. and Entelagent Software
Corp. (incorporated by reference to Exhibit 2.4 to Patron Holdings
Current Report on Form 8-K filed November 27, 2002).
2.6 Agreement and Plan of Merger dated as of March 26, 2003, Patron
Systems, Inc. and Patron Holdings, Inc. (incorporated by reference to
Exhibit A to Patron Holdings' Definitive Information Statement on
Schedule 14C filed with the SEC on March 7, 2003).
3.1 Second Amended and Restated Certificate of Incorporation of Patron
Systems, Inc. dated as of February 24, 2003 (incorporated by reference
to Exhibit B to Patron Holdings' Definitive Information Statement on
Schedule 14C filed with the SEC on March 7, 2003).
3.2 Amended and Restated By-laws of Patron Systems, Inc., dated as of
October 7, 2002 (incorporated by reference to Exhibit C to Patron
Holdings' Definitive Information Statement on Schedule 14C filed with
the SEC on March 7, 2003).
10.1 Agreement dated as of July 18, 2002, between Combined Professional
Services, Inc. and Jeff Spanier (incorporated by reference to Exhibit
10.0 to Patron Holdings' Current Report on Form 8-K filed August 14,
2002).
10.2 Employment Agreement dated as of October 2, 2002, between Patrick J.
Allin and Patron Systems, Inc.(1)
10.3 Employment Agreement dated as of October 2, 2002, between Brett
Newbold and Patron Systems, Inc.(1)
10.4 Employment Agreement dated as of October 2, 2002, between Richard L.
Linting and Patron Systems, Inc.(1)
10.5 Employment Agreement dated as of December 6, 2002, between Marie
Meisenbach Graul and Patron Systems, Inc.(1)
16.1 Letter of Grassano Accounting PA regarding change in certifying
accountant (incorporated by reference to Exhibit 16.1 to Patron
Holdings' Current Report on Form 8-K filed December 16, 2002).
21.1 Subsidiaries of the registrant.(1)
23.1 Consent of Grant Thornton LLP.(1)
99.1 Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of
the United States Code - Chief Executive Officer - Patron Systems.(1)
99.2 Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of
the United States Code - Chief Financial Officer - Patron Systems.(1)
(1) Filed herewith.
(b) Reports on Form 8-K.
During the fourth quarter of 2002, Patron filed the following Current
Reports on Form 8-K:
(ii) Current Report on Form 8-K dated September 27, 2002, reporting
under Items 5 and 7 the execution of its share exchange agreement
with Patron Systems, Inc. and the Shareholders of Patron Systems,
Inc.
(iii) Current Report on Form 8-K/A Number 3 dated October 11, 2002,
reporting under Items 1, 2, 5 and 7 the completion of its share
exchange and the execution of an Amended and Restated Share
Exchange Agreement with Patron Systems, Inc. and the Shareholders
of Patron Systems, Inc.
48
(iv) Current Report on Form 8-K dated October 22, 2002, reporting
under Items 5 and 7 the execution of its letter of intent to
acquire Entelagent Software Corp., as well as its intention to
redomesticate from Nevada to Delaware.
(v) Current Report on Form 8-K dated October 24, 2002, reporting
under Items 5 and 7 the execution of its letter of intent to
acquire TrustWave Corp.
(vi) Current Report on Form 8-K dated November 20, 2002, reporting
under Items 5 and 7 the execution of a letter of intent by Patron
Systems, Inc. to acquire the assets of Patron Global, Ltd., and
the decision of the corporation to change its name to Patron
Holdings, Inc.
(vii) Current Report on Form 8-K dated November 23, 2002, reporting
under Items 5 and 7 the execution of definitive documents to
acquire TrustWave Corp. and Entelagent Software Corp. in separate
transactions.
(viii) Current Report on Form 8-K dated December 3, 2002, reporting
under Item 1 the appointment of Richard G. Beggs, Warren K. K.
Luke and Robert E. Yaw II to the Board of Directors of Patron
Holdings, Inc.
(ix) Current Report on Form 8-K dated December 11, 2002, reporting
under Items 4 and 7 the change in the corporation's accountants
from Grassano Accounting, PA to Grant Thornton, LP.
(x) Current Report on Form 8-K dated January 13, 2003, reporting
under Items 5 and 7 the entry into an investment facility of up
to $40 million with a private group of international investors.
(xi) Current Report on Form 8-K dated January 22, 2003, reporting
under Items 5 and 7 the execution of a Memorandum of
Understanding with TELSECURE (UK) LTD to develop an information
security platform and broad-based suite of security products to
support TELSECURE's wireless business application development
project. The corporation also reported that it expects the
TrustWave and Entelagent acquisitions to close during the first
quarter of 2003.
ITEM 14. CONTROLS AND PROCEDURES
Within 90 days before the date of this report, Grant Thornton carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer, Patrick
J. Allin, and Chief Financial Officer, Marie Meisenbach Graul, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined in Rules 13a-14(c) and 15d-14(c)). Based upon that
evaluation, Mr. Allin and Ms. Graul concluded that the Company's disclosure
controls and procedures are effective in causing material information to be
collected, communicated and analyzed by management of the Company on a timely
basis and to ensure that the quality of information contained in, and the
timeliness of, the Company's public disclosures complies with its SEC disclosure
obligations.
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
PATRON SYSTEMS, INC., a Delaware corporation
/s/ Patrick J. Allin
----------------------------------------------------------
By: Patrick J. Allin, Chief Executive Officer
Date 3/31/03
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ Patrick J. Allin
----------------------------------------------------------
By: Patrick J. Allin, Director and Chief Executive Officer
Date 3/31/03
/s/ Marie Meisenbach Graul
----------------------------------------------------------
By: Marie Meisenbach Graul, Chief Financial Officer, Secretary and Treasurer
Date 3/31/03
/s/ Richard C. Beggs
----------------------------------------------------------
By: Richard C. Beggs, Director
Date 3/31/03
/s/ Anthony J. Carbone
----------------------------------------------------------
By: Anthony J. Carbone, Director
Date 3/30/03
---------------------------------------------------------
/s/ Warren K. K. Luke
----------------------------------------------------------
By: Warren K. K. Luke, Director
Date 3/31/03
/s/ Robert E. Yaw, II
----------------------------------------------------------
By: Robert E. Yaw II, Director
Date 3/31/03
50
PATRON SYSTEMS, INC.
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Marie Meisenbach Graul, Chief Financial Officer of Patron Systems, Inc.,
certify that:
1. I have reviewed this annual report on Form 10-KSB of Patron Systems,
Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
By: /s/ Marie Meisenbach Graul
----------------------------
Marie Meisenbach Graul
Chief Financial Officer
51
PATRON SYSTEMS, INC.
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Patrick J. Allin, Chief Executive Officer of Patron Systems, Inc., certify
that:
1. I have reviewed this annual report on Form 10-KSB of Patron Systems,
Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
By: /s/ Patrick J. Allin
--------------------------------
Patrick J. Allin
Chief Executive Officer
52