UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549-1004





Form 10-Q





(Mark One)


x  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange


Act of 1934





FOR THE QUARTERLY PERIOD ENDED March 31, 2011





or





o  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 000-26455





ISECURETRAC CORP.


(Exact name of registrant as specified in its charter)




DELAWARE

87-0347787(State or other jurisdiction of

(I.R.S. Employer Identification No.)





5078 S. 111th Street


OMAHA, NEBRASKA 68137


(Address of principal executive offices, Zip Code)





(402) 537-0022


(Registrant’s telephone number, including area code)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.


Yes x        No o





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).


Yes o        No o





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company in Rule 12b-2 of the Exchange Act.    (Check one)


Large accelerated filer o      Accelerated filer o


Non-accelerated filer o (Do not check if a smaller reporting company)        Smaller reporting company x





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


Yes o      No x





The number of shares of issuer’s common stock outstanding as of April 25, 2011 was 10,930,117.










iSecureTrac Corp.


Table of Contents





Item



PagePART I1

Financial Statements

012.

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

123.

Quantitative and Qualitative Disclosures About Market Risk

184.

Controls and Procedures

18PART II1.

Legal Proceedings

181A.

Risk Factors (Not Required for SRC)

182.

Unregistered Sales of Equity Securities and Use of Proceeds

193.

Defaults Upon Senior Securities

194.

Reserved

195.

Other Information

196.

Exhibits

19











PART I.  FINANCIAL INFORMATION





Item 1.  Financial Statements





iSECUREtrac Corp. and SUBSIDIARY


CONSOLIDATED BALANCE SHEETS




(Unaudited)

March 31,

2011


December 31,

2010ASSETSCurrent AssetsCash and cash equivalents

$
564,686


$
88,956Accounts receivable, net of allowance for doubtful accounts of $524,938 in 2011 and $470,998 in 2010


1,474,043



1,717,235Inventories


168,564



223,629Prepaid expenses and other


249,591



158,749Total current assets


2,456,884



2,188,569Leasehold improvements and equipment, net of accumulated depreciation of $12,737,062 in 2011 and $12,428,434 in 2010


3,976,292



3,719,361Goodwill


2,302,179



2,302,179Other assets


68,059



68,059Total assets

$
8,803,414


$
8,278,168LIABILITIES AND STOCKHOLDERS' DEFICITCurrent LiabilitiesAccounts payable

$
654,023


$
449,414Accrued expenses


406,218



298,009Revolving Line of Credit


1,092,886



642,886Current maturities of long-term debt


986,965



1,185,254Deferred revenues


62,412



71,024Accrued interest payable


89,351



-Total current liabilities


3,291,855



2,646,587Long-term debt, less current maturities, including accrued interest on long-term debt


15,530,215



15,266,221Total liabilities


18,822,070



17,912,808Redeemable convertible Series C preferred stock


16,265,015



15,896,210Commitments and contingencyStockholders' deficitCommon stock


10,930



10,928Additional paid-in capital


55,582,948



55,551,402Accumulated deficit


(81,877,549
)


(81,093,180
)Total stockholders' deficit


(26,283,671
)


(25,530,850
)Total liabilities and stockholders' deficit

$
8,803,414


$
8,278,168





See Notes to Consolidated Financial Statements (unaudited).




1





iSECUREtrac Corp. and SUBSIDIARY


CONSOLIDATED STATEMENTS OF OPERATIONS


Three Months Ended March 31, 2011 and 2010


(Unaudited)





2011


2010Revenues:Equipment leasing

$
2,341,293


$
2,440,014Administrative, field & support service revenues


119,822



114,647Equipment sales


39,300



8,185Royalty revenue


-



125,283Total revenues


2,500,415



2,688,129Operating expenses:Cost of revenues


836,043



954,053Research and development


231,889



314,236Sales, general and administrative


1,538,278



1,541,828Total operating expenses


2,606,210



2,810,117Operating loss


(105,795
)


(121,988
)Interest income (expense):Interest income


1



4Interest expense


(359,492
)


(324,372
)Total interest income (expense)


(359,491
)


(324,368
)Loss before provision for income taxes


(465,286
)


(446,356
)Provision for income taxes


-



-Net loss

$
(465,286
)

$
(446,356
)Preferred stock dividends and accretion


(368,805
)


(344,200
)Net loss available to common stockholders

$
(834,091
)

$
(790,556
)Basic and diluted loss per common share

$
(0.08
)

$
(0.07
)Weighted average shares of common stock outstanding


10,928,784



10,817,225





See Notes to Consolidated Financial Statements (unaudited).




2





iSECUREtrac Corp. AND SUBSIDIARY


STATEMENT OF STOCKHOLDERS' DEFICIT


For the Three Months Ended March 31, 2011


(Unaudited)





AdditionalCommon Stock


Paid -in


AccumulatedShares


Amount


Capital


Deficit


TotalBalance, December 31, 2010


10,927,451


$
10,928


$
55,551,402


$
(81,093,180
)

$
(25,530,850
)Shares issued for directors' fees


2,666



2



1,998



-



2,000Stock based compensation


-



-



79,270



-



79,270Series C preferred stock dividends


-



-



-



(319,083
)


(319,083
)Accretion to redemption value of preferred stock


-



-



(49,722
)


-



(49,722
)Net loss


-



-



-



(465,286
)


(465,286
)Balance, March 31, 2011


10,930,117


$
10,930


$
55,582,948


$
(81,877,549
)

$
(26,283,671
)





See Notes to Consolidated Financial Statements (unaudited).




3





iSECUREtrac CORP. AND SUBSIDIARY


CONSOLIDATED STATEMENTS OF CASH FLOWS


Three Months Ended March 31, 2011 and 2010


(Unaudited)




2011


2010Cash Flows From Operating ActivitiesNet loss

$
(465,286
)

$
(446,356
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


308,628



493,909Stock based compensation


81,270



47,650Provision for Doubtful Accounts


53,940



-Changes in operating assets and liabilities:Accounts receivable


189,252



192,589Inventories


55,065



8,238Prepaid expenses and other assets


(90,842
)


(27,648
)Accounts payable


(104,566
)


(31,819
)Accrued expenses


108,209



(397,193
)Deferred revenues


(8,612
)


(8,830
)Accrued interest payable


316,434



215,181Net cash provided by operating activities


443,492



45,721Cash Flows From Investing ActivitiesPurchases of leasehold improvements and equipment


(159,647
)


(33,392
)Capitalization of software development costs


(96,738
)


(88,793
)Net cash used in investing activities


(256,384
)


(122,185
)Cash Flows From Financing ActivitiesPrincipal proceeds from long-term debt


275,000



-Proceeds from revolving line of credit


450,000



-Proceeds from equipment term loan


-



618,805Principal payments on long-term debt


(436,378
)


(421,331
)Net cash provided by financing activities


288,622



197,474Increase in cash


475,730



121,010Cash at beginning of period


88,956



719,662Cash at end of period

$
564,686


$
840,672Supplemental Non-cash DisclosurePurchase of leasehold improvements and equipment included in Accounts Payable


309,175



52,469





See Notes to Consolidated Financial Statements.




4




iSECUREtrac CORP. AND SUBSIDIARY


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Three months ended March 31, 2011 and 2010


(Unaudited)




Note 1.  General




The unaudited interim condensed consolidated financial statements as of March 31, 2011 and for the three month periods ended March 31, 2011 and 2010, included herein, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X.




The consolidated balance sheet of iSECUREtrac Corp. (“iSECUREtrac”, or the “Company”) and its wholly-owned subsidiary, iSt Services, Inc., at December 31, 2010, has been taken from the audited consolidated financial statements at that date.  The condensed consolidated financial statements for the three months ended March 31, 2011 and March 31, 2010 are unaudited and reflect all normal and recurring accruals and adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position, operating results and cash flows for the interim periods presented in this quarterly report.  The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2010.  The results of operations and cash flows for the three months ended March 31, 2011 are not necessarily indicative of the results for the entire fiscal year ending December 31, 2011.  Where appropriate, items of an insignificant nature within the condensed consolidated financial statements have been reclassified from the previous periods’ presentation.




The Company believes that its current working capital and the undrawn amounts available under the Company’s Revolving Line of Credit Agreement combined with the amounts available to it through the capital lease financing arrangements described in Note 6 are sufficient to meet its liquidity needs through 2011.




Note 2.  Common Stock Options and Warrants




The Company may issue stock options and other types of equity-based compensation under its 2006 Omnibus Equity Incentive Plan (the “2006 Plan”) which was implemented on May 31, 2006.  This is the only plan under which the Company may now issue additional equity-based compensation.  The Company also has outstanding stock options that were issued under its 2001 Omnibus Equity Incentive Plan (the “2001 Plan”) and which were issued under employment agreements with executive officers.  On May 4, 2011, the stockholders of the Company approved the adoption of the Company’s 2011 Omnibus Equity Incentive Plan which is more fully discussed in Note 8.




5




During the three months ended March 31, 2011, the Company granted options to purchase a total of 5,500 shares of common stock to two employees pursuant to the 2006 Plan.  During the three months ended March 31, 2011, 14,480 options issued under the 2006 Plan were forfeited, 20,625 options issued under the 2001 Plan were forfeited and no options issued under employment agreements outside the 2006 Plan and the 2001 Plan were forfeited.  No options were exercised during the three months ended March 31, 2011.  The following table shows stock option activity during the three month period ended March 31, 2011:




Options

Number of

Shares


Weighted

Average

ExercisePrice

PerShare

Weighted

Average

Remaining

Contractual

Life(Years)

Aggregate Intrinsic

ValueOutstanding at December 31, 2010


3,282,529


$
1.31

7.1 Years

$
535,829Granted


5,500



0.63Exercised


-



-Forfeited


(35,105
)


1.55Outstanding at March 31, 2011


3,252,924


$
1.30

6.34 Years

$
225,830Exercisable at March 31, 2011


2,579,631


$
1.41

5.56 Years

$
200,360




As of March 31, 2011, the aggregate intrinsic value of outstanding and exercisable options, which is the actual value of the options if exercised, was $225,830 and $200,360, respectively.




During the three month period ended March 31, 2011, 21,550 warrants expired and no warrants were granted or exercised by warrant holders.




At March 31, 2011, the Company had 3,252,924 outstanding stock options, 6,287,045 shares issuable upon exercise of warrants to be issued upon exchange of Preferred Stock, and 658,018 shares issuable upon the exercise of outstanding warrants that were not included in the computation of diluted EPS because to do so would have been anti-dilutive for the period presented.




The Company accounts for its stock-based compensation by recognizing compensation costs relating to share-based compensation awards, including grants of employee stock optionsas these awards become vested, based on the grant date fair value of the equity instruments issued.




The Company estimated the grant date fair value of each option granted during the periods set forth below using the Black-Scholes option pricing model with the following weighted average assumptions:




Three MonthsEnded

March 31, 2011


Year Ended

December 31,2010Risk free interest rate


3.28
%


3.29
%Expected volatility factor


81.39
%


81.28
%Expected option term in years

3.5 to 6.5


3.5 to 6.5Dividends

$
0.00


$
0.00Forfeitures for senior executives and non-senior executives

0% and 3
%

0% and 3
%





The risk-free interest rate is determined on the date the grant is issued.  This rate is equal to the rates based on yields from U.S. Treasury zero-coupon issues with maturity of 3.5 years to 6.5 years.  Expected volatilities are based upon looking back at historical stock prices of the Company since the date of adoption of the plan.




The Company estimates forfeitures of stock options. The forfeiture rate is the rate at which options are expected to be forfeited prior to full vesting.  The forfeiture rate is determined based on actual forfeiture rate experience as follows:  For each historical year of option issuance, the total options issued for the year is compared to the options forfeited prior to having vested.  For option years in which the two year vesting period has not passed, past experience is used to project future forfeitures.  The total of pro forma forfeitures is then compared to total options awarded and the resultant percentage is used as the forfeiture rate.    This rate is recalculated on an annual basis.




6




The annual rate of quarterly dividends is 0% since iSECUREtrac has historically not paid dividends on its common stock.




The Company recorded compensation expense of $79,270 and $45,650 for the three months ended March 31, 2011 and March 31, 2010, respectively, related to employee stock-based compensation awards.




As of March 31, 2011, there was approximately $405,036 of total unrecognized compensation costs related to non-vested stock option agreements granted to the Company’s executives and employees.  The future compensation expense the Company will recognize if and as these options vest according to their contractual terms is as follows:




2011

$
223,8852012


180,8852013


266Total

$
405,036




Note 3.  Leasehold Improvements and Equipment




The cost and accumulated depreciation of our leasehold improvements and equipment as of March 31, 2011 and December 31, 2010 are as follows:




March 31,2011


December 31, 2010Accumulated


Net Book





Accumulated


Net BookCost


Depreciation


Value


Cost


Depreciation


ValueEquipment

$
1,081,810


$
866,515


$
215,295


$
1,074,334


$
834,957


$
239,377Leasehold improvements


175,819



103,388



72,431



173,521



98,365



75,156Components held for future monitoring equipment builds


210,000



-



210,000



210,000



-



210,000Software development costs


620,617



131,758



488,859



523,879



99,483



424,396Monitoring equipment


14,625,108



11,635,401



2,989,707



14,166,061



11,395,629



2,770,432Total leasehold improvements and equipment

$
16,713,354


$
12,737,062


$
3,976,292


$
16,147,795


$
12,428,434


$
3,719,361




During the three month period ended June 30, 2010 management increased the estimated useful life of certain monitoring equipment from three years to five years to more accurately reflect the expected life of the related assets.  The effect of the increase in estimated useful life was a decrease in depreciation expense for the three months ended March 31, 2011 by $165,000, an earnings per share impact of approximately $0.01.




During the periods ending March 31, 2011 and March 31, 2010, the Company capitalized software development costs of $96,738 and $88,793, respectively.





Note 4.  Goodwill




Goodwill is the excess of the cash paid over the fair value of the net assets acquired and liabilities assumed in an acquisition, less the amount of identifiable intangible assets.  Goodwill is not amortized, but is tested for impairment on an annual basis at the end of each calendar year or if certain events or circumstances occur.  The Company determined that there was no impairment of goodwill as of December 31, 2010.  No events transpired in the three months ended March 31, 2011 that required a reevaluation of this conclusion.




7




Note 5.  Credit Agreements




On November 10, 2008, the Company entered into a loan agreement (the “Loan Agreement”) with Crestpark LP, Inc. (“Crestpark”) and in connection with the Loan Agreement executed two separate promissory notes.  The first note for $750,000 for working capital via a Revolving Credit Commitment and the second note for $1,750,000 for equipment financing via an Equipment Term Loan.  The Loan Agreement was subsequently amended, as disclosed in interim filings, leaving only the Revolving Credit Commitment terms in effect as outlined below as of March 31, 2011.




Revolving Credit Commitment -The proceeds of the Revolving Credit Commitment of $1,468,788 are to be used for working capital needs and are anticipated to be repaid from cash flow generated by the operations of the Company.  The Revolving Credit Commitment has a term ending on January 1, 2015, is unsecured and bears interest at a fixed noncompounded rate of 12% per annum, payable quarterly.  The Company is also required to pay Crestpark an unused fee of 0.25% per annum on the average daily unused amount of the Revolving Credit Commitment.  Interest expense, including the unused commitment fee, to Crestpark was $25,914 for the three months ended March 31, 2011, as compared to $10,603 for the same period of 2010.  As of March 31, 2011, the Company had $1,092,886 outstanding under the Revolving Credit Commitment and $375,902 available, compared with $642,886 outstanding and $825,902 available as of December 31, 2010.  Amounts borrowed and repaid remain available under the Revolving Credit Commitment.




Equipment Term Loan -The proceeds of the $1,750,000 Equipment Term Loan were to be used to purchase GPS-based offender tracking and monitoring equipment that is leased or sold by the Company to its clients.  It is anticipated that borrowings under the Equipment Term Loan will be repaid from permanent equipment financing secured by the Company from time to time.  At Crestpark’s discretion, any borrowings under the Equipment Term Loan that remain outstanding more than 30 days can be converted into separate 36 Month Notes, which are notes payable over 36 month terms.  The Equipment Term Loan had a term ending January 1, 2012, bears interest at a fixed rate of 12% per annum and was secured by the monitoring equipment purchased with the proceeds of the Equipment Term Loan.  The Company is also required to pay Crestpark an unused fee of 0.25% per annum on the average daily unused amount of the Equipment Term Loan.  Interest expense, including the unused commitment fee, to Crestpark for the three months ended March 31, 2011 was $0, as compared to $15,280 for the same period of 2010.    The outstanding principal balance on the Equipment Term Loan of $818,000 was capitalized into the new note payable under the Credit and Security Agreement, as amended December 31, 2010 and the Equipment Term Loan was terminated.




Crestpark is an affiliate of Mykonos 6420 LP (“Mykonos”).  As the sole holder of the Company’s Series C Preferred Stock, Mykonos has the right to elect a majority of the Company’s Board of Directors.  The terms of the Loan Agreement were approved by a Special Committee of the Board of Directors consisting solely of disinterested directors.




8





Note 6.  Long-Term Debt




The Company had the following long-term debt at March 31, 2011 and December 31, 2010:





March 31,

2011


December 31,

2010Crestpark LP, IncOne secured note payable in the amount of $14,891,086 maturing on January 1, 2015Fixed Tranche ~ with an interest rate of 9.5% effective December 31, 2010


9,891,086


$
9,891,086Floating Tranche ~ with an interest rate of 2% over prime (5.25% at March 31, 2011)


5,000,000



5,000,000Crestpark LP, Inc Total

$
14,891,086


$
14,891,086AHK Leasing, LLCThirteen separate capital leases with related parties that are carrying interest rates at 8.50% to 11.15% and maturingMay 2011 to February 2014


1,399,011



1,560,389Total long-term debt

$
16,290,097


$
16,451,475Less current maturities


(986,965
)


(1,185,254
)Total long-term debt less current maturities

$
15,303,132


$
15,266,221Accrued interest on long-term debt related to the note payable to Crestpark LP, Inc


227,083



-Total long-term debt less current maturities, including accrued interest on long-term debt


15,530,215



15,266,221





Crestpark LP, Inc.




As of March 31, 2011, the Company has outstanding a Note Payable (“Note”) with Crestpark for $14,891,086 under a Credit and Security Agreement originally dated December 18, 2007 and subsequently amended.  Outstanding borrowings are due and payable on the earlier of (i) January 1, 2015 or (ii) the first date on which the Company either issues equity securities or arranges for additional indebtedness (other than trade indebtedness incurred in the ordinary course of business) in a transaction or series of transactions which generates aggregate net proceeds to the Company of not less than the then current principal amount outstanding under this Note, plus all accrued but unpaid interest.  The Company may prepay the Note at any time without premium or penalty.




The Note provides, among other things, that $9,891,086 (“Fixed Tranche”) of the borrowings thereunder shall bear interest at 9.5% per annum and that such interest will be due and payable at maturity of the Note.  The remaining $5,000,000 of borrowings (the “Floating Tranche”) under the Note will bear interest at a floating rate equal to 2% over the prime rate (the “Base Rate”), payable quarterly beginning March 31, 2011.  In addition, quarterly principal payments of $125,000 are due beginning March 31, 2012.




Accrued interest on the Note was $290,521 and $0 at March 31, 2011 and December 31, 2010, respectively, of which $227,083 was accrued in relation to the fixed tranche and $63,438 was related to the floating tranche and paid on April 1, 2011.




The borrowings under the Note are secured by a first priority security interest in all of the assets of the Company except that Crestpark’s security interest in certain monitoring equipment is subordinate to the interest of AHK Leasing, LLC under its sale leaseback arrangements.




Crestpark is an affiliate of Mykonos 6420 LP (“Mykonos”).  As the sole holder of the Company’s Series C Preferred Stock, Mykonos has the right to elect a majority of the Company’s Board of Directors.  The terms of the Loan Agreement were approved by a Special Committee of the Board of Directors consisting solely of disinterested directors.




Capital Leases - AHK Leasing, LLC.




AHK Leasing, LLC (“AHK”) is a company controlled by three stockholders, one of which is a current director.  These loans were in the form of capital leases with 36 month terms and bearing interest at a rate of 8.50% to 11.15% per annum and mature between May 2011 and February 2014.   There was no accrued interest payable to AHK at March 31, 2011.




9




Total interest expense, including unused commitment fees, for the three months ended March 31, 2011 and March 31, 2010 is as follows:




Three Months

Ended

Mar 31, 2011


Three Months

Ended

Mar 31, 2010AHK interest on long term debt

$
40,140


$
77,218Crestpark LP interest on long-term debt


291,720



216,410Crestpark LP credit agreements


25,914



25,883Other


1,718



4,861Total interest expense

$
359,492


$
324,372





Note 7.  Redeemable Exchangeable Series C Preferred Stock




On June 27, 2005, the Company issued 1,000,000 shares of its $0.01 par value Series C 8% Cumulative, Compounding Exchangeable Preferred Stock (the “Series C Preferred Stock”).  The Series C Preferred Stock is exchangeable for 4,782,609 shares of common stock and warrants to acquire 6,287,045 shares of common stock at an exercise price of $2.30 per share at anytime at the discretion of the preferred stockholder.




If, after June 27, 2010, the closing price of the common stock exceeds $20.00 per share for at least 120 consecutive trading days, the Company can require the conversion of the Series C Preferred Stock into common stock in accordance with the above exchange provisions.




The Series C Preferred Stock is redeemable on the tenth anniversary of the original issue date. The redemption price per share of the Series C Preferred Stock will equal the per share original issue price ($11.00 per share) plus an amount equal to all accrued but unpaid dividends thereon (and any interest payable thereon).  The interest method will be utilized to accrete the carrying amount of the Series C Preferred Stock over the ten year period to the earliest redemption date so that the carrying amount will equal the redemption amount at the earliest possible redemption date.  Due to the accumulated deficit position of the Company, the periodic accretion will be charged to Additional Paid-In Capital.  As of March 31, 2011, the Company had accrued Series C Preferred Stock dividends totaling $6,147,162 and accretion to redemption value of the Series C Preferred Stock totaling $1,098,773.  Of these amounts, $319,083 and $49,722, respectively, were accrued during the three months ended March 31, 2011.




Upon any liquidation of the Company, no distribution can be made to the holders of shares of common stock or other stock ranking junior to the Series C Preferred Stock unless, prior thereto, the holders of shares of Series C Preferred Stock have received an amount per share equal to the per share original issue price plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, multiplied by a factor of 105%.




Except as otherwise required by law, the holders of shares of Series C Preferred Stock vote together with the holders of shares of the common stock of the Company on all matters submitted to the stockholders of the Company and not as a separate class, and each share of Series C Preferred Stock entitles the holder thereof to 11 votes or the equivalent amount of voting power thereof as determined by the Board of Directors.  In addition, until such time that less than 500,000 shares of Series C Preferred Stock are outstanding, the Series C Preferred Stockholders have the ability to appoint a majority of the Company’s directors.




10




Note 8.  Subsequent Events.




On May 4, 2011, the Company’s 2011 Omnibus Equity Incentive Plan (the “2011 Plan”) was approved by stockholders and went into effect.  The 2011 Plan authorizes the issuance of stock options, nonqualified stock options, stock appreciation rights, restricted stock, stock units and performance units and provides that 3,000,000 shares of common stock will be available for such awards.




Note 9.  Recent Accounting Pronouncements




In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition(ASC 605):Multiple-Deliverable Revenue Arrangements (a consensus of the FASB Emerging Issues Task Force); effective for years beginning after June 15, 2010. Vendors often provide multiple products and/or services to their customers as part of a single arrangement.  These deliverables may be provided at different points in time or over different time periods.  The existing guidance regarding how and whether to separate these deliverables and how to allocate the overall arrangement consideration to each was originally captured in EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, which is now codified at ASC 605-25, Revenue Recognition - Multiple-Element Arrangements.  The issuance of ASU 2009-13 amends ASC 605-25 and represents a significant shift from the existing guidance that was considered abuse-preventative and heavily geared toward ensuring that revenue recognition was not accelerated.  The application of this new guidance is expected to result in accounting for multiple-deliverable revenue arrangements that better reflects their economics as more arrangements will be separated into individual units of accounting.  Our adoption of ASU No. 2009-13 did not have a material effect on our consolidated financial statements.




In October 2009, the FASB issued ASU No. 2009-14, Software (ASC 985): Certain Revenue Arrangements That Include Software Elements (a consensus of the FASB Emerging Issues Task Force);effective for years beginning after June 15, 2010.  ASU 2009-14 modifies the existing scope guidance in ASC 985-605, Software Revenue Recognition, for revenue arrangements with tangible products that include software elements.  This modification was made primarily due to the changes in ASC 605-25 noted previously, which further differentiated the separation and allocation guidance applicable to non-software arrangements as compared to software arrangements.  Prior to the modification of ASC 605-25, the separation and allocation guidance for software and non-software arrangements was more similar.  Under ASC 985-605, which was originally issued as AICPA Statement of Position 97-2, Software Revenue Recognition, an arrangement to sell a tangible product along with software was considered to be in its scope if the software was more than incidental to the product as a whole.    Our adoption of ASU No. 2009-14 did not have a material effect on our consolidated financial statements.




In December 2010, the FASB issued ASU 2010-28, Intangibles – Goodwill and Other (Topic 350).  This ASU modifies the first step of the goodwill impairment test to include reporting units with zero or negative carrying amounts.  For these reporting units, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any, when it is more likely than not that goodwill impairment exists.  This ASU is effective for fiscal years and interim periods beginning after December 15, 2010.    Our adoption of ASU No. 2010-28 did not have a material effect on our consolidated financial statements.




Note 10.  Fair Value of Financial Instruments




The following methods and assumptions were used to estimate fair value of each class of financial instruments for which it is practicable to estimate that value;




11




Accounts receivable:  The carrying amount approximates fair value.




Long-term debt:  Based on the borrowing rates available to the Company for bank loans with similar terms and maturities, the carrying value approximates fair value due to the refinancing at December 31, 2010.




Accounts payable and accrued expenses:  The carrying amount approximates fair value.




Redeemable Exchangeable Series C Preferred Stock:  The Company does not believe a fair value is determinable at this time based on the duration from the securities original issuance and the lack of a ready market through which the holder may liquidate such security.




Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.




Forward-Looking Statements




This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including statements regarding guidance, industry prospects and future results of operations or financial position, made in this Quarterly Report on Form 10-Q are forward-looking. We use words such as anticipates, believes, expects, future, intends, and similar expressions to identify forward-looking statements. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Actual results could differ materially for a variety of reasons, including , among others without limitation the risks set forth in Item 1A of Part I, “Risk Factors” contained in the Company’s 2010 Annual Report on Form 10-K.




General




The following discussion is intended to provide a better understanding of the significant changes in trends relating to the Company’s financial condition and results of operations.  Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto.




Overview




iSECUREtrac develops, markets, leases and services products that assist in “monitoring compliance and modifying behavior” of individuals who are under the supervision of the criminal justice system and social service agencies, primarily in the United States.




The Company’s principal sources of revenue are daily leasing of electronic monitoring equipment including access to the corresponding web-based monitoring software, and providing administrative, field and support services, generally charged on a per offender basis.




General Comments Regarding the Electronic Monitoring Industry





Over the past twelve to eighteen months, management has observed signs that the electronic monitoring industry may be showing early signs of maturing.  Specifically management has observed the following trends:




·
Increasing price competition




·
Relative standardization of GPS tracking equipment across the industry, and




·
Marked increase in mergers and acquisitions




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It is too early to know precisely what impact, if any, these trends will have on iSECUREtrac.  However iSECUREtrac is taking strategic steps to maintain or improve the competitive position of the Company in the face of these trends.  For example, in response to the standardization of equipment, the Company continues to invest in increasing the functionality and performance of the tracNET24 platform and the Salesforce.comTM service delivery system.





Outlook for 2011





In the short term, management anticipates that quarterly revenue may continue to decline for the next quarter or two.  However over that same time, the principal payments on long-term capital leases will also decline.  Based upon leases in place at March 31, 2011 – principal payments over the next four quarters will decline from approximately $436,000 reported this quarter to $354,000, $297,000, $261,000 and $164,000, respectively.  As a result, despite the anticipated decline in revenue, management anticipates that the Company’s cash flow from normal operating activities (equipment leasing and services) will exceed principal payments on long-term debt before the end of 2011.




Summary of Financial Information




The following table provides a comparison of selected financial highlights, in thousands, for the three months ended March 31, 2011 and 2010:




CONDENSED CONSOLIDATED FINANCIAL HIGHLIGHTSThree Months Ended March 31, 2011 and 2010(In thousands)





2011


2010


Fav / (Unfav)ChangeRevenue:Equipment revenue

$
2,380


$
2,448


$
(68
)Services revenue


120



115



5Royalty revenue


-



125



(125
)Total revenue


2,500



2,688



(188
)Costs of revenue


836



954



118Gross profit margin


1,664



1,734



(70
)Gross profit margin %


66.6
%


64.5
%Research and development expenses (R&D)


232



314



82Sales, general and administrative expenses (SG&A)


1,538



1,542



4Total R&D and SG&A


1,770



1,856



86Operating loss


(106
)


(122
)


16Interest expense, net


359



324



(35
)Net loss

$
(465
)

$
(446
)

$
(19
)Preferred stock dividends and accretion


369



344



(25
)Net loss available to common stockholders

$
(834
)

$
(790
)

$
(44
)





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Quarterly Highlights




In addition to the selected financial highlights above, the following selected quarterly financial and non-financial data over the past 5 quarters is important in understanding the trend in the Company’s results of operations:




CONDENSED CONSOLIDATED QUARTERLY FINANCIAL HIGHLIGHTS


QuarterlyTrend


(In Thousands)





Mar 31

2010


Jun 30

2010


Sept 30

2010


Dec 31

2010


Mar 31

2011Cash Flows From Operating ActivitiesNet loss

$
(446
)

$
(174
)

$
(230
)

$
(157
)

$
(465
)Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization


494



185



262



259



309Stock based compensation


48



34



35



74



81Provision for Doubtful Accounts


-



-



-



-



54Changes in operating assets and liabilities:Accounts receivable


192



(195
)


(154
)


317



189Inventories


8



57



(19
)


15



55Prepaid expenses


(28
)


27



(59
)


18



(90
)Accounts payable


(31
)


(17
)


105



(162
)


(105
)Accrued expenses


(397
)


(288
)


(35
)


(160
)


108Deferred revenue


(9
)


(15
)


(1
)


(1
)


(9
)Accrued interest payable


215



205



201



146



316Net cash provided by (used in) operating activities


46



(181
)


105



349



443Adjustment for payment of royalty expenses for comparativepurposes (1)


508



-



-



-



-Adjusted Net cash provided by (used in) operating activities


554



(181
)


105



349



443Principal payments on long-term debt


(421
)


(433
)


(436
)


(433
)


(436
)Adjusted Net cash provided by (used in) operating activities less principal payments on long-term debt

$
133


$
(614
)

$
(331
)

$
(84
)

$
7








(1)
As outlined in the Company’s 2010 Annual Report on Form 10-K, on March 4, 2010, the Company paid Pro Tech Monitoring, Inc $507,790  for a limited license to provide certain technology to specific customers and the settlement of all royalties due under the November 27, 2007 Confidential Settlement Agreement (“Agreement”).   The decrease in Accrued Expenses in the cash flow statement above is reflective of this payment. Royalty expenses were estimated and accrued on a monthly basis throughout 2008 and 2009. Management views the payment of these expenses during the three months ended March 31, 2010 as unrelated to operations which distorts the evaluation of cash provided by the operating activities for that same period. Management believes that removing the effect of this payment on Net cash provided by operating activities provides a more accurate picture of the cash flow trends of the Company which is consistent with the other periods presented above.





Because the Company finances the majority of all equipment purchases through long-term leases, the investing activities (e.g. purchase of leasehold improvements and equipment) of the Company are generally offset by the proceeds of long-term debt reported in financing activities.  Accordingly in evaluating the cash flow of operations, management looks at the net cash provided by operating activities (as per the Consolidated Statement of Cash Flows) and subtracts the principal payments on long-term debt.




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For the three months ended March 31, 2011 compared to the three months ended March 31, 2010





Revenue





Equipment Revenue




Equipment revenue consists of the daily leasing of electronic monitoring equipment and periodic charges for lost or damaged equipment.  For the three month period ended March 31, 2011 the Company had equipment revenue of $2,381,000 compared with $2,448,000 for the same period in 2010.





Service Revenues




Service revenues consist of daily charges for Monitoring Center Intervention, in connection with the leasing of GPS equipment outlined above.   For the three months ended March 31, 2011 the Company reported service revenue of $120,000 compared to $115,000 for the same period in 2010.





Royalty Revenue




The Company earn ed royalty revenues of $125,000 per quarter through June 30, 2010 under a Patent License Agreement with Satellite Tracking of People, L.L.C. (STOP) which grants STOP a license to utilize specific technology that is patented by the Company.  The Company earned a royalty equal to 2.5% of STOP’s revenue utilizing this technology.  The royalty was paid annually.  The Company has earned the maximum amount of royalties it could earn under the STOP Patent License Agreement.  Accordingly, the Company expects no future royalty revenue to be recognized and all payments have been received as of March 31, 2011.





Cost of Revenue





Cost of revenue represents all direct costs related to delivery of proprietary and third-party monitoring equipment including amortization of the acquisition costs, lease costs on third-party equipment, repairs and maintenance of the monitoring equipment, royalty expenses, transportation costs, communication costs associated with the equipment, as well as costs to upgrade existing units for advancements in technology.





For the three month period ended March 31, 2011 the Company reported costs of revenue of $836,000 compared to $954,000 for the same period in 2010 which represent decreases of approximately 12%.





For the three months ended March 31, 2011 the $118,000 decrease in costs of revenue is attributable to the following:


·
$169,000 decrease in depreciation, of which $165,000 is attributed to the lengthening of the estimated useful life of the System 5000 effected during the three months ended June 30, 2010


·
$40,000 increase in communications costs




·
$27,000 increase in freight costs




·
$16,000 decrease in various other costs including supply and repair costs




Management anticipates that Cost of Revenue will not change except in connection with an increase in revenue, in which case there will be an increase in the Cost of Revenue proportionate to the growth.




Research and Development Expenses





Research and Development (R&D) expenses represent the on-going direct costs associated with the development of the Company’s  proprietary hardware and software including  staffing expenses for the Company’s own engineers and software developers, the cost of outside contracted engineering and design, and the actual costs of components, prototypes, and testing equipment and services used in the product development functions.




15





R&D expenses for the three months ended March 31, 2011 were $232,000 compared to $314,000 for the same period in 2010, a decrease of $82,000 for the three months ended March 31, 2011.  R&D expenses decreased largely as a result of the capitalization of certain payroll costs associated with the development of applications and technology as described below.





The Company is currently in the process of redesigning several major software systems and technology improvements and has capitalized certain payroll and related costs associated with the related development of the applications and technology.   For the three months ended March 31, 2011 the Company capitalized $40,000 compared to $26,000 for the same period in 2010, an increase of $14,000.





Over the remainder of the year management anticipates continuing to have resources dedicated to capitalizable projects.  Accordingly, the reported R&D in future periods will be in part dependent on the resources devoted to these projects.





Sales, General and Administrative Expenses





Sales, General and Administrative (SG&A) expenses are all the expenses associated with the operations of the Company, other than the expenses described above.  These expenses include payroll, taxes and benefits and related travel for executive, sales, administrative, customer support and accounting staff.  In addition these costs include rent on property, corporate communications, office leases and supplies, marketing, advertising, trade shows, recruiting and training expenses, professional fees and bad debt expense.





For the three month period ended March 31, 2011, SG&A expenses decreased $4,000 from $1,542,000 reported in 2010 to $1,538,000 reported in 2011.   Significant increases and decreases of SG&A expense in the comparable periods are highlighted below:




·
Personnel related expenses included salaries, benefits, incentive compensation, recruiting, and travel decreased approximately $48,000 as a result of the implemented cost control measures




·
Consulting fees decreased $21,000 in connection with the use of fewer consultants to staff open positions




·
Bad debt expense increased $54,000 in connection with the uncertainty of collectability of a certain accounts receivable




·
Stock option expenses increased $34,000




·
Various other expenses including advertising, insurance, communications, and other expenses decreased an aggregate of $23,000




The cost reductions implemented by management over the past several years have significantly reduced SG&A expenses. These reductions have strategically positioned the Company to support material future revenue growth.    Management expects that SG&A expenses will continue at or about the same level as reported for the three months ended March 31, 2011.




16




Interest Expense, Net




Net interest expense represents the total interest expense incurred by the Company reduced by the interest income earned by the Company during the year. During the three months ended March 31, 2011 the Company reported net interest expense of $359,000 in comparison to $324,000 reported for the three months ended March 31, 2010.  The increase is attributable to additional borrowings from Crestpark LP, Inc offset by a decrease in the outstanding equipment financing lease facilities.





As a result of the additional borrowing from Crestpark and the Company’s continuing use of capital leases to finance its equipment purchases, we expect to see net interest expense continue at or slightly above the levels recorded in the three months ended March 31, 2011.





Net Loss





The Company’s net loss for the three month period ended March 31, 2011 and 2010 was $465,000, and $446,000, respectively, for the reasons described above.





Preferred Stock Dividends and Accretion




For the three month period ended March 31, 2011, preferred stock dividends and accretion totaled $369,000 as compared to $344,000 for the three months ended March 31, 2010.  This increase was due to compounding interest on accrued but unpaid dividends on our Series C Preferred Stock.  The Series C Exchangeable Preferred Stock accrues interest at a cumulative compounded rate of 8.0% per annum.




Liquidity and Capital Resources




The Company’s principal uses of cash are the payment of operating expenses and debt service payments on its debt obligations, including its capital lease financing.   In general, the Company expects to meet these liquidity needs by generating positive cash flow from operating activities.  The Company also uses cash to acquire the monitoring equipment that it leases or sells to its customers.  For the three months ended March 31, 2011, the Company generated $443,000 of cash from operating activities. Investing activities used $256,000 of cash and financing activities generated cash of $289,000.   The total of all cash flow activities resulted in an increase in the balance of cash for the three months ended March 31, 2011 of $476,000.  For the same period of 2010, the Company generated $46,000 of cash in operating activities, used $122,000 in investing activities, and generated $197,000 in cash from financing activities.  The total of all cash flow activities in the three months ended March 31, 2010 resulted in an increase in the balance of cash of $121,000.




The Company believes that its current working capital and the undrawn amounts available under the Company’s Revolving Line of Credit Agreement combined with the amounts available to it through the capital lease financing arrangements with AHK are sufficient to meet its liquidity needs through 2011.




The Company expects to return to generating positive cash flow (from normal operating activities) during 2011 due to anticipated increases in equipment and services revenues as new monitoring contracts begin to produce revenues, its continued efforts to control operating costs and the decrease in principal payments on long-term capital leases which mature throughout 2011.




Application of Critical Accounting Estimates




Management uses estimates and assumptions in preparing our financial statements in accordance with accounting principles generally accepted in the United States. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. On an on-going basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances.  Management believes that our estimates and assumptions are reasonable under the circumstances; however, actual results may vary from these estimates and assumptions under different future circumstances. We do not believe that any of the accounting estimates are critical at this time, however we expect to continue to review our accounting estimates in order to determine if any of these accounting estimates are critical.  For further discussion of our significant accounting policies, refer to Note 1 – “Nature of Business and Significant Accounting Policies” in the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.




17




Off-Balance Sheet Arrangements




We do not have any off-balance sheet arrangements.




Item 3.  Quantitative and Qualitative Disclosures About Market Risk.




Not required for smaller reporting companies.




Item 4.  Controls and Procedures




The Company maintains disclosure controls and procedures designed to ensure that the information the Company must disclose in its filings with the Securities and Exchange Commission is recorded, processed, summarized and reported on a timely basis. The Company's principal executive officer and principal financial officer have reviewed and evaluated the Company's disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in bringing to their attention on a timely basis material information relating to the Company required to be included in the Company's periodic filings under the Exchange Act.




The Company’s principal executive officer and principal financial officer determined that there have not been any changes in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.




PART II. OTHER INFORMATION




Item 1.  Legal Proceedings.




The Company is not subject to any material pending or threatened lawsuits.




Item 1A.  Risk Factors.




Not required for smaller reporting companies.




18




Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.




On February 24, 2011, the Company issued an aggregate of 2,666 shares of common stock to two directors in partial payment of directors’ fees.  The shares had a market value on the date of the board meeting of $2,000.  The issuance of these shares is exempt from registration under Section 4(2) of the Securities Act of 1933.





Item 3.  Defaults Upon Senior Securities.




None




Item 4.  Reserved.




Item 5.  Other Information.




None




Item 6.  Exhibits.




3.1

Amended and Restated Certificate of Incorporation of the Company, as amended (3)3.2

Restated Bylaws of the Company (1)3.3

Certificate of Designations, Preferences and Rights of Series C 8% Cumulative, Compounding Exchangeable Preferred Stock of the Company (2)4.1

Form of Common Stock Certificate (1)31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




(1)
Incorporated by reference from the registrant’s registration statement on Form 10-SB, filed on June 22, 1999 (Commission File No. 0-26455).




(2)
Incorporated by reference from the registrant’s current report on Form 8-K, filed on June 23, 2005 (Commission File No. 0-26455).




(3)
Incorporated by reference from the registrant’s current report on Form 8-K, filed on December 14, 2006 (Commission File No. 0-26455).





19





SIGNATURES





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




iSECUREtrac Corp.By:
/s/ Peter A. MichelPeter A. MichelPresident & CEODated:  May 16, 2011


By:
/s/Lincoln ZehrLincoln ZehrChief Financial OfficerDated:  May 16, 2011




20