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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(AMENDMENT NO. 1)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002 OR
[ ] 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 0-23049
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SVI SOLUTIONS, INC.
-------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0896617
---------------------------------- ---------------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
5607 PALMER WAY, CARLSBAD, CALIFORNIA 92008
---------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(877) 784-7978
--------------
(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 [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date:
Common Stock, $0.0001 Par Value - 30,901,927 shares as of October 31, 2002.
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EXPLANATORY NOTE
This quarterly report on Form 10-Q/A is an amendment to the Form 10-Q filed by
the Company on November 19, 2002 for the quarter ended September 30, 2002.
This quarterly report on Form 10-Q/A is being filed to reflect the restatement
of the Company's Condensed Consolidated Financial Statements (the
"Restatement"). The Restatement reflects the following:
1. Separately present revenues earned from product and services revenues
and related cost of revenues,
2. Reclassification of amortization of purchased and capitalized software
to cost of revenues, and
3. Recognition of unamortized balance of debt discount and beneficial
conversion interest related to a convertible note payable as interest
expense.
The Company will not file an amended Form 10-K/A for the year ended March 31,
2003 due to the immateriality of adjustments. However, certain disclosures that
relate to and appear in Form 10-K/A for the year ended March 31, 2003 have been
updated in the restated filings.
THIS REPORT DOES NOT OTHERWISE ATTEMPT TO UPDATE THE INFORMATION PROVIDED HEREIN
BEYOND THE ORIGINAL FILING DATE.
TABLE OF CONTENTS
PAGE
----
PART I. - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of September
30, 2002 (Unaudited) (Restated) and March 31, 2002 (Audited) ........3
Condensed Consolidated Statements of Operations for
the Three And Six Months Ended September 30, 2002 (Restated)
and 2001(Unaudited) .................................................4
Condensed Consolidated Statements of Cash Flows for
the Six Months Ended September 30, 2002 (Restated) and 2001
(Unaudited) .........................................................5
Notes to Condensed Consolidated Financial Statements ................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................14
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........32
Item 4. Controls and Procedures.............................................32
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings...................................................33
Item 2. Changes in Securities and Use of Proceeds...........................34
Item 4. Submission of Matters to a Vote of Security Holders.................34
Item 6. Exhibits and Reports on Form 8-K....................................35
SIGNATURES....................................................................36
FORM 10-Q CERTIFICATIONS......................................................37
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SVI SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
SEPTEMBER 30, MARCH 31,
2002 2002
--------- ---------
(unaudited) (audited)
(As restated -
See Note 13)
ASSETS
Current assets:
Cash and cash equivalents $ 124 $ 1,309
Accounts receivable, net 1,550 1,946
Other receivables, including $9 and $31
from related parties, respectively 234 255
Inventories 119 126
Current portion of non-compete agreements 917 917
Prepaid expenses and other current assets 169 150
--------- ---------
Total current assets 3,113 4,703
Property and equipment, net 496 641
Purchased and capitalized software, net 16,416 17,612
Goodwill, net 14,795 15,422
Non-compete agreements, net 1,126 1,585
Other assets 58 42
--------- ---------
Total assets $ 36,004 $ 40,005
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Demand loans due to stockholders $ 438 $ 618
Current portion of term loan 7,269 435
Accounts payable 2,262 1,497
Accrued expenses 3,554 3,864
Deferred revenue 1,833 3,528
Income tax payable -- 98
--------- ---------
Total current liabilities 15,356 10,040
Term loan refinanced in July 2002 -- 6,472
Convertible notes due to stockholders 1,271 1,421
Other long-term liabilities 104 120
--------- ---------
Total liabilities 16,731 18,053
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.0001 par value;
5,000,000 shares authorized; Series A
Convertible Preferred, 7.2% cumulative
141,100 shares authorized and
outstanding with a stated value of
$100 per share, dividends in arrears of
$761 and $254, respectively 14,100 14,100
Committed common stock, 2,500,000 shares 1,383 --
Common stock, $.0001 par value; 100,000,000
shares authorized; 39,686,727 and
38,993,609 shares issued; and 28,986,727
and 28,293,609 shares outstanding 4 4
Additional paid in capital 55,723 54,685
Accumulated deficit (42,756) (37,772)
Treasury stock, at cost; shares - 10,700,000 (8,906) (8,580)
Shares receivable (275) (485)
--------- ---------
Total stockholders' equity 19,273 21,952
--------- ---------
Total liabilities and stockholders' equity $ 36,004 $ 40,005
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
SVI SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
September 30, September 30,
2002 2001 2002 2001
--------- --------- --------- ---------
(As restated - (As restated -
See Note 13) See Note 13)
Revenues:
Product $ 2,383 $ 3,405 $ 4,935 $ 5,405
Services 1,822 4,561 4,591 10,070
--------- --------- --------- ---------
Total revenues 4,205 7,966 9,526 15,475
Cost of revenues
Product 1,243 1,363 2,388 2,503
Services 1,157 2,656 2,842 5,831
--------- -------- -------- ---------
Total cost of revenues 2,400 4,019 5,230 8,334
--------- --------- --------- ---------
Gross profit 1,805 3,947 4,296 7,141
Expenses:
Product development 1,343 1,263 2,244 1,752
Depreciation and amortization 315 1,057 631 1,950
Selling, general and administrative 2,190 3,783 4,452 7,693
--------- --------- --------- ---------
Total expenses 3,848 6,103 7,327 11,395
--------- --------- --------- ---------
Loss from operations (2,043) (2,156) (3,031) (4,254)
Other income (expense):
Interest income -- 5 1 5
Other income (expense) -- (28) 2 (34)
Interest expense (985) (975) (1,393) (2,037)
Gain (loss) on foreign currency transaction 4 (8) 7 10
--------- --------- --------- ---------
Total other expenses (981) (1,006) (1,383) (2,056)
--------- --------- --------- ---------
Loss before provision for income taxes (3,024) (3,162) (4,414) (6,310)
Provision for income taxes (benefits) (57) -- (57) 37
--------- --------- --------- ---------
Loss before cumulative effect of a change
in accounting principle (2,967) (3,162) (4,357) (6,347)
Cumulative effect of changing accounting
principle - goodwill valuation under SFAS 142 -- -- (627) --
--------- --------- --------- ---------
Loss from continuing operations (2,967) (3,162) (4,984) (6,347)
Loss from discontinued Australian operations,
net of applicable income taxes -- (426) -- (755)
--------- --------- --------- ---------
Net loss (2,967) (3,588) (4,984) (7,102)
Cumulative preferred dividends (254) -- (508) --
--------- --------- --------- ---------
Net loss available to common stockholders $ (3,221) $ (3,588) $ (5,492) $ (7,102)
========= ========= ========= =========
Basic and diluted loss per share:
Loss before cumulative effect of a change in
accounting principle $ (0.10) $ (0.08) $ (0.15) $ (0.17)
Cumulative effect of a change in accounting
principle - goodwill valuation under SFAS 142 -- -- (0.02) --
--------- --------- --------- ---------
Loss from continuing operations (0.10) (0.08) (0.17) (0.17)
Loss from discontinued operations -- (0.01) -- (0.02)
Cumulative preferred dividends (0.01) -- (0.02) --
--------- --------- --------- ---------
Net loss available to common stockholders $ (0.11) $ (0.09) $ (0.19) $ (0.19)
========= ========= ========= =========
Basic and diluted weighted-average common
shares outstanding 28,855 37,931 28,685 37,907
========= ========= ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
SVI SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands and unaudited)
SIX MONTHS ENDED
SEPTEMBER 30,
2002 2001
-------- --------
(As restated -
See Note 13)
Cash flows from operating activities:
Net loss $(4,984) $(7,102)
Adjustments to reconcile net loss to net cash used for operating
activities:
Depreciation and amortization 2,082 3,616
Cumulative effect of a change in accounting principle - goodwill
valuation under SFAS 142 627 --
Amortization of debt discount and conversion option 879 517
Gain on disposal of furniture and equipment -- 50
Gain on foreign currency transactions (7) (10)
Stock-based compensation 8 518
Common stock issued for services rendered 64 --
Changes in deferred taxes -- (114)
Changes in assets and liabilities net of effects from acquisitions:
Accounts receivable and other receivables 417 (182)
Inventories 7 36
Prepaid expenses and other current assets (34) (102)
Accounts payable and accrued expenses 348 (1,068)
Accrued interest on stockholders' loans, convertible notes and term loan 465 915
Deferred revenue (1,696) 1,419
Income taxes payable (106) --
-------- --------
Net cash used for operating activities (1,930) (1,507)
-------- --------
Cash flows from investing activities:
Purchases of furniture and equipment (26) (223)
Proceeds from disposals of furniture and equipment -- 7
Capitalized software development costs (255) --
-------- --------
Net cash used for investing activities (281) (216)
-------- --------
Cash flows from financing activities:
Payments on amounts due to stockholders, net (287) (243)
Payments on line of credit -- (46)
Payments on term loan (125) --
Proceeds from committed common stock 1,383 1,250
Proceeds from short-term loan from related party 120 --
Payments on short-term loan from related party (70) --
-------- --------
Net cash provided by financing activities 1,021 961
-------- --------
Effect of exchange rate changes on cash 5 21
-------- --------
Net decrease in cash and cash equivalents (1,185) (741)
Cash and cash equivalents, beginning of period 1,309 1,267
-------- --------
Cash and cash equivalents, end of period $ 124 $ 526
======== ========
Supplemental disclosure of cash flow information:
Interest paid $ 246 $ 437
Supplemental schedule of non-cash investing and financing activities:
Issued 100,000 shares of common stock for services in connection
with an equity financing in December 2000 $ 4 --
Issued 140,000 shares of common stock to pay for penalty for late
effectiveness of the registration statement $ 60 --
Received 262,500 shares of common stock related to early termination
of a service contract $ 210 --
Issued 568,380 and 105,232 shares of common stock as payments for bonuses,
interest and services rendered in prior periods $ 237 $ 117
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
SVI SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - ORGANIZATION AND BASIS OF PREPARATION
The accompanying unaudited condensed consolidated financial statements (as
restated) have been prepared in accordance with generally accepted accounting
principles applicable to interim financial statements. Accordingly, they do not
include all of the information and notes required for complete financial
statements. In the opinion of management, all adjustments necessary to present
fairly the financial position, results of operations and cash flows at September
30, 2002 and for all the periods presented have been made.
Certain amounts in the prior period have been reclassified to conform to the
presentation for the three and six months ended September 30, 2002. The
financial information included in this quarterly report should be read in
conjunction with the consolidated financial statements and related notes thereto
in the Company's Form 10-K/A (as amended) for the year ended March 31, 2002.
The results of operations for the three and six months ended September 30, 2002
and 2001 are not necessarily indicative of the results to be expected for the
full year.
NOTE 2 - DISCONTINUED OPERATIONS
Due to the declining performance of the Company's wholly-owned Australian
subsidiary, management decided in the third quarter of fiscal 2002 to sell
certain assets of the Australian subsidiary to the former management of such
subsidiary, and then cease Australian operations. Such sale was however subject
to the approval of National Australia Bank, the subsidiary's secured lender. The
bank did not approve the sale and the subsidiary ceased operations in February
2002. The bank caused a receiver to be appointed in February 2002 to sell
substantially all of the assets of the Australian subsidiary and pursue
collections on any outstanding receivables. The receiver proceeded to sell
substantially all of the assets for $300,000 in May 2002 to the entity
affiliated with former management, and is actively pursuing the collection of
receivables. If the sale proceeds plus collections on receivables are
insufficient to discharge the indebtedness to National Australia Bank, the
Company may be called upon to pay the deficiency under its guarantee to the
bank. At September 30, 2002, the Company has accrued $187,000 as the maximum
amount of our potential exposure. The receiver has also claimed that the Company
is obligated to it for inter-company balances of $636,000, but the Company does
not believe any amounts are owed to the receiver, who has not as of the date of
this report acknowledged the monthly corporate overhead recovery fees and other
amounts charged by the Company to the Australian subsidiary offsetting the
amount claimed to be due.
The disposal of the Australian subsidiary resulted in a loss of $3.2 million,
which was recorded in the fiscal year ended March 31, 2002. Accordingly, the
operating results of the Australian subsidiary for the three and six months
ended September 30, 2001 are restated as discontinued operations.
NOTE 3 - INVENTORIES
Inventories consist of finished goods and are stated at the lower of cost or
market, on a first-in, first-out basis.
6
NOTE 4 - TERM LOAN
UNION BANK OF CALIFORNIA, N.A.
The Company's term loan at September 30, 2002 and March 31, 2002 consist of the
following (in thousands):
September 30, March 31,
2002 2002
----------- -----------
Term loan payable to bank $ 7,269 $ 6,907
Less term loan payable to bank classified
as long-term as discussed below -- 6,472
----------- -----------
Current portion of term loan $ 7,269 $ 435
=========== ===========
On May 21, 2002, the Company and the bank entered into a second amendment to the
restated term loan. The second amendment extended the maturity date of the loan
to May 1, 2003 and revised other terms and conditions. The Company agreed to pay
the bank up to $200,000 as a refinance fee in connection with the second
amendment.
Effective July 15, 2002, the bank further amended the restated term loan
agreement. Under this third amendment to the restated agreement, the bank agreed
to waive the application of the additional 2% interest rate for late payments of
principal and interest, and to waive the $100,000 of the $200,000 as a refinance
fee required by the second amendment. The bank also agreed to convert $361,000
in accrued interest and fees to term loan principal, and the Company executed a
new term note in total principal amount of $7.2 million. The Company is required
to make a principal payment of $35,000 on October 15, 2002, principal payments
of $50,000 on each of November 15, 2002 and December 15, 2002, and consecutive
monthly principal payments of $100,000 each on the 15th day of each month
thereafter through August 15, 2003. The entire amount of principal and accrued
interest is due August 31, 2003. The bank also agreed to eliminate certain
financial covenants and to ease others. The bank waived compliance with certain
financial covenant for the quarter ended September 30, 2002.
The Company also agreed to issue a contingent warrant to an affiliate of the
bank to purchase up to 4.99% of the number of outstanding common shares on
January 2, 2003 for $0.01 per share. The warrant will be issued and exercisable
for shares equal to 1% of the Company's outstanding common stock on January 2,
2003, and will become exercisable for shares equal to an additional 0.5% of the
outstanding common stock on the first day each month thereafter, until it is
exercisable for the full 4.99% of the outstanding common stock. The warrant will
not become exercisable to the extent that the Company has discharged in full its
bank indebtedness prior to a vesting date. Accordingly, the warrant will not
become exercisable for any shares if the Company discharges its bank
indebtedness in full prior to January 2, 2003; and if the warrant does become
partially exercisable on such date, it will cease further vesting as of the date
the Company discharges in full the bank indebtedness.
NOTE 5 - CONVERTIBLE NOTES DUE TO STOCKHOLDERS
During the quarter ended June 30, 2001, the Company raised gross proceeds of
$1.3 million from the sale of the convertible notes and warrants to a limited
number of accredited investors related to existing stockholders. The investors
received a convertible promissory note for the amount of their investments and
warrants to purchase 250 shares of the Company's common stock for each $1,000
borrowed by the Company. The holders of the notes had the option to convert the
unpaid principal and interest to common stock at any time at a conversion price
of $1.35 per share. The notes matured on August 30, 2001 and earned interest at
12% per annum to be paid at maturity. The interest rate increased to 17% per
annum on August 30, 2001 as a result of the non-payment on the maturity date.
In July 2002, the Company and the investors agreed to amend the terms of the
notes and warrants. The investors agreed to replace the existing notes with new
notes having a maturity date of September 30, 2003. The interest rate on the new
notes was reduced to 8% per annum, increasing to 13% in the event of a default
in payment of principal or interest. The Company is required to pay accrued
interest on the new notes calculated from July 19, 2002, in quarterly
installments beginning September 30, 2002. The investors agreed to reduce
accrued interest and late charges on the original notes by $16,000, and to
accept payment of the reduced amount in 527,286 shares of the Company's common
stock valued at $0.41 per share, which was the average closing price of its
shares on the American Stock Exchange for the 10 trading days prior to July 19,
2002. The new notes are convertible at the option of the holders into shares of
the Company's common stock valued at $0.60 per share. The Company does not have
7
a right to prepay the notes. Pursuant to the term loan agreement with the bank,
the Company is prohibited from making any payments on these convertible notes.
As a result, interest payment due on September 30, 2002 was not made. As of
September 30, 2002, the balance of these convertible notes is $1.3 million.
The Company also agreed that the warrants previously issued to certain of the
investors to purchase an aggregate of 3,033,085 shares at exercise prices
ranging from $0.85 to $1.50, and expiring on various dates between December 2002
and June 2004, would be replaced by new warrants to purchase an aggregate of
1,600,000 shares at $0.60 per share, expiring July 19, 2007. The original
warrants were issued in connection with private placement transactions in the
third and fourth quarters of fiscal 2001, and included warrants issued in
connection with registration obligations. The replacement warrants are not
callable by the Company.
The Company also agreed to file a registration statement for the resale of all
shares held by or obtainable by these investors. In the event such registration
statement is not declared effective by the SEC within 150 days after July 19,
2002, the Company will be obligated to issue five-year penalty warrants for the
purchase of 5% of the total number of registrable securities at an exercise
price of $0.60 per share. For the first 30 day period after the initial 150 day
period after such date in which the registration statement is not effective, the
Company will be obligated to issued additional penalty warrants for the purchase
of 5% of the total number of registrable securities at an exercise price of
$0.60 per share. For each 30 day period after the first 30 day period and
initial 150 day period after such date in which the registration statement is
not effective, the Company will be obligated to issue additional penalty
warrants for the purchase of 2.5% of the total number of registrable securities
at an exercise price of $0.60 per share. As of the date of this report, the
registration statement was not filed. The Company was granted a 90-day extension
of the initial requirement for the effectiveness of the registration statement.
NOTE 6 - COMMITED COMMON STOCK (AS RESTATED)
In May 2002, Toys "R" Us ("Toys"), the Company's major customer, agreed to
invest $1.3 million for the purchase of a non-recourse convertible note and a
warrant to purchase 2,500,000 shares of common stock. In connection with this
transaction, Toys signed a two-year software development and services agreement
(the "Development Agreement") that expires in February 2004. The note is
non-interest bearing, and the face amount is either convertible into shares of
common stock valued at $0.553 per share or payable in cash at the option of the
Company, at the end of the term. The note is due May 29, 2009, or if earlier
than that date, three years after the completion of the development project
contemplated in the Development Agreement. The Company does not have the right
to prepay the convertible note before the due date. The face amount of the note
is 16% of the $1.3 million purchase price as of May 29, 2002, and increases by
4% of the $1.3 million purchase price on the last day of each succeeding month,
until February 28, 2004, when the face amount is the full $1.3 million purchase
price. The face amount will cease to increase if Toys terminates the Development
Agreement for a reason other than the Company's breach. The face amount will be
zero if the Company terminates the Development Agreement due to an uncured
breach by Toys of the Development Agreement. As of September 30, 2002, the
Company had received proceeds of $1.3 million.
The warrant entitles Toys to purchase up to 2,500,000 of shares of the Company's
common stock at $0.553 per share. The warrant is initially vested as to 400,000
shares as of May 29, 2002, and vests at the rate of 100,000 shares per month
until February 28, 2004. The warrant will cease to vest if Toys terminates the
Development Agreement for a reason other than the Company's breach. The warrant
will become entirely non-exercisable if the Company terminates the Development
Agreement due to an uncured breach by Toys of the Development Agreement. Toys
may elect a "cashless exercise" where a portion of the warrant is surrendered to
pay the exercise price. As of September 30, 2002, 800,000 shares of the warrant
are exercisable.
The note conversion price and the warrant exercise price are each subject to a
10% reduction in the event of an uncured breach by the Company of certain
covenants to Toys. These covenants do not include financial covenants.
Conversion of the note and exercise of the warrant each require 75 days advance
notice. The Company also granted Toys certain registration rights for the shares
of common stock into which the note is convertible and the warrant is
exercisable.
The note has originally been classified as debt in the balance sheet of the
Company. However, in November 2002, the Board decided that this note will be
converted solely for equity and will not be repaid in cash. The note has
therefore been re-classified as equity at September 30, 2002.
8
In accordance with generally accepted accounting principles, the difference
between the conversion price of the note of $0.553 and the Company's stock price
on the date of issuance of the notes amounted to $473,000 and was being
amortized over the term of the note. A total of $151,000 had been amortized
during the period from the date of issuance to the date the note was classified
as equity. Upon classifying the note as equity at September 30, 2002, the
remaining balance of $322,000 was expensed.
The Company has also allocated the proceeds received from debt or convertible
debt with detachable warrants using the relative fair value of the individual
elements at the time of issuance. The amount allocated to the warrants was
$406,000 and was being amortized over the term of the note. A total of $19,000
had been amortized during the period from the date of issuance to the date the
note was classified as equity. Upon classifying the note as equity at September
30, 2002, the remaining balance of $386,000 was expensed.
NOTE 7 - CHANGE IN ACCOUNTING PRINCIPLE
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets," which is effective for fiscal years beginning after December
15, 2001. SFAS 142 prohibits the amortization of goodwill and intangible assets
with indefinite useful lives but requires that these assets be reviewed for
impairment at least annually or on an interim basis if an event occurs or
circumstances change that could indicate that their value has diminished or been
impaired. Other intangible assets will continue to be amortized over their
estimated useful lives. In addition, the standard includes provisions for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the identification of reporting units for purposes of assessing potential future
impairments of goodwill.
Effective April 1, 2002, the Company adopted SFAS 142 and ceased amortization of
goodwill recorded in business combinations prior to June 30, 2001. The Company
recorded amortization expenses of $1.1 million on goodwill during the six months
ended September 30, 2001. The Company currently estimates that application of
the non-amortization provisions of SFAS 142 will reduce amortization expense and
decrease net loss by approximately $2.2 million in fiscal 2003. The Company
evaluates the remaining useful lives of these intangibles on an annual basis to
determine whether events or circumstances warrant a revision to the remaining
period of amortization.
Pursuant to SFAS 142, the Company completed the transitional analysis of
goodwill impairment as of April 1, 2002 and recorded an impairment of $627,000
as a cumulative effect of a change in accounting principle in the quarter ended
June 30, 2002. The Company also evaluated the remaining useful lives of its
intangibles in the quarter ended June 30, 2002 and no adjustments have been made
to the useful lives of its intangible assets.
NOTE 8 - EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per common share are calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
reporting period. Diluted earnings per common shares ("diluted EPS") reflect the
potential dilutive effect, determined by the treasury method, of additional
common shares that would have been outstanding if the dilutive potential common
shares had been issued. The following potential common shares have been excluded
from the computation of diluted net loss per share for the periods presented
because the effect would have been anti-dilutive:
September 30,
2002 2001
------------ ------------
Outstanding options under the Company's
stock option plans 5,181,082 4,367,829
Outstanding options granted outside the
Company's stock option plans 5,074,312 1,346,812
Warrants issued in conjunction with
private placements 4,232,000 2,503,325
Warrants issued for services rendered 804,002 512,336
Convertible notes due to stockholders 2,083,333 967,803
Committed common stock 2,500,000 --
Series A Convertible Preferred Stock 18,576,750 --
------------ ------------
Total 38,451,479 9,698,105
============ ============
9
NOTE 9 - BUSINESS SEGMENTS AND GEOGRAPHIC DATA (AS RESTATED)
The Company is a leading provider of multi-channel application software
technology and associated services for the retail industry including enterprise,
direct-to-consumer and in-store solutions and related training products and
professional and support services. The Company also develops and distributes PC
courseware and skills assessment products. Up to March 31, 2002, the Company
considered its business to consist of one reportable operating segment.
Effective April 1, 2002, the Company reorganized its operations into three
business units that have separate management teams and reporting
infrastructures. Each unit is evaluated primarily based on total revenues and
operating income. Identifiable assets are also managed by business units. The
units are as follows:
o ISLAND PACIFIC - provides Retail Enterprise Solutions and
associated professional services for multi-channel retailers
in the specialty, mass merchandising and department store
markets.
o SVI STORE SOLUTIONS - offers retailers multi-platform, client
server In-Store Solutions providing all point-of-sale and
in-store processor functions.
o SVI TRAINING PRODUCTS, INC. - develops and distributes PC
Courseware and skills assessment products for both desktop and
retail applications.
A summary of the revenues and operating income (loss) attributable to each of
these business units and identifiable assets is as follows (in thousands):
Quarter ended Six months ended
September 30, September 30,
2002 2002
-------- --------
(As restated)
Revenues:
Island Pacific $ 3,528 $ 7,973
SVI Store Solutions 270 718
SVI Training Products, Inc. 407 835
-------- --------
Consolidated revenues $ 4,205 $ 9,526
======== ========
Operating income (loss):
Island Pacific $(1,039) $(1,043)
SVI Store Solutions (416) (797)
SVI Training Products, Inc. 93 197
Other (see below) (681) (1,388)
-------- --------
Consolidated operating loss $(2,043) $(3,031)
======== ========
Depreciation:
Island Pacific $ 50 $ 100
SVI Store Solutions 13 26
Other 23 47
-------- --------
Consolidated depreciation $ 86 $ 173
======== ========
Other operating loss:
Depreciation $ (23) $ (48)
Administrative costs and other
non-allocated expenses (658) (1,340)
-------- --------
Consolidated other operating loss $ (681) $(1,388)
======== ========
September 30,
2002
--------------
(Restated)
Identifiable assets:
Island Pacific $ 30,634
SVI Store Solutions 4,756
SVI Training Products, Inc. 298
--------------
Total $ 35,688
==============
Goodwill:
Island Pacific $ 13,903
SVI Store Solutions 892
SVI Training Products, Inc. --
--------------
Total $ 14,795
==============
10
Operating income (loss) in Island Pacific, SVI Store Solutions and SVI Training
Products, Inc. includes direct expenses for software licenses, maintenance
services, programming and consulting services, sales and marketing expenses,
product development expenses, and direct general and administrative expenses.
The "Other" caption includes non-allocated costs and other expenses that are not
directly identified with a particular business unit and which management does
not consider in evaluating the operating income of the business unit.
The Company currently operates in the United States and the United Kingdom.
Prior to February 2002, the Company also had operations in Australia. The
following is a summary of local operations by geographic area (in thousands):
Three Months Ended Six Months Ended
September 30, September 30,
2002 2001 2002 2001
-------- -------- -------- --------
Revenues:
United States $ 3,590 $ 6,820 $ 8,413 $13,811
United Kingdom 615 1,146 1,113 1,664
Australia (discontinued operations) -- 818 -- 1,538
-------- -------- -------- --------
Total revenues $ 4,205 $ 8,784 $ 9,526 $17,013
======== ======== ======== ========
September 30, March 31,
2002 2002
------------ ------------
Long-lived Assets:
United States $ 33,777 $ 36,197
United Kingdom 32 22
------------ ------------
Total long-lived assets $ 33,809 $ 36,219
============ ============
For the three months ended September 30, 2002 and 2001, revenues from one
customer, Toys "R" Us, accounted for 25% and 44% of total revenues,
respectively. For the six months ended September 30, 2002 and 2001, revenues
from one customer, Toys "R" Us, accounted for 32% and 48% of total revenues,
respectively.
NOTE 10 - RECENT ACCOUNTING PRONOUNCEMENTS
In November 2001, the FASB issued the guidance of Financial Accounting Standards
Board Emerging Issues Task Force Issue No. 01-14 ("EITF 01-14"), "Income
Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred". EITF 01-14 establishes that reimbursements received for out-of-pocket
expenses should be reported as revenue in the income statement. The Company
adopted EITF 01-14 in its consolidated statement of operations beginning April
1, 2002 and its consolidated statement of operations for prior periods was
reclassified to conform to the new presentation. The Company previously
classified reimbursed out-of-pocket expenses as a reduction in cost of
consulting services. The adoption of EITF 01-14 does not impact the Company's
total gross profit or operating income, but it will increase revenues and cost
of revenues and as a result reduce gross profit and operating margin
percentages. Reimbursed expenses were $188,000 and $398,000 in the three and six
months ended September 30, 2002, respectively. In addition, the Company has
reclassified $365,000 and $744,000 in reimbursed expenses to revenues and costs
of revenues in the consolidated statement of operations for the three and six
months ended September 30, 2001, respectively.
In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections". SFAS 145 updates, clarifies,
and simplifies existing accounting pronouncements. This statement rescinds SFAS
No. 4, which required all gains and losses from extinguishment of debt to be
aggregated and, if material, classified as an extraordinary item, net of related
income tax effect. As a result, the criteria in APB No. 30 will now be used to
classify those gains and losses. SFAS No. 64 amended SFAS No. 4 and is no longer
necessary as SFAS No. 4 has been rescinded. SFAS No. 44 has been rescinded as it
is no longer necessary. SFAS 145 amends SFAS No. 13 to require that certain
lease modifications that have economic effects similar to sale-leaseback
transactions to be accounted for in the same manner as sale-lease transactions.
This statement also makes technical corrections to existing pronouncements.
While those corrections are not substantive in nature, in some instances, they
may change accounting practice. The Company does not expect adoption of SFAS 145
to have a material impact on its consolidated financial position or results of
operations.
11
In July 2002, the FASB issued Statement of Financial Accounting Standards No.
146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities". SFAS 146 replaces current accounting literature and requires the
recognition of costs associated with exit or disposal activities when they are
incurred rather than at the date of commitment to an exit or disposal plan. The
provisions of the SFAS 146 are effective for exit or disposal activities that
are initiated after December 31, 2002. The Company does not expect adoption of
SFAS No. 146 to have a significant effect on its results of operations or
financial condition.
In October 2002, the FASB issued Statement of Financial Accounting Standards No.
147 ("SFAS 147"), "Acquisition of certain Financial Institutions". SFAS 147
removes the requirement in SFAS 72 and Interpretation 9 thereto, to recognize
and amortize any excess of the fair value of liabilities assumed over the fair
value of tangible and identifiable intangible assets acquired as an
unidentifiable intangible asset. This statement requires that those transactions
be accounted for in accordance with SFAS No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets". In addition, this
statement amends SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets, to include certain financial institution related intangibles.
This statement is not likely to have any impact on the Company's financial
statements.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
The Company's former Chief Executive Officer, Thomas A. Dorosewicz, filed in
April, 2002 a demand with the California Labor Commissioner for $256,250 in
severance benefits allegedly due under a disputed employment agreement, plus
attorney's fees and costs. Mr. Dorosewicz's demand was later increased to
$283,893.53. On June 18, 2002, the Company filed an action against Mr.
Dorosewicz, Michelle Dorosewicz, and an entity affiliated with him in the San
Diego Superior Court, Case No. GIC790833, alleging fraud and other causes of
action relating to transactions Mr. Dorosewicz caused the Company to enter into
with his affiliates and related parties without proper board approval. On July
31, 2002, Mr. Dorosewicz filed cross-complaints in that action alleging breach
of statutory duty, breach of contract, fraud and other causes of action relating
his employment with the Company and other transactions he entered into with the
Company. These matters are still pending and the parties have agreed to resolve
all claims in binding arbitration.
On August 30, 2002, Cord Camera Centers, Inc., an Ohio corporation ("Cord
Camera"), filed a lawsuit against one of the Company's subsidiaries, SVI Retail,
Inc. ("SVI Retail"), as the successor to Island Pacific Systems Corporation
("Island Pacific"), in the United States District Court for the Southern
District of Ohio, Eastern Division (Case No. C2 02 859). The lawsuit claims
damages in excess of $1.5 million, plus punitive damages of $250,000, against
SVI Retail based upon alleged fraud, negligent misrepresentation, breach of
express warranties, and breach of contract. These claims pertain to a certain
License Agreement dated December, 1999, as amended, between Cord Camera and
Island Pacific for the use of certain software products, a certain Services
Agreement between the parties for consulting, training and product support for
the software products, and a POS Software Support Agreement between the parties
for maintenance and support services for a certain software product. The Company
cannot at this time predict the merits of this case because it is in its
preliminary stage and discovery has not yet commenced. However, SVI Retail
intends to vigorously defend the action and possibly file one or more
counter-claims.
12
NOTE 12 - SUBSEQUENT EVENTS
Subsequent to September 30, 2002, the Company had issued shares of its common
stock as follows:
o 1,010,000 shares to repay in full the loan due to a
stockholder with the outstanding balance of $388,000.
o 500,000 shares to Softline Limited ("Softline") to pay off
$326,000 refinancing fee associated with the $10 million loan
from Softline acquired in the second quarter of fiscal year
2001.
o 95,200 shares to Softline to pay off $63,000 payables for
services provided in prior periods.
o Aggregate of 200,000 shares to employees as payment for
commissions and bonuses earned in prior periods.
o 60,000 shares to pay for legal services provided in prior
periods.
NOTE 13 - RESTATEMENT
Subsequent to the issuance of our condensed consolidated financial statements
for the three and six months ended September 30, 2002, our management
determined that:
o The revenues and cost of revenues should be presented separately as
product and services revenues and corresponding cost of revenues,
o The amortization of purchased and capitalized software should be
reported as cost of revenues, and
o The unamortized balance of debt discount and beneficial conversion
charge relating to a convertible note payable should be expensed as
interest expense instead of taking to equity.
As a result, the condensed consolidated financial statements for the three and
six-month periods ended September 30, 2002 have been restated from the amounts
previously reported. A summary of the significant effects of the restatement is
as follows:
As Previously Restatement As
Reported Adjustements Restated Reference
------------ ------------ ------------ -----
At September 30, 2002:
Additional paid-in capital $ 55,015 $ 708 $ 55,723 [1]
Accumulated deficit (42,048) (708) (42,756)
For the three-month period ended September 30, 2002:
Cost of revenues $ 1,667 $ 733 $ 2,400 [2]
Gross profit 2,538 (733) 1,805
Depreciation and amortization 1,048 (733) 315 [2]
Total expenses 4,581 (733) 3,848
Interest expense (277) (708) (985) [1]
Net loss (2,259) (708) (2,967)
Net loss available to common stockholders (2,513) (708) (3,221)
Basic and diluted EPS (0.08) (0.02) (0.10)
Basic and diluted EPS available to common stockholders (0.09) (0.02) (0.11)
For the six-month period ended September 30, 2002:
Cost of revenues $ 3,779 $ 1,451 $ 5,230
Gross profit 5,747 (1,451) 4,296
Depreciation and amortization 2,082 (1,451) 631
Total expenses 8,778 (1,451) 7,327
Interest expense (685) (708) (1,393)
Net loss (4,276) (708) (4,984)
Net loss available to common stockholders (4,784) (708) (5,492)
Basic and diluted EPS (0.15) (0.02) (0.17)
Basic and diluted EPS available to common stockholders (0.17) (0.02) (0.19)
13
Adjustments to the financial statements for the three and six-month periods
ended September 30, 2002 are as follows:
1. Additional paid-in capital and interest expense were revised to
recognize $708,000 amortization of debt discount and beneficial
conversion interest as interest expense.
2. Cost of revenues and depreciation and amortization expense were revised
to report amortization of purchased and capitalized software in the
amounts of $733,000 and $1,451,000 in the three and six-month periods
ended September 30, 2002, respectively.
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS ABOUT SVI SOLUTIONS, INC. ("WE"
OR "US"). THESE STATEMENTS RELATE TO FUTURE EVENTS OR OUR FUTURE FINANCIAL
PERFORMANCE. IN SOME CASES, YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY
TERMINOLOGY SUCH AS THE WORDS MAY, WILL, SHOULD, EXPECT, PLAN, ANTICIPATE,
BELIEVE, ESTIMATE, PREDICT, POTENTIAL OR CONTINUE, OR THE NEGATIVES OF SUCH
WORDS OR OTHER COMPARABLE TERMINOLOGY. THESE STATEMENTS ARE ONLY PREDICTIONS.
ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY.
ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKING
STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE RESULTS, LEVELS OF
ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. MOREOVER, NEITHER WE, NOR ANY OTHER
PERSON, ASSUMES RESPONSIBILITY FOR THE ACCURACY OR COMPLETENESS OF THE
FORWARD-LOOKING STATEMENTS. WE ARE UNDER NO OBLIGATION TO UPDATE ANY OF THE
FORWARD-LOOKING STATEMENTS AFTER THE FILING OF THIS REPORT TO CONFORM SUCH
STATEMENTS TO ACTUAL RESULTS OR TO CHANGES IN OUR EXPECTATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND THE RELATED NOTES AND OTHER FINANCIAL INFORMATION
APPEARING ELSEWHERE IN THIS FORM 10-Q/A. READERS ARE ALSO URGED TO CAREFULLY
REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE BY US WHICH ATTEMPT TO ADVISE
INTERESTED PARTIES OF THE FACTORS WHICH AFFECT OUR BUSINESS, INCLUDING WITHOUT
LIMITATION THE DISCLOSURES MADE UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," AND THE AUDITED
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED IN OUR ANNUAL
REPORT FILED ON FORM 10-K (AS AMENDED) FOR THE YEAR ENDED MARCH 31, 2002, AND
THE DISCLOSURES UNDER THE HEADING "RISK FACTORS" IN THE FORM 10-K, AS WELL AS
OTHER REPORTS AND FILINGS MADE WITH THE SECURITIES AND EXCHANGE COMMISSION.
OVERVIEW
We are an independent provider of multi-channel application software technology
and associated services for the retail industry including enterprise,
direct-to-consumer and store solutions and related training products and
professional and support services. Our applications and services represent a
full suite of offerings that provide retailers with a complete end-to-end
business solutions. We also develop and distribute PC courseware and skills
assessment products for both desktop and retail applications.
Our operations are conducted principally in the United States and the United
Kingdom.
Up to March 31, 2002, we considered our business to consist of one reportable
operating segment. Effective April 1, 2002, we reorganized our operations into
three business units with separate management teams and reporting
infrastructures. Each unit is evaluated primarily based on total revenues and
operating income. Identifiable assets are also managed by business units. The
units are as follows:
o ISLAND PACIFIC - provides Retail Enterprise Solutions and
associated professional services for multi-channel retailers
in the specialty, mass merchandising and department store
markets.
o SVI STORE SOLUTIONS - offers retailers multi-platform, client
server In-Store Solutions providing all point-of-sale and
in-store processor functions.
o SVI TRAINING PRODUCTS, INC. - develops and distributes PC
Courseware and skills assessment products for both desktop and
retail applications.
14
We currently derive the majority of our revenues from the sale of application
software licenses and the provision of related professional and support
services. Application software license fees are dependent upon the sales volume
of our customers, the number of users of the application(s), and/or the number
of locations in which the customer plans to install and utilize the
application(s). As the customer grows in sales volume, adds additional users
and/or adds additional locations, we charge additional license fees. We
typically charge for support, maintenance and software updates on an annual
basis pursuant to renewable maintenance contracts. We typically charge for
professional services including consulting, implementation and project
management services on an hourly basis. Our sales cycles for new license revenue
historically ranged from three to twelve months, but new license revenues were
limited during the past two fiscal years and sales cycles are now difficult to
estimate. Our long sales cycles have in the past caused our revenues to
fluctuate significantly from period to period.
RESTATEMENTS
As discussed in the notes to condensed financial statements, we restated our
September 30, 2002 financial statements to:
1. Present revenues and cost of revenues separately as product and
services revenues and corresponding cost of revenues,
2. Report amortization of purchased and capitalized software as cost of
revenues, and
3. Recognize unamortized balance of debt discount and beneficial
conversion interest related to a convertible note payable as interest
expense.
These changes had no impact on the net cash flows from operations.
RECENT DEVELOPMENTS
In October 2002, we appointed Steven Beck, a retail industry expert, to the
position of President of Island Pacific. Mr. Beck's vision for Island Pacific is
to become the dominant provider of "Thoughtware" to the retail industry. Mr.
Beck's goals are to develop high quality, high value products and services to
the retail industry; using breakthrough technologies and processes, and to
provide these products and their associated services in partnership with major
consulting organizations and other best of breed solution providers. These said
products and services will be offered at the most appropriate cost to small and
mid-size retailers. Our goal is to expand alternatives to retailers, matching
innovative solutions to emerging industry complexities so retailers will realize
ongoing successes. Also to make available to retailers at affordable prices a
"dashboard" of decision makers, the best minds in the industry, yielding a range
of velocity management alternatives for review and actions that span
merchandising and marketing activities from conception to consumption.
Mr. Beck has already brought two strategic partners aboard, ANT USA, Inc. and IT
Resources, Inc. Under terms of the reseller agreement, Island Pacific will
market, sell, install, interface to, and support ANT USA's products including
Buyer's Toolbox(tm), a leading suite of merchandise and assortment planning
software that has been successfully implemented by over 140 retailers worldwide.
The software will extend Island Pacific's assortment and planning capabilities
by providing a solid planning methodology accessed through an easy-to-use
interface, in a cost-effective offering.
The marketing license agreement with IT Resources Inc. allows Island Pacific to
market, sell, install, support and integrate IT Resources' Buyer's WorkMate(r)
Suite, an innovative decision support software platform developed for
merchandising organizations. The software will bring mobility and other
timesaving benefits to the buying process. Mr. Beck is strengthening the product
offerings through the addition of such partnerships as ANT USA and IT Resources
Inc.
Mr. Beck is growing the sales pipeline not only through additional product
offerings but also through aggressive IBM co-funded direct marketing campaigns.
These campaigns are geared towards rapid lead generation targeting the Tier 3
and 4 retailers with our prepackaged InVision 1.5 enterprise solution.
In October of 2002, we created a new position, President of Island Pacific's
International division to expand our international sales and operations and
appointed John Frabasile, a 23 year retail software industry veteran, to the
position.
15
Also in September, Island Pacific hosted a successful widely attended User's
conference with over 40% user attendance.
We issued a total of $1.25 million in convertible notes to a limited number of
accredited investors related to ICM Asset Management, Inc. of Spokane,
Washington, a significant beneficial owner of our common stock in fiscal 2001.
In July 2002, we amended the convertible notes to extend the maturity date to
September 30, 2003 and we replaced the warrants issued to these investors. See
"Liquidity and Capital Resources -- Indebtedness -- ICM Asset Management, Inc."
below.
In July 2002, we negotiated an extension of our senior bank lending facility to
August 31, 2003. See "Liquidity and Capital Resources -- Indebtedness -- Union
Bank" below.
In May 2002, we entered into a new two-year software development and services
agreement with our largest customer, Toys "R" Us, Inc. ("Toys"). Toys also
agreed to invest $1.3 million for the purchase of a non-recourse convertible
note and a warrant to purchase up to 2,500,000 common shares. For a further
details, see "Liquidity and Capital Resources - Indebtedness -- Toys "R" Us"
below.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, based on
historical experience, and various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies affect significant
judgments and estimates used in the preparation of our consolidated financial
statements:
o REVENUE RECOGNITION. Our revenue recognition policy is
significant because our revenue is a key component of our
results of operations. In addition, our revenue recognition
determines the timing of certain expenses such as commissions
and royalties. We follow specific and detailed guidelines in
measuring revenue; however, certain judgments affect the
application of our revenue policy.
We license software under non-cancelable agreements and
provide related services, including consulting, training,
customization of software and customer support. We recognize
revenue in accordance with Statement of Position 97-2 (SOP
97-2), Software Revenue Recognition, as amended and
interpreted by Statement of Position 98-9, Modification of SOP
97-2, Software Revenue Recognition, with respect to certain
transactions, as well as Technical Practice Aids issued from
time to time by the American Institute of Certified Public
Accountants. We adopted Staff Accounting Bulletin No. 101 (SAB
101), Revenue Recognition in Financial Statements, during the
first quarter of 2000. SAB 101 provides further interpretive
guidance for public companies on the recognition,
presentation, and disclosure of revenue in financial
statements. The adoption of SAB 101 did not have a material
impact on our licensing or revenue recognition practices.
Software license revenue, including third party license
revenues or partner products, is generally recognized when a
license agreement has been signed, the software product has
been delivered, there are no uncertainties surrounding product
acceptance, the fees are fixed and determinable, and
collection is considered probable. If a software license
contains an undelivered element, the fair value of the
undelivered element is deferred and the revenue recognized
once the element is delivered. We can establish vendor
16
specific objective evidence ("VSOE") for all elements and not
just undelivered elements. The undeliverable elements are
primarily training, consulting and maintenance services. VSOE
of fair value for training and consulting services is based
upon hourly rates charged when those services are sold
separately. VSOE of fair value for maintenance is the price
the customer will be required to pay when it is sold
separately (that is, the renewal rate). In addition, if a
software license contains contingencies, such as specific
customer acceptance criteria, right of return or a
cancellation right, the software revenue is recognized upon
the later of customer acceptance or the expiration of the
acceptance period or cancellation right. Typically, payments
for our software licenses are due in installments within
twelve months from the date of delivery. Where software
license agreements call for payment terms of twelve months or
more from the date of delivery, revenue is recognized as
payments become due and all other conditions for revenue
recognition have been satisfied. Deferred revenue consists
primarily of prepaid maintenance support revenues, prepaid
services revenue and deferred licenses.
Consulting services are separately priced, are generally
available from a number of suppliers, and are not essential to
the functionality of our software products. Consulting
services, which include project management, system planning,
design and implementation, customer configurations, and
training are billed on both an hourly basis and under fixed
price contracts. Consulting services revenue billed on an
hourly basis is recognized as the work is performed. Under
most fixed price contracts, consulting services revenue is
recognized using the percentage of completion method of
accounting by relating hours incurred to date to total
estimated hours at completion. In instances where our fixed
price contracts require the achievement of certain milestones,
the milestones are agreed with the customer and revenues are
recognized only when the milestones are delivered and accepted
by the customer.
Customization of software is billed on both an hourly basis
and under fixed price contracts. Customization services billed
on an hourly basis are recognized as the work is performed.
Under most fixed price contracts, customization services
revenue is recognized using the percentage of completion
method of accounting by relating hours incurred to date to
total estimated hours at completion. In instances where our
fixed price contracts require the achievement of certain
milestones, the milestones are agreed with the customer and
revenues are recognized only when the milestones are delivered
and accepted by the customer.
Customer support services include post contract support and
the rights to unspecified upgrades and enhancements.
Maintenance revenues from ongoing customer support services
are billed on a monthly basis and recorded as revenue in the
applicable month, or on an annual basis with the revenue being
deferred and recognized ratably over the maintenance period.
If an arrangement includes multiple elements, the fees are
allocated to the various elements based upon vendor-specific
objective evidence of fair value.
o ACCOUNTS RECEIVABLE. We typically extend credit to our
customers. Software licenses are generally due in installments
within twelve months from the date of delivery. Billings for
customer support and consulting services performed on a time
and material basis are due upon receipt. From time to time
software and consulting services are provided under fixed
price contracts where the revenue is only recognized and the
payments are only due upon customer acceptance and the
achievement of certain milestones. Management estimates the
probability of collection of the receivable balances and
provides an allowance for doubtful accounts based upon an
evaluation of the customer's ability to pay and general
economic conditions.
17
o VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL.
For fiscal 2003, we have adopted SFAS No. 142 resulting in a
change in the way we value long-term intangible assets and
goodwill. We were required to perform an initial transitional
analysis of goodwill impairment. We concluded this analysis in
July 2002 and recorded an impairment of $0.6 million as a
cumulative effect of a change in accounting principle. We will
no longer amortize goodwill, but will instead test goodwill
for impairment on an annual basis or more frequently if
certain events occur. Goodwill is to be measured for
impairment by reporting units, which currently consist of our
operating segments. At each impairment test for a business
unit, we are required to compare the carrying value of the
business unit to the fair value of the business unit. If the
fair value exceeds the carrying value, goodwill will not be
considered impaired. If the fair value is less than the
carrying value, we will perform a second test comparing the
implied fair value of reporting unit goodwill with the
carrying amount of that goodwill. The difference if any
between the carrying amount of that goodwill and the implied
fair value will be recognized as an impairment loss, and the
carrying amount of the associated goodwill will be reduced to
its implied fair value. These tests require us to make
estimates and assumptions concerning prices for similar assets
and liabilities, if available, or estimates and assumptions
for other appropriate valuation techniques.
For our intangible assets with finite lives, including our
capitalized software and non-compete agreements, we assess
impairment at least annually or whenever events and
circumstances suggest the carrying value of an asset may not
be recoverable based on the net future cash flows expected to
be generated from the asset on an undiscounted basis. When we
determine that the carrying value of intangibles with finite
lives may not be recoverable, we measure any impairment based
on a projected discounted cash flow method using a discount
rate determined by our management to be commensurate with the
risk inherent in our current business model.
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2001
REVENUES
Product revenues decreased $1.0 million, or 29%, to $2.4 million in the quarter
ended September 30, 2002 from $3.4 million in the quarter ended September 30,
2001, primarily due to a $1.0 million decrease in new licenses. Services
revenues decreased by $2.8 million, or 61% to $1.8 million in the quarter ended
September 30, 2002 from $4.6 million in the quarter ended September 30, 2001
primarily due to a $2.9 million decrease from Toys R Us., Inc. "(Toys"). Toys
had been a major customer since fiscal 2000 and in May 2000, we entered into a
new development agreement for the provision of development services through
February 2004. We expect that the overall level of services to be performed for
Toys in fiscal 2003 will be substantially less than fiscal 2002. The loss of
Toys will have a significant impact on future revenues as we attempt to replace
those revenues with revenues generated from new customers. Total revenues
decreased $3.8 million, or 48%, to $4.2 million in the quarter ended September
30, 2002 from $8.0 million in the quarter ended September 30, 2001 due to the
above factors. Excluding Toys revenues of $1.0 million and $3.9 million in the
quarter ended September 30, 2002 and September 30, 2001, respectively, total
revenues were $3.2 million for the quarter ended September 30, 2002 compared to
$4.1 million in the quarter ended September 30, 2001, a 22% decrease.
The first six months of fiscal 2003 remained a challenging period in which to
close new application license sales. We continue to feel the effects of the
economic slowdown in the United States and the United Kingdom, which has made
many larger customers reluctant to invest in new information technology
initiatives. In October 2001, we took aggressive steps designed to improve sales
of new application software licenses, and to streamline our operations around
services to our existing customers. These steps included a restructuring of our
operations and repositioning of the sales force to better focus on the
historical markets of our retail enterprise solution and our retail store
solution. We are currently focusing our efforts on selling our Invision 1.5
product, containing our core technology, to smaller high-growth retailers. We
believe that sales cycles for these types of retailers are likely to be shorter,
and that these retailers are less likely to be deferring technology investments
in the current economic climate. The focus on smaller retailers began during the
quarter ended September 30, 2002 and we expect to see results beginning in the
quarters ending December 31, 2002, and thereafter. We are also continuing to
market our larger applications to the larger retailers we have historically
served.
18
COST OF REVENUES/GROSS PROFIT
Cost of revenues decreased by $1.6 million, or 40%, to $2.4 million in the
quarter ended September 30, 2002 from $4.0 million in the quarter ended
September 30, 2001. Cost of product revenues decreased $0.2 million, or 14%, to
$1.2 million in the quarter ended September 30, 2002 from $1.4 million in the
quarter ended September 30, 2001. Cost of services revenue decreased $1.5
million, or 56%, to $1.2 million in the quarter ended September 30, 2002 from
$2.7 million in the quarter ended September 30, 2002. Total gross profit
decreased $2.1 million, or 54%, to $1.8 million in the quarter ended September
30, 2002 from $3.9 million in the quarter ended September 30, 2001. Total gross
margin was 43% and 49% for the quarter ended September 30, 2002 and September
30, 2001, respectively. Gross margin on products was 50% and 59% for the
quarters ended September 30, 2002 and September 30, 2001, respectively, while
gross margin on services was 383% and 41% for the quarters ended September 30,
2002 and September 30, 2001, respectively. Amortization of capitalized software
included in cost of product revenues remained at $0.7 million in the quarter
ended September 30, 2002 and the quarter ended September 30, 20012. The decrease
in gross margin for product revenues is due primarily a $1.0 million decrease in
new licenses in the quarter ended September 30, 2002 compared to the quarter
ended September 30, 2001, while amortization of capitalized software remained
the same during both quarters. The decrease in gross margin on services was due
to a large decrease in services and modification revenues which was not offset
by decreased cost of services.
PRODUCT DEVELOPMENT EXPENSE
Product development expense was $1.3 million in the quarter ended September 30,
2002 and 2001. We are continuely involved in the on-going enhancement of our
applications. The new version 2.0 of our Retail Enterprise Solutions will be
released in the fourth quarter of the current fiscal year.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased by $0.8 million, or 73%, to $0.3 million
in the quarter ended September 30, 2002 from $1.1 million in the quarter ended
September 30, 2001, as a result of our ceasing to amortize goodwill upon
adoption of SFAS No. 142.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased by $1.6 million, or 42%,
to $2.2 million in the three months ended September 30, 2002 from $3.8 million
in the three months ended September 30, 2001. The decrease was primarily related
to stringent cost control and improved management of expenditures.
LOSS FROM OPERATIONS
Loss from operations, which included depreciation and amortization expense, was
$2.0 million for the quarter ended September 30, 2002, compared to a loss from
operations of $2.2 million for the quarter ended September 30, 2001.
INTEREST EXPENSE
Interest expense remained at $1.0 million in the quarter ended September 30,
2002 and the quarter ended September 30, 2001.
SIX MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO SIX MONTHS ENDED SEPTEMBER 30,
2001
REVENUES
Product revenues decreased $0.5 million, or 9%, to $4.9 million in the six
months ended September 30, 2002 from $5.4 million in the six months ended
September 30, 2001, primarily due to a $0.6 million decrease in new licenses,
offset by $0.1 million increase in maintenance revenues. Services revenue
decreased by $5.5 million, or 54% to $4.6 million in the six months ended
September 30, 2002 from $10.1 million in the six months ended September 30, 2001
primarily due to a $5.1 million decrease from Toys R Us., Inc. "(Toys") and $0.3
million decrease in non- Toys services revenue. Toys had been a major customer
since fiscal 2000 and in May 2000, we entered into a new development agreement
for the provision of development services through February 2004. We expect that
the overall level of services to be performed for Toys in fiscal 2003 will be
substantially less than fiscal 2002. The loss of Toys will have a significant
impact on future revenues as we attempt to replace those revenues with revenues
generated from new customers. Total revenues decreased $6.0 million, or 39%, to
$9.5 million in the six months ended September 30, 2002 from $15.5 million in
the six months ended September 30, 2001 due to the above factors. Excluding Toys
revenues of $3.1 million and $8.1 million in the six months ended September 30,
2002 and September 30, 2001, respectively, total revenues were $6.4 million for
the six months ended September 30, 2002 compared to $7.4 million in the six
months ended September 30, 2001, an 14% decrease.
19
COST OF REVENUES/GROSS PROFIT
Cost of revenues decreased by $3.1 million, or 37%, to $5.2 million in the six
months ended September 30, 2002 from $8.3 million in the six months ended
September 30, 2001. Cost of product revenues decreased $0.1 million, or 4%, to
$2.4 million in the six months ended September 30, 2002 from $2.5 million in the
six months ended September 30, 2001. Cost of services revenue decreased $3.0
million, or 52%, to $2.8 million in the six months ended September 30, 2002 from
$5.8 million in the six months ended September 30, 2002. Total gross profit
decreased $2.8 million, or 39%, to $4.3 million in the six months ended
September 30, 2002 from $7.1 million in the six months ended September 30, 2001.
Total gross margin was 45% and 46% for the six months ended September 30, 2002
and September 30, 2001, respectively. Gross margin on products was 51% and 54%
for the six months ended September 30, 2002 and September 30, 2001,
respectively, while gross margin on services was 39% and 43% for the six months
ended September 30, 2002 and September 30, 2001, respectively. Amortization of
capitalized software included in cost of product revenues increased $0.1 million
to $1.5 million in the six months ended September 30, 2002 from $1.4 million in
the six months ended September 30, 2001.
PRODUCT DEVELOPMENT EXPENSE
Product development expense increased by $0.4 million, or 22%, to $2.2 million
in the six months ended September 30, 2002 from $1.8 million in the six months
ended September 30, 2001. We focus on the on-going enhancement of our existing
products and research for new value-added products. The new version 2.0 of our
Retail Enterprise Solutions will be released in the fourth quarter of the
current fiscal year.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased by $1.4 million, or 70%, to $0.6 million
in the six months ended September 30, 2002 from $2.0 million in the six months
ended September 30, 2001, as a result of our ceasing to amortize goodwill upon
adoption of SFAS No. 142.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased by $3.2 million, or 42%,
to $4.5 million in the six months ended September 30, 2002 from $7.7 million in
the six months ended September 30, 2001. The decrease was primarily related to
the 20% reduction of non-essential personnel in the third quarter of fiscal 2002
and improved management of expenditures.
LOSS FROM OPERATIONS
Loss from operations, which included depreciation and amortization expense,
was $3.0 million for the six months ended September 30, 2002, compared to a
loss from operations of $4.3 million for the six months ended September 30,
2001.
INTEREST EXPENSE
Interest expense decreased by $0.6 million, or 30%, to $1.4 million in the six
months ended September 30, 2002 from $2.0 million in the six months ended
September 30, 2001. Interest expense in the 2001 period included $0.8 million
interest expense on the note due Softline Limited. Our obligations related to
this note were released by Softline effective January 1, 2002 in connection with
the integrated series of recapitalization transactions with Softline. The
balance of the difference was a $0.5 million decrease in amortization of debt
discount.
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE
Pursuant to SFAS 142, we completed the transitional analysis of goodwill
impairment as of April 1, 2002 and recorded an impairment of $0.6 million as the
cumulative effect of a change in accounting principle in the quarter ended June
30, 2002. We also evaluated the remaining useful lives of our intangibles in the
quarter ended June 30, 2002 and no adjustments have been made to the useful
lives of our intangible assets.
20
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
During the six months ended September 30, 2002, we financed our operations using
cash on hand, internally generated cash, proceeds from the sale of a convertible
note to Toys "R" Us and loans from an entity affiliated with Donald S.
Radcliffe, one of our directors. At September 30, 2002 and March 31, 2002, we
had cash of $0.1 million and $1.3 million, respectively.
Operating activities used cash of $1.9 million in the six months ended September
30, 2002 and $1.5 million in the six months ended September 30, 2001. Cash used
for operating activities in the three months ended September 30, 2002 resulted
from $5.0 million of net losses and $1.7 million decrease in deferred revenue;
offset in part by $2.1 million of depreciation and amortization, $0.9 million of
debt discount and conversion option, $0.6 million of goodwill impairment, $0.2
million of non-cash interest expense related to the convertible note issued to
Toys "R" Us, $0.4 million decrease in accounts receivable and other receivables,
$0.4 million increase in accounts payable and accrued expenses and $0.4 million
increase in accrued interest on notes payable.
Investing activities used cash of $0.3 million in the six months ended September
30, 2002 and $0.2 million in the six months ended September 30, 2001. Cash used
for investing activities in the current quarter was primarily for capitalization
of software development costs.
Financing activities provided cash of $1.0 million in the six months ended
September 30, 2002 and 2001. The 2002 financing activities included $1.4 million
of proceeds from a convertible note issued to Toys "R" Us and $0.1 million loan
from an entity affiliated with one of our directors; offset in part by $0.3
million of payments on a stockholder loan and $0.1 million of payments on a term
loan.
Accounts receivable decreased to $1.5 million at September 30, 2002 from $1.9
million at March 31, 2002. The decrease was mainly due to the decrease in sales
in the six months ended September 30, 2002.
Accounts payable increased to $2.3 million at September 30, 2002 from $1.5
million at March 31, 2002.
Deferred revenue decreased to $1.8 million at September 30, 2002 from $3.5
million at March 31, 2002. The decrease was primarily due to $1.5 million
decrease in prepaid modification and services revenue from our major customer,
Toys R Us.
We believe that our cash and cash equivalent and funds generated from operations
will provide adequate liquidity to meet our normal operating requirements for at
least the next twelve months. Our future capital requirements depend on many
factors, including our application development, sales and marketing activities.
In addition, we have incurred losses for the last three fiscal years and we had
a negative working capital at September 30, 2002. In the next twelve months, we
anticipate raising additional capital through public or private equity or debt
financings. In the long-term, we anticipate that cash from operations will be
sufficient to provide liquidity for our normal operating requirements. As such,
we do not know whether additional financing will be available when needed, or
available on terms acceptable to us. We may raise capital through public or
private equity or debt financings. If we are unable to raise the needed funds,
we may be forced to curtail some or all of our activities and we may not be able
to grow.
INDEBTEDNESS
UNION BANK
On May 21, 2002, we and Union Bank of California, N.A. entered into a second
amendment to our restated term loan agreement. The second amendment extended the
maturity date to May 1, 2003 and revised other terms and conditions. We agreed
to pay to the bank $100,000 as a loan extension fee, payable in four monthly
installments of $25,000 each commencing on June 30, 2002. If we failed to pay
any installment when due, the loan extension fee was to increase to $200,000,
and the monthly payments were to increase accordingly. We also agreed to pay all
overdue interest and principal by June 30, 2002, and to pay monthly installments
of $24,000 commencing on June 30, 2002 and ending April 30, 2003 for the bank's
legal fees.
21
Effective July 15, 2002, the bank further amended the restated term loan
agreement. Under this third amendment to the restated agreement, the bank agreed
to waive the application of the additional 2% interest rate for late payments of
principal and interest, and to waive the additional $100,000 refinance fee
required by the second amendment. The bank also agreed to convert $361,000 in
accrued interest and fees to term loan principal, and we executed a new term
note in total principal amount of $7.2 million. We are required to make a
principal payment of $35,000 on October 15, 2002, principal payments of $50,000
on each of November 15, 2002 and December 15, 2002, and consecutive monthly
principal payments of $100,000 each on the 15th day of each month thereafter
through August 15, 2003. The entire amount of principal and accrued interest is
due August 31, 2003. The bank also agreed to eliminate certain financial
covenants and to ease others. The bank waived compliance with certain financial
covenant for the quarter ended September 30, 2002.
We also agreed to issue a contingent warrant to an affiliate of the bank to
purchase up to 4.99% of the number of outstanding common shares on January 2,
2003 for $0.01 per share. The warrant will be issued and exercisable for shares
equal to 1% of our outstanding common stock on January 2, 2003, and will become
exercisable for shares equal to an additional 0.5% of our outstanding common
stock on the first day each month thereafter, until it is exercisable for the
full 4.99% of our outstanding common stock. The warrant will not become
exercisable to the extent that we have discharged in full our bank indebtedness
prior to a vesting date. Accordingly, the warrant will not become exercisable
for any shares if we discharge our bank indebtedness in full prior to January 2,
2003; and if the warrant does become partially exercisable on such date, it will
cease further vesting as of the date we discharge in full the bank indebtedness.
NATIONAL AUSTRALIA BANK LIMITED
Due to the declining performance of our Australian subsidiary, we decided in the
third quarter of fiscal 2002 to sell certain assets of the Australian subsidiary
to the former management of such subsidiary, and then cease Australian
operations. Such sale was however subject to the approval of National Australia
Bank, the subsidiary's secured lender. The bank did not approve the sale and the
subsidiary ceased operations in February 2002. The bank caused a receiver to be
appointed in February 2002 to sell substantially all of the assets of the
Australian subsidiary and pursue collections on any outstanding receivables. The
receiver proceeded to sell substantially all of the assets for $300,000 in May
2002 to the entity affiliated with former management, and is actively pursuing
the collection of receivables. If the sale proceeds plus collections on
receivables are insufficient to discharge the indebtedness to National Australia
Bank, we may be called upon to pay the deficiency under our guarantee to the
bank. At September 30, 2002, we have accrued $187,000 as the maximum amount of
our potential exposure. The receiver has also claimed that we are obligated to
it for inter-company balances of $636,000, but we do not believe any amounts are
owed to the receiver, who has not as of the date of this report acknowledged the
monthly corporate overhead recovery fees and other amounts charged by us to the
Australian subsidiary offsetting the amount claimed to be due.
ICM ASSET MANAGEMENT, INC.
In May and June 2001, we issued a total of $1.25 million in convertible notes to
a limited number of accredited investors related to ICM Asset Management, Inc.
The notes were originally due August 30, 2001, and required interest at the rate
of 12% per annum to be paid until maturity, with the interest rate increasing to
17% after maturity. Any portion of the unpaid amount of principal and interest
was convertible at any time by the investors into common shares valued at $1.35
per share. We also agreed to issue to the investors three-year warrants to
purchase 250 common shares for each $1,000 in notes purchased, at an exercise
price of $1.50 per share.
In July 2002, we agreed to amend the terms of the notes and warrants issued to
the investors related to ICM. The investors agreed to replace the existing notes
with new notes having a maturity date of September 30, 2003. The interest rate
on the new notes was reduced to 8% per annum, increasing to 13% in the event of
a default in payment of principal or interest. We are required to pay accrued
interest on the new notes calculated from July 19, 2002, in quarterly
installments beginning September 30, 2002. The investors agreed to reduce
accrued interest and late charges on the original notes by $16,000 and accept
payment of the reduced amount with 527,286 shares of our common stock valued at
$0.41 per share, which was the average closing price of our shares on the
American Stock Exchange for the 10 trading days prior to July 19, 2002. The new
notes are convertible at the option of the holders into shares of our common
stock valued at $0.60 per share. We do not have a right to prepay the notes.
Pursuant to the term loan agreement with the bank, the Company is prohibited
from making any payments on these convertible notes. As a result, interest
payment due on September 30, 2002 was not made. As of the date of this report,
the balance of these convertible notes is $1.3 million.
22
We also agreed that the warrants previously issued to the investors to purchase
an aggregate of 3,033,085 shares at exercise prices ranging from $0.85 to $1.50,
and expiring on various dates between December 2002 and June 2004, would be
replaced by new warrants to purchase an aggregate of 1,600,000 shares at $0.60
per share, expiring July 19, 2007. The replacement warrants are not callable by
us.
We also agreed to file a registration statement for the resale of all shares
held by or obtainable by these investors. In the event such registration
statement is not declared effective by the SEC within 150 days after July 19,
2002, we will be obligated to issue five-year penalty warrants for the purchase
of 5% of the total number of registrable securities at an exercise price of
$0.60 per share. For the first 30 day period after the initial 150 day period
after such date in which the registration statement is not effective, the
Company will be obligated to issued additional penalty warrants for the purchase
of 5% of the total number of registrable securities at an exercise price of
$0.60 per share. For each 30 day period after the first 30 day period and
initial 150 day period after such date in which the registration statement is
not effective, the Company will be obligated to issue additional penalty
warrants for the purchase of 2.5% of the total number of registrable securities
at an exercise price of $0.60 per share. As of the date of this report, the
registration statement was not filed. The Company was granted a 90-day extension
of the initial requirement for the effectiveness of the registration statement.
FINANCING
TOYS "R" US
In May 2002, Toys "R" Us ("Toys"), our major customer, agreed to invest $1.3
million for the purchase of a non-recourse convertible note and a warrant to
purchase 2,500,000 common shares. The note is non-interest bearing, and the face
amount is either convertible into shares of our stock valued at $0.553 per share
or payable in cash at our option, at the end of the term. The note is due May
29, 2009, or if earlier than that date, three years after the completion of the
development project contemplated in the development agreement between us and
Toys entered into at the same time. We do not have the right to prepay the
convertible note before the due date. The face amount of the note is 16% of the
$1.3 million purchase price as of May 29, 2002, and increases by 4% of the $1.3
million purchase price on the last day of each succeeding month, until February
28, 2004, when the face amount is the full $1.3 million purchase price. The face
amount will cease to increase if Toys terminates its development agreement with
us for a reason other than our breach. The face amount will be zero if we
terminate the development agreement due to an uncured breach by Toys of the
development agreement. As of October 31, 2002, we had received proceeds of $1.3
million from this note.
The warrant entitles Toys to purchase up to 2,500,000 of our common shares at
$0.553 per share. The warrant is initially vested as to 400,000 shares as of May
29, 2002, and vests at the rate of 100,000 shares per month until February 28,
2004. The warrant will cease to vest if Toys terminates its development
agreement with us for a reason other than our breach. The warrant will become
entirely non-exercisable if we terminate the development agreement due to an
uncured breach by Toys of the development agreement. Toys may elect a "cashless
exercise" where a portion of the warrant is surrendered to pay the exercise
price. As of October 31, 2002, 900,000 shares of the warrant are exercisable.
The note conversion price and the warrant exercise price are each subject to a
10% reduction in the event of an uncured breach by us of certain covenants to
Toys. These covenants do not include financial covenants. Conversion of the note
and exercise of the warrant each require 75 days advance notice to us. As a
result, under the rules of the SEC, Toys will not be considered the beneficial
owner of the common shares into which the note is convertible and the warrant is
exercisable until 15 days after it has given notice of conversion or exercise,
and then only to the extent of such noticed conversion or exercise. We also
granted Toys certain registration rights for the common shares into which the
note is convertible and the warrant is exercisable, including the right to
demand registration on Form S-3 if such form is available to us, and the right
to include shares into which the note is convertible and the warrant is
exercisable in other registration statements we propose to file.
The note had originally been classified as debt in the balance sheet. However,
in November 2002, the Board decided that this note will be converted solely for
equity and will not be repaid in cash. The note has therefore been re-classified
as equity at September 30, 2002.
23
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations, including purchase
commitments at September 30, 2002, and the effect such obligations are expected
to have on our liquidity and cash flow in future periods.
For the fiscal years ending March 31,
-------------------------------------
Contractual Cash Obligations 2003 2004 2005 2006 Thereafter
---------------------------- --------- --------- --------- --------- ----------
(in thousands)
Operating leases $ 502 $ 780 $ 704 $ 192 $ 7
Capital leases $ 73 $ 18
Term loans $ 742 $ 7,145
Convertible notes due stockholders $ -- $ 1,384
Demand loans due related party $ 50
Payables aged over 90 days $ 1,635
--------- --------- --------- --------- ---------
Total contractual cash obligations $ 3,002 $ 9,327 $ 704 $ 192 $ 7
========= ========= ========= ========= =========
For the fiscal years ending March 31,
-------------------------------------
Other Commercial Commitments 2003 2004 2005 2006 Thereafter
---------------------------- --------- --------- --------- --------- ----------
(in thousands)
Guarantees $ 187
---------
Total commercial commitments $ 187
=========
CASH POSITION AND NEED FOR CAPITAL
As a result of our indebtedness and net losses for the past three years, we have
experienced strains on our cash resources. In order to manage our cash
resources, we reduced expenses and discontinued our Australian operations. We
have also extended payment terms with many of our trade creditors wherever
possible, and we have focused our collection efforts on our accounts receivable.
We had a negative working capital of $12.2 million and $5.3 million at September
30, 2002 and March 31, 2002, respectively.
Other than cash on hand, we have no unused sources of liquid assets.
Management has been actively engaged in attempts to resolve our liquidity
problems. We negotiated extensions of the maturity of our major indebtedness to
the second quarter of fiscal 2004, and as a result, we believe we will have
sufficient cash to remain in compliance with our debt obligations, and meet our
critical operating obligations, for the next twelve months. We are nonetheless
actively seeking a private equity placement to help discharge aged payables,
pursue growth initiatives and prepay bank indebtedness. We have no binding
commitments for funding at this time. Financing may not be available on terms
and conditions acceptable to us, or at all.
RECENT ACCOUNTING PRONOUNCEMENTS
A number of new pronouncements have been issued for future implementation as
discussed in the footnotes to our interim financial statements (see Note 10). As
discussed in the notes to the interim financial statements, the implementation
of some of these new pronouncements is expected to have a material effect on our
financial position or results of operations.
BUSINESS RISKS
Investors should carefully consider the following risk factors and all other
information contained in our Form 10-K (as amended) for the year ended March 31,
2002 and Form 10-Q/A for the quarter ended September 30, 2002. Investing in our
common stock involves a high degree of risk. In addition to those described
below, risks and uncertainties that are not presently known to us or that we
currently believe are immaterial may also impair our business operations. If any
of the following risks occur, our business could be harmed, the price of our
common stock could decline and our investors may lose all or part of their
investment. See the note regarding forward-looking statements included at the
beginning of Item II - Management's Discussion And Analysis of Financial
Condition and Results of Operations in this Form 10-Q/A.
24
WE HAVE INCURRED LOSSES FOR THE LAST THREE FISCAL YEARS AND IN THE CURRENT
PERIOD. WE MAY NOT ACHIEVE PROFITABILITY IN FUTURE PERIODS.
We incurred losses of $5.0 million in the first six months ended September 30,
2002 and $14.7 million, $28.9 million and $4.1 million in the fiscal years ended
March 31, 2002, 2001 and 2000, respectively. The losses in the past two years
have generally been due to difficulties completing sales for new application
software licenses, the resulting change in sales mix toward lower margin
services, and debt service expenses. We will need to generate additional revenue
to achieve profitability in future periods. Failure to achieve profitability, or
maintain profitability if achieved, may have a material adverse effect on our
business and stock price.
WE HAVE NEGATIVE WORKING CAPITAL, AND WE HAVE EXTENDED PAYMENT TERMS WITH A
NUMBER OF OUR SUPPLIERS.
At September 30, 2002 and March 31, 2002, we had negative working capital of
$12.2 million and $5.3 million, respectively. We have had difficulty meeting
operating expenses. We have at times deferred payroll for our executive
officers, and borrowed from related parties to meet payroll obligations. We have
extended payment terms with our trade creditors wherever possible.
As a result of extended payment arrangements with suppliers, we may be unable to
secure products and services necessary to continue operations at current levels
from these suppliers. In that event, we will have to obtain these products and
services from other parties, which could result in adverse consequences to our
business, operations and financial condition.
OUR REVENUES HAVE DECLINED. WE EXPERIENCED A SUBSTANTIAL DECREASE IN APPLICATION
SOFTWARE LICENSE REVENUE. OUR GROWTH AND PROFITABILITY IS DEPENDENT ON THE SALE
OF HIGHER MARGIN LICENSES.
Our revenues decreased by 38% in the first six months ended September 30, 2002
compared to the first six months ended September 30, 2001. We experienced a
substantial decrease in application license software revenue in the past two
years. We must improve new application license revenue to become profitable. We
have taken steps to refocus our sales strategy on core historic competencies,
but our typically long sales cycles make it difficult to evaluate whether and
when sales will improve. We cannot be sure that the decline in sales has not
been due to factors, which might continue to negatively affect sales.
OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY IN THE PAST, AND THEY MAY
CONTINUE TO DO SO IN THE FUTURE, WHICH COULD ADVERSELY AFFECT OUR STOCK PRICE.
Our quarterly operating results have fluctuated significantly in the past and
may fluctuate in the future as a result of several factors, many of which are
outside of our control. If revenue declines in a quarter, our operating results
will be adversely affected because many of our expenses are relatively fixed. In
particular, sales and marketing, application development and general and
administrative expenses do not change significantly with variations in revenue
in a quarter. It is likely that in some future quarter our net sales or
operating results will be below the expectations of public market analysts or
investors. If that happens, our stock price will likely decline.
OUR REVENUE MAY VARY FROM PERIOD TO PERIOD, WHICH MAKES IT DIFFICULT TO PREDICT
FUTURE RESULTS.
Factors outside our control that could cause our revenue to fluctuate
significantly from period to period include:
o the size and timing of individual orders, particularly with
respect to our larger customers;
o general health of the retail industry and the overall economy;
o technological changes in platforms supporting our software
products; and
o market acceptance of new applications and related services.
In particular, we usually deliver our software applications when contracts are
signed, so order backlog at the beginning of any quarter may represent only a
portion of that quarter's expected revenues. As a result, application license
revenues in any quarter are substantially dependent on orders booked and
delivered in that quarter, and this makes it difficult for us to accurately
predict revenues. We have experienced, and we expect to continue to experience,
quarters or periods where individual application license or services orders are
significantly larger than our typical application license or service orders.
Because of the nature of our offerings, we may get one or more large orders in
one quarter from a customer and then no orders the next quarter.
25
OUR EXPENSES MAY VARY FROM PERIOD TO PERIOD, WHICH COULD AFFECT QUARTERLY
RESULTS.
If we incur additional expenses in a quarter in which we do not experience
increased revenue, our results of operations would be adversely affected and we
may incur losses for that quarter. Factors that could cause our expenses to
fluctuate from period to period include:
o the extent of marketing and sales efforts necessary to promote
and sell our applications and services;
o the timing and extent of our development efforts; and
o the timing of personnel hiring.
IT IS DIFFICULT TO EVALUATE OUR PERFORMANCE BASED ON PERIOD TO PERIOD
COMPARISONS OF OUR RESULTS.
Many factors which can cause revenues and expenses to vary make meaningful
period to period comparisons of our results difficult. We do not believe period
to period comparisons of our financial performance are necessarily meaningful,
and you cannot rely on them as an indication of our future performance.
OUR DEBT COULD ADVERSELY AFFECT US.
As of October 31, 2002, our debt is as follows:
o A $7.3 million term loan from Union Bank due August 31, 2003.
The term loan is secured by substantially all of our assets
and 10,700,000 shares of our treasury stock.
o $1.3 million in convertible notes reissued in July 2002 to
entities related to ICM Asset Management due September 30,
2003.
Our indebtedness could impact us in a number of ways:
o We have to dedicate a portion of cash flow from operations to
principal and interest payments on the debt, which reduces
funds available for other purposes.
o We may not have sufficient funds to pay monthly principal and
interest payments, which could lead to a default.
o The existing debt makes it difficult for us to obtain
additional financing for working capital or other purposes.
o The debt detracts from our ability to successfully withstand
downturns in our business or in the economy.
o If we default on our Union Bank indebtedness, the bank could
take control of the substantial majority of our assets.
These factors generally place us at a disadvantage to our less leveraged
competitors. Any or all of these factors could cause our stock price to decline.
During the past three fiscal years, we renegotiated on several occasions our
agreements with Union Bank after we were unable to make payments required under
these agreements. Union Bank may not be willing to renegotiate our indebtedness
in the future if we are unable to make required payments. We will likely need
outside sources of capital to pay our Union Bank obligations upon maturity.
OUR BANK LOAN IMPOSES RESTRICTIONS ON US AND ON OUR ABILITY TO TAKE IMPORTANT
ACTIONS. THESE RESTRICTIONS MAY AFFECT OUR ABILITY TO SUCCESSFULLY OPERATE OUR
BUSINESS.
We are restricted by the terms of our outstanding Union Bank loan agreement from
taking various actions, such as incurring additional indebtedness, paying
dividends, paying subordinated obligations, entering into transactions with
affiliates, merging with other entities and selling all or substantially all of
our assets. These restrictions could also limit our ability to obtain future
financing, make needed capital expenditures, withstand a future downturn in our
business or the economy in general, or otherwise conduct our business. We may
also be prevented from taking advantage of business opportunities that arise
because of the limitations imposed on us by the restrictive covenants under the
Union Bank loan. A breach of any of these provisions could result in a default
under the loan agreement, and upon a default, Union Bank could declare all
indebtedness immediately due and payable. If we were unable to pay those
amounts, Union Bank could take control of the substantial majority of our
assets.
26
WE HAVE RELIED ON CAPITAL CONTRIBUTED BY RELATED PARTIES, AND SUCH CAPITAL MAY
NOT BE AVAILABLE IN THE FUTURE.
Our cash from operations has not been sufficient to meet our operational needs,
and we have relied on capital from related parties. A company affiliated with
Donald S. Radcliffe, one of our directors, made short-term loans to us in fiscal
2002 and in the first six months of fiscal 2003 to meet payroll when cash on
hand was not sufficient. Softline loaned us $10 million to make a required
principal payment on our Union Bank term loan in July 2000. A subsidiary of
Softline loaned us an additional $600,000 in November 2000 to meet working
capital needs. This loan was repaid in February 2001, in part with $400,000 we
borrowed from Barry M. Schechter, our Chairman and CEO. We borrowed an
additional $164,000 from Mr. Schechter in March 2001 for operational needs
related to our Australian subsidiary.
We may not be able to obtain capital from related parties in the future. Neither
Softline, Mr. Schechter, Mr. Radcliffe nor any other officers, directors,
stockholders or related parties are under any obligation to continue to provide
cash to meet our future liquidity needs.
WE NEED TO RAISE CAPITAL TO REPAY DEBT AND GROW OUR BUSINESS. OBTAINING THIS
CAPITAL COULD IMPAIR THE VALUE OF YOUR INVESTMENT.
We need to raise capital to discharge our aged payables and grow our business.
We will also likely need to raise capital to pay our Union Bank obligations upon
maturity in August 2003. We may also need to raise further capital to:
o support unanticipated capital requirements;
o take advantage of acquisition or expansion opportunities;
o continue our current development efforts;
o develop new applications or services; or
o address working capital needs.
Our future capital requirements depend on many factors including our application
development, sales and marketing activities. We do not know whether additional
financing will be available when needed, or available on terms acceptable to us.
If we cannot raise needed funds for the above purposes on acceptable terms, we
may be forced to curtail some or all of the above activities and we may not be
able to grow our business or respond to competitive pressures or unanticipated
developments.
We may raise capital through public or private equity offerings or debt
financings. To the extent we raise additional capital by issuing equity
securities, our stockholders may experience substantial dilution and the new
equity securities may have greater rights, preferences or privileges than our
existing common stock.
WE HAVE A SINGLE CUSTOMER REPRESENTING A SIGNIFICANT AMOUNT OF OUR BUSINESS.
Toys "R" Us, accounted for 32% and 48% of our revenues for the six months ended
September 30, 2002 and 2001, respectively. While we have a development agreement
with this customer, Toys has the right to terminate the agreement without cause
with limited advance notice. A reduction, delay or cancellation of orders from
Toys "R" Us would significantly reduce our revenues and force us to
substantially curtail operations. We cannot provide any assurances that Toys "R"
Us or any of our current customers will continue at current or historical levels
or that we will be able to obtain orders from new customers.
WE ARE DEPENDENT ON THE RETAIL INDUSTRY, AND IF ECONOMIC CONDITIONS IN THE
RETAIL INDUSTRY DECLINE, OUR REVENUES MAY DECLINE. RETAIL SALES MAY BE SLOWING.
Our future growth is critically dependent on increased sales to the retail
industry. We derive the substantial majority of our revenues from the licensing
of software applications and the performance of related professional and
consulting services to the retail industry. Demand for our applications and
services could decline in the event of consolidation, instability or downturns
in the retail industry. This decline would likely cause reduced revenues and
could impair our ability to collect accounts receivable. The result would be
reduced earnings and weakened financial condition, each or both of which would
likely cause our stock price to decline.
The success of our customers is directly linked to economic conditions in the
retail industry, which in turn are subject to intense competitive pressures and
are affected by overall economic conditions. In addition, the retail industry
may be consolidating, and it is uncertain how consolidation will affect the
industry. The retail industry as a whole is currently experiencing increased
competition and weakening economic conditions that could negatively impact the
27
industry and our customers' ability to pay for our products and services. Such
consolidation and weakening economic conditions have in the past, and may in the
future, negatively impact our revenues, reduce the demand for our products and
may negatively impact our business, operating results and financial condition.
Weakening economic conditions and the September 11, 2001 terrorist attacks have
adversely impacted sales of our software applications, and we believe mid-tier
specialty retailers may be reluctant during the current economic slowdown to
make the substantial infrastructure investment that generally accompanies the
implementation of our software applications.
THERE MAY BE AN INCREASE IN CUSTOMER BANKRUPTCIES DUE TO WEAK ECONOMIC
CONDITIONS.
We have in the past and may in the future be impacted by customer bankruptcies.
During weak economic conditions, such as those currently being experienced in
many geographic regions around the world, there is an increased risk that
certain of our customers will file bankruptcy. When our customers file
bankruptcy, we may be required to forego collection of pre-petition amounts
owed, and to repay amounts remitted to us during the 90-day preference period
preceding the filing. Accounts receivable balances related to pre-petition
amounts may in certain of these instances be large due to extended payment terms
for software license fees, and significant billings for consulting and
implementation services on large projects. The bankruptcy laws, as well as the
specific circumstances of each bankruptcy, may severely limit our ability to
collect pre-petition amounts, and may force us to disgorge payments made during
the 90-day preference period. We also face risk from international customers
which file for bankruptcy protection in foreign jurisdictions, in that the
application of foreign bankruptcy laws may be less certain or harder to predict.
Although we believe that we have sufficient reserves to cover anticipated
customer bankruptcies, there can be no assurance that such reserves will be
adequate, and if they are not adequate, our business, operating results and
financial condition would be adversely affected.
WE MAY NOT BE ABLE TO MAINTAIN OR IMPROVE OUR COMPETITIVE POSITION BECAUSE OF
THE INTENSE COMPETITION IN THE RETAIL SOFTWARE INDUSTRY.
We conduct business in an industry characterized by intense competition. Most of
our competitors are very large companies with an international presence. We must
also compete with smaller companies, which have been able to develop strong
local or regional customer bases. Many of our competitors and potential
competitors are more established, benefit from greater name recognition and have
significantly greater resources than us. Our competitors may also have lower
cost structures and better access to the capital markets than us. As a result,
our competitors may be able to respond more quickly than we can to new or
emerging technologies and changes in customer requirements. Our competitors may:
o introduce new technologies that render our existing or future
products obsolete, unmarketable or less competitive;
o make strategic acquisitions or establish cooperative
relationships among themselves or with other solution
providers, which would increase the ability of their products
to address the needs of our customers; and
o establish or strengthen cooperative relationships with our
current or future strategic partners, which would limit our
ability to compete through these channels.
We could be forced to reduce prices and suffer reduced margins and market share
due to increased competition from providers of offerings similar to, or
competitive with, our applications, or from service providers that provide
services similar to our services. Competition could also render our technology
obsolete.
OUR PROPRIETY RIGHTS OFFER ONLY LIMITED PROTECTION AND OUR COMPETITORS MAY
DEVELOP APPLICATIONS SUBSTANTIALLY SIMILAR TO OUR APPLICATIONS AND USE SIMILAR
TECHNOLOGIES, WHICH MAY RESULT IN THE LOSS OF CUSTOMERS. WE MAY HAVE TO BRING
COSTLY LITIGATION TO PROTECT OUR PROPRIETARY RIGHTS.
Our success and competitive position is dependent in part upon our ability to
develop and maintain the proprietary aspects of our intellectual property. Our
intellectual property includes our trademarks, trade secrets, copyrights and
other proprietary information. Our efforts to protect our intellectual property
may not be successful. Effective copyright and trade secret protection may be
unavailable or limited in some foreign countries. We hold no patents.
Consequently, others may develop, market and sell applications substantially
equivalent to ours or utilize technologies similar to those used by us, so long
as they do not directly copy our applications or otherwise infringe our
intellectual property rights.
28
We may find it necessary to bring claims or litigation against third parties for
infringement of our proprietary rights or to protect our trade secrets. These
actions would likely be costly and divert management resources. These actions
could also result in counterclaims challenging the validity of our proprietary
rights or alleging infringement on our part. The ultimate outcome of any
litigation will be difficult to predict.
OUR APPLICATIONS MAY INFRINGE ON THE PROPRIETARY RIGHTS OF THIRD PARTIES, WHICH
MAY EXPOSE US TO LITIGATION.
We may become involved in litigation involving patents or proprietary rights.
Patent and proprietary rights litigation entails substantial legal and other
costs, and we do not know if we will have the necessary financial resources to
defend or prosecute our rights in connection with any such litigation.
Responding to and defending claims related to our intellectual property rights,
even ones without merit, can be time consuming and expensive and can divert
management's attention from other business matters. In addition, these actions
could cause application delivery delays or require us to enter into royalty or
license agreements. Royalty or license agreements, if required, may not be
available on terms acceptable to us, if they are available at all. Any or all of
these outcomes could have a material adverse effect on our business, operating
results and financial condition.
DEVELOPMENT AND MARKETING OF OUR OFFERINGS DEPEND ON STRATEGIC RELATIONSHIPS
WITH OTHER COMPANIES. OUR EXISTING STRATEGIC RELATIONSHIPS MAY NOT ENDURE AND
MAY NOT DELIVER THE INTENDED BENEFITS, AND WE MAY NOT BE ABLE TO ENTER INTO
FUTURE STRATEGIC RELATIONSHIPS.
Since we do not possess all of the technical and marketing resources necessary
to develop and market our offerings to their target markets, our business
strategy substantially depends on our strategic relationships. While some of
these relationships are governed by contracts, most are non-exclusive and all
may be terminated on short notice by either party. If these relationships
terminate or fail to deliver the intended benefits, our development and
marketing efforts will be impaired and our revenues may decline.
We may not be able to enter into new strategic relationships, which could put us
at a disadvantage to those of our competitors, which do successfully exploit
strategic relationships.
OUR PRIMARY COMPUTER AND TELECOMMUNICATIONS SYSTEMS ARE IN A LIMITED NUMBER OF
GEOGRAPHIC LOCATIONS, WHICH MAKES THEM MORE VULNERABLE TO DAMAGE OR
INTERRUPTION. THIS DAMAGE OR INTERRUPTION COULD HARM OUR BUSINESS.
Substantially all of our primary computer and telecommunications systems are
located in two geographic areas. These systems are vulnerable to damage or
interruption from fire, earthquake, water damage, sabotage, flood, power loss,
technical or telecommunications failure or break-ins. Our business interruption
insurance may not adequately compensate us for our lost business and will not
compensate us for any liability we incur due to our inability to provide
services to our customers. Although we have implemented network security
measures, our systems are vulnerable to computer viruses, physical or electronic
break-ins and similar disruptions. These disruptions could lead to
interruptions, delays, loss of data or the inability to service our customers.
Any of these occurrences could impair our ability to serve our customers and
harm our business.
IF PRODUCT LIABILITY LAWSUITS ARE SUCCESSFULLY BROUGHT AGAINST US, WE MAY INCUR
SUBSTANTIAL LIABILITIES AND MAY BE REQUIRED TO LIMIT COMMERCIALIZATION OF OUR
APPLICATIONS.
Our business exposes us to product liability risks. Any product liability or
other claims brought against us, if successful and of sufficient magnitude,
could negatively affect our financial performance and cause our stock price to
decline.
Our applications are highly complex and sophisticated and they may occasionally
contain design defects or software errors that could be difficult to detect and
correct. In addition, implementation of our applications may involve
customer-specific customization by us or third parties, and may involve
integration with systems developed by third parties. These aspects of our
business create additional opportunities for errors and defects in our
applications and services. Problems in the initial release may be discovered
only after the application has been implemented and used over time with
different computer systems and in a variety of other applications and
environments. Our applications have in the past contained errors that were
discovered after they were sold. Our customers have also occasionally
experienced difficulties integrating our applications with other hardware or
software in their enterprise.
29
We are not currently aware of any defects in our applications that might give
rise to future lawsuits. However, errors or integration problems may be
discovered in the future. Such defects, errors or difficulties could result in
loss of sales, delays in or elimination of market acceptance, damage to our
brand or to our reputation, returns, increased costs and diversion of
development resources, redesigns and increased warranty and servicing costs. In
addition, third-party products, upon which our applications are dependent, may
contain defects, which could reduce or undermine entirely the performance of our
applications.
Our customers typically use our applications to perform mission-critical
functions. As a result, the defects and problems discussed above could result in
significant financial or other damage to our customers. Although our sales
agreements with our customers typically contain provisions designed to limit our
exposure to potential product liability claims, we do not know if these
limitations of liability are enforceable or would otherwise protect us from
liability for damages to a customer resulting from a defect in one of our
applications or the performance of our services. Our product liability insurance
may not cover all claims brought against us.
SOFTLINE LIMITED HAS THE RIGHT TO ACQUIRE A CONTROLLING PERCENTAGE OF OUR COMMON
STOCK, SO WE MAY BE EFFECTIVELY CONTROLLED BY SOFTLINE AND OUR OTHER
STOCKHOLDERS ARE UNABLE TO AFFECT THE OUTCOME OF STOCKHOLDER VOTING.
Softline Limited beneficially owns 57.0% of our outstanding common stock,
including shares Softline has the right to acquire upon conversion of its Series
A Convertible Preferred Stock. Ivan M. Epstein, Softline's Chief Executive
Officer, and Robert P. Wilkie, Softline's Chief Financial Officer, serve on our
board of directors. If Softline converts its Series A Preferred Stock, it may
have effective control over all matters affecting us, including:
o the election of all of our directors;
o the allocation of business opportunities that may be suitable
for Softline and us;
o any determinations with respect to mergers or other business
combinations involving us;
o the acquisition or disposition of assets or businesses by us;
o debt and equity financing, including future issuance of our
common stock or other securities;
o amendments to our charter documents;
o the payment of dividends on our common stock; and
o determinations with respect to our tax returns.
OUR BUSINESS MAY BE DISADVANTAGED OR HARMED IF SOFTLINE'S INTERESTS RECEIVE
PRIORITY OVER OUR INTERESTS.
Conflicts of interest have and will continue to arise between Softline and us in
a number of areas relating to our past and ongoing relationships. Conflicts may
not be resolved in a manner that is favorable to us, and such conflicts may
result in harmful consequences to our business or prospects.
SOFTLINE'S INFLUENCE ON OUR COMPANY COULD MAKE IT DIFFICULT FOR ANOTHER COMPANY
TO ACQUIRE US, WHICH COULD DEPRESS OUR STOCK PRICE.
Softline's potential voting control could discourage others from initiating any
potential merger, takeover or other change of control transaction that may
otherwise be beneficial to our business or our stockholders. As a result,
Softline's control could reduce the price that investors may be willing to pay
in the future for shares of our stock, or could prevent any party from
attempting to acquire us at any price.
OUR STOCK PRICE HAS BEEN HIGHLY VOLATILE.
The market price of our common stock has been, and is likely to continue to be,
volatile. When we or our competitors announce new customer orders or services,
change pricing policies, experience quarterly fluctuations in operating results,
announce strategic relationships or acquisitions, change earnings estimates,
experience government regulatory actions or suffer from generally adverse
economic conditions, our stock price could be affected. Some of the volatility
in our stock price may be unrelated to our performance. Recently, companies
similar to ours have experienced extreme price fluctuations, often for reasons
unrelated to their performance.
30
WE HAVE NEVER PAID A DIVIDEND ON OUR COMMON STOCK AND WE DO NOT INTEND TO PAY
DIVIDENDS IN THE FORESEEABLE FUTURE.
We have not previously paid any cash or other dividend on our common stock. We
anticipate that we will use our earnings and cash flow for repayment of
indebtedness, to support our operations, and for future growth, and we do not
have any plans to pay dividends in the foreseeable future. Our agreement with
Union Bank prohibits us from paying dividends, and Softline is entitled to
dividends on its Series A Convertible Preferred Stock in preference and priority
to common stockholders. Future equity financing(s) may further restrict our
ability to pay dividends.
THE TERMS OF OUR PREFERRED STOCK MAY REDUCE THE VALUE OF YOUR COMMON STOCK.
We are authorized to issue up to 5,000,000 shares of preferred stock in one or
more series. We issued 141,000 shares of Series A Convertible Preferred Stock to
Softline in May 2002. Our board of directors may determine the terms of
subsequent series of preferred stock without further action by our stockholders.
If we issue additional preferred stock, it could affect your rights or reduce
the value of your common stock. In particular, specific rights granted to future
holders of preferred stock could be used to restrict our ability to merge with
or sell our assets to a third party. These terms may include voting rights,
preferences as to dividends and liquidation, conversion and redemption rights,
and sinking fund provisions. We are actively seeking capital, and some of the
arrangements we are considering may involve the issuance of preferred stock.
FAILURE TO COMPLY WITH THE AMERICAN STOCK EXCHANGE'S LISTING STANDARDS COULD
RESULT IN OUR DELISTING FROM THAT EXCHANGE AND LIMIT THE ABILITY TO SELL ANY OF
OUR COMMON STOCK.
Our stock is currently traded on the American Stock Exchange. The Exchange has
published certain guidelines it uses in determining whether a security warrants
continued listing. These guidelines include financial, market capitalization and
other criteria, and as a result of our financial condition or other factors, the
Exchange could in the future determine that our stock does not merit continued
listing. If our stock were delisted from the American Stock Exchange, the
ability of our stockholders to sell our common stock could become limited, and
we would lose the advantage of some state and federal securities regulations
imposing lower regulatory burdens on exchange-traded issuers.
DELAWARE LAW AND SOME PROVISIONS OF OUR CHARTER AND BYLAWS MAY ADVERSELY AFFECT
THE PRICE OF YOUR STOCK.
Special meetings of our stockholders may be called only by the Chairman of the
Board, the Chief Executive Officer or the Board of Directors. Stockholders have
no right to call a meeting and may not act by written consent. Stockholders must
also comply with advance notice provisions in our bylaws in order to nominate
directors or propose matters for stockholder action. These provisions of our
charter documents, as well as certain provisions of Delaware law, could delay or
make more difficult certain types of transactions involving a change in control
of the company or our management. Delaware law also contains provisions that
could delay or make more difficult change in control transactions. As a result,
the price of our common stock may be adversely affected.
SHARES ISSUED UPON THE EXERCISE OF OPTIONS AND WARRANTS COULD DILUTE YOUR STOCK
HOLDINGS AND ADVERSELY AFFECT OUR STOCK PRICE.
We have issued options and warrants to acquire common stock to our employees and
certain other persons at various prices, some of which are or may in the future
be below the market price of our stock. If exercised in the money, these options
and warrants will cause immediate and possibly substantial dilution to our
stockholders. We currently have all of the outstanding options and warrants for
3,101,185 shares at prices above the recent market price of $1.08 per share, and
if the current market price increases, these options and warrants could have a
dilutive effect on stockholders if exercised. Our existing stock option plan
currently has approximately 1,542,650 shares available for issuance. Future
options issued under the plan may have further dilutive effects.
Sales of shares pursuant to exercisable options and warrants could lead to
subsequent sales of the shares in the public market, and could depress the
market price of our stock by creating an excess in supply of shares for sale.
Issuance of these shares and sale of these shares in the public market could
also impair our ability to raise capital by selling equity securities.
31
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our consolidated
financial position, results of operations or cash flows. We are exposed to
market risks, which include changes in interest rates, changes in foreign
currency exchange rate as measured against the U.S. dollar and changes in the
value of stock of a publicly traded company, which secures a promissory note we
hold.
INTEREST RATE RISK
Our exposure to market risk for changes in interest rates relates to our
revolving credit borrowings and variable rate term loans, which totaled $7.3
million at October 31, 2002. Based on this balance, a change in one percent in
the interest rate would cause a change in interest expense of approximately
$73,000 or $0.01 per basic and diluted share, on an annual basis.
These instruments were not entered into for trading purposes and carry interest
at a pre-agreed upon percentage point spread from the bank's prime interest
rate. Our objective in maintaining these variable rate borrowings is the
flexibility obtained regarding early repayment without penalties and lower
overall cost as compared with fixed-rate borrowings.
FOREIGN CURRENCY EXCHANGE RATE RISK
We conduct business in various foreign currencies, primarily in Europe. Revenues
are typically denominated in the local foreign currency, which creates exposures
to changes in exchange rates. These changes in the foreign currency exchange
rates as measured against the U.S. dollar may positively or negatively affect
our revenues, gross margins and retained earnings. We attempt to minimize
currency exposure risk through decentralized sales, development, marketing and
support operations, in which substantially all costs are local-currency based.
There can be no assurance that such an approach will be successful, especially
in the event of a significant and sudden decline in the value of the foreign
currency. We do not hedge against foreign currency risk. Approximately 12% and
19% of our total revenues were denominated in currencies other than the U.S.
dollar for the six months ended September 30, 2002 and 2001, respectively.
EQUITY PRICE RISK
We have no direct equity investments.
ITEM 4 - CONTROLS AND PROCEDURES
VALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer believe the
Company's disclosure controls and procedures, as defined in Securities Exchange
Act Rules 13a-14 and 15d-14, are effective. This conclusion was reached after an
evaluation of these controls and procedures as of September 30, 2002.
CHANGES IN INTERNAL CONTROLS
We are not aware of any significant changes in the Company's internal controls,
including any corrective actions with regard to significant deficiencies and
material weaknesses, or in other factors that could significantly affect these
controls after September 30, 2002.
32
PART II. - OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
In the Form 10K that we filed for the year ended March 31, 2002, we reported
that our former Chief Executive Officer, Thomas A. Dorosewicz, filed in April,
2002 a demand with the California Labor Commissioner for $256,250 in severance
benefits allegedly due under a disputed employment agreement, plus attorney's
fees and costs. Mr. Dorosewicz's demand was later increased to $283,893.53. On
June 18, 2002, we filed an action against Mr. Dorosewicz, Michelle Dorosewicz,
and an entity affiliated with him in the San Diego Superior Court, Case No.
GIC790833, alleging fraud and other causes of action relating to transactions
Mr. Dorosewicz caused us to enter into with his affiliates and related parties
without proper board approval. On July 31, 2002, Mr. Dorosewicz filed
cross-complaints in that action alleging breach of statutory duty, breach of
contract, fraud and other causes of action relating his employment with the
Company and other transactions he entered into with the Company. These matters
are still pending and the parties have agreed to resolve all claims in binding
arbitrations.
On August 30, 2002, Cord Camera Centers, Inc., an Ohio corporation ("Cord
Camera"), filed a lawsuit against one of our subsidiaries, SVI Retail, Inc.
("SVI Retail"), as the successor to Island Pacific Systems Corporation ("Island
Pacific"), in the United States District Court for the Southern District of
Ohio, Eastern Division (Case No. C2 02 859). The lawsuit claims damages in
excess of $1.5 million, plus punitive damages of $250,000, against SVI Retail
based upon alleged fraud, negligent misrepresentation, breach of express
warranties, and breach of contract. These claims pertain to a certain License
Agreement dated December, 1999, as amended, between Cord Camera and Island
Pacific for the use of certain software products, a certain Services Agreement
between the parties for consulting, training and product support for the
software products, and a POS Software Support Agreement between the parties for
maintenance and support services for a certain software product. We cannot at
this time predict the merits of this case because it is in its preliminary stage
and discovery has not yet commenced. However, SVI Retail intends to vigorously
defend the action and possibly file one or more counter-claims.
Due to the declining performance of our Australian subsidiary, we decided in the
third quarter of fiscal 2002 to sell certain assets of our Australian subsidiary
to the former management of such subsidiary, and then cease Australian
operations. Such sale was however subject to the approval of National Australia
Bank, the subsidiary's secured lender. The bank did not approve the sale and the
subsidiary ceased operations in February 2002. The bank caused a receiver to be
appointed in February 2002 to sell substantially all of the assets of the
Australian subsidiary and pursue collections on any outstanding receivables. The
receiver proceeded to sell substantially all of the assets for $300,000 in May
2002 to the entity affiliated with former management, and is actively pursuing
the collection of receivables. If the sale proceeds plus collections on
receivables are insufficient to discharge the indebtedness to National Australia
Bank, we may be called upon to pay the deficiency under our guarantee to the
bank. We have accrued $187,000 as the maximum amount of our potential exposure.
The receiver has also claimed that we are obligated to it for inter-company
balances of $636,000, but we do not believe any amounts are owed to the
receiver, who has not as of the date of this report acknowledged the monthly
corporate overhead recovery fees and other amounts charged by us to the
Australian subsidiary offsetting the amount claimed to be due.
Except as set forth above, we are not involved in any material pending
legal proceedings, other than ordinary routine litigation incidental to
our business.
33
ITEM 2. - CHANGES IN SECURITIES AND USE OF PROCEEDS
During the quarter ended September 30, 2002, we issued:
o an aggregate of 527,286 shares of common stock to stockholders
as payment of accrued interest on the convertible notes due to
stockholders.
o 5,000 shares of common stock for consulting fee incurred in
current quarter.
The foregoing securities were offered and sold without registration under the
Securities Act of 1933 to sophisticated investors who had access to all
information which would be pertinent to their investment decisions..
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On September 19, 2002, we held our annual meeting of stockholders. 22,433,844
shares out of eligible 28,891,727 shares were represented at the meeting in
person or by proxy. The following matters were considered and approved:
o Seven directors were elected. The nominees received the
following votes:
------------------------ ------------------ -------------------- ----------------- -------------------------
NAME VOTES FOR VOTES AGAINST ABSTENTIONS BROKER NON-VOTES
------------------------ ------------------ -------------------- ----------------- -------------------------
Barry M. Schechter 22,210,911 22,000 200,933 0
------------------------ ------------------ -------------------- ----------------- -------------------------
Arthur S. Klitofsky 22,210,911 22,000 200,933 0
------------------------ ------------------ -------------------- ----------------- -------------------------
Donald S. Radcliffe 22,232,911 0 200,933 0
------------------------ ------------------ -------------------- ----------------- -------------------------
Ivan M. Epstein 22,210,911 22,000 200,933 0
------------------------ ------------------ -------------------- ----------------- -------------------------
Michael Silverman 22,210,911 22,000 200,933 0
------------------------ ------------------ -------------------- ----------------- -------------------------
Ian Bonner 22,210,911 22,000 200,933 0
------------------------ ------------------ -------------------- ----------------- -------------------------
Robert P. Wilkie 22,210,911 22,000 200,933 0
------------------------ ------------------ -------------------- ----------------- -------------------------
o Amendments to our 1998 Incentive Stock Plan. The measure
passed with 21,933,586 votes for, 481,740 votes against,
18,518 abstained and no broker non-votes.
o Ratification of the Company's continued engagement of Singer
Lewak Greenbaum & Goldstein, LLP as the Company's independent
auditors for fiscal year 2003. The measure passed with
22,175,536 votes for, 131,720 votes against, 126,588 abstained
and no broker non-votes.
34
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
2.1 Business Sale Agreement dated May 3, 2002 among the receivers and
managers of the assets of SVI Retail (Pty) Limited and QQQ Systems PTY
Limited, incorporated by reference to exhibit 2.3 to the Company's Form
10-K for the fiscal year ended March 31, 2002.
3.1 Certificate of Designation, incorporated by reference to exhibit 4.1 of
the Company's Form 8-K filed May 16, 2002.
10.1 Second Amendment to Amended and Restated Term Loan Agreement between
the Company and Union Bank of California, N.A. dated as of May 21,
2001, incorporated by reference to exhibit 10.5 to the Company's Form
10-K for the fiscal year ended March 31, 2002.
10.2 Third Amendment to Amended and Restated Term Loan Agreement between the
Company and Union Bank of California, N.A. dated as of July 15, 2002,
incorporated by reference to exhibit 10.6 to the Company's Form 10-K
for the fiscal year ended March 31, 2002.
10.3 Amendment Agreement to between the Company, Koyah Leverage Partners,
Koyah Partners, L.P., Raven Partners, L.P., Nigel Davey, and Brian
Cathcart dated July 15, 2002, incorporated by reference to exhibit
10.11 to the Company's Form 10-K for the fiscal year ended March 31,
2002.
10.4 Summary of loan transactions between the Company and World Wide
Business Centres, incorporated by reference to exhibit 10.12 to the
Company's Form 10-K for the fiscal year ended March 31, 2002.
10.5 Purchase Agreement between the Company and Toys "R" Us, Inc. dated May
29, 2002, incorporated by reference to exhibit 10.14 to the Company's
Form 10-K for the fiscal year ended March 31, 2002.
10.6 Convertible Note in favor of Toys "R" Us, Inc. dated May 29, 2002,
incorporated by reference to exhibit 10.15 to the Company's Form 10-K
for the fiscal year ended March 31, 2002.
10.7 Warrant in favor of Toys "R" Us, Inc. dated May 29, 2002, incorporated
by reference to exhibit 10.16 to the Company's Form 10-K for the fiscal
year ended March 31, 2002.
10.8 Development Agreement between the Company and Toys "R" Us, Inc. dated
May 29, 2002, incorporated by reference to exhibit 10.17 to the
Company's Form 10-K for the fiscal year ended March 31, 2002. Portions
of this exhibit (indicated by asterisks) have been omitted pursuant to
a request for confidential treatment pursuant to Rule 24b-2 of the
Securities Exchange Act of 1934.
99.1 Written Statement of Principal Executive Officer.
99.2 Written Statement of Principal Financial Officer.
(b) REPORTS ON FORM 8-K
On August 1, 2002, we filed a Form 8-K disclosing in Item 5 the Company's Annual
Stockholder Meeting on September 19, 2002.
35
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly cause this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SVI Holdings, Inc.
Registrant
/S/ Ran Furman
-----------------------------------
Date: November 15, 2004 Ran Furman
Principal Financial Officer
36
FORM 10-Q CERTIFICATIONS
I, Michael Tomczak, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of SVI Solutions,
Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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
we 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 quarterly 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 quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly 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 function):
(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
quarterly report whether or not 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: November 15, 2004 /s/ Michael Tomczak
-------------------------------
Michael Tomczak
President, Chief Operating Officer
and Director
37
FORM 10-Q CERTIFICATIONS
I, Ran Furman, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of SVI Solutions,
Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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
we 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 quarterly 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 quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly 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 function):
(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
quarterly report whether or not 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: November 15, 2004 /s/ Ran Furman
-------------------------------
Ran Furman
Chief Financial Officer
38