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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 DECEMBER 31, 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 - 30,866,632 shares as of January 31, 2003.
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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 February 14, 2003 for the quarter ended December 31, 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 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 December 31, 2002 (Unaudited) (Restated)
and March 31, 2002 (Audited) .............................................................3
Condensed Consolidated Statements of Operations for the Three And Nine
Months Ended December 31, 2002 (Restated) and 2001 (Unaudited) ...........................4
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended December 31, 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 6. Exhibits and Reports on Form 8-K...............................................................34
SIGNATURES ...............................................................................................36
FORM 10-Q CERTIFICATIONS..................................................................................37
2
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SVI SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
DECEMBER 31, 2002 MARCH 31, 2002
----------------- --------------
(unaudited) (audited)
(As restated -
See Note 12)
ASSETS
Current assets:
Cash and cash equivalents $ 659 $ 1,309
Accounts receivable, net 4,685 1,946
Other receivables, including $7 and $31 from related parties, respectively 213 255
Inventories 111 126
Current portion of non-compete agreements 917 917
Prepaid expenses and other current assets 129 150
------------ ------------
Total current assets 6,714 4,703
Property and equipment, net 426 641
Purchased and capitalized software, net 15,529 17,612
Goodwill, net 14,795 15,422
Non-compete agreements, net 897 1,585
Other assets 58 42
------------ ------------
Total assets $ 38,419 $ 40,005
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Convertible notes due to stockholders $ 1,295 $ 618
Current portion of term loan 7,233 435
Accounts payable 2,154 1,497
Accrued expenses 4,216 3,864
Deferred revenue 2,925 3,528
Income tax payable -- 98
------------ ------------
Total current liabilities 17,823 10,040
Term loan refinanced in July 2002 -- 6,472
Convertible notes due to stockholders -- 1,421
Other long-term liabilities 99 120
------------ ------------
Total liabilities 17,922 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
$1,015 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; 41,541,632 and
38,993,609 shares issued; and 30,841,632 and 28,293,609 shares outstanding 4 4
Additional paid in capital 56,563 54,685
Accumulated deficit (42,372) (37,772)
Treasury stock, at cost; shares - 10,700,000 (8,906) (8,580)
Shares receivable (275) (485)
------------ ------------
Total stockholders' equity 20,497 21,952
------------ ------------
Total liabilities and stockholders' equity $ 38,419 $ 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 Nine Months Ended
December 31, December 31,
2002 2001 2002 2001
------------ ------------ ------------ ------------
(As restated - See Note 12) (As restated - See Note 12)
Revenues:
Product $ 4,357 $ 2,625 $ 9,292 $ 8,030
Services 3,035 3,346 7,626 13,416
------------ ------------ ------------ ------------
Total revenues 7,392 5,971 16,918 21,446
Cost of revenues:
Product 1,204 940 3,592 3,443
Services 1,739 2,126 4,581 7,957
------------ ------------ ------------ ------------
Total cost of revenues 2,943 3,066 8,173 11,400
------------ ------------ ------------ ------------
Gross profit 4,449 2,905 8,745 10,046
Expenses:
Product development 650 1,180 2,894 2,932
Depreciation and amortization 315 888 946 2,838
Selling, general and administrative 2,913 2,695 7,365 10,388
------------ ------------ ------------ ------------
Total expenses 3,878 4,763 11,205 16,158
------------ ------------ ------------ ------------
Income (loss) from operations 571 (1,858) (2,460) (6,112)
Other income (expense):
Interest income -- 3 1 8
Other income (expense) 6 (1) 8 (35)
Interest expense (209) (758) (1,602) (2,795)
Gain (loss) on foreign currency transaction 16 (10) 23 --
------------ ------------ ------------ ------------
Total other expenses (187) (766) (1,570) (2,822)
------------ ------------ ------------ ------------
Income (loss) before provision for income taxes 384 (2,624) (4,030) (8,934)
Provision for income taxes benefits -- (39) (57) (2)
------------ ------------ ------------ ------------
Income (loss) before cumulative effect of a change in
accounting principle 384 (2,585) (3,973) (8,932)
Cumulative effect of changing accounting principle -
goodwill valuation under SFAS 142 -- -- (627) --
------------ ------------ ------------ ------------
Income (loss) from continuing operations 384 (2,585) (4,600) (8,932)
Loss from discontinued Australian operations, net of
applicable income taxes -- (385) -- (1,140)
------------ ------------ ------------ ------------
Net income (loss) 384 (2,970) (4,600) (10,072)
Cumulative preferred dividends (253) -- (761) --
------------ ------------ ------------ ------------
Net income (loss) available to common stockholders $ 131 $ (2,970) $ (5,361) $ (10,072)
============ ============ ============ ============
Basic and diluted income (loss) per share:
Income (loss) before cumulative effect of a change in
accounting principle $ 0.01 $ (0.07) $ (0.14) $ (0.23)
Cumulative effect of a change in accounting principle -
goodwill valuation under SFAS 142 -- -- (0.02) --
------------ ------------ ------------ ------------
Income (loss) from continuing operations 0.01 (0.07) (0.16) (0.23)
Loss from discontinued operations -- (0.01) -- (0.03)
Cumulative preferred dividends (0.01) -- (0.03) --
------------ ------------ ------------ ------------
Net income (loss) available to common stockholders $ -- $ (0.08) $ (0.19) $ (0.26)
============ ============ ============ ============
Weighted-average common shares outstanding:
Basic 30,395 37,942 29,257 38,092
============ ============ ============ ============
Diluted 58,734 37,942 29,257 38,092
============ ============ ============ ============
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)
NINE MONTHS ENDED DECEMBER 31,
2002 2001
------------ ------------
(As restated -
See Note 12)
Cash flows from operating activities:
Net loss $ (4,600) $ (10,072)
Adjustments to reconcile net loss to net cash used for operating
activities:
Depreciation and amortization 3,122 5,289
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 -- 53
Gain on foreign currency transactions (23) 14
Stock-based compensation 8 487
Common stock issued for services rendered 390 --
Changes in deferred taxes -- (135)
Changes in assets and liabilities net of effects from acquisitions:
Accounts receivable and other receivables (2,697) (64)
Inventories 15 56
Prepaid expenses and other current assets 5 216
Accounts payable and accrued expenses 1,014 (1,955)
Accrued interest on stockholders' loans, convertible notes and term loan 664 2,071
Deferred revenue (603) 2,792
Income taxes payable (98) 57
------------ ------------
Net cash used for operating activities (1,297) (674)
------------ ------------
Cash flows from investing activities:
Purchases of furniture and equipment (39) (240)
Proceeds from disposals of furniture and equipment -- 7
Capitalized software development costs (93) --
------------ ------------
Net cash used for investing activities (132) (233)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock -- 16
Payments on amounts due to stockholders, net (287) (475)
Payments on term loan (336) (559)
Proceeds from committed common stock 1,383 1,260
Proceeds from short-term loan from related party 120 --
Payments on short-term loan from related party (120) --
------------ ------------
Net cash provided by financing activities 760 242
------------ ------------
Effect of exchange rate changes on cash 19 15
------------ ------------
Net decrease in cash and cash equivalents (650) (650)
Cash and cash equivalents, beginning of period 1,309 1,267
------------ ------------
Cash and cash equivalents, end of period $ 659 $ 617
============ ============
Supplemental disclosure of cash flow information:
Interest paid $ 408 $ 788
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 $ 45 --
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 1,223,580 and 1,193,837 shares of common stock as payments for
bonuses, interest and services rendered in prior periods $ 657 $ 955
Issued 1,010,000 shares of common stock to repay in full a stockholder's
loan $ 388 --
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 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 December 31, 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 nine months ended December 31, 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 (as amended) for the year ended March 31, 2002.
The results of operations for the three and nine months ended December 31, 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 an 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 December 31,
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 nine months
ended December 31, 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 December 31, 2002 and March 31, 2002 consist of the
following (in thousands):
December 31, March 31,
2002 2002
-------------- --------------
Term loan payable to bank $ 7,233 $ 6,907
Less term loan payable to bank classified
as long-term as discussed below -- 6,472
-------------- --------------
Current portion of term loan $ 7,233 $ 435
============== ==============
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 Company is not in breach of the
financial covenants at December 31, 2002. As of the date of this report,
principal and interest payments due as of December 31, 2002 were paid.
On January 2, 2003, the Company issued a warrant to an affiliate of the bank to
purchase up to 1.5 million shares of the Company's common stock for $0.01 per
share. The warrant is 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 various
vesting date. As all of the shares become exercisable, it would result in a
finance charge of $909,000 which $273,000 has been incurred through February
2003. As all of the shares become exercisable, it would result in a finance
charge of $909,000, of which $273,000 has been incurred through February 2003.
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 convertible promissory notes 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 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. In December 2002, the investors
agreed to extend the accrued interest payments to September 30, 2003. 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. As
of December 31, 2002, the balance of these convertible notes is $1.3 million.
7
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 December 2002, the investors
agreed to amend the terms of the amended notes and warrants to extend the
effectiveness of the registration statement to March 17, 2003. In the event such
registration statement is not declared effective by the SEC by March 17, 2003,
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 March 17, 2003 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 from March 17, 2003 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 has not been
filed.
NOTE 6 - COMMITED COMMON STOCK (AS RESTATED)
In May 2002, Toys "R" Us, Inc. ("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 December 31, 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 December 31, 2002, 1.1 million 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.
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 classified as
equity at December 31, 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 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 $1.7 million on goodwill during the nine
months ended December 31, 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. For the quarter ended December 31, 2002, the diluted EPS
calculation included common shares equivalent of 4,861,327 from outstanding
options and warrant, 18,894,000 from Series A Preferred stock and 4,583,333 from
convertible notes. The following potential common shares have been excluded from
the computation of diluted net loss per share for the three months ended
December 31, 2001 and six months ended December 31, 2002 and 2001 because the
effect would have been anti-dilutive:
December 31,
2002 2001
------------ ------------
Outstanding options under the Company's stock option plans 4,835,367 4,062,114
Outstanding options granted outside the Company's stock option plans 5,054,312 1,246,812
Warrants issued in conjunction with private placements 4,232,000 2,807,245
Warrants issued for services rendered 804,002 1,012,336
Convertible notes due to stockholders 2,083,333 1,009,867
Committed common stock 2,500,000 --
Series A Convertible Preferred Stock 18,894,000 --
------------ ------------
Total 38,403,014 10,138,374
============ ============
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 excluding depreciation and amortization. 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 Nine months ended
December 31, 2002 December 31, 2002
----------------- -----------------
(As restated)
Revenues:
Island Pacific $ 6,382 $ 14,355
SVI Store Solutions 735 1,453
SVI Training Products, Inc. 275 1,110
------------- -------------
Consolidated revenues $ 7,392 $ 16,918
============= =============
Operating income (loss):
Island Pacific $ 989 $ (55)
SVI Store Solutions 235 (562)
SVI Training Products, Inc. (13) 185
Other (see below) (640) (2,028)
------------- -------------
Consolidated operating income (loss) $ 571 $ (2,460)
============= =============
Depreciation:
Island Pacific $ 50 $ 151
SVI Store Solutions 12 37
Other 22 70
------------- -------------
Consolidated depreciation $ 84 $ 258
============= =============
Other operating loss:
Depreciation $ (22) $ (70)
Administrative costs and other non-allocated
expenses (618) (1,958)
------------- -------------
Consolidated other operating loss $ (640) $ (2,028)
============= =============
December 31, 2002
-----------------
(Restated)
Identifiable assets:
Island Pacific $ 32,948
SVI Store Solutions 4,914
Other 282
-------------
Total $ 38,144
=============
Goodwill:
Island Pacific $ 13,903
SVI Store Solutions 892
Other --
-------------
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, administrative and selling
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 Nine Months Ended
December 31, December 31,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenues:
United States $ 6,473 $ 5,466 $ 14,885 $ 19,278
United Kingdom 919 505 2,033 2,168
Australia (discontinued operations) -- 571 -- 2,110
------------ ------------ ------------ ------------
Total revenues $ 7,392 $ 6,542 $ 16,918 $ 23,556
============ ============ ============ ============
December 31, March 31,
2002 2002
------------ ------------
Long-lived Assets:
United States $ 32,594 $ 36,154
United Kingdom 28 22
------------ ------------
Total long-lived assets $ 32,622 $ 36,176
============ ============
For the three months ended December 31, 2002 and 2001, revenues from one
customer, Toys "R" Us, Inc., accounted for 30% and 44% of total revenues,
respectively. For the nine months ended December 31, 2002 and 2001, revenues to
one customer, Toys "R" Us, Inc., accounted for 31% and 47% of total revenues,
respectively.
NOTE 10 - RECENT ACCOUNTING PRONOUNCEMENTS
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.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation-Transition and
Disclosure". This Statement amends SFAS 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS 148 amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
11
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
transition guidance and annual disclosure provisions of SFAS 148 are effective
for fiscal years ending after December 15, 2002, with earlier application
permitted in certain circumstances. The interim disclosure provisions are
effective for financial reports containing financial statements for interim
periods beginning after December 15, 2002. SFAS 148 is not expected to have a
material 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.
NOTE 12 - RESTATEMENT
Subsequent to the issuance of our condensed consolidated financial statements
for the three and nine months ended December 31, 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 should be expensed as interest
expense instead of being taken to equity.
12
As a result, the condensed consolidated financial statements for the three and
nine months ended December 31, 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 Adjustments Restated Reference
------------ ------------ ------------ ------
At December 31, 2002:
Additional paid-in capital $ 55,855 $ 708 $ 56,563 [1]
Accumulated deficit (41,664) (708) (42,372) [1]
For the three-month period ended December 31, 2002:
Cost of revenues $ 2,218 $ 725 $ 2,943 [2]
Gross profit 5,174 (725) 4,449
Depreciation and amortization 1,040 (725) 315 [2]
Total expenses 4,603 (725) 3,878
For the nine-month period ended December 31, 2002:
Cost of revenues $ 5,997 $ 2,176 $ 8,173 [2]
Gross profit 10,921 (2,176) 8,745
Depreciation and amortization 3,122 (2,176) 946 [2]
Total expenses 13,381 (2,176) 11,205
Interest expense (894) (708) (1,602) [1]
Net loss (3,892) (708) (4,600)
Net loss available to common stockholders (4,653) (708) (5,361)
Basic and diluted EPS (0.13) (0.03) (0.16)
Basic and diluted EPS available to common
stockholders (0.16) (0.03) (0.19)
Adjustments to the financial statements for the three and nine-month periods
ended December 31, 2002 are as follows:
1. Additional paid-in capital, accumulated deficit 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 $725,000 and $2,176,000 in the three and nine-month periods
ended December 31, 2002, respectively.
Statements of operations for the three and nine-month periods ended December 31,
2001 were restated to report amortization of purchased and capitalized software
in the amounts of $714,000 and $2,153,000 in the three and nine-month periods
ended December 31, 2001, respectively, as cost of revenues, previously reported
as depreciation and amortization expense.
13
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.
We currently derive the majority of our revenues from three sources: the initial
sale of application software licenses or license revenues, professional service
and support services or maintenance 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. Professional services relate to implementation of our software,
training of customer personnel and modifications or customization work. Support,
maintenance and software updates are a source of recurring revenues and are
generally based on a percentage of the software license revenues and are charged
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
sales historically ranged from three to twelve months, but new license sales
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.
14
RESTATEMENT OF QUARTERLY INFORMATION
As discussed in the notes to condensed consolidated financial statements, we
restated our December 31, 2002 financial statements to:
1. Separately present revenues earned from product and services and
related 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
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. We will 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.
In January 2003, we appointed Harvey Braun, a well-known and highly-respected
retail industry veteran, to the position of Chief Executive Officer of Island
Pacific. Together with Mr. Beck, Mr. Braun will lead Island Pacific through the
next evolution of product and service offerings to meet the ever-changing needs
of retailers worldwide.
We are strengthening our product offerings through strategic relationships with
Planalytics, KMG Solutions, VisionCompass Inc., Raymark, Inc., Wazagua LLC, ANT
USA, Inc. and IT Resources Inc.
Under a partnership agreement with Planalytics Inc., Island Pacific will market
Impact LR, an internet-based application that measures the specific effects of
future weather on consumer demand by product, location and time. Using Impact
LR, our customers can plan the timing of in-season markdowns, as well as the
season-to-season flow of merchandise into their stores with maximum
effectiveness.
Under a marketing license agreement with KMG Solutions, Island Pacific will
integrate, market and support Traxion(TM) process management solutions.
Traxion's business process management solution consists of three modules.
Traxion ProcessEngine(TM) is the real-time process management platform that
retailers use to actively manage and support their organizations' unique
business processes. Traxion ProcessModeler(TM), includes simulation functions
such as same-time comparison of process variations and the use of actual cost
data to produce process-based financial estimates. Traxion
OrganizationModeler(TM) simplifies the creation of sophisticated models
including inter-company workgroups, payroll information, and roles.
Island Pacific will market VisionCompass(TM) collaborative enterprise management
software, which uniquely combines the best of performance management, business
intelligence, resource planning, and collaboration capabilities into one
straightforward, web-based application. The system enables decision makers and
teams to develop specific business goals, work on them together, and measure
their collective results objectively. The highly flexible system is easily
customizable to fit each organization's unique needs and leads directly to
improved quality and visibility of key indicators throughout the enterprise.
Under an OEM agreement with Raymark, Inc., Island Pacific will integrate, market
and support Xpert Store point-of-sale ("POS") software solution under the Island
Pacific brand. Raymark's full-featured POS solution streamlines the checkout
process in order to increase sales associate efficiency and augment customer
satisfaction. The software supports multi-channel, multi-language,
multi-currency and multi-taxation requirements.
15
Under a agreement with Wazagua LLC, Island Pacific will exclusively offer to
retailers worldwide Wazagua's products and services including web-based Loss
Prevention Case Management Package, ASP Data Hosting and POS Exception
Reporting. WAZAGUA(TM) ASP Hosted Suite of Modules automates data management for
the Loss Prevention, Operations, Human Resources, Safety & Risk Management
community. These ASP-hosted productivity tools allow retailers to capture the
power of the internet. Retailers can create efficiencies, manage and share
information, make better use of their staff, eliminate redundant data entry -
and work from virtually any point in the world.
Under terms of a 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.
A 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.
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.
16
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 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 or
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 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 DECEMBER 31, 2002 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2001
REVENUES
Product revenues increased $1.8 million, or 69%, to $4.4 million in the quarter
ended December 31, 2002 from $2.6 million in the quarter ended December 31,
2001, primarily due to a $1.7 million increase in software license revenues.
Services revenues decreased by $0.3 million, or 9% to $3.0 million in the
quarter ended December 31, 2002 from $3.3 million in the quarter ended December
31, 2001 primarily due to a $0.6 million decrease from Toys R Us., Inc.
"(Toys"), offset by an increase of $0.3 million 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 increased $1.4 million, or 23%, to $7.4 million in the quarter ended
December 31, 2002 from $6.0 million in the quarter ended December 31, 2001 due
to the above factors. Excluding Toys revenues of $2.2 million and $2.9 million
in the quarters ended December 31, 2002 and December 31, 2001, respectively,
total revenues were $5.2 million for the quarter ended December 31, 2002
compared to $3.1 million in the quarter ended December 31, 2001, September 30,
2001, a 68% increase.
COST OF REVENUES/GROSS PROFIT
Cost of revenues decreased by $0.2 million, or 6%, to $2.9 million in the
quarter ended December 31, 2002 from $3.1 million in the quarter ended December
31, 2001. Cost of product revenues increased $0.3 million, or 33%, to $1.2
million in the quarter ended December 31, 2002 from $0.9 million in the quarter
ended December 31, 2001. Cost of services revenue decreased $0.4 million, or
19%, to $1.7 million in the quarter ended December 31, 2002 from $2.1 million in
the quarter ended December 31, 2001. Total gross profit increased $1.5 million,
or 52%, to $4.4 million in the quarter ended December 31, 2002 from $2.9 million
in the quarter ended December 31, 2001. Total gross margin was 59% and 48% for
the quarter ended December 31, 2002 and December 31, 2001, respectively. Gross
margin on products was 73% and 62% for the quarters ended December 31, 2002 and
December 31, 2001, respectively, while gross margin on services was 43% and 36%
for the quarters ended December 31, 2002 and December 31, 2001, respectively.
Amortization of capitalized software included in cost of product revenues
remained at $0.7 million in the quarter ended December 31, 2002 and the quarter
ended December 31, 2001. The increase in gross margin for product revenues is
due primarily a $1.0 million increase in license revenues in the quarter ended
December 31, 2001 compared to the quarter ended December 31, 2001, while
amortization of capitalized software remained the same during both quarters. The
increase in gross margin on services was due an in increase in non-Toys service
revenues which generally carry higher margins.
18
PRODUCT DEVELOPMENT EXPENSE
Product development expense decreased by $0.5 million, or 42%, to $0.7 million
in the quarter ended December 31, 2002 from $1.2 million in the quarter ended
December 31, 2001. As we are close to the completion of the new version 2.0 of
our Retail Enterprise Solutions, product development efforts, especially from
outsourced programming services, are decreased. The version 2.0 is scheduled to
be released in the next quarter.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization decreased by $0.6 million, or 67%, to $0.3 million
in the quarter ended December 31, 2002 from $0.9 million in the quarter ended
December 31, 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 increased by $0.2 million, or 7%,
to $2.9 million in the three months ended December 31, 2002 from $2.7 million in
the three months ended December 31, 2001. The increase was primarily related to
an increase in sales related commissions.
INCOME (LOSS) FROM OPERATIONS
Income (loss) from operations, which included depreciation and
amortization expense, increased by $2.5 million to $0.6 million for
the quarter ended December 31, 2002, compared to a loss from operations of $1.9
million for the quarter ended December 31, 2001.
INTEREST EXPENSE
Interest expense decreased by $0.6 million, or 75%, to $0.2 million in the
quarter ended December 31, 2002 from $0.8 million in the quarter ended December
31, 2001. The decrease is primarily due to a $0.4 million decrease in interest
expense on the note due to Softline Limited, which was repaid in January 2002 in
connection with the integrated series of recapitalization transactions with
Softline.
NINE MONTHS ENDED DECEMBER 31, 2002 COMPARED TO NINE MONTHS ENDED DECEMBER 31,
2001
REVENUES
Product revenues increased $1.3 million, or 16%, to $9.3 million in the nine
months ended December 31, 2002 from $8.0 million in the nine months ended
December 31, 2001, primarily due to a $1.1 million increase in software license
revenues and $0.2 million increase in maintenance revenues. Services revenues
decreased by $5.8 million, or 43% to $7.6 million in the nine months ended
December 31, 2002 from $13.4 million in the nine months ended December 31, 2001
primarily due to a $5.7 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
increased $4.5 million, or 21%, to $16.9 million in the nine months ended
December 31, 2002 from $21.4 million in the nine months ended December 31, 2001
due to the above factors. Excluding Toys revenues of $5.3 million and $11.0
million in the nine months ended December 31, 2002 and December 31, 2001,
respectively, total revenues were $11.6 million for the nine months ended
December 31, 2002 compared to $10.4 million in the nine months ended December
31, 2001, a 12% increase.
COST OF REVENUES/GROSS PROFIT
Cost of revenues decreased $3.2 million, or 28%, to $8.2 million in the nine
months ended December 31, 2002 from $11.4 million in the nine months ended
December 31, 2001. Cost of product revenues increased $0.2 million, or 6%, to
$3.6 million in the nine months ended December 31, 2002 from $3.4 million in the
nine months ended December 31, 2001. Cost of services revenue decreased $3.4
million, or 43%, to $4.6 million in the nine months ended December 31, 2002 from
$8.0 million in the nine months ended December 31, 2001. Total gross profit
19
decreased $1.3 million, or 13%, to $8.7 million in the nine months ended
December 31, 2002 from $10.0 million in the nine months ended December 31, 2001.
Total gross margin was 51% and 47% for the nine months ended December 31, 2002
and December 31, 2001, respectively. Gross margin on products was 61% and 58%
for the nine months ended December 31, 2002 and December 31, 2001, respectively,
while gross margin on services was 39% and 40% for the nine months ended
December 31, 2002 and December 31, 2001, respectively. Amortization of
capitalized software included in cost of product revenues remained at $2.2
million in the nine months ended December 31, 2002 and the quarter ended
December 31, 2001. The increase in gross margin for product revenues is due
primarily a $1.3 million increase in license revenues in the nine months ended
December 31, 2002 compared to the nine months ended December 31, 2001, while
amortization of capitalized software remained the same during both quarters. The
increase in gross margin on services was due to Toys service revenues, which
typically carry lower margin than non-Toys service revenue, as a percentage of
total service revenues decreasing to 69% in the nine months ended December 31,
2002 compared to 82% in the nine months ended December 31, 2001.
PRODUCT DEVELOPMENT EXPENSE
Product development expense was $2.9 million in the nine months ended December
31, 2002 and 2001, respectively. 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 $1.9 million, or 68%, to $0.9 million
in the nine months ended December 31, 2002 from $2.8 million in the nine months
ended December 31, 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 $3.0 million, or 29%,
to $7.4 million in the nine months ended December 31, 2002 from $10.4 million in
the nine months ended December 31, 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 $2.5 million for the nine months ended December 31,
2002, compared to a loss from operations of $6.1 million for the nine months
ended December 31, 2001.
INTEREST EXPENSE
Interest expense decreased by $1.2 million, or 43%, to $1.6 million in the nine
months ended December 31, 2002 from $2.8 million in the nine months ended
December 31, 2001. Interest expense in the 2001 period included $1.2 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.
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.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
During the nine months ended December 31, 2002, we financed our operations using
cash on hand, internally generated cash, proceeds from the sale of a convertible
note to Toys "R" Us, Inc. and loans from an entity affiliated with Donald S.
Radcliffe, one of our directors. At December 31, 2002 and March 31, 2002, we had
cash of $0.7 million and $1.3 million, respectively.
20
Operating activities used cash of $1.3 million and $0.7 million in the nine
months ended December 31, 2002 and 2001, respectively. Cash used for operating
activities in the nine months ended December 31, 2002 resulted from $4.6 million
of net losses and $2.7 million increase in accounts receivable; offset in part
by $3.1 million of depreciation and amortization, $0.9 million of amortization
of debt discount and conversion option, $0.6 million of goodwill impairment,
$1.0 million increase in accounts payable and accrued expenses and $0.7 million
increase in accrued interest on notes payable.
Investing activities used cash of $0.1 million and $0.2 million in the nine
months ended December 31, 2002 and 2001, respectively. Cash used for investing
activities in the current quarter was primarily for capitalization of software
development costs.
Financing activities provided cash of $0.8 million and $0.2 million in the nine
months ended December 31, 2002 and 2001, respectively. The 2002 financing
activities included $1.4 million of proceeds from a convertible note issued to
Toys "R" Us, Inc.; offset in part by $0.3 million payments on a stockholder loan
and $0.3 million payments on term loan.
Accounts receivable increased to $4.7 million at December 31, 2002 from $1.9
million at March 31, 2002. The increase was due to increase in revenues and
invoicing semi-annual maintenance contracts in the quarter ended December 31,
2002.
Accounts payable increased to $2.2 million at December 31, 2002 from $1.5
million at March 31, 2002.
Deferred revenue decreased to $2.9 million at December 31, 2002 from $3.5
million at March 31, 2002. The decrease was primarily due to decreases in
prepaid modification and services revenues of $1.5 million from our major
customer, Toys `R' Us, Inc., and $0.5 million from other customers; offset in
part by $1.4 million increase in prepaid support services revenue.
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 December 31, 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
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 were 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. We are not in breach of the financial covenants in
the quarter ended December 31, 2002. As of the date of this report, principal
and interest payments due as of December 31, 2002 were paid.
21
On January 2, 2003, we issued a warrant to an affiliate of the bank to purchase
up to 1.5 million shares of our common stock for $0.01 per share. The warrant is
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 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 we have discharged in full its bank
indebtedness prior to a vesting date. As of the date of this report, 463,000
shares of the warrant are exercisable. As all of the shares become exercisable,
it would result in a finance charge of $909,000, of which $273,000 has been
incurred through February 2003.
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 December 31, 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. In December 2002, the investors
agreed to extend the accrued interest payments to September 30, 2003. 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. As of the date of this report, the balance of these
convertible notes is $1.3 million.
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 by March 17, 2003, 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 March 17, 2003 after such date in which the
registration statement is not effective, the Company will be obligated to issued
22
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 from March 17, 2003 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.
FINANCING
TOYS "R" US, INC.
In May 2002, Toys "R" Us, Inc. ("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 January 31, 2003, 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 January 31, 2003, 1.2 million 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.
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 classified as
equity.
23
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations, including purchase
commitments at December 31, 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 $ 293 $ 864 $ 816 $ 192 $ 7
Capital leases $ 73 $ 18
Term loans $ 631 $ 7,076
Convertible notes due stockholders $ -- $ 1,370
Payables and accrued expenses aged over 90
days $ 2,868
--------- --------- --------- --------- ---------
Total contractual cash obligations $ 3,865 $ 9,328 $ 816 $ 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 $11.1 million and $5.3 million at December
31, 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.
24
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 December 31, 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.
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 $4.6 million in the first nine months ended December 31,
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 December 31, 2002 and March 31, 2002, we had negative working capital of
$11.1 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 SALES. OUR GROWTH AND PROFITABILITY IS DEPENDENT ON
THE SALE OF HIGHER MARGIN LICENSES.
Our revenues decreased by 21% in the first nine months ended December 31, 2002
compared to the first nine months ended December 31, 2001. We experienced a
substantial decrease in application license software revenues in the past two
years. We must improve new application license sales 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 revenues has not
been due to factors, which might continue to negatively affect revenues.
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 revenues or
operating results will be below the expectations of public market analysts or
investors. If that happens, our stock price will likely decline.
25
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.
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 January 31, 2003, 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 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.
26
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.
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 Limited ("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, Inc. ("Toys") accounted for 31% and 47% of our revenues for the
nine months ended December 31, 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 would significantly reduce our revenues and
force us to substantially curtail operations. We cannot provide any assurances
that Toys 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.
27
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 sales 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
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.
28
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 PROPRIETARY 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 upon our
intellectual property rights.
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.
WE MAY RECEIVE CLAIMS THAT 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.
29
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.
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.
30
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.
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.
31
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
3,104,569 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 1,766,465 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.
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 January 31, 2003. 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
18% of our total revenues were denominated in currencies other than the U.S.
dollar for the nine months ended December 31, 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 Operating 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 December 31, 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 December 31, 2002.
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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 December 31, 2002, we issued:
o an aggregate of 595,200 shares of common stock to Softline Limited, our
majority stockholder, as payments for $390,000 past due loan
refinancing fees and payables.
o 1,010,000 shares of common stock to a stockholder as repayment of a
loan with the outstanding balance of $388,000. This loan was acquired
in connection with the acquisition of Island Pacific.
o 100,000 shares of common stock to an employee as bonus payment of
$25,000 earned in the current fiscal year.
o 60,000 shares of common stock to our attorney as payment for $30,000
legal services provided in prior periods.
o 50,000 shares of common stock as payment for $8,000 consulting fee
incurred in current quarter.
The foregoing securities were offered and sold without registration pursuant to
Section 4(2) of the Securities Act of 1933 to sophisticated investors who had
access to all information which would be pertinent to their investment
decisions.
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 Fourth Amendment to Amended and Restated Term Loan Agreement between
the Company and Union Bank of California, N.A. dated as of November 15,
2002.
10.4 Warrant in favor of UNIONBANCAL EQUITIES, Inc. dated January 2, 2003.
10.5 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.
10.6 First Amendment to Amendment Agreement between the Company, Koyah
Leverag Partners, Koyah Partners, L.P., Raven Partners, L.P., Nigel
Davey, and Brian Cathcart dated December 5, 2002.
10.7 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.
10.8 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.
10.9 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.
34
10.10 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.
10.11 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
None
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
Principal Executive Officer
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
Principal Executive Officer
38