UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
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 no. 1-9728
J NET ENTERPRISES, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
NEVADA 88-0169922
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4020 W. Lake Creek Drive, #100, Wilson, Wyoming 83014
- ----------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
307-739-8603
----------------------------------------------------
(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 |_|
There were 8,524,552 shares of the Registrant's common stock outstanding as of
May 4, 2001.
J NET ENTERPRISES, INC. AND SUBSIDIARIES
INDEX
Page No.
--------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (Unaudited) -
March 31, 2001 and June 30, 2000 3-4
Condensed Consolidated Statements of Operations (Unaudited) -
Three and Nine Months Ended March 31, 2001 and 2000 5
Condensed Consolidated Statement of Stockholders'
Equity (Unaudited) - Nine Months Ended March 31, 2001 6
Condensed Consolidated Statements of Cash Flows (Unaudited) -
Nine Months Ended March 31, 2001 and 2000 7
Notes to Condensed Consolidated Financial Statements 8-22
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosure About Market Risk 28
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 29
-2-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
March 31, June 30,
ASSETS 2001 2000
------- --------
Current assets:
Cash and cash equivalents $29,911 $ 60,090
Marketable securities 26,576 --
Current portion of notes receivable 1,000 --
Net assets of discontinued operations -- 16,645
Other current assets 532 697
------- --------
Total current assets 58,019 77,432
------- --------
Note receivable - related parties 1,303 1,000
Investments in technology-related businesses 23,232 24,136
Excess of costs over equity in underlying
net assets of investments in technology-related
businesses, net of amortization 1,444 1,657
Notes receivable, net of allowance 4,404 --
Leasehold improvements and other equipment,
net of accumulated depreciation 2,218 --
Deferred tax asset 4,702 --
Other non-current assets 570 510
------- --------
Total assets $95,892 $104,735
======= ========
See Notes to Condensed Consolidated Financial Statements.
-3-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
(Concluded)
(Unaudited)
March 31, June 30,
LIABILITIES AND STOCKHOLDERS' EQUITY 2001 2000
-------- ---------
Current liabilities:
Accounts payable and other current liabilities $ 1,417 $ 799
Accrued federal taxes payable 907 --
-------- ---------
Total current liabilities 2,324 799
Convertible subordinated notes, net of amortized
discount of $736 and $2,500 27,013 12,750
Deferred income tax -- 762
Minority interest in subsidiary 1,114 2,514
-------- ---------
Total liabilities and minority interest 30,451 16,825
-------- ---------
Stockholders' equity:
Preferred stock - authorized
1,000,000 shares of $1 par value;
none issued
Common stock - authorized
60,000,000 shares of $.01 par
value; 10,233,470 shares issued 102 102
Additional paid-in capital 75,250 73,875
Retained earnings 5,070 27,710
Less 1,480,328 and 1,258,624 shares of
common stock in treasury, at cost (14,981) (13,777)
-------- ---------
Total stockholders' equity 65,441 87,910
-------- ---------
Total liabilities and
stockholders' equity $ 95,892 $ 104,735
======== =========
See Notes to Condensed Consolidated Financial Statements.
-4-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED MARCH 31,
2001 AND 2000
(Dollars in thousands, except per share data)
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
--------------------- ----------------------
2001 2000 2001 2000
-------- ------- -------- --------
Costs and expenses:
Depreciation and amortization $ 139 $ -- $ 363 $ --
Impairment on technology-related
businesses -- -- 8,665 --
Loss on sale of investments 1,650 -- 1,650 --
General and administrative 1,568 3,322 5,181 4,909
Allowance on receivables 7,980 -- 7,980 --
-------- ------- -------- --------
Totals 11,337 3,322 23,839 4,909
-------- ------- -------- --------
Operating loss from continuing operations 11,337 3,322 23,839 4,909
-------- ------- -------- --------
Other income (expense):
Net fee from terminated merger -- -- -- 11,116
Equity in income (loss) in technology-related
businesses (14,623) -- (19,426) --
Gain on sale of short-term investments -- -- -- 2,361
Interest and other income 2,026 539 4,066 1,475
Interest expense (1,660) -- (4,572) --
-------- ------- -------- --------
Totals (14,257) 539 (19,932) 14,952
-------- ------- -------- --------
Income (loss) from continuing operations
before provision (benefit) for income tax (25,594) (2,783) (43,771) 10,043
Provision (benefit) for Federal income tax (2,823) (1,113) (8,355) 2,893
-------- ------- -------- --------
Net income (loss) from continuing operations (22,771) (1,670) (35,416) 7,150
Gain (loss) from discontinued operations,
net of tax of $145 and $(190) -- 281 -- (369)
Gainon sale of discontinued operations,
net of operating results of $ - and $(250),
net of tax, and $6,711 tax from gain for
nine months ended 137 -- 12,776 --
-------- ------- -------- --------
Net income (loss) $(22,634) $(1,389) $(22,640) $ 6,781
======== ======= ======== ========
Basic earnings (loss) per share:
Income (loss) from continuing operations $ (2.57) $ (.19) $ (3.96) $ .83
Income (loss) from discontinued operations .02 .03 1.43 (.04)
-------- ------- -------- --------
$ (2.55) $ (.16) $ (2.53) $ .79
======== ======= ======== ========
Diluted earnings (loss) per share:
Income (loss) from continuing operations $ (2.57) $ (.19) $ (3.96) $ .82
Income (loss) from discontinued operations .02 .03 1.43 (.04)
-------- ------- -------- --------
$ (2.55) $ (.16) $ (2.53) $ .78
======== ======= ======== ========
See Notes to Condensed Consolidated Financial Statements.
-5-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED MARCH 31, 2001
(Dollars and shares in thousands)
(Unaudited)
Common Stock Additional Treasury Stock
------------------ Paid-In Retained -------------------
Shares Amount Capital Earnings Shares Amount Totals
------ ------ ---------- -------- ------ ------ ------
Balance July 1, 2000 10,233 $ 102 $73,875 $ 27,710 (1,259) $(13,777) $ 87,910
Comprehensive loss:
Net loss from
continuing operations (35,416) (35,416)
Gain on sale of discontinued
operations, net of tax 12,776 12,776
Repurchase of common stock (221) (1,204) (1,204)
Amount allocated to additional
paid-in capital in connection
with the issuance of the 8%
convertible subordinated
notes (See Note 2) 1,375 1,375
------ ------ ------- -------- ------ -------- --------
Balance March 31, 2001 10,233 $ 102 $75,250 $ 5,070 (1,480) $(14,981) $ 65,441
====== ====== ======= ======== ====== ======== ========
See Notes to Condensed Consolidated Financial Statements.
-6-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED MARCH 31, 2001 AND 2000
(Dollars in thousands)
(Unaudited)
2001 2000
-------- --------
Operating activities:
Net income (loss) $(22,640) $ 7,150
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Equity in loss of technology-related businesses 19,426 --
Loss on sale of investments 1,650 --
Impairment on technology-related investments 8,665 --
Allowance for uncollectable receivables 7,980 --
(Gain) loss from discontinued operations, net of taxes
of $6,711 and $(190) (12,776) 369
Net fee from terminated merger -- (11,116)
Depreciation and amortization 363 --
Amortization of original issue debt discount 3,139 --
Deferred Federal income tax asset (4,702) (18)
Gain on sale of short-term investments -- (2,361)
Increase (decrease) from changes in:
Prepaid expenses and other current assets 165 (105)
Notes receivable from related parties (303) 8
Other non-current assets (60) --
Accounts payable and other current liabilities (1,269) 784
Accrued current federal income taxes (3,917)
Current tax liabilities and assets, net of taxes related to
discontinued operations (2,559) --
-------- --------
Net cash used in operating activities (6,838) (5,289)
-------- --------
Investing activities:
Investments in technology-related businesses (30,034) (6,183)
Investment in notes receivable (12,446)
Investments in marketable securities (25,444) --
Break-up fee from terminated merger -- 13,500
Proceeds from sale of short-term investments -- 8,488
Net proceeds from discontinued operations 35,815 6,002
Purchases of property and equipment (2,278) --
Increase in lease acquisition costs and other intangible
and non-current assets -- (1,669)
-------- --------
Net cash provided by (used in) investing activities (34,387) 20,138
Financing activities:
Proceeds from convertible subordinated notes 12,250 --
Proceeds from issuance of common stock -- 295
Purchases of treasury stock (1,204) (1)
-------- --------
Net cash provided by (used in) financing activities 11,046 294
-------- --------
Net increase (decrease) in cash and cash equivalents (30,179) 15,143
Cash and cash equivalents at beginning of period 60,090 47,637
-------- --------
Cash and cash equivalents at end of period $ 29,911 $ 62,780
======== ========
Supplemental disclosures of cash flow data:
Cash paid during the period for:
Federal income tax $ 2,300 $ 1,275
Interest $ 1,515 $ --
Non-cash investing and financial activities:
Debt discount on convertible subordinated notes $ 1,375 $ --
Note receivable - related parties $ 250 $ --
Issuance of common stock for investments in
technology-related businesses $ -- $ 1,746
See Notes to Condensed Consolidated Financial Statements.
-7-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Significant accounting policies and business:
Business:
J Net Enterprises, Inc. (formerly known as "Jackpot Enterprises,
Inc." and referred to hereinafter as "J Net" or the "Company") is a
technology holding company with concentrated investments in
enterprise software and technology infrastructure companies (the
"Technology-Related Businesses") . The assets of the Company consist
primarily of cash and investments. Prior to the Company's change in
emphasis to a technology holding company, the Company had been
actively engaged, through its subsidiaries, in the gaming industry
for over 30 years.
The Company invests directly in Technology-Related Businesses or
through J Net Ventures I ("Venture I"), a fund managed by J Net
Venture Partners, LLC (the "Manager"), an affiliate of the Company.
The Company and Venture I will make investments primarily in early
stage ventures (first and second round financing) exhibiting
reasonable risk adjusted valuations and may also make later stage
investments based on the merits of the transaction, the quality of
the investment and the company's ability to go public or have the
investment monetized through some other clearly defined exit
strategy. Additionally, investments in the securities of public
companies may be made when an opportunity exists for value creation.
This might occur in the case of companies with existing products,
services and customer base that have been affected by the decline in
the interest in funding by capital markets (referred to herein as
"fallen angels"). Investments generally will range in size from $1
million to $10 million. J Net and the Manager intends to play a role
in helping to advise and assist its partner/portfolio companies in
meeting and exceeding their objectives. The Company expects the
average investment holding period to be three years with investment
emphasis in the following: (1) B2B infrastructure and solutions for
legacy businesses with valuable branding, (2) Restructuring of B2B
and B2C fallen angels and (3) Technology and infrastructure
investments. As of March 31, 2001, the Company owned 100% of Venture
I. While entities affiliated with Gilbert Global Equity Partners
have committed an aggregate of $15 million to the fund, they have
not yet exercised any of their co-investment rights. As of March 31,
2001, the Company had invested approximately $68 million in
Technology-Related Businesses and notes receivable discussed in Note
3 and Note 4 to the condensed consolidated financial statements. Of
the $68 million, the Company invested approximately $32 million on
behalf of Venture I.
Business segments:
The Company operates in a single business segment, its
Technology-Related Business segment. In November 2000, the Company
completed the sale of its gaming machine route operations ("Route
Operations") segment. Activities of the Route Operations up to the
effective date of the sale are reported as discontinued operations.
For additional information on the Route Operations, please refer to
Note 9 in the condensed consolidated financial statements and
disclosures included in the Company's Annual Report to the
Securities and Exchange Commission on Form 10-K for the fiscal year
ended June 30, 2000 (the "2000 Form 10-K").
-8-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Significant accounting policies and business (continued):
Basis of presentation:
The accompanying unaudited condensed consolidated financial
statements included herein have been prepared by the Company
pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such rules and
regulations, although management believes that the disclosures are
adequate to make the information presented not misleading.
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments,
consisting of normal recurring accruals, necessary to present fairly
the Company's financial position as of March 31, 2001, the results
of its operations for the three and nine months ended March 31, 2001
and 2000 and its cash flows for the nine months ended March 31, 2001
and 2000. The results for the nine months ended March 31, 2001 and
2000 are not necessarily indicative of results for a full year.
Information included in the condensed consolidated balance sheet as
of June 30, 2000 has been derived from the 2000 Form 10-K. These
unaudited condensed consolidated financial statements should be read
in conjunction with the consolidated financial statements and
disclosures included in the 2000 Form 10-K.
Investments in Technology-Related Businesses:
The various interests that the Company acquires in
Technology-Related Businesses are accounted for under one of three
methods: consolidation, equity or cost. The applicable accounting
method is generally determined based on the Company's voting
interest and its ability to influence or control the applicable
entity. For investments accounted for under the equity method, the
excess of the cost of the investment over the Company's equity in
the underlying net assets of such investment is amortized on a
straight-line basis over 5 years. Such amortization is included in
the line captioned depreciation and amortization in the accompanying
condensed consolidated statements of operations.
The Company periodically assesses the investment value and/or
recoverability of its investments in accordance with Statement of
Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of" ("SFAS No. 121") and Accounting Principles Board
Opinion No. 17, "Intangible Assets" ("APB No. 17").
During the nine months ended March 31, 2001, the Company determined
the value of certain investments had been permanently impaired. Such
assessments were based on internal evaluations of the ongoing
business models presented by the applicable entities, discounted
cash flow models and projections, or by dilutive transactions caused
by the Company's election not to participate in additional
financings. Such impairments totaled $8,665,000 for the nine months
ended March
-9-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Significant accounting policies and business (continued):
Investments in Technology-Related Businesses (concluded):
31, 2001. No such impairments were incurred during the three months
ended March 31, 2001 or for the three and nine months ended March
31, 2000.
Investments in debt and equity securities:
The Company accounts for investments in debt and equity securities
in accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"). This statement addresses the accounting
and reporting for investments in equity securities that have readily
determinable fair values and for all investments in debt securities,
and requires such securities be classified as either held to
maturity, trading, or available-for-sale. Management determines the
appropriate classification of its investments in securities at the
time of purchase and reevaluates such classification at each balance
sheet date.
Marketable securities:
In October and November 2000 and January 2001, the Company invested
a total of $25 million in Mariner Partners, L.P. ("Mariner"), a
private investment fund. Mariner employs a multi-strategy approach,
emphasizing market neutral and event driven styles, to
opportunistically seek, identify, and capitalize on investment
opportunities across the financial markets. This approach mitigates
the episodic returns generally experienced by single sector funds.
According to fund documents, Mariner has consistently generated
above average returns relative to hedge fund industry benchmarks
while taking lower levels of risk as indicated by comparative
measures such as Sharpe Ratios, actual volatility, cumulative loss,
and % of months profitable. J Net can withdraw all or a portion of
its investment upon 45 days prior written notice. The Company
classifies those securities as trading under definitions provided in
SFAS 115 and records changes in the value of the accounts in the
item captioned interest income and other income in the condensed
consolidated statement of operations. Interest and other income
representing the increase in the Company's investment in Mariner
Partners, L.P. were $688,000 and $1,132,000 respectively, for the
three and nine months ended March 31, 2001. Realized gains from the
sale of securities for the three and nine months ended March 31,
2000 were $0 and $2,361,000, respectively.
-10-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Significant accounting policies and business (continued):
Accounting for equity method investments:
When the Company uses the equity method to account for its
investments in technology-related-businesses it uses the procedures
outlined in the "Summary of Proceedings of the FASB Emerging Issues
Task Force" issue number 98-13 ("EITF 98-13"), which covers
accounting by equity method investors for investee losses when the
investor has loans to and investments in other securities of the
investee. EITF 98-13 generally defined other investments in the
investee to include preferred stock, debt securities and loans. The
conclusions of the task force also prescribes the order in which
equity method losses shall be recognized as the seniority of the
other investments (that is, priority in liquidation).
The company uses the equity method to account for its investments in
InterWorld Corporation, Alistia Inc., and Tech Trader, Inc. All of
the investments are in the form of preferred stock. In addition, the
common stockholders equity in each of the investee's is in a deficit
position. Therefore, equity losses are recognized in accordance with
the company's proportionate ownership percentages, in preferred
stock the applicable percentage of equity losses were 100% for
InterWorld Corporation, 39.8% for Alistia, Inc. and 42.1% for Tech
Trader, Inc. As a result of the business combination with
InterWorld, the consolidation method will be used beginning in the
quarter ending June 30, 2001.
Leasehold improvements and other equipment:
Leasehold improvements and other equipment are recorded at cost and
are depreciated on a straight line basis over the estimated useful
lives of the assets, as follows: 3 to 7 years for equipment; and 3
to 10 years for leasehold improvements. Property sold or retired is
eliminated from the accounts in the year of disposition.
Recently adopted accounting standards:
In June 1998, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"), as amended by Statements of Financial Accounting
Standards No. 137 and No. 138 in June 1999 and June 2000,
respectively. These statements, which were required to be adopted
for fiscal years beginning after June 15, 2000, established
additional accounting and reporting standards for derivative
instruments and hedging activities. The statements require that an
entity recognize all derivatives as either assets or liabilities in
the statement of financial position. This statement also defines and
allows companies to apply hedge accounting to its designated
derivatives under certain instances. It also requires that all
derivatives be marked to market on an ongoing basis. This applies
whether the derivatives are stand-alone instruments, such as
warrants or interest rate swaps, or embedded derivatives, such as
call options contained in convertible debt investments. Along with
the derivatives, in the case of qualifying hedges, the underlying
hedged items are also to be marked to market. These market value
adjustments are to be included either in the income statement or
other comprehensive income, depending on the nature of the hedged
transaction. The fair value of financial instruments is generally
determined by reference to market values resulting from trading on a
national securities exchange or in an over the counter
-11-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Significant accounting policies and business (concluded):
Recently adopted accounting standards (concluded):
market. In cases where derivatives relate to financial instruments
of nonpublic companies, or where quoted market prices are otherwise
not available, such as for derivative financial instruments, fair
value is based on estimates using present value or other valuation
techniques. Based on management's review, the Company has determined
that the warrant purchased by the Company in connection with the
Company's purchase of an interest in Series B Preferred Stock of
TechTrader, Inc. in fiscal 2000 is a derivative as defined in SFAS
133. On July 1, 2000, the Company adopted SFAS 133, as amended and
recorded the Tech Trader derivatives at fair market value. The
cumulative effect of the change in accounting principle for the nine
months ended March 31, 2001 was not significant.
In March 2000, the FASB issued FASB Interpretation 44 "Accounting
for Certain Transactions involving Stock Compensation" ("FIN 44"),
which provides clarification on the application of Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees". The Company adopted the provisions of FIN 44 on July 1,
2000. Such adoption had no effect on the Company's results of
operations.
Recently issued accounting standards:
In December 1999, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). SAB 101 clarifies existing accounting
principles related to revenue recognition in financial statements.
The Company is required to comply with the provisions of SAB 101 in
its year ended June 30, 2001. Based upon the current nature of the
Company's continuing operations, management believes that SAB 101
will not have a significant impact on the Company's results of
operations.
Note 2 - Convertible subordinated notes:
On October 2, 2000, the Company completed its offering of $27.75
million of unregistered 8% convertible subordinated notes (the
"Notes") to a small group of investors. The stockholders at the
Annual Stockholders' meeting on December 6, 2000 approved issuance
of a portion of the Notes pursuant to rules of the New York Stock
Exchange.
Due to market fluctuation between commitment and funding dates, the
Company is required to amortize a portion of the notes. Such noncash
amortization totaled approximately $3.9 million at issuance, which
will be fully amortized at June 1, 2001, the earliest possible
conversion date.
For the nine months ended March 31, 2001, interest expense related
to the Notes was $4,572,000. Of such amount, approximately
$3,139,000 was from the noncash amortization of the debt discount
and the remaining $1,433,000 represented interest paid to the Note
holders at 8% on the principal amount. For further information
concerning the Notes, see Note 2 of Notes to Consolidated Financial
statements in the 2000 Form 10-K.
-12-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Convertible subordinated notes (concluded):
As of March 31, 2001, three directors of J Net or entities
controlled by such directors, the adult children of certain
directors or entities controlled by such children, Meister Brothers
Holdings, LLC, and one officer of the Company have invested $3
million, $4 million, $3 million, and $.5 million, respectively, in
the Notes. In connection with the issuance of the Notes, the Company
loaned $1 million and $250,000 to Meister Brothers Holdings, LLC and
the officer, respectively. Interest on the loans accrues at 8% per
annum. The principal amount and accrued interest is payable on June
30, 2002. Both obligations are full recourse in nature and are also
secured by the right, title and interest in and to the Notes
purchased by such persons.
Mark W. Hobbs, President and Chief Operating Officer of the Company
entered into an agreement with Mariner GP, an unaffiliated entity,
with respect to Mr. Hobbs' participation in the ownership of $2
million of the Company's Notes owned by Mariner GP. Pursuant to the
arrangement, Mr. Hobbs obtains the full economic benefit with
respect to $1 million of the Notes including the interest thereon
and the potential upside upon conversion to common stock and the
sale thereof. With respect to an additional $1 million, Mr. Hobbs
obtained the potential upside upon conversion to common stock and
the sale thereof. Mr. Hobbs is at risk in the event of default on
the two million dollar original purchase price and has pledged his
limited partnership interests in Mariner GP, L.P. as collateral
against such default. Mariner GP, L.P., a Delaware limited
partnership is the general partner of Mariner Partners, L.P. In
connection with such transaction, Mr. Hobbs waived his right under
his employment agreement to receive up to a $1 million loan from the
Company to purchase up to $2 million of the Notes. For information
regarding J Net's investment in Mariner Partners, L.P., see Note 1,
Marketable securities.
For the nine months ended March 31, 2001, interest expense related
to the Notes was $4,572,000. Of such amount, approximately
$3,139,000 was from the amortization of the debt discount and the
remaining $1,433,000 represented interest paid to the Note holders
at 8% on the principal amount. For further information concerning
the Notes, see Note 2 of Notes to Consolidated Financial statements
in the 2000 Form 10-K.
Note 3 - Investments in Technology-Related Businesses:
As of March 31, 2001, all of the Company's investments in
Technology-Related Businesses under the applicable accounting
methods are summarized as follows (dollars in thousands):
March 31, 2001 June 30, 2000
-------------- -------------
Consolidation $ 1,140 $ 2,540
Equity method, net
of accumulated
equity losses 10,149 13,544
Cost method 11,943 8,052
------- -------
Total $23,232 $24,136
======= =======
-13-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Investments in Technology-Related Businesses (continued):
In March 2001, the Company entered into an agreement in principal to
sell its membership interest in Digital Boardwalk, LLC. On April 6,
2001, the Company entered into a purchase agreement with an
unrelated party to sell the membership interests and forgive a loan
in the amount of $250,000. As a result of the sale, a loss of
$1,650,000 was incurred. The Company accounted for its investment in
Digital Boardwalk under the equity method. Although the transaction
was executed on April 6, 2001, the loss was recognized in the March
31, 2001 condensed consolidated financial statements.
The Company will participate in a Series B financing for Alistia,
Inc. The initial funding for Series B placement is expected to occur
in early May 2001. Additional funding will be required if certain
performance criteria are met. The Company accounts for its
investment in Alistia under the equity method.
On October 12, 2000, J Net and InterWorld Corporation ("InterWorld")
entered into a definitive Securities Purchase Agreement (the
"Securities Purchase Agreement"). Pursuant to the terms of the
Securities Purchase Agreement, J Net purchased $20 million in
aggregate principal amount of Series A Preferred Stock of InterWorld
(the "Series A Preferred Stock") on November 10, 2000. Each share of
Series A Preferred Stock is initially convertible into shares of
Common Stock of InterWorld (the "Common Stock") at a conversion
price of $6.25 per share (the "Conversion Price"), subject to
adjustment on the six month anniversary of the date of issue, to 90%
of the average daily closing price of Common Stock for such
six-month period, but in no event less than $2.00 per share.
Furthermore, as of April 12, 2001, J Net, at its sole discretion,
had the option to require InterWorld to redeem the Series A
Preferred Stock for cash at 150% of the purchase price plus accrued
dividends; provided that such right would expire if InterWorld
consummated a change of control transaction with J Net on or prior
to such date.
In connection with the issuance of the Series A Preferred Stock,
InterWorld issued to J Net warrants to purchase shares of Common
Stock at an exercise price of $7.25 per share, subject to
adjustment, exercisable at any time until October 12, 2005, equal to
19.999% of the current outstanding shares of Common Stock less the
amount of shares issuable upon the conversion of the Series A
Preferred Stock. The Company has determined these warrants are a
derivative as defined by SFAS 133, as amended. Because there is no
public market for these warrants, the value of the warrants has been
determined using the Black-Scholes methodology.
Pursuant to the Securities Purchase Agreement, J Net appointed two
of its board members to InterWorld's Board of Directors. Based on
the Company's representation on the Board of Directors and the
Company's ability to otherwise influence direction of InterWorld's
activities, the Company uses the equity method to account for its
investment in InterWorld.
-14-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Investments in Technology-Related Businesses (continued):
On January 25, 2001, J Net and InterWorld entered into a Stock
Purchase Agreement and a Stand-By Purchase Agreement (collectively,
the "Agreements"). Pursuant to the Agreements, J Net was to exchange
all of its InterWorld Series A Preferred Stock and the related
warrants for 46,153,846 newly-issued shares of InterWorld Common
Stock. In connection with such exchange, J Net had agreed to suspend
its option to require InterWorld to redeem its Series A Preferred
Stock, provided such exchange is approved by InterWorld's
shareholders. In addition, pursuant to the Agreements, InterWorld
had agreed to offer for sale to all holders of InterWorld Common
Stock up to $20 million of newly-issued InterWorld Common Stock at a
price per share of $.65. If such holders did not purchase all of the
new issuance, the Company had agreed to purchase the difference
between $20 million and the amount purchased by other InterWorld
shareholders (the "Stand-By Commitment"). The Agreements also
provided J Net with an option to purchase an additional $20 million
of InterWorld Common Stock (the "Over Allotment Option"). A portion
of the Over Allotment Option would have been exercisable at a price
per share of $.65 and a portion would have been exercisable at a
price per share equal to 90% of the volume-weighted average trading
price of InterWorld Common Stock for the 10 trading day period prior
to the time of exercise. The portions exercisable at each price
would have depended on the number of shares purchased pursuant to
the Stand-By Commitment, as described in the Agreements. The
transactions described in the Agreements were subject to numerous
conditions, including obtaining various InterWorld shareholder
approvals and the making of various regulatory filings, as described
in the Agreements. On February 7, 2001, Mark Hobbs, J Net's
President and Chief Operating Officer was appointed to InterWorld's
Board of Directors. J Net shall maintain the right to designate up
to 4 nominees to InterWorld's Board of Directors (subject to certain
percentage ownership thresholds) after the closing of the Stand-By
Commitment and Over Allotment Option.
On April 19, 2001, the Company announced that there were several
factors which precluded consummation of the transactions
contemplated by the Agreements. As a result, J Net and InterWorld
announced that the agreements had been terminated. In addition, it
was disclosed that the NASDAQ, the securities exchange where
InterWorld is traded, had notified InterWorld that unless certain
conditions were satisfied, that InterWorld's stock would be
delisted. Such delisting was effective May 4, 2001.
As a result of the cancellation of the Agreements, J Net announced
it would require InterWorld to redeem its Series A Preferred Stock
in accordance with its terms. Those provisions entitle J Net to
receive a cash payment or to convert the Preferred Stock into common
stock at a fixed discount of the then market price. Such issuance of
stock will result in J Net holding over 92% of the outstanding
common stock of InterWorld.
-15-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Investments in Technology-Related Businesses (concluded):
For the companies in which J Net uses the equity accounting method,
the percentages owned vary from approximately 10% to 42%. For the
three and nine months ended March 31, 2001, the Company's equity in
losses from the investments, excluding impairments of such
investments, was $14,623,000 and $19,426,000, respectively. The
amounts consist of the Company's proportionate losses in InterWorld,
Alistia, Inc., and TechTrader, Inc. No losses for Digital Boardwalk
are included in the three months due to the sale of the investment.
In the case of InterWorld, the Company owns approximately 10% of
voting rights as the sole owner of the Series A Preferred Stock.
During December 2000, InterWorld's common shareholders' equity
became a deficit. As a result of the Company's 100% ownership of the
Preferred Stock, the Company is required to recognize 100% of
InterWorld's losses using the equity method or to such amounts that
would adjust our invested balance to its net realizable value. Such
losses and adjustments were approximately $13,200,000 and
$14,300,000 for the three and nine months ended March 31,2001.
Note 4 - Notes receivable:
On October 12, 2000 J Net, on behalf of Venture I, entered into a
Loan Assumption and Forbearance Agreement with Michael Donahue, Vice
Chairman of InterWorld, pursuant to which J Net purchased from
Salomon Smith Barney ("SSB") a loan from SSB to Mr. Donahue in the
amount of $12,445,500. The loan is secured by 4,270,406 shares of
InterWorld Common Stock and other assets owned by Mr. Donahue. The
loan is due in October 2003, subject to an acceleration in October
2001 if InterWorld does not effect a merger transaction with J Net,
and bears interest payable at 8% per annum. In connection therewith,
J Net entered into a Call/Participation Agreement with Mr. Donahue
whereby he agreed that J Net would share in the profit on a portion
of the stock securing the loan once certain conditions, including
the repayment of the loan, were met. Mr. Donahue has sole power to
vote and dispose of the shares, although he is required to vote the
shares in favor of a merger of InterWorld and J Net and consult with
J Net on other matters put before InterWorld's shareholders for a
vote thereon. The loan agreement contains certain events of default
beyond non-payment, the most significant of which include failure by
Mr. Donahue to vote the stock in favor of a merger between
InterWorld and J Net and any time that the closing price of the
stock pledged as collateral falls below $2.00 per share for more
than 10 days. J Net has notified Mr. Donahue of such closing price
default but has elected not to enforce its rights relating to such
closing price default as of the date hereof.
-16-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 4 - Notes receivable (concluded):
On April 4, 2001, the Company, on behalf of Venture I, entered into
an Amended and Restated Loan Assumption and Forbearance Agreement
(the "Amended Agreement") with Mr. Donahue. The Amended Agreement
replaced the Loan and Forbearance Agreement (the "Original
Agreement") dated October 12, 2000. The significant components in
the Amended Agreement added Excalibur Polo Farm ("Excalibur") as a
debtor, changed interest payment terms, revised certain collateral
provisions and changed events allowing acceleration. The amended
loan is secured by 4,270,406 shares of InterWorld common stock and
the assets of Excalibur.
The loan is due on October 11, 2003, subject to acceleration to
October 11, 2001, if on or before July 31, 2001, InterWorld did not
commence with the rights offering contemplated by the Stock Purchase
and Standby Purchase Agreements dated January 25, 2001. J Net has
elected not to enforce its rights relating to such defaults at this
time. The loan bears interest at 8% per annum and calls for payment
of accrued interest at the end of each calendar quarter. Principal
payments of $500,000 commencing December 31, 2001 are due each
quarter.
The Call/Participation Agreement contained in the original agreement
whereby J Net would share in the profit on a portion of the stock
securing the loan once certain conditions, including the repayment
of the loan, remained intact in the Amended Agreement. This
agreement was not deemed to have any value.
During the three months ended March 31, 2001, management assessed
the value of the assets securing the loan and related interest and
determined a reserve was necessary due to, among other things, the
probable delisting of InterWorld's common stock by the NASDAQ and
the net realizable value of Excalibur. The reserve against the value
of the loan was $7,980,000.
Note 5 - Federal income taxes:
The effective tax rate for the three and nine month period ended
March 31, 2001 was approximately 11% and 21%, respectively, which
differs from the statutory rate due to differences in recognition of
expenses between the tax accounting regulations and financial
statements prepared in accordance with generally accepted accounting
principles in the United States of America. The rate is also
impacted by an allowance against deferred tax benefits of
$4,850,000. The allowance lowered the effective rate for the three
months ended March 31, 2001 by approximately 20% and by 7% for the
nine months ended March 31, 2001.
The Company has a net deferred tax asset of $4,702,000 as of March
31, 2001. Management believes it is more likely than not that this
asset can be carried back against the recognized gains from asset
and securities sales for prior fiscal years or forward to offset
anticipated gains in future years.
-17-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 5 - Federal income taxes (concluded):
In March 2001, the Company paid a $2,300,000 deposit for estimated
federal income taxes for fiscal year 2001, which ends on June 30,
2001.
Note 6 - Earnings (loss) per share:
Basic earnings (loss) per share from continuing operations for the
three and nine months ended March 31, 2001 and 2000 and diluted loss
per share from continuing operations for the three and nine months
ended March 31, 2001 are computed by dividing net income (loss) from
continuing operations by the weighted average number of common
shares outstanding for the respective period. Diluted earnings per
share from continuing operations for the nine months ended March 31,
2000 is computed by dividing net income by the weighted average
number of common and common equivalent shares outstanding. Options
and warrants to purchase common stock, whose exercise price was
greater than the average market price for the three and nine months
ended March 31, 2000, have been excluded from the computation of
diluted earnings per share from continuing operations. Such
antidilutive options and warrants were 712,217. Because the three
and nine months ended March 31, 2001 and three months ended March
31, 2000 had a loss from continuing operations, no potential common
shares from the assumed exercise of stock options, the put options
and the assumed conversion of the 8% convertible subordinated notes
have been included in the diluted loss per share from continuing
operations computation pursuant to accounting principles generally
accepted in the United States of America. The following is the
amount of income (loss) and the number of
-18-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 6 - Earnings (loss) per share (concluded):
shares used in the basic and diluted earnings (loss) per share
computations for continuing operations (dollars and shares in
thousands, except per share data):
Three Months Ended Nine Months Ended
March 31, March 31,
--------------------- ---------------------
2001 2000 2001 2000
-------- ------- -------- -------
Basic earnings per share:
Earnings:
Income (loss) available to
common stockholders $(22,771) $(1,670) $(35,416) $ 7,150
======== ======= ======== =======
Shares:
Weighted average number of
common shares outstanding 8,865 8,631 8,938 8,620
======== ======= ======== =======
Basic earnings (loss) per share
from continuing operations $ (2.57) $ (.19) $ (3.96) $ .83
======== ======= ======== =======
Diluted earnings (loss) per share
from continuing operations:
Earnings (loss):
Income (loss) available to
common stockholders $(22,771) $(1,670) $(35,416) $ 7,150
Effect of dilutive securities -- -- -- --
-------- ------- -------- -------
Income (loss), as adjusted $(22,771) $(1,670) $(35,416) $ 7,150
======== ======= ======== =======
Shares:
Weighted average number of
common shares outstanding 8,865 8,631 8,938 8,620
Common shares issuable upon
assumed exercise of dilutive
stock options -- -- -- 1,056
Less common shares assumed
to be repurchased by
application of the treasury
stock method to the
proceeds using the average
market price for the period -- -- -- (1,005)
Common shares issuable upon
assumed conversion of the
8% convertible subordinated
notes -- -- -- --
Common shares issuable upon
assumed exercise of the put
option -- -- -- --
-------- ------- -------- -------
Weighted average number of
common shares and
common share equivalents
outstanding 8,865 8,631 8,938 8,671
======== ======= ======== =======
Diluted earnings (loss) per share
from continuing operations $ (2.57) $ (.19) $ (3.96) $ .82
======== ======= ======== =======
-19-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 7 - The 1992 Incentive and Non-qualified Stock Option Plan:
On September 29, 2000, the exercise price of the June 30, 2000 grant
of nonqualified stock options to purchase an aggregate of 110,000
shares of common stock (27,500 each to four directors) was vested at
$9.50 per share, the fair market value of the stock on that date,
pursuant to the terms of the 1992 Incentive and Non-qualified Stock
Option Plan (the "1992 Plan"). See Note 6 of Notes to Consolidated
Financial Statements in the 2000 Form 10-K for further information
regarding the 1992 Plan and option grants. On November 22, 2000,
23,936 stock options were issued to former officers under
termination provisions in employment agreements associated with the
sale of the Route Operations. Such options are vested at $6.63 per
share, the fair market value of the stock on that date and expire 24
months after the date of issue. There were no options issued during
the three months ended March 31, 2001.
Note 8 - Commitments and contingencies:
Employment agreements:
J Net entered into employment agreements with Mark W. Hobbs,
President and Chief Operating Officer, and Steven L. Korby,
Executive Vice President and Chief Financial Officer on October 1,
2000. Such agreements expire on June 21, 2003. The aggregate
commitment for future salaries at March 31, 2001, excluding bonuses,
under the employment agreements is approximately $1,200,000.
Note 9 - Discontinued operations:
Definitive agreement and conditional modification agreement:
The Company completed the sale of its Route Operations on November
22, 2000 pursuant to a definitive agreement dated July 8, 2000 and a
conditional modification agreement dated October 30, 2000. Total
cash received was approximately $44,000,000 representing $38,000,000
of proceeds related to the subsidiaries sold and $6,000,000 of
working capital and prorated expense reimbursements. The gain from
the sale of the Route Operations, net of estimated income taxes of
$6,711,000 and selling expenses of $1,096,000 was $13,026,000.
In accordance with accounting principles applicable to discontinued
operations, the results of operations up to the effective date of
the sale and previously reported financial statements have been
reclassified to reflect the Route Operations as discontinued.
Settlement with Rite Aid Corporation:
On March 27, 2000, J Net entered into amendments to its two license
agreements with Rite Aid Corporation ("Rite Aid"). As a result of
the subsequent receipt of certain administrative approvals from the
Nevada State Gaming Control Board ("Nevada Board") for 31 Rite Aid
locations, such amendments became effective October 9, 2000.
Pursuant to the terms of the amendments, license fees payable to
Rite Aid were reduced by approximately $2.5 million annually over
the remaining term of the amended agreements. Such reductions were
effective March1, 2000. All disputes between the parties, including
J Net's lawsuit against Rite Aid have been resolved or settled as a
result of the filing by the parties of the Stipulation for Dismissal
on October 16, 2000.
-20-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 9 - Discontinued operations (concluded):
For the fiscal year ended June 30, 2000, the Company incurred an
operating loss of approximately $3,400,000 at the Rite Aid
locations. As a result of the reduction in license fees described
above, the Company's operating loss at the Rite Aid locations for
the period up to the sale of the Route Operations was reduced
substantially.
The following are the summary operating results of the discontinued
operations (dollars in thousands):
July 1, 2000 to Nine Months Ended
November 22, 2000 March 31, 2000
----------------- -----------------
Revenues $ 28,002 $ 66,689
Costs and expenses (28,387) (67,278)
-------- --------
Operating income (loss) (385) (589)
Other income 7 30
-------- --------
Income (loss) before provision
(benefit) for income tax (378) (559)
Provision (benefit) for income tax (128) (190)
-------- --------
Income (loss) from discontinued
operations, net of tax $ (250) $ (369)
======== ========
The following are the net assets of the discontinued operations sold
on November 22, 2000 (dollars in thousands):
As of November 22, 2000 As of June 30, 2000
----------------------- -------------------
Assets:
Cash $ 3,500 $ 3,500
Prepaid expenses 819 1,209
Other current assets 2,223 1,020
Deferred income tax -- 384
Property and equipment
at cost, net 10,803 11,907
Lease acquisition costs and
other intangible assets, net 5,279 5,190
------- -------
Total assets $22,624 $23,210
======= =======
Liabilities:
Accounts payable and
other current liabilities $ 1,490 $ 2,516
Deferred rent 3,945 4,049
------- -------
Total liabilities 5,435 6,565
------- -------
Net assets of discontinued
operations $17,189 $16,645
======= =======
-21-
J NET ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 10 - Subsequent events:
Please refer to Note 3 Investments in Technology-Related Businesses
for discussions related to InterWorld.
-22-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements; Risks and Uncertainties
Certain information included in this Form 10-Q as well as other materials
filed, or to be filed, by the Company with the Securities and Exchange
Commission contains statements that may be considered forward-looking. All
statements other than statements of historical information provided herein may
be deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects", "should" and similar
expressions are intended to identify forward-looking statements. In addition,
from time to time, the Company may release or publish forward-looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments and similar matters. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, the Company notes that a variety of factors could cause the Company's
actual results and experience to differ materially from the anticipated results
or other expectations expressed in the Company's forward-looking statements.
The risks and uncertainties that may affect the operations, performance,
development and results of the Company's Technology-Related Businesses include,
but are not limited to, the ability of the Company to identify and negotiate on
terms acceptable to the Company an acquisition of systems development or other
technology infrastructure companies and the ability to successfully integrate
and grow such business if acquired, the success of those entities in which the
Company has invested, the ability of those entities, in which the Company has
existing minority investments, to raise additional capital on terms that such
entities find attractive to themselves and to the Company or to otherwise
monetize their securities, and the ability of the Company to raise additional
outside capital for J Net Ventures I, LLC or for any future funds to be
established.
Readers are cautioned not to place undue reliance on any forward-looking
statements, which speak only as of the date thereof. The Company assumes no
obligation to update or supplement forward-looking statements as a result of new
circumstances or subsequent events.
Overview
J Net Enterprises, Inc. (formerly known as "Jackpot Enterprises, Inc." and
referred to hereinafter as "J Net" or the "Company") is a technology holding
company with concentrated investments in enterprise software and technology
infrastructure companies (the "Technology-Related Businesses"). The assets of
the Company consist primarily of cash and investments. Prior to the Company's
change in emphasis to a technology holding company, the Company had been
actively engaged, through its subsidiaries, in the gaming industry for over 30
years.
The Company invests directly in Technology-Related Businesses or through J
Net Ventures I ("Venture I"), a fund managed by J Net Venture Partners, LLC (the
"Manager"), an affiliate of the Company. The Company and Venture I will make
investments primarily in early stage ventures (first and second round financing)
exhibiting reasonable risk adjusted valuations and may also make later stage
investments based on the merits of the
-23-
transaction, the quality of the investment and the company's ability to go
public or have the investment monetized through some other clearly defined exit
strategy. Additionally, investments in the securities of public companies may be
made when an opportunity exists for value creation. This might occur in the case
of companies with existing products, services and customer base that have been
affected by the decline in the interest in funding by capital markets (referred
to herein as "fallen angels"). Investments generally will range in size from $1
million to $10 million. J Net and Venture I intends to play a role in helping to
advise and assist its partner/portfolio companies in meeting and exceeding their
objectives. The Company expects the average investment holding period to be
three years with investment emphasis in the following: (1) B2B infrastructure
and solutions for legacy businesses with valuable branding, (2) Restructuring of
B2B and B2C fallen angels and (3) Technology and infrastructure investments. As
of March 31, 2001, the Company owned 100% of Venture I. While entities
affiliated with Gilbert Global Equity Partners have committed an aggregate of
$15 million to the fund, they have not yet exercised any of their co-investment
rights. As of March 31, 2001, the Company had invested approximately $68 million
in Technology-Related Businesses and notes receivable discussed in Note 3 and
Note 4 to the condensed consolidated financial statements. Of the $68 million,
the Company invested approximately $32 million on behalf of Venture I.
The Company operates in a single business segment, its Technology-Related
Business segment. In November 2000, the Company completed the sale of its gaming
machine route operations ("Route Operations") segment. Activities of the Route
Operations up to the effective date of the sale are reported as discontinued
operations. For additional information on the Route Operations, please refer to
Note 9 in the condensed consolidated financial statements and disclosures
included in the Company's Annual Report to the Securities and Exchange
Commission on Form 10-K for the fiscal year ended June 30, 2000 (the "2000 Form
10-K").
At various times during the past several years, the Company engaged in the
active consideration of potential acquisitions and expansion opportunities,
including most recently in 1999 in connection with the potential acquisition of
Players International, Inc. ("Players") and CRC Holdings, Inc. d/b/a Carnival
Resorts & Casinos ("CRC"), a privately owned company. The Company devoted
significant management and other resources to these efforts and incurred
substantial expenses in connection with such activities. The discussion that
follows is based on giving retroactive effect to the discontinued operations.
Since the Route Operations was the Company's only business segment from its
inception through February 2000, the following discussion focuses primarily on J
Net's continuing operations, which consisted primarily of general and
administrative activities of the parent company and since March 2000, J Net's
Technology-Related Businesses segment.
Results of Operations
Revenues:
The Company had no revenues from continuing operations for the three and
nine months ended March 31, 2001 (the "2001 three months" and the "2001 nine
months") and 2000 (the "2000 three months" and the "2000 nine months").
-24-
Costs and expenses:
Cash based costs and expenses for J Net consist primarily of general and
administrative expenses. The Company also had substantial noncash expenses for
impairment reserves and realized losses from sales of its investments in
Technology-Related Businesses. In addition, for the three months ended March 31,
2001, the Company reserved $7,980,000 against the notes receivable with Michael
Donahue, the Vice Chairman of InterWorld.
General and administrative costs for the nine months ended March 31, 2001
of $5,181,000 were unchanged for the nine months ended March 31, 2000. Both
periods contain nonrecurring severance costs of $1,140,000 and $2,835,000 for
the nine months ended March 31, 2001 and 2000, respectively. Excluding these
nonrecurring costs, the ongoing expenses in the 2001 nine months are
approximately $4,000,000 compared to $2,100,000 for the 2000 nine months. Most
of the increase between periods reflects higher costs from increased staff and
facilities. In addition, the three months ended March 31, 2001 included
increases of outside legal fees of approximately $200,000.
For the 2001 nine months, the Company made impairment provisions of
$8,665,000 to reflect estimated permanent declines in values of investments in
certain Technology-Related Businesses. For the 2001 three months, a loss of
$1,650,000 was recognized as a result of the sale of the Company's investment in
Digital Boardwalk, LLC. There were no such losses in the 2000 three months or
the 2000 nine months.
Other income (expense):
For the nine months ended March 31, 2001, net other expenses were
$19,932,000 consisting of equity losses in Technology-Related Businesses of
$19,426,000 and interest expense of $4,572,000. Interest income of $4,066,000
partially offset the other expenses. For the 2000 nine months, the Company
reported net other income of $14,952,000, which included net fees from a
terminated merger of $11,116,000 and gains from the sale of short-term
investments of $2,361,000. Both the terminated merger fee and security sales
gains were related to the Company's transaction with Players International, Inc.
Complete details related to the Players International, Inc. transactions are
disclosed in the Company's 2000 Form 10-K filed with the Securities and Exchange
Commission.
For the three months ended March 31, 2001, net other expenses were
$14,257,000. The majority of the loss is related to equity losses from
InterWorld Corporation ("InterWorld"), Alistia, Inc. and TechTrader.
Income (loss) from continuing operations before provision (benefit) for
income tax:
Income (loss) from continuing operations before provision for income tax
was a loss of $43,771,000 for the 2001 nine months compared with income of
$10,043,000 for the 2000 nine months. For the 2001 three months and 2000 three
months, the pretax results were a loss of $25,594,000 compared with a loss of
$2,783,000. The variances for both of the 2001 periods are due mostly to the
impairments on certain Technology-Related Business investments, the allowances
for accounts and notes receivable, higher general and administrative expenses
and the items in other income (expenses) previously discussed.
-25-
Income taxes:
Effective income tax rates for the 2001 three and nine months are lower
due to a deferred income tax allowance of $4,850,000 established by the Company.
Net income (loss):
Net income (loss) for the 2001 nine months was a loss of $22,640,000
compared with net income of $6,781,000 for the 2000 nine months. The 2001 nine
month results reflect the equity losses, asset impairments, and bad debt
provision, which are partially offset by the gain from the sale of the route
operations, while the 2000 nine months were largely the result of the
nonrecurring gains related to the previously discussed Players International,
Inc. transactions.
Net losses from continuing operations for the 2001 three months and 2000
three months were $22,771,000 and $1,670,000, respectively. The large increase
between the two periods is due primarily to the equity losses and bad debt
provisions recognized in the 2001 three months.
Capital Resources and Liquidity
Liquidity:
Cash and cash equivalents at March 31, 2001 totaled $29,911,000 and
marketable securities were $26,576,000, providing the Company with $56,487,000
of liquidity to support ongoing operations and continue its investment strategy.
At March 31, 2001, the Company did not have any revenue sources other than
earnings on its cash and securities.
On January 4, 2001, the Board of Directors authorized the repurchase of up
to 1,000,000 shares of common stock. Repurchases under this program as of April
27, 2001 were 370,294 shares for an aggregate cost of $1,872,000. In addition,
80,000 shares with an aggregate cost of $405,000 were repurchased in the current
year under a separate, now terminated, program.
On October 12, 2000, J Net and InterWorld entered into a definitive
Securities Purchase Agreement (the "Purchase Agreement"). Pursuant to the terms
of the Purchase Agreement, J Net purchased $20 million in aggregate principal
amount of Series A Preferred Stock of InterWorld on November 10, 2000. On April
19, 2001, J Net and InterWorld announced that under certain provisions contained
in the Purchase Agreement, J Net would redeem the Series A Preferred Stock for
common stock of InterWorld. After such redemption, J Net will own more than 92%
of InterWorld and will be its controlling shareholder.
On October 12, 2000, J Net, on behalf of Venture I, entered into a Loan
Assumption and Forbearance Agreement with Michael Donahue, Vice Chairman of
InterWorld. Such agreement was modified on April 6, 2001. The loan, as amended,
has a face value of $12,445,000 and bears interest at 8% per annum. The loan is
secured by 4,270,406 shares of InterWorld common stock and other assets of Mr.
Donahue. In March 2001, the Company made a book reserve against the loan to
reflect the actual market value of the assets securing the loan.
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The Company raised $27,750,000 through the issuance of Notes between June
2000 and October 2000. As a result of this placement, management believes its
resources are sufficient to fund its commitment to Venture I, InterWorld and
other investees and operations. With respect to the Company's commitments of $55
million to Venture I, approximately $32 million has been invested on behalf of
the fund as of March 31, 2001.
Cash Flows:
J Net's principle sources of cash for the 2001 nine months consisted of
$12,250,000 received from the issuance of notes, and its available cash and
marketable securities, which were $56,487,000 at March 31, 2001.
Net cash used in investing activities for the 2001 three months consisted
of $67,924,000 of investments in Technology-Related Businesses, investments in
Mariner Partners, L.P. and notes receivable offset by proceeds received from the
sale of the route operations of $35,815,000.
While it is anticipated that InterWorld will require additional funds to
support their operations, recent reductions in operating expenses should
minimize the need for incremental cash. InterWorld's operating expenses during
the most recent quarter were roughly half those of the preceding quarter.
InterWorld's cost structure is continually being re-evaluated for savings. J Net
has received various inquiries from potential partners in InterWorld and intends
to continue those discussions. Management believes the Company maintains
adequate resources to complete and implement its business plan with InterWorld.
It is expected that InterWorld will begin to provide positive cash flow in the
next calendar year.
Recently Issued Accounting Standards:
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 clarifies existing accounting principles related to revenue
recognition in financial statements. The Company is required to comply with the
provisions of SAB 101 in its fiscal year ending June 30, 2001. Based upon the
current nature of the Company's continuing operations, management does not
believe that SAB 101 will have a significant impact on the Company's results of
operations.
Factors Which May Affect Future Results
With its change in business strategy, the Company is operating in a
significantly different environment involving a number of risks and
uncertainties. Some factors including, but not limited to the following, may
affect the Company's future results of operations: (1) the Company's ability to
successfully execute its new business model; (2) the development of the internet
and the infrastructure that supports it; (3) the Company's success may depend
greatly on increased use of the internet by businesses and individuals; (4) the
ability of the Company's investees to compete against direct and indirect
competitors; (5) the Company's ability to acquire interests in additional
Technology-Related Businesses; (6) the ability of the Company's investees to
raise additional capital; and (7) changes in the market for securities of
Technology-Related Businesses in general and for initial public offerings of
internet companies in particular.
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By their very nature, the entities in which the Company has and will be
investing capital will be in an earlier stage of development and maturity, and
therefore a higher level of risk and reward. Except for the proposed
transactions with InterWorld (See Note 3 of Notes to Condensed Consolidated
Financial Statements), all of the Company's investments in Technology-Related
Businesses are in nonpublic companies. Substantially all such companies are
development stage companies and are presently incurring operating losses. There
can be no assurance that such companies will generate operating income in the
future.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The Company is generally exposed to market risk from adverse changes in
interest rates. The Company's interest income is affected by changes in the
general level of U.S. interest rates. Changes in U.S. interest rates could
affect interest earned on the Company's cash equivalents, debt instruments and
money market funds. A majority of the interest earning instruments earns a fixed
rate of interest over short periods (7-35 days). Based upon the invested
balances at March 31, 2001, a 10% change in interest rates would change pretax
interest income by approximately $280,000 per year. Therefore, the Company does
not anticipate that exposure to interest rate market risk will have a material
impact on the Company due to the nature of the Company's investments.
From June 2000 through October 2, 2000, the Company raised approximately
$28 million from the issuance of unregistered 8% convertible subordinated notes
("the Notes"). The principal amount of the Notes is payable on March 31, 2007
and bears interest at 8% per annum, payable on a quarterly basis. For financial
statement purposes, certain of the Notes were deemed to have been beneficially
converted, as the conversion feature was in-the-money at the commitment date.
The Company has calculated the beneficial conversion feature as the difference
between the fair value of the common stock at the commitment date and the
initial conversion price, multiplied by the number of shares into which the debt
is convertible. Approximately $3.9 million of the proceeds from issuance of the
Notes, equal to the intrinsic value, has been recorded as debt discount and
allocated to additional paid-in capital. Management believes that the carrying
value of the Notes approximates fair value as of March 31, 2001.
On July 1, 2000, the Company adopted SFAS 133. The Company has one
derivative instrument in the form of warrants to purchase common stock in a
nonpublic company. There is currently no public market for these warrants. A 10%
change in the value of the warrants based upon the Company's valuation of the
warrants using Black Scholes valuation techniques would affect earnings by
$160,000.
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PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.31 Stock Purchase Agreement by and between InterWorld
Corporation and J Net Enterprises, Inc. dated January
25, 2001. (A)
10.32 Stand-By Purchase Agreement dated January 25, 2001. (A)
10.33 Amended and Restated Loan Assumption and Forbearance
Agreement.
(A) Incorporated by reference to the Registrants Form
8-K filed February 2, 2001.
(b) Reports on Form 8-K:
During the three months ended March 31, 2001, no reports were filed on
Form 8-K.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
J NET ENTERPRISES, INC.
(Registrant)
By: /s/ Steven L. Korby
----------------------------------------
STEVEN L. KORBY
Executive Vice President and
Chief Financial Officer
Date: May 15, 2001
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